Ford’s third quarter loss of $5.8B, or $3.08 a share, is its biggest quarterly loss in 14 years. The results follow an 8.6% decline in U.S. auto sales this year as buyers look to more fuel-efficient vehicles and shun pickups trucks and large sport utility vehicles (SUVs), such as the Ford Explorer.

Sales of SUVs and pickups are down more than 17% for the year, or about 250,000 units, which equates to $6B in revenue. Meanwhile, Toyota truck sales are up more than 40% for the year, with the world’s second largest automaker, poised to be No. 1, preparing to launch its new Tundra pickup in 2007, which is predicted to steal even more market share.

Products will always make the difference

As the SUV and pickup truck markets continue to decline because of macroeconomic (fuel prices and housing market) and demographic issues (baby boomers downsizing, and Gen Y and Z requiring increased personalization), the market is skyrocketing for premium, subcompact, and crossover vehicles, or CUVs. CUVs are sport-utility-like vehicles that are built on a more economical, car-based platform rather than a truck one, like the Toyota Highlander or Honda CR-V.

CUV sales are up 9% overall for the year, while small cars outsold trucks and pickups for 8 of the past 10 months.?The good news is that the new Ford Edge CUV appears on dealer lots next month, and is expected to sell 100,000 vehicles annually.?Ford says it already has 20,000 dealer orders for the vehicle.?However, the CUV market already has 44 different models.?The Edge’s biggest competitors in this space will be the Nissan Murano, Toyota RAV4, Honda CR-V, GM Acadia, and the Mazda CX-7.?The Edge will likely cannibalize Ford’s Escape and Explorer because of product price ranges.?

The gap in Ford’s North American market is in the sub-compact segment, which has been spurred on by high fuel prices.?Toyota quickly responded by rebadging one of its Japanese products, the Yaris. Honda launched the Fit, and Chevrolet has the rebadged Aveo.?For its play, Ford could bring the KA-2 from its European market.

Ford’s big challenge is to determine how it will compete in the premium or luxury markets.?With Lincoln, Aston Martin, Jaguar, and Land Rover, Ford’s premium brand is not clear.?Toyota has Lexus, Nissan has Infinity, and GM has Cadillac—there’s no mistaking that these are the premium brands.

Way Forward needs to shift into high gear

To return itself to profitability by 2009, Ford revamped its Way Forward restructuring plan.?It currently calls for 30,000 fewer hourly and 15,000 fewer salaried employees. The plan also involves closing 16 manufacturing plants over the next several years to bring its capacity in line with its projected North American market share of 15%.?To reduce the hourly work force, Ford will offer buyouts to 75,000 of its hourly employees, hoping for 30,000 takers.

In the earnings announcement, Ford’s new CEO Alan Mulally said a major goal of the new Way Forward plan was to reduce Ford’s operating costs by $5B over the next three years.?One aspect of this will be reducing direct materials and manufacturing operations.?Direct material cost reductions would come from improving the reuse of strategic components across its product platforms, while manufacturing operations would be the result of plant closings and hourly and salary employee reductions.

But reuse and staff reductions are only two of the strategies Ford must employ to improve its cost competitiveness, especially when Toyota has a number of cost-per-vehicle advantages over Ford:

• Healthcare costs are about $900 less per vehicle.
• Reuse of common components and architectures costs are about $1,000 less than Ford’s.
• Warranty costs are about $200 better than Ford’s.

If incentives are added in, it is easy to see how Toyota has a $2,500 profit gap per vehicle over Ford.

Albeit important elements of Ford’s restructuring plan, there are still some areas that need clarification and additional details, especially as it relates to how Ford will accomplish the following:

Reduce time to market

Product lifecycles continue to compress.?The current lifecycle of Ford cars averages from four to six years, while Toyota is about three years.?What this means is that Toyota has a fresher lineup of new vehicles and significant improvements to exiting models.?

If Ford can shorten lifecycles, it can get closer to the market and respond faster to market changes and new demands.?Toyota has been able to do this by mastering common components and systems across its various vehicle platforms. While Ford has been experimenting with component reuse for the past few years, it hasn’t been able to achieve significant results.?Effective execution of this strategy involves top-down commitment (Mr. Mulally has identified it as strategic), global organizational alignment around strategic commodities and architectures, and integration of Ford’s product lifecycle management (PLM)?systems with other key business systems.

Increase manufacturing flexibility

Hyundai’s plant in Montgomery, Alabama, assembles the Sonata and its CUV counterpart the Santa Fe down the same assembly line, with both vehicles built on the same platform.?BMW can produce almost all of its different vehicle models in the Spartanburg, Virginia, facility, and BMW can flex its manufacturing operations from 60 to 140 hours per week without incurring any overtime.?

For Ford, this model would definitely require some drastic rework on the current labor agreement. Having this level of flexibility allows these companies to better use assets and flex order books.?Do the Ford Edge and Fusion use the same platform, and why is one built in Canada and the other in Mexico??One would hope that there are plans to build the models in both plants.

Build to demand

Build to demand has always been the North American vehicle manufacturer’s Holy Grail.?Their traditional business models have plants sustaining capacity by keeping them operating, even when there are no real customer orders.?North American dealer orders are typically 30%, while sales program orders (a.k.a. forecast) are typically 70%, which results in excessive inventories.

Ford currently has more than 100 days of inventory, but 60 days is considered ideal for North American vehicle manufacturers. Toyota operates at 26 days.?To clear this inventory, Ford reduced it production 11% for Q3, and is planning to reduce it again in the fourth quarter.?It is also offering incentives on its 2006 models of up to $4,500, and already has $1,500 cash incentives on some new 2007 models.

Toyota and BMW, leaders in the automotive industry, have somewhat different models on build to demand.?Toyota’s model is simple, focusing on only maintaining 30 days of inventory, or 3% of its monthly sales volume, and a 85%/15% dealer order to forecast.

Toyota also manages its production so as not to exceed the strategic inventory level.?It does this through flexible manufacturing facilities and flexing the number of production hours.?BMW’s model is somewhat more complex, with most BMW production based on actual dealer orders. What makes this model complex is that a customer can change the configuration of its vehicle five days before the actual production date. Both models require a major shift in culture as well as in planning and execution systems to manage orders and collaborations with dealers and suppliers.

Looking forward

Many industry experts have commented on the lack of experience Alan Mulally has in automotive, but this could be an advantage. He brings a perspective to Ford that is untarnished by any Motor City legacy.?Mr. Mulally faced similar challenges at Boeing that Ford is experiencing today. He had to restructure Boeing’s manufacturing operations into a lean global enterprise, and right size its overall operation to make it profitable. He also slashed the development time of the new Boeing 787 Dreamliner by 50%.

In the meantime, Mr. Mulally has several tough decisions to make:

• What should the product portfolio look like??Does Ford maintain the eight different brands it has, or does it move closer to a three-brand strategy similar to Toyota’s?
• What global organizations and processes need to be established to create commonalty around vehicle architectures, manufacturing operations, and purchasing?
• Can low-volume niche vehicles be profitable, or should the work be outsourced to a coach-builder like Magna Steyr or Carmen Ghia?
• Can Ford’s culture and union agreements be renegotiated to afford Ford the flexibility to become a build-to-demand vehicle manufacturer?
• How will Ford reduce its dealer network?
• How will Ford establish collaborative relationships so it does not end up with another Collins Aikman?

Mr. Mulally faces all this as Ford’s operating outlook for most of 2007 looks less than promising.?Ford will continue to right size its operations to support a 12% to 15% market share.?It will need to continue to invest in research and development to freshen its product lineup, reduce time to market, and improve manufacturing flexibility.?

The clock is ticking. Analysts and investors will be looking for some level of progress starting in Q4 of this year. The important factor in automotive is that progress is not measured by cutting to prosperity.?A true measure of Mr. Mulally’s success will require at least one full product cycle that he can influence, which could take two to four years.