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.)