OM in the News: Overcapacity Hits China’s Auto Industry
“For much of the past decade, China’s auto industry seemed to be a perpetual growth machine,” writes BusinessWeek (Nov. 9, 2015). Annual vehicle sales surged to 23 million units in 2014 from 5 million in 2004. That provided a welcome bounce to Western carmakers such as VW and GM and fueled the rapid expansion of local manufacturers including BYD and Great Wall Motor. No more. Automakers in China have gone from adding extra factory shifts 6 years ago to running some plants at half-pace today—even as they continue to spend billions of dollars to bring online even more plants that were started during the good times. The construction spree has added 17 million units of annual production capacity since 2009, compared with an increase of 10.6 million units in annual sales.
“The Chinese market is hypercompetitive, so many automakers are afraid of losing market share. The players tend to build more capacity in hopes of maintaining or gaining market share,” says a Bloomberg analyst. Worse, the combination of too many new factories and slowing demand has dragged down the industry’s average plant utilization rate, a measure of profitability and efficiency. The industrywide average plunged from more than 100% six years ago (the result of adding work hours or shifts) to about 70% today, leaving it below the 80% level generally considered healthy. Some carmakers are averaging 50% utilization.
Excess capacity is raising the pressure on carmakers to step up discounts to push sales and keep production lines busy. The markdowns can be huge. Motorists can buy an Anhui Jianghuai car for $9,642, 60% off its sticker price. The offering price of Audi’s A1 is being cut by up to 35%. And with capacity growth expected to continue outpacing demand, the industry’s return on invested capital in China will decline from 19% in 2014 to 10.5% by 2018.
Classroom discussion questions:
- Why is overcapacity an operations problem?
- What is causing overcapacity in the industry today?