Who will automakers listen to: Angels or devils?

Most auto manufacturers have long ignored the wisdom of the angels. And yet we all hear them so clearly:

• "Never exceed a 60 days' supply of on-ground inventory."
• "Keep fleet to less than 12 percent of your total sales."
• "Incentives should never exceed 10 percent of your transaction price."

Before 2020, most automakers disregarded one or more of these long-standing principles for running a healthy auto business.

Conventional wisdom has always been that the manufacturers with the highest output and largest scale would enjoy a competitive advantage over smaller volume producers.

Ford Motor Co. was the first automaker to demonstrate the enormous benefits of economies of scale. In 1908, it built 10,000 Model T's at a unit cost of $950. By 1924, it was building 2 million Model T's per year at a unit cost of $300. As volume exploded, so did their margins — and their bottom lines.

Nearly 100 years later, most car companies were still running their "the more we build, the more we make" playbook by consistently adding production capacity to their manufacturing operations. Unfortunately, this added capacity often creates extreme imbalances between available supply and natural demand.

It's the devil's work. Carmakers pile on incentives and volume-based bonus programs and fulfill big fleet orders to chase volume and share and maintain capacity. Margins suffer significantly from this behavior. According to Securities and Exchange Commission filings, Ford's margins dropped to 3 percent in 2019, when in the past they've been well above 10 percent.

Henry Ford once said, "Don't find fault, find a remedy."

As it turns out, the remedy found the automakers.

With the onset of the global COVID-19 pandemic, 2 million units were cut from North American auto production in the spring of 2020, and the ensuing microchip shortage cost the industry 7.7 million units. Suddenly, the financial equation flipped: Demand now greatly exceeds supply, and margins for manufacturers and dealers have never been better.

Many automotive CEOs are saying that as parts availability improves, they are not going back to the days of big inventories. They are going to remain disciplined with lean production and maintain tight availability.

The angels feel vindicated by these words.

But will the manufacturers continue listening to their better angels as parts availability improves? Or will the devils entice the car companies with the prospect of growing market share and driving revenue?

I wouldn't bet against the devils.

Before the pandemic, North American auto manufacturing ran at only 80 percent capacity.

Today, it ranges from 40 to 65 percent as parts shortages drag on. Domestic production has fallen from 300,000 units a month to 120,000, according to the Bureau of Economic Analysis.

There's not a single car company that's satisfied with this level of plant utilization.

As Michelle Krebs, Cox Automotive executive analyst, wrote in a June 16 article, "New-vehicle inventory remained at the same level it has been for months [in May], according to Cox Automotive's analysis of vAuto Available Inventory data, despite comments from some automotive executives that the global computer chip shortage is easing, and vehicle production is resuming to normal levels."

But the problem only gets worse: Over the next five years, AlixPartners estimates that automakers will invest $330 billion on new electric vehicle production capacity.

Massive investments are already underway in North America, with Ford spending $11.4 billion on new EV plants in Tennessee and Kentucky. Hyundai announced $5.5 billion on a new plant in Georgia.

Others are rapidly following suit. Once these new EV plants come online, it will place even more downward pressure on existing internal combustion engine plant utilization as EV models become more prevalent.

It's my view the manufacturers will be highly motivated to sell as many $65,000 ICE pickups and SUVs as they can to satisfy their shareholders and continue funding these massive EV investments.

It's easy for auto executives to talk about discipline in this current environment when the constraints are outside their control. But how much discipline will we see when one company starts losing share because another is maximizing their available capacity to win share?

They say in a commoditized market, you are only as good as your dumbest competitor.

The devils have a strong track record of success after major economic events. Federal Reserve Economic Data tracks the U.S. auto inventory-to-sales ratio. In 2001 after the dot-com crash, the ratio fell to 1.4 (new-vehicle availability vs. sales). But two years later it was back to 2.8. In 2009, during the Great Recession, the ratio fell to 1.4. In two years, it was back to 2.7. Today, the ratio sits at 0.46.

Let's give the devil his due and listen with a fair amount of skepticism as we hear executives talking about not going back to the "old ways of doing things." With this current environment of a slowing economy, lower consumer sentiment and improving auto production, things might be very different in a year.

In fact, the July 4th holiday of 2023 might once again be a weekend of tent events, hot dogs, balloons and big cash rebates galore.