Financial Challenges

Chapter 10
Real Options and the Automobile Production Process

The car preferences of North American consumers have been changing rapidly. At one time the overwhelming top vehicle choice was the four-door family sedan. Each major automobile manufacturer had multiple entries in this large and lucrative market. Then Chrysler brought out the first minivan. It was an instant hit among the baby-boomer generation seeking to haul around a load of kids to soccer practice and other after-school events. Although the minivan remains popular, the sport utility vehicle, or SUV, has become the hot vehicle of choice. Manufacturers rushed to make SUVs in every size class, from the monster Ford Excursion to the compact Honda CR-V. Changing consumer preferences have been the result of growing consumer affluence, family life cycles, and the desire for individual self-expression. Consumer preferences have also fluctuated in response to volatility in the cost of gasoline.

Faced with a highly volatile demand function of consumers for vehicles, car manufacturers have often found themselves stuck with excess capacity in plants capable of making only one type of vehicle. When demand for that vehicle type declines, the manufacturers are forced to resort to costly incentives to sell their unpopular models. In many cases, expensive plants have been closed either temporarily or permanently.

It used to take two years or more to convert a plant from making cars to making small SUVs, for example. With the high volatility of demand for various vehicle types, automobile manufacturers have increasingly been developing flexible plant designs that give them the option to convert a plant from one vehicle type to another in less than six months. Toyota has refitted its assembly plants around the world, including its Canadian factory in Cambridge, Ontario, with common assembly equipment and plant layouts. Their goal is to be able to produce any vehicle type, from a car to a large SUV, without going through a major retooling of the plant.

Other auto manufacturers are pursuing similar goals. Honda claims that its plants, including the one in Alliston, Ontario, can produce a new model in as little as three months. Similar plant reengineering efforts are underway at General Motors and most other major car companies.

The value of this increased flexibility can be seen in the case of Honda’s Swindon plant in the United Kingdom. Because of weak sales in Europe, Honda has found it difficult to operate this plant at anything close to its full capacity of 150,000 cars per year. During 2000, the plant produced only 76,500 vehicles. To complicate matters, the Swindon plant opened a second production line during the summer of 2001 with an additional capacity of 100,000 vehicles. At the same time, Honda found that it was running out of capacity at its Japanese and North American plants that produced their compact SUV.

By making investments in the manufacturing flexibility of the Swindon plant, Honda will be able to shift production of its compact SUV, the CR-V, and the hatchback version of the Honda Civic to Swindon, from Japan and North America. These vehicles will then be exported to the North American market.

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