Ford 2014 Annual Report Download - page 35

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
As a result, we analyze the profit impact of certain cost changes holding constant present-year volume and mix and
currency exchange, in order to evaluate our cost trends absent the impact of varying production and currency exchange
levels. We analyze these cost changes in the following categories:
• Material excluding commodity costs - primarily reflecting the change in cost of purchased parts used in the
assembly of our vehicles.
• Commodity costs - reflecting the change in cost for raw materials (such as steel, aluminum, and resins) used in
the manufacture of our products.
• Structural costs - reflecting the change in costs that generally do not have a directly proportionate relationship to
our production volumes, such as labor costs, including pension and health care; other costs related to the
development and manufacture of our vehicles; depreciation and amortization; and advertising and sales
promotion costs.
• Warranty and other costs - reflecting the change in cost related to warranty coverage, field service actions, and
customer satisfaction actions, as well as the change in freight and other costs related to the distribution of our
vehicles and support for the sale and distribution of parts and accessories.
While material (including commodity), freight, and warranty costs generally vary directly in proportion to production
volume, elements within our structural costs category are impacted to differing degrees by changes in production volume.
We also have varying degrees of discretion when it comes to controlling the different elements within our structural costs.
For example, depreciation and amortization expense largely is associated with prior capital spending decisions. On the
other hand, while labor costs do not vary directly with production volume, manufacturing labor costs may be impacted by
changes in volume, for example when we increase overtime, add a production shift or add personnel to support volume
increases. Other structural costs, such as advertising or engineering costs, do not necessarily have a directly
proportionate relationship to production volume. Our structural costs generally are within our discretion, although to
varying degrees, and can be adjusted over time in response to external factors.
We consider certain structural costs to be a direct investment in future growth and revenue. For example, increases
in structural costs are necessary to grow our business and improve profitability as we expand around the world, invest in
new products and technologies, respond to increasing industry sales volume, and grow our market share.
Automotive total costs and expenses for full-year 2014 was $133.8 billion. Material costs (including commodity costs)
make up the largest portion of our Automotive total costs and expenses, representing in 2014 about two-thirds of the total
amount. Of the remaining balance of our Automotive costs and expenses, the largest piece is structural costs. Although
material costs are our largest absolute cost, our margins can be affected significantly by changes in any category of costs.
Key Economic Factors and Trends Affecting the Automotive Industry
Currency Exchange Rate Volatility. The U.S. Federal Reserve has ended financial asset purchases, and the resulting
shifts in capital flows have contributed to downward pressure on several emerging market currencies. In some cases that
pressure is aggravated by high inflation, unstable policy environments, or both. Additionally, the yen and euro have
depreciated as a result of policy changes by the Bank of Japan, and European Central Bank. The weak yen, in particular,
adds significant potential downward pressure on vehicle pricing across many markets globally. In most markets,
exchange rates are market-determined, and all are impacted by many different macroeconomic and policy factors, and
thus likely to remain volatile. However, in some markets, exchange rates are heavily influenced or controlled by
governments.
Excess Capacity. According to IHS Automotive, an automotive research firm, the estimated automotive industry global
production capacity for light vehicles of about 116 million units exceeded global production by about 29 million units in
2014. In North America and Europe, two regions where a significant share of industry revenue is earned, excess capacity
as a percent of production in 2014 was an estimated 7% and 30%, respectively. In China, the auto industry also
witnessed excess capacity at 45% of production in 2014, as manufacturers competed to capitalize on China’s future
market potential. According to production capacity data projected by IHS Automotive, global excess capacity conditions
could continue for several years at an average of about 32 million units per year during the period from 2015 to 2019.
Pricing Pressure. Excess capacity, coupled with a proliferation of new products being introduced in key segments, will
keep pressure on manufacturers’ ability to increase prices. In North America, the industry restructuring of the past few
years has allowed manufacturers to better match production with demand, although Japanese and Korean manufacturers
also have capacity located outside of the region directed to North America. In the future, Chinese and Indian
manufacturers are expected to enter U.S. and European markets, further intensifying competition. Over the long term,
intense competition and excess capacity will continue to put downward pressure on inflation-adjusted prices for similarly-
29