Ford: We're Maxed Out

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Are the production lines at Ford (NYSE: F  ) really maxed out?

It sure sounds like they're close, if you listen to CEO Alan Mulally. Speaking to reporters on Wednesday, Mulally said that while Ford is working hard to increase production of key models, it can't currently build enough of its hottest vehicles to meet demand. That will limit Ford's sales growth in coming months.

Nobody wants to leave sales on the table, but given the recent history of the American auto industry, that might sound like a good problem to have.

It might be. But it's not a simple problem to solve.

Why can't they just build more cars?
They can, up to a point. But beyond that point -- which is the point where the company's current factories are running at maximum capacity -- things get complicated.

One of the biggest reasons Ford has been so profitable in the U.S. over the last couple of years, despite a level of sales that is still well below last decade's historical trend, is because it has been able to keep its fixed costs in check. In the auto industry, fixed cots -- factories, tooling, labor -- are massive. Controlling them is key to Ford's strategy for profitability.

Consider just this one part of the equation: It's often said that it takes a billion dollars to develop and start production of an all-new car or truck from scratch. Production tooling, like the massive, specialized dies needed to stamp thousands and thousands of body panels to a very high degree of precision, can account for a quarter or more of that cost. Multiply that times a few dozen models, some of which are produced in several different factories around the world, and then add in the cost of running all those factories, including labor contracts. It's a big number.

And for each model, there's a calculation. Whether Ford sells 5,000 of the new model every month or 50,000, the tooling has to be paid for, the factory has to be kept running, and the workers have to be paid. Obviously, the more vehicles Ford sells, the more profitable its fixed-cost investment, but it has to invest conservatively, lest it end up with more production capacity than its sales can support.

The problem of too much production capacity is the problem that nearly sank Detroit; which did sink Ford's ancient rival General Motors (NYSE: GM  ) . Arguably, the most important part of GM's "bailout" wasn't the cash it got from the Feds, it was the bankruptcy court restructuring that allowed it to shut down and discard over a dozen of its U.S. factories, a major contributor to GM's current profitability.

With that in mind, Mulally, like most other auto executives, will be very conservative about increasing fixed costs by adding factories.

Long story short, Ford is bumping up against a wall.

What can it do?
Ford can take steps to make sure it's getting the most out of its current factories by adding extra work shifts and fiddling with production schedules to maximize output. These things are happening, and Ford will be able to increase its production of hot models like the Focus and Explorer to some extent over the next few months.

But beyond that, increasing production will be a challenge. And it's not just a Ford challenge: Ford, like all automakers, is dependent on a network of suppliers who make many of the parts that go into its cars and trucks. Those companies, which include giants like Johnson Controls (NYSE: JCI  ) and Lear (NYSE: LEA  ) , as well as many smaller, specialized firms, have their own memories of near-death experiences during the financial crisis and their own good reasons for being reluctant to invest in added production capacity in a still-uncertain auto market.

Persuading those companies to invest is a big part of the challenge facing Ford. As Mulally put it Wednesday, "As we restructure the entire business, we're bringing along the entire supply chain." It's a process that will take time. In the meantime, Ford's sales growth might seem subdued, particularly in comparison with a resurgent Toyota (NYSE: TM  ) .

But in the context of recent history, things could certainly be a lot worse.

Are we optimistic about Ford's stock beating the market in the future? To answer that, one of our top equity analysts has compiled a premium research report with in-depth analysis on whether Ford is a buy right now, and why. Simply click here to get instant access to this premium report. And if you'd like to take a look at a company outside the cyclical manufacturing sector, check out our special free report "The Motley Fool's Top Stock for 2012," which features a high-growth company our chief investment officer uncovered that's revolutionizing commerce in Latin America.

Fool contributor John Rosevear owns shares of Ford and General Motors. Follow him on Twitter at @jrosevear. The Motley Fool owns shares of Ford. Motley Fool newsletter services have recommended buying shares of Ford and General Motors, as well as creating a synthetic long position in Ford. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (13)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 31, 2012, at 3:07 PM, Smalls62 wrote:

    Parts suppliers are becoming the bigger issue. A statement from a person working in a Ford factory....

    Adding of third shifts is just beginning with several in May initiated by Ford. They can make increased usage of "100%" capacity plants by adding a third shift but the true hangup right now appears to be a lack of parts from suppliers - why Mullaly's comments touched on the supply lines. Suppliers will need to add third shifts or expand just as Ford. Nice problem to have for the auto sector after such a rough patch it has been through.

  • Report this Comment On May 31, 2012, at 6:57 PM, Milligram46 wrote:

    Ummmm...if Ford has too little capacity here are some ideas:

    1) As the leader in fleet sales in 2011, with 33% of all sales going to fleet buyers, and 45% of all Focus sales going to fleets, how about scaling back fleet sales and selling those vehicles to consumers for more margin.

    2) Ford has cranked up incentives in the second half of May (about $300 per vehicle) because sales are slowing. Rampant demand does not require bigger incentives to drive people to the showroom. If sales are that good, how about cutting back on incentives and increasing profit.

  • Report this Comment On June 01, 2012, at 12:57 PM, TMFMarlowe wrote:

    @Milligram46: Ford said on Friday that the incentives boost was mostly about selling down the Fusion and Escape -- the inventory constraints are apparently hitting Focus and Explorer hardest, and incentives on both of those remain modest as far as I can tell right now. Incentives don't look a lot different from mid-April levels otherwise, aside from some increases on a couple of Lincolns.

    I don't have the fleet breakdowns in hand yet but I know that Ford's daily-rental sales have been trending down. I don't know how many Focuses are going to fleets, and I don't know if Ford will tell me, but I'll try to find out.

    Thanks for reading.

    John Rosevear

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