Volatility in autos – and the demise of brand loyalty

Any casual observer to the auto industry can sense that brand loyalty has been declining. But the following graphic, posted in today’s NY Times (http://www.nytimes.com/2009/10/21/business/21auto.html) illustrates how dramatic the decline has been:

So what does this mean for strategy? Clearly, this has interesting implications for marketing (does it mean you have to do more advertising or less?).  But it also has interesting implications for operations. Logic suggests that if brand loyalty decreases, market shares should be more volatile – customers will move quickly to products they like and then just as fast they will move away to another brand’s products. It would seem that this places an extra premium on flexibility – it should become (or has become) harder to predict a model’s market share, and so flexible capacity is needed to manage the unavoidable demand-supply mismatches.  Throw in uncertainty in the economy, fuel prices, and the diffusion rate of green transportation and you have a very challenging environment ahead – as if we didn’t know that.

Production smoothing on a grand scale

It was just reported that the US GDP fell at an annual rate of 3.8% in the fourth quarter of 2008 but it would have fallen 5.1% had it not been for the inventory adjustment – demand “fell off the cliff” but firms kept producing, thereby causing inventories to rise.  One might interpret this as a nice demonstration of the production smoothing strategy on a grand scale – it is costly to shut down production, so keep producing and build inventory with the assumption that eventually demand will exceed your production and you can then draw down your inventory.  Production smoothing is particularly effective for coping with seasonal demand because then the firm has a good sense that demand will indeed return during the high season.  Now it is a little bit different. The drop in demand is not seasonal but systematic and it is not clear when demand will level off or at what level it will converge to. In particular, if the economy is still producing above the new long term rate of demand, then further adjustments to production will be needed.

The depth of the downturn may hinge on firms’ willingness to hold inventory. If they want to reduce their current inventories to their levels over the past five years, then they will need to really slam on the break (in effect, we have already produced for future demand and to return to equilibrium requires stopping production so that demand can catch up).  However, if firms are willing to hold on to their additional inventories, then the adjustment need not be so severe – in that case all that is necessary is that the firms align their current production with their current demand rate.

These issues are exhibited on a more “micro” scale at Chrysler. They stopped production in December 2008 because their inventories were higher than they could manage (or wanted) and continuing to produce would have only increased them further. They only just resumed production. If their current production rate equals their current demand rate, then their inventory level will remain unchanged. If they want to reduce their inventories, then they will have to produce at a rate that is lower than demand for some time.

So this raises the question of whether inventories are stabilizing or destabilizing to an economy.  You can tell a story for either one, and some additional data collection is needed to resolve the conflict.

Wall Street Journal, Jan 31, 2009, Economy Dives as Goods Pile Up

Is JIT dragging us down?

We all know these are tough economic times, but do we know why the economy is struggling so mightily? One theory is that JIT (and other lean manufacturing practices) are to blame. See, for example,

http://jamesfallows.theatlantic.com/archives/2008/12/pensee_dept_followup_on_the_no.php

The metaphor is simple, animals with stored fat are more likely to survive in times of scarcity than thin animals.  Alternatively, think of a group of hikers on a glacier. JIT means they all tied together with very short ropes so when one falls, they all fall in quick succession.  Are these metaphors correct? Is lean manufacturing the cause of our woes? There is reason to believe it is in fact the scapegoat.

Consider the auto industry and GM in particular.  Their demand is now much lower than their capacity.  (Actually, it has been for a long time, just now there is a very large discrepancy.) If they maintain production at their capacity, then their inventory continues to build, converting cash into inventory. This can work for a little while but eventually you run out of cash, risking bankruptcy.  This is the problem they currently have.  The alternative is to stop production, but then you pay your workers to do nothing, so you still burn through cash but then have no product to show for it. This is very costly – in theory, inventory can eventually be converted into some revenue.  

Now consider the role of lean production in this mess. If you turn back time to one year ago, had GM been less lean, then they would have had less cash and more inventory.  Consequently, they would have had less of a buffer to weather the current storm, so their problems would have hit earlier or would have been more severe.  If they had been even leaner, then they would have had less inventory at that time and more cash, thereby giving them a bigger cushion to survive the downturn.  Based on this reasoning, their current problems are as bad as they are because they weren’t lean enough, not the other way around. 

It is possible to defend JIT in another way – if JIT were the problem, then we would expect the leanest of the auto manufacturers to be suffering the most.  Toyota and Honda are among the leanest, and they are suffering, but not by as much, which is again consistent with the notion that during this crisis, being lean is a help and not a hindrance. Maybe the better metaphor is the following.  Two people are thrown overboard a cruise ship and nobody notices, so they need to fend for themselves. They see an island in the distance and start to swim for safety.  Who is more likely to make it, the fit and lean person or the “master of the buffet” person?

Honda’s Flexible Plants Provide Edge

This has been a tough year for most auto makes :  so far this year sales are down 24% at Chrysler, 18% at GM, 15% at Ford and 7.8% at Toyota.  But U.S. sales at Honda are up 1.7%.  There are two reasons for Honda’s success. (1) Honda’s product mix depends less on SUVs and pickups than the others (i.e., fuel efficient models make up a larger portion of their portfolio). (2) Honda has some of the most flexible plants in the U.S. To illustrate that flexibility, Honda is able to switch from producing  Civics to CR-Vs with only 5 minutes of downtime!  Honda has achieved this flexibility through many different decisions.  For example, the Civic and CR-Vs were designed to be manufacturered in the same sequence of steps, so the same step (such as a door installation) can occur at the same location on the assembly line.  Honda did have to invest $400m several years ago to improve its flexibility.  That looks like a good investment in the current climate.  

Wall Street Journal, Sep 23, 2008 – Honda’s Flexible Plants Provide Edge

Environmental Kaizen

Kaizen, or “continuous improvement”, means constantly working towards improving processes, no matter how small the improvement.  The idea of kaizen has famously been applied at Toyota to their manufacturing process but the concept has also been applied by GM to make their manufacturing plants more environmentally friendly.

GM’s Lansing Delta assembly plant in the the world’s only to have received Gold Certification from the U.S. Green Building Council’s Leadership in Energy and Environmental Design (LEED) system. They achieved this goal by making many small (and some large) improvements to their processes. For example, they use bright lights were tasks are needed and dim or no lighting where light is not needed (such as where robots are working).  The restrooms use rainwater collected from the roof and the roof is painted white to reduce heat absorption. (Both the light and rainwater examples emphasize that an important resource should be used only where needed.) But more important than any single idea, the implementation of Kaizen changes how employees view their environment and motivates them to generate further ideas.

Automotive News, August 11, 2008 – GM Factory a Model of Sustainable Manufacturing

Allocation and production when demand is hot

Although most of the news in the U.S. auto industry is bad, Honda is selling more of its small car – Fits and Civics – than it can make.  So this creates two problems - (1) how do you allocate vehicles when dealers are scrambling for more and (2) how can you make more of the hot selling vehicles?

Honda uses turn-and-earn allocation – if a dealer sells a vehicle, they earn the right to another one. Seems fair but more importantly, it makes sure that dealers don’t charge too much or else risk slowing their sales, thereby jeopardizing future allocations (our conjecture, not in the article).  In other words, its a legal way to discpline dealership pricing and sales effort.

But Honda still wants more of those Fits and Civics, so it is making plans to move truck capacity around and free up capacity for its smaller vehicles. Toyota and the other makes are doing the same thing.  The winner from all of this will be the firm that has the most flexible production – who can turn a truck assembly line into a small vehicle assembly line the quickest and at the lowest cost?  Flexibility is like insurance – its seems a waste when you don’t need it and critical when you do!

Automotive News, June 17, 2008, Honda dealers scramble amid stampede to small cars