If chip production is recovering, why are automakers still making fewer cars?

Automakers trimmed 76,000 vehicles from global production plans in mid-September, according to analysts from AutoForecast Solutions. They will make about 3.23 million less this year than planned, the company says.

Analysts have long predicted that the global microchip shortage plaguing the auto industry would ease toward the end of 2022. New production cuts appear to be giving that hope a boost.

How did we get here, and how long will it last?

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The size of the problem

In 2019, before the first hint of COVID-19, Americans bought more than 17 million cars. It was the fifth year in a row that we did so.

By the time 2022 rolls around, parent company Kelley Blue Book Cox Automotive expects as few as 13.3 million Americans may have bought one.

The fall comes despite strong demand for new cars, with prices reaching record highs this summer. The average new vehicle sold in August for $48,301—10.8% higher than a year ago.

The problem? Global microchip shortage.

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How did we get here

A generation ago, only the most expensive cars had microchips. Today, even a high-priced relatively low-tech car like the Mitsubishi Mirage—with a starting price of just $14,645—has dozens of tiny microprocessors. They control everything from traction control systems to cabin temperature.

A high-end luxury car, like the Mercedes-Benz EQS, with its programmable fragrance and hands-free highway driving system, can be in the hundreds.

A perfect storm of events has left the auto industry with a limited supply of those critical chips.

In the early days of the COVID-19 pandemic, as governments around the world imposed travel restrictions to limit the spread of the virus, demand for new cars plummeted. Automakers have limited their orders for microchips, anticipating months of delayed vehicle production.

But chip factories didn’t slow down like car factories did. Consumers ordered new electronics to facilitate working and attending school from home.

When vaccines allowed people to travel again, the demand for new cars increased. Automakers tried to spool up their orders for new chips. But chip factories were already working at full capacity. They haven’t come up yet.

To complicate matters, Americans’ thirst for new electronic features in their cars is only growing. In August, a record 17.5% of new car sales were luxury vehicles.

Chip production recovering

Global microchip production is recovering.

Susquehanna Financial Group reports that in August, chip makers were fulfilling orders an average of one day faster than in July.

Other industries that use chips are seeing their sales slow. Susquehanna analyst Chris Rolland reports that demand for new cell phones has slowed, easing the pressure on chip supply.

Dell Technologies DELL,
-2.09%
Chief Financial Officer Tom Sweet recently told Bloomberg that the PC supply chain is “operating more like the historical norm” in September.

Investors seem to believe that the chip market is slowing down. At press time for this article, the Philadelphia Stock Market’s SOX Semiconductor Index,
-1.45%
down more than 36% year to date.

But it’s the wrong type of chip

If chip production is recovering, why are automakers still cutting their production numbers?

Because the high-end chips used in computers and cell phones aren’t the chips that automakers need.

The automotive industry’s modular design approach – the power window switches in a manufacturer’s most expensive vehicle are often the same as the least expensive – means that today’s cars are littered with older, low-power microchips performing simple functions .

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Automakers go through a rigorous quality process to certify chips for use. They cannot easily swap out a more complex chip for an older chip that has already been through safety testing.

“We will have significantly more semiconductor capacity in the second half of 2022 – we are coming to the end of the supply crunch,” said Sandeep Deshpande, Head of European Technology Research for JP Morgan JPM.
-1.86%.
“However, the capacity must be qualified for use in the automotive industry. …If it wasn’t for this issue, I would think things could be back to normal by the end of the year.”

Spool chip production is a slow process

Chip makers will only convert foundries from producing high-end computer-connected chips to building the cheaper devices used in cars when that’s the most profitable decision. So change comes slowly.

When it comes, it takes time to fulfill orders. Mohit Sharma, an India-based supply chain and supply chain expert who advises Fortune 500 companies, told Financial Management Magazine,A typical semiconductor production line could involve 700 manufacturing steps over 14 weeks.”

Chip manufacturers are working to increase production capacity. But starting new factories is a long process.

Intel INTC,
-1.96%
announced plans for two new microprocessor factories in Ohio last January. They will make their first usable chips sometime in 2026.

Domestic production may be part of the answer. According to a September 2020 report from the Semiconductor Industry Association, the US produced 37% of the world’s chip supply in 1990. Today, only 12% of the global supply is made at home.

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More chips don’t necessarily mean more cars

For years, the practice of the car industry was to keep a stockpile of new cars for sale. Dealers routinely kept so much inventory on hand that they discounted most cars to sell them.

Even when chip production returns, that practice may not return.

“We will not go back to the level of inventories we had before the pandemic because we have learned that we can be much more efficient,” GM GM,
-5.08%
CEO Mary Barra told reporters last year.

BMW BMW,
-0.18%
Chief Financial Officer Nicolas Peter told the Financial Times last fall that the automaker plans to clearly adhere to the way we manage supply to maintain our pricing power at the current level.”

Mercedes-Benz parent Daimler AG has the same idea. “We will consciously undersupply the level of demand,” Daimler Chief Financial Officer Harald Wilhelm told the FT.

Ford F,
-3.60%
CEO Jim Farley suggested the company may move closer to a build-to-order business model, although he recently promised dealers that Ford would not sell cars directly to customers, like TSLA’s Tesla.
-4.59%
does.

Dealer groups also say that large inventories and deep discounts may not come back.

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The automakers are financially interested in making as many cars as Americans will buy. But perhaps the shortage of chips is teaching them not to do more than that.

This story ran first KBB.com.

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