Great article on Subaru in BusinessWeek called “Subaru Sells Out: Will a Fast-Growing Carmaker Decide to Stay Small?”  It is interesting (and even a bit humorous) to read the business press and the auto industry try to wrap their heads around the matter of capacity.

You can’t understand anything about Subaru without first understanding that they are the best manufacturer in the auto industry, hands down, and their plant in Indiana is most likely the best manufacturing operation by just about any measure in the United States.  There's a reason why Toyota owns a stake in Subaru and has outsourced some of its Camry production to the Indiana plant.

The article centers on capacity and why Subaru isn’t doing whatever it takes to get more of it as their sales are going through the roof. John Krafcik, former CEO of Hyundai North America said, "Most automakers would have moved sooner.  To me, it looks like they're OK with having this capacity constraint."  Yes they are, and for reasons few can understand.

Capacity is the huge under-appreciated driver of both profits and culture – that’s right – culture.  If you aren’t putting capacity planning, and capacity optimization at the center of your management focus neither profits nor culture can be optimized.  Subaru gets that even if most companies and most business ‘experts’ don’t.

The most profitable a company can be is when its sales volumes equal production capacity.  The fact that Subaru is at that point is why “Last year, Subaru made a profit of nine cents on every dollar of sales, some $2.4 billion in net income. That’s nine cents free and clear—after all of the workers had been paid and the fancy crash-avoidance technology had been tested and the checks had gone out to charities. No other automaker hit that threshold—not Toyota (8 percent), not BMW (7.2 percent), and certainly not Ford (2.2 percent).”

The simple minded but hugely erroneous thinking behind economy of scale that goes into statements like “It's true that for most carmakers, simply ramping up production is a no-brainer. The economic model is straightforward: The fixed costs in making cars, from engineer salaries to metal-stamping machines, are so large that the more units a company can spread those costs over, the more profit it can make per vehicle.” Is very common.  In fact, the cost of capacity is not linear.  It moves in big steps.  Selling 10 or 20% more cars would not increase profits – it would erode them.

Production capacity cannot be added in a linear fashion like some sort of variable cost.  It is added in big chunks, and capacity = cost; in fact cost is all about capacity, not the isolated bits such as direct labor efficiency.  If Subaru were to simply cut their sales folks loose and then try to chase them up the peaks, then drag the factory down into the valleys as sales ebb and flow like most companies do they would continually be out of synch with capacity – either selling over capacity and incurring the costs of overtime, expediting and all of the cost and quality issues that result from having too many new hires; or under-capacity and failing to leverage their costs. 

What Subaru (and Toyota) do better than just about anyone is to continually synchronize sales with capacity.  That means the sales folks are an integral part of the business, rather than an independent silo tasked with selling as much as they can of whatever they can to whoever they can.  Most companies view sales independently and even give the sales folks commissions and bonuses for overselling capacity, blaming the factory for its failure to somehow keep up; and then make it a factory problem when sales turn down and the cost base (capacity) is too high.  It all stems from thinking that more sales is always better, no matter what, and from managing the ‘top line’ as an independent driver of good things.  Subaru knows better.

And culture?  Capacity = cost and cost = people.  Adding capacity means hiring people and most managers are no more disciplined in their hiring decisions than we are in our personal decisions.  Just like we have another drink or eat another piece of pie knowing that there will be long term consequences, we decide to reap the immediate pleasure and deal with those consequences later.  Similarly we hire to meet this year’s sales opportunity, to reap this year’s profits, even though we aren’t at all sure we will have sufficient long term demand to keep those people employed.  We hire them anyway and far too often end up having to let them go next year or the year after that.  The consequence – the price we eventually pay – is that we can never realize the sort of high powered culture the excellent companies enjoy.

And this is why one Subaru dealer said, “I firmly believe none of the other companies would have the patience to do what they’ve done.  It’s a cultural thing.”  It is a “cultural thing” and they have the patience to manage profits and culture for the long haul.