Indicators in Focus: Automakers seek solutions after inventories reach record lows

Indicators in Focus examines measures of business and economic activity that will help tell the story of 2022.

COVID-19 has impacted every sector of the economy, but few industries have felt the pandemic’s effects quite like auto manufacturing.

In Missouri, auto manufacturing has been a critical driver of the economy, with General Motors plants in the Kansas City and St. Louis areas and a Ford factory in Kansas City. All three facilities have been forced to shut down for extended periods since the onset of the pandemic because of a shortage of microchips that are critical for the production of vehicles.

Production stoppages like those led to shortages of cars on lots and an inventory-to-sales ratio of 0.24 in November, the lowest figure ever recorded.

The inventory-to-sales ratio measures the value of automotive inventory at the end of the month compared to the value of total sales during the month. Typically, the figure lies in the two to three range, meaning there are at least twice as many cars in stock at month’s end as there are cars sold during the month. A lower ratio is indicative of struggles producing enough cars to sell.

Hear more: Part 2 of a look at key 2022 indicators from the Market Dives podcast

The shortage has its roots at the start of the pandemic, according to James Noble, a University of Missouri professor and expert on industrial manufacturing systems. When the pandemic started, the demand for cars dropped as people were forced to stay home and had less need to travel. As a result, a lot of microchip production was modified so that the chips could be used for things like personal electronics, which saw demand increasing with people spending more time in front of screens due to having more time at home and shifting to virtual work.

As demand for cars started to slowly tick up, auto manufacturers were confronted with a problem that they had created.

“When the (auto) industry came back and said, ‘Hey, yeah, don’t forget about us; we need chips,’ the chip manufacturer is like, ‘Tough, we’ve already got contracts that we sold capacity,'” Noble said.

There was no simple solution to the shortage either. Noble explained that, in the 1990s, a lot of auto manufacturing companies adopted a system of production that Toyota had popularized in prior decades. The philosophy, known as “just-in-time production,” emphasizes reducing waste by intentionally keeping inventory low throughout a supply chain so that there is limited excess. The tradeoff, though, is an industry that isn’t always well equipped for supply-side shocks like the microchip shortage.

Noble said those two factors, along with worker disengagement, led to a “perfect storm” of events that crippled auto manufacturers. Seeing an immediate turnaround could be difficult, though, as there isn’t really a widespread fix for the issue.

“The thing that makes the chips such a challenge is capacity is inelastic. A chip (fabrication) operation is over a billion dollars worth of investment, and that takes a year or two to actually build that,” Noble said. “So you can’t just, boom, make more capability.”

Noble see a route to a short-term fix for companies, though. He believes most companies have adapted their purchasing contracts by now to establish a way of buying up chips quickly to act as a holdover until other issues along the supply chain also begin to smooth over.

A bigger thing to focus on, Noble says, is whether companies learn from what happened and begin to adapt to account for future disruptions. Building a more resilient system that is capable of surviving variations will be key.

“You have to realize that these disruptions truly have major implications, and we’ve seen it here,” Noble said. “The McKinsey Research Group has done some really good characterization of the frequency and magnitude of disruptions that are occurring that are going to hit the supply chain, and they’re not over yet.”

Preparing for such shocks would mean incurring costs up front, but Noble says the payoff down the line is worth it. He said research has shown that overestimating the probability of a disruption is less costly than underestimating it.

Noble admits it is a complex issue that will require a variety of solutions to adequately overcome the shortfalls caused by COVID-19, but he believes production could return to a fairly normal level by the summer of 2022.

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