69-Industry Capacity Expansion Despite Overcapacity

The global automobile industry is in world-wide overcapacity. In 2006, the industry had the capacity to build 80 million vehicles. It produced just under 65 million vehicles that year. The industry breaks even on factory output at about an 80% utilization rate, roughly where the industry was in 2006. And with demand falling globally by 3% or so in 2008, you would think that the industry would not be adding capacity, but it is. Capacity is increasing rapidly. By 2011, the global auto industry is likely to be able to produce 100 million vehicles in a year.

Why would this be happening? There are three reasons that capacity might expand in an industry despite overcapacity. The first reason is that some geographic segments are growing faster than average. India and China, in particular, are growing faster than the average world-wide demand and will add capacity to meet local needs. (See the Symptom & Implication, “Both new entrants as well as existing competitors have added capacity” on StrategyStreet.com.) Second, some industry competitors can afford to add capacity under the pricing umbrella of other competitors. This is going on today in North America. Honda is just opening a new assembly plant in Indiana. Honda is operating under the pricing umbrella set by the UAW and its big three auto plants. Third, virtually all industries see capacity expansion through what we call the “learning curve” effect. A plant in operation can become more productive each year simply by learning to do things more efficiently. This increase in productivity causes the plant capacity and, therefore, the industry capacity to increase.

We have studied over fifty industries in overcapacity. In each of those industries where we had the opportunity to measure plant productivity, capacity increased every year due to the “learning curve” effect. This effect works even in slow-growing industries, such as newsprint. Its effect on capacity grows as the rate of growth in the industry increases. A high tech plant would have a greater growth in productivity and capacity from the “learning curve” effect than would a newsprint facility.

Industries that appear to be in severe overcapacity may still be adding capacity. This growth in capacity adds to the pressure on industry prices and margins. It prolongs the industry’s pain from overcapacity. (See the Symptom & Implication, “The company believes the industry will be more diplomatic about adding capacity” on StrategyStreet.com.)

Posted 12/29/08

Update:

2019 was the last normal year before Covid for light vehicle worldwide production. The industry was shrinking at about 2% a year in total production in 2019. Still, the industry continued to add capacity despite the fact that it was already in overcapacity.  2019 saw 50 new light vehicle plants opened compared to 14 plant closures, for a net increase of 36 new plants. This brings the total to 758 light vehicle plants worldwide. 2019 added 3.6 million units of new capacity on top of the already existing 45 million units of idle capacity. This produces a plant utilization rate of 63%. Most of the new capacity went to China where the rate of capacity expansion was running at more than twice the pace of market growth. Other regions witnessing significant plant capacity expansion include the US, India and Mexico.

The light vehicle industry continues to add capacity, even the most expensive form of capacity, greenfield capacity. In addition to this new greenfield capacity coming on stream, it is likely that the industry’s existing plants are becoming more productive every year. This is a form of capacity addition we call “capacity creep”.  This latter form of capacity addition occurs in virtually all markets, even the most hostile. See HERE for descriptions of alternatives to add capacity and their implications for industry margins.

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