If you listened to the rhetoric from President Donald Trump during the election you would think one of the most important factors to Americans is where their car was produced. Trump spent a lot of time criticizing vehicle production in Mexico, and studies classifying which vehicles are most "American-made" continue to get a lot of attention. Ford Motor Company (NYSE: F) is going against the grain, though, and gambling that where the vehicle is produced doesn't matter as much as we believe.
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Out of the frying pan into the fire?
As we know, Ford recently canceled its plan to construct a new $1.6 billion plant in Mexico to build the next-generation Focus. And while Trump was quick to claim victory, the truth is Ford isn't bringing that production back into the United States. In fact, it's going even further away, to China.
"We've done a lot of research, and consumers care a lot more about the quality and the value than they do about the sourcing location," said Joe Hinrichs, Ford's president of global operations, in a conference call, according to Automotive News. "IPhones are produced in China, for example, and people don't really talk about it."
In fact, starting next year Ford will go roughly a full year without producing a single Ford Focus aimed for the U.S. market and production of the vehicle in Michigan will end in the middle of next year before coming online in China roughly a year afterwards.
Why the change of heart?
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The bottom line for these decisions is almost always the same, especially when it comes to smaller and lower-margin passenger cars: profits. As demand for smaller vehicles continues to decline in the U.S., it's simply a better business decision to avoid retooling two plants in North America to produce the next-generation Focus, compared to just its Chongqing plant in China. Ford believes moving the production to China will save an additional $500 million -- that's incremental to the $500 million it saved by canceling its Mexico plant plans -- for a total of $1 billion.
That's a hefty chunk to save, especially as profits tighten with the U.S. automotive industry plateauing. The move doesn't come without risks, though. That's a large gap in production between mid-2018 and 2019 that Ford will have to fill by stockpiling inventory beforehand. If Ford doesn't predict the necessary supply and demand it could face bloated inventory, which would require higher profit-eroding incentives to move the vehicles. On the flip side, it could face a shortage and leave incremental sales and revenue on the table.
This is a scenario investors will become more familiar with in the coming years. In fact, General Motors (NYSE: GM) is facing a similar scenario with its Chevrolet Cruze, and it's possible GM will one day decide to shift production of that vehicle to its Mexico plants or even its Chinese operations. One thing is for sure, Ford's feeling the pressure to make these decisions to fatten its bottom line, and the risks that come with those decisions are worth watching for investors.
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