Part A. Change or Die

Ford's Crisis

Let's look at the dimensions of the current crisis. It provides an excellent opportunity to review accounting concepts and illuminates how the company does business.

Some Key Statistics from Yahoo Finance:

View Financials (provided by EDGAR Online):
Income Statement

Ford is losing money, but more seriously, it is not generating value for its invested capital.

Some Points to Note and Explain:

• Market cap is 1/10 the invested capital
• Compare cash flows and note the leverage
• Compare debt to capitalization

Income analysis (From AR 2006)

Ford's automotive divisions lost $17B offset by $2B revenue from financial services. Can one derive a (crude) business model from the annual report data? (Gross figures are used here--The data would allow a closer breakdown by business segment.)

Current Model

World wide, Ford's auto division sold $143B worth of products in 2006.Cost of sales was $148B, that is $5B more than break even. Adding SGA expenses raises costs by another $12.4B to $17.4B, a cost of sales/sales ratio of 12%. That is, 12 cents of every dollar earned on the sale of a car in 2006 went to overheads. In financial services, 88 cents of every dollar was consumed by costs ($1.00 paid to lease generates 12 cents for Ford). Essentially, Ford sells its vehicles below cost and pays the uncovered costs of its auto production with the money made from leasing the vehicles. (North American losses amounted to $16B of the $17B world-wide figure so if a new strategy "fixes" North America, it will fix world wide results.) Is this a value-driven business model? (Note that depreciation and loss-generated tax assets exceed earnings.)

The Proposed Turnaround

In the management discussion, the CEO has called for $5B in production cost cuts, focused on North American operations. That would bring North American auto production costs back in line with 2006 sales. But it would still leave $12.4B in SG&A expenses uncovered by vehicle sales and paid through Ford's financial services.

Cost cutting will mean closing nine plants and cutting back the work force by 14,000 jobs --about one-third of the workforces--and reducing capacity to 3 million units from the current capacity of 3.6 million straight time manned assembly capacity. This is a reduction of 17% in production volume, but equivalent to the amount of capacity actually supported by sales. But the new plans said nothing about Ford's financial arm, without which its current results would have been worse. What then is the role of Ford's financial arm in the new model going forward? How does it add value to Ford's production of vehicles and returns to the company's bottom line?

New Products

Plans announced for Ford North America the next two years will focus on the following models (AR2006 p. 14 (.pdf 16))

These are the same products (albeit enhanced) whose failure to sell in 2006 provoked the current crisis. True, under the new plan costs of production will more closely match costs. But on the reduced volumes, consumers will have to be prepared to pay more--and they have already become accustomed to paying below costs for Ford vehicles. Early returns on 2007 sales seem to confirm this pessimism. (New York Times, 27.04.07). Or will Ford's financial services arm make up the difference (for example by the depreciation on leases?)

Is anything missing from Ford's announced recovery plan? What will this plan do to turn around returns on invested capital?

Part B North American Supply Chain

The case raises the question of the sustainability of the North American auto supply chains under pressure from low cost trans-Pacific trade and over-loaded and deteriorating conditions on the North Americans routes. The reserve role of the US$ helps keep US currency overvalued against those of other countries. Tightly managed supply chains taking component systems from suppliers to assembly plants enabled the North American automotive industry to stay competitive. As the chart below shows, delays in just-in-time manufacture can be costly (CAR 2002 p.21).

With the risks of JIT supply chains rising, suppliers and OEMs are trying a number of techniques to keep both risks and costs as low as possible (Hill et. al. n.d.). One is to create supplier facilities within 100 miles or so of the OEM and to try to spread plant costs among shipments to various OEMs within range. Another is to create a number of facilities and try to save money by sequencing shipments among facilities and spread costs among components. But these solutions raise risks of parts damage in transit as well as shipment delays. Indeed, since 9-11 the danger of shipment delays at North American borders has increased significantly. The obvious hedge is to create some system slack by accumulating inventory--but this has the disadvantage of adding to production costs and estimating the parts needed poses additional problems.

Two relatively new approaches now being used are the supplier park and the modular consortium. Ford's European operations have made extensive use of supplier parks--grouping suppliers into parks around the OEM in such close proximity that either short haul trucks--or even no trucks--can be used to deliver a component on orders "broadcast" by fax or e-mail from the OEM. This radically reduces if not completely eliminates OEM inventory and transportation delays. The close proximity of suppliers and OEM also promotes innovation and rapid adjustment to changing consumer demand. Modular consortiums are relatively rare, but offer OEMs even more cost advantages: in effect, they bring together system and sub-system suppliers in close proximity and organize them so that the can create the modules necessary for final assembly and then can even assemble the final vehicle. The OEM owns the modular consortium facility and pays suppliers on receipt of the vehicle. Making this work requires a human resources strategy that is the same for everyone working in the facility (Hill n.d.).

Ford is already very experienced with supplier parks and its planned cutbacks in plants will simplify its logistical arrangements even further. However, "The Way Forward" plans for the future call for greater inter-operation across regions and centralizing product development suggests that basic platforms and components will be used even more extensively in all Ford products globally. This raises the question of how much Ford production will continue in North America after 2009. Health care and pension costs already add substantially to the costs of its vehicles ($13.9 Billion--almost 10 per cent of sales worldwide.) and the JIT infrastructure will not support much greater shipment volume than is already occurring.

Part C: Canada

Canada makes automotive components and assembles components into final vehicles for Canadian and North American markets. As OEMs have focused on "brand ownership" the manufacturing capability as component suppliers has grown. Outstanding among the Canadian auto parts suppliers is Magna International, now the third largest supplier in North America.

• For statistics on Ontario's auto sector, see: http://strategis.ic.gc.ca/canadian_industry_statistics/
  cis.nsf/IDE/cis3361date.html

Part D. Next Steps

Globalization and informatics--the world "flatteners" to use NYT columnist Thomas Friedman's words--have forced the North American auto industry to continuously reinvent itself. This case illustrates some aspects of that challenge. Students should be challenged to look beyond the numbers.

Is Operation the Same as Strategy?

William Clay Ford jr., Executive Chairman and Chairman of the Board, attributed Ford's problem to lack of cost competitiveness and the need to strengthen product development (Ford 2006 Annual Report, p.2). Alan Mullaly, CEO newly hired from Boeing, put it succinctly: the need to build more of the products people want and value. More operationally, he wrote in his letter to shareholders (Ford 2006 AR p.4), he was focusing on four tasks: downsizing to be profitable at lower costs and volumes, changing the product mix, improving quality, setting up the financing to take the company through its adjustment, and improving management accountability. The latter would be achieved by making Ford's regional divisions report directly to him and by creating a single product development unit to serve all three product divisions (Americas, Europe, Premier Group, Asia-Africa/Mazda.).

Tighter management controls and reporting channels and simplifying product design to emphasize inter-changeability of systems and subsystems across markets: these steps will certainly generate increased operational efficiencies. Ultimately, the company is collapsing three value chains into one. But is pursuit of efficiency the same as a new strategy? Or does all strategy come down to efficiency?

Here are some comparative statistics on Ford from Yahoo Finance:

Direct Competitor Comparison (F=Ford)

DCX = Daimlerchrysler AG
GM = General Motors Corporation
TM = Toyota Motor Corp.
Industry = Auto Manufacturers - Major