Ford: We're Maxed Out


Are the production lines at Ford (NYS: 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 (NYS: 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 (NYS: JCI) and Lear (NYS: 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 (NYS: TM) .

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

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At the time thisarticle was published 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 serviceshave recommended buying shares of Ford and General Motors, as well as creating a synthetic long position in Ford. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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