Supply Chain Challenges Part 1: Automobile Manufacturing When the Chips Are Down
Whether you are a homeowner who wants to add a back deck but can’t find lumber, or a global automaker who cannot produce cars without computer chips, issues with supply chains can be frustrating. In an economic environment where demand is plentiful but cannot be satisfied, supply chain woes have become a popular answer to what ails us.
Though the pandemic exposed them, most of today’s supply chain issues were in place well before COVID-19 arrived. Exploring those drivers can answer the question “how did this happen?” and provide insight into what people really want to know these days — when will this get better? In this three-part series, we look at three industries of great interest, automobile manufacturing, trucking, and lumber production, to see what light they shed on these questions.
Automobile manufacturing has received a massive dose of media coverage, and it’s an ideal place to start an investigation of the causes and cures for supply chain issues. Stories of sad buyers paying a premium over sticker prices for new cars due to low dealer inventories abound. The most often cited reason is a lack of semiconductors, or computer chips, necessary for car manufacturing. The chip shortage is an issue (albeit not the only one) which was ripe to bloom prior to the pandemic.
Trade wars with China made chip production a potential national security issue early in the prior administration. The 2011 Tohoku earthquake (which caused a tsunami that greatly affected Japanese chip manufacturing capabilities) exposed how vulnerable supply chains were to natural disasters. Outdated management and production systems, as well as a general lack of cooperation between parties in the supply chain, further undermined the stability of chip supply.
When auto manufacturers dialed back car production at the dawn of the pandemic, they left available chip supply to be snapped up by other industries experiencing increased demand for products like home computers and media streaming devices. They also misjudged industry recovery times. The prevailing thought in the initial days of the pandemic was that the economic reaction would be like the Great Recession, which was driven by a lack of demand. But the crux of COVID-related economic fallout has been a lack of supply. Stimulus funds, paired with historically low rates, fueled demand for new cars and caught manufacturers flat-footed.
All manufacturers weren’t affected equally, and car industry experts generally agree that three have fared better than others during the pandemic. Toyota, having seen its chip supply line severed by 2011’s earthquake and tsunami one-two punch, instituted a policy to stockpile up to a six-month supply of semiconductors. This hasn’t proven sufficient, as evidenced by Toyota’s August 2021 announcement that they too will scale back production due to chip shortages. The supply stockpile did allow Toyota to go longer without reducing production.
Kia and Hyundai, both based in Korea, have strong ties with the country’s largest chip manufacturers and work in cooperation with suppliers to ensure adequate supply. There is also an ongoing and intense South Korean government effort to support the semiconductor industry that ties producers and suppliers together. It’s no coincidence that these companies have outperformed their peers by either hedging supply chain risks or increasing transparency and cooperation with their chip suppliers.
Limited production reduced used car inventory.
Used cars have also grabbed their share of the headlines in recent months as prices have skyrocketed. Inventories of used cars are driven in part by trade-ins on new cars, so it follows that the inability to buy new cars would impact used car inventory. The larger consideration, often ignored by media accounts, is that the U.S. car industry has produced fewer cars each year since 2013. Adopting just-in-time manufacturing methods, plant closures, and low anticipated demand contributed to the currently thin supply of used cars (see Figure 1). Manufacturing and supply chain shocks experienced in the auto industry are driving inflation in the used car market.
Figure 1: Domestic Automobile Production vs. Sales, 2013-2020
Source: Bureau of Transportation Statistics
How long will the shortage last and how do we fix it?
The seemingly obvious answer to the auto shortage is “make more chips so you can build more cars!” but, as with most supply chain issues, the reality is more complicated. Semiconductor production plants are among the most expensive manufacturing facilities to build due to their complexity and clean room requirements. A high-end facility can cost $30 billion. The return on the build investment must be recouped quickly because the average time between the start of production and facility obsolescence is only five years. These factors combined with U.S. labor costs would normally preclude development of chip plants domestically. However, the Biden administration has cited semiconductor supply as a national security issue and identified it as one of four critically important supply chain issues to address. Nevertheless, it will take several years before production capacity would be available in the U.S.
COVID-19 has directly impacted labor as the Delta variant continues to affect workers in the Asia-Pacific region where most chip production facilities are located. So, the more practical approach is to address supply chain issues that existed before the pandemic, namely modernizing both production (through chip recycling and use of newer components) and logistics, while ensuring that the interactions between chip suppliers and buyers such as automakers are more cooperative and transparent. This won’t fix the current supply chain issues, but it does help to mitigate future risks.
The only other solution is time. Estimates for resolution of current issues call for the shortage of chips (and therefore the shortage of new cars) to continue well into 2022 and potentially into 2023. As pent-up demand is slowly satisfied, stimulative efforts wind down, and corrective steps are taken to make the supply chain more efficient, supply and demand will normalize. Car manufacturers will catch up, but they must be careful not to overproduce because normalization will bring back demand trends similar to those in place before the arrival of COVID-19.
In the next article, we explore the trucking industry, one of the most important cogs in the supply chain, to see how the impact from labor issues reverberate through the sector and beyond.
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