Soaring Subaru closing in on difficult crossroads

The tornado tore through Lafayette at 3 p.m. on Nov. 17, 2013, a Sunday.

Most of the 4,000 workers at the local Subaru factory—the only such facility outside Japan—were between shifts when the twister slammed into the building at almost 140 miles per hour. It tore off a section of roof, flung a three-ton air-conditioning unit like an empty beer can, and toppled a concrete wall onto the assembly line.

“Monday was a day off. Tuesday morning, we were open at 6 a.m.” says Tom Easterday, the executive vice president who runs the factory.

The roof was a patchwork of temporary panels, the floor was covered in a few inches of rainwater, and the plant was cold. But shutting down production wasn’t an option. Subaru had enough inventory in the U.S. to last about 11 days, an impossibly slim buffer in an industry famous for revving supply far beyond demand. The 2014 Outback that wound up under the concrete wall was driven off the line, retouched, and sold.

Tornadoes have kept their distance from Subaru’s Indiana factory in the months since, but the pressure to churn out more vehicles has only increased. Since 2011, Subaru’s global sales have surged 45 percent, to 913,100 vehicles, a pace bested only by a few burgeoning Chinese brands and Fiat Chrysler, which has been intent on making Jeep a popular choice in Europe and Asia. In the U.S., Tesla is the only car company that has increased sales as quickly in that period on a percentage basis..

And Subaru has done all this while cranking out the best profit margin in the industry.

The company, however, couldn't be less suited to handle a sales surge. Last year, Toyota, the world’s largest automaker, sold a car about every three seconds, while it took 35 seconds for a Subaru to leave the lot. Almost any car company one can name is far bigger than little Fuji Heavy Industries, Subaru's parent.

BMW? More than twice the size in terms of unit sales. Kia? Almost three Subarus. Even Mazda sells 50 percent more cars.

Being small, though, is the reason Subaru has become such a big deal. With manufacturing capacity maxed out, it now has to decide what kind of company it wants to be.

“We were getting the tar kicked out of us”

All you need is love … and dogs

Tom Doll is an unlikely chief executive for a car company. For one, he’s an accountant by training, not a salesman or marketer. Crumpled into a Marriott easy chair down the road from the Indiana plant, he’s soft-spoken with a trim build that suggests a diet comprised of more sushi than steak. The 61-year-old is also the closest thing one will find to a company man in today’s car business. He’s been with Subaru since 1982 and has never worked for a competitor, though he did once consider switching careers to teach math and economics to high school students.

Doll was there for the dark days of the late 1980s, when Subaru lost almost half its U.S. sales volume. And he remembers the greased lightning that was the Outback launch in 1995, which helped the company recover all that ground.

By 2005, however, most of Subaru’s competitors were selling something similar in terms of shape and capabilities, and the little Japanese giant killer was once again losing ground. The brand wasn’t moving the needle beyond its base of crunchy, fairly liberal consumers on the coasts, and the company’s global sales fell 3 percent, to 569,000 vehicles.

Doll, then chief operating officer of Subaru in North America, pitched a bold plan to the top executives in Tokyo: Stop crowing about horsepower and prices and start talking about the love customers have for their cars. Don't stop there, Doll suggested. Talk about the love customers have for their cars, their kids, their dogs, their kayaks, and their communities. “We were getting the tar kicked out of us,” Doll says. “I realized we couldn’t compete with these bigger companies at their game. We had to come at it in a completely different way.”

Doll was given the green light, as well as the top job at Subaru’s branch in North America, its largest market. “They gave me three years,” he says. “If I wasn’t successful, I would have been gone. And, of course, I didn’t know we were going to have a financial crisis.”

In late 2006, Doll hired a new creative agency, Minneapolis-based Carmichael Lynch, a unit of Interpublic Group. The first change was simple: The tag line—"It's what makes a Subaru, a Subaru"—was prefaced by "Love." A slate of emotionally charged ads followed. Kids and dogs were everywhere. The only features the company lingered on were safety-related. Instead of buying a Super Bowl slot, the company sponsored Animal Planet's Puppy Bowl. "Before 2008, you kind of knew about Subaru or you didn't," says marketing chief Alan Bethke. "That all changed with the 'Love' campaign."

Cutting prices

Meanwhile, Doll drew up a program to make dealerships a more pleasant experience. In 2007, Subaru cut prices across the board in the U.S., mostly to short-circuit the long rounds of negotiation that tend to poison any kind of brand loyalty. The company also set up a robust philanthropy program, tying transactions at dealerships to donations to local charities. Suddenly, a Subaru dealership became a place where one could buy Girl Scout cookies or adopt a puppy rather than wrestle over the cost of floor mats and financing rates. “In our industry, you can’t go wrong with kids and dogs,” says John Krafcik, former CEO of Hyundai North America and president of TrueCar, an online car-shopping platform. “Subaru gets this better than anyone else.”

Doll and his team also started stretching the brand beyond its traditional strongholds in the Northeast and Northwest. It shopped for dealers in the Sun Belt, promising its all-wheel- drive lineup offered safer driving on dry, sunny roads, not just wet, snowy ones. “In a lot of ways, we were nation-building,” Doll says. “The whole hearts-and-minds thing.”

Feeling the love

The streets around Powerhorn Park in southern Minneapolis have long crawled with Volvos—the safe, sturdy, pragmatic car for drivers who didn't want European luxury or mass-market machines from Michigan. Shari Albers and her late husband had five Volvos over the years. “We’re straight-down-the-middle-of- the-road people,” she says. “Nothing flashy.”

But when she went shopping in May 2013, Volvos were far more expensive than she'd expected. Albers, 65, wasn’t keen on SUVs either, nor the machines coming out of Detroit and Germany. Saab, another favorite of middle-class Minnesotans, was long gone, its plants grinding to a halt in 2011 after a protracted bankruptcy. “I noticed people drive old Subarus, just like they drive old Volvos,” Albers says. “That made an impression on me.”

She made three trips to the dealer and liked the place more and more each time. When she finally bought her Forester, she didn’t dicker on price. Within weeks, a rash of neighbors followed suit. The Volvo block began turning Japanese. Doll’s goofy love campaign was working.

These days, almost two-thirds of Subaru buyers, like Albers, have never owned one before. In the past five years, the share of Subarus sold in the U.S. jumped from 54 percent to 73 percent. The company also got a little lucky in that period. Its marquee model, the Outback, was perfectly positioned to capitalize on the craze for so-called crossover vehicles that are smaller than traditional SUVs, yet bigger and burlier than sedans.

The segment was crowded, but Subaru had a head start. And while the marketing team was fine-tuning their emotional commercials, Subaru's engineers started ramping up the brand's crossover credentials. With an overhaul in 2008, the Forester essentially became a taller version of the Outback, more akin to a traditional SUV. The XV Crosstrek, which went on sale in late 2012, lured Outback fans who wanted a hybrid.

Robert Alvine, president of two Connecticut dealerships selling Kia, Subaru, and Volvo vehicles, says most of his business of late has been customers trading in a range of foreign cars for an Outback or one of its siblings. “I firmly believe none of the other companies would have the patience to do what they’ve done,” he says. “It’s a cultural thing.”

“In a lot of ways, we were nation-building. The whole hearts-and-minds thing”

Running out of road

The list of things Subaru doesn’t do remains long. It doesn’t have a luxury brand like Honda’s Acura or Toyota’s Lexus. It still doesn’t make a giant SUV, or a truck, or a super-expensive “halo car” designed to drum up interest from teenagers and the Top Gear crowd. Its sedans aren't particularly popular and the company doesn’t make much of an effort to sell cars in Europe, the Middle East, or South America, like Nissan or Ford does. Kansas is the closest thing it has to an emerging market. Subaru still can’t meet demand. By the end of next year, Subaru’s factories in the U.S. and Japan won’t be able to produce more vehicles.

In mid-May, representatives from Subaru’s 600 or so U.S. dealerships streamed into Lafayette for the company's annual meeting—an event that is equal parts conference, pep rally, and party. Local food trucks served pulled-pork sandwiches, Italian ice, and homemade granola bars, while a stream of Subaru salesmen in polo shirts gunned new Outbacks over a boulder-strewn off-road-driving course. “I’ve spoken today with a lot of these guys and every one of them has said if they had more cars, they could sell them,” Easterday said.

The driving course is part of about 600 largely undeveloped acres where the plant could, conceivably, expand. Of course, that requires money and no small dose of optimism. To date, Easterday has tried to make more cars with kaizen, the Japanese mantra of slow steady improvement made famous by Toyota in the 1980s. In early 2012, the company poured $75 million into the plant to boost capacity by 15 percent. Just a few months later, it committed to an additional $400 million in expansion costs, including a new paint shop, an assembly line, and a machine the size of a small apartment building to stamp metal sheets into doors and body panels.

Next year, the Indiana plant will stop producing Camrys for Toyota, which owns 16.5 percent of Subaru and, as such, is an implicit partner. All of those changes, however, will only push annual capacity to 400,000 cars. With some tweaking to its plants in Japan, Subaru expects to just barely break the 1 million-vehicle mark next year.

Krafcik at TrueCar says the company could easily sell at least another 300,000 cars a year, based on how many people are searching for Subaru online. "Most automakers would have moved sooner," he says. "To me, it looks like they're OK with having this capacity constraint."

Patience pays

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. Push out 10 million vehicles a year and all the extras from your suppliers—seats, air bags, mats—come at a discount.

Volume, however, has its drawbacks. If a company outruns demand, a string of reactions unfolds that ends in a very dented reputation among consumers. First, profit gets pinched, as prices are cut and incentives are added to move the excess metal. Friction builds between dealers and the manufacturer over whose margin should be sacrificed. Meanwhile, the discounting weighs on resale values, which can turn off prospective buyers.

This is the gimlet view Subaru tends to cast on production decisions. Traditionally, the company has spurned the volume game for steadier prices and better relationships with its dealers. Because supplies are so tight, a Subaru sitting on a sales lot right now might be the closest thing the car business has ever seen to a fixed price. Last month, the average incentive on a Subaru in the U.S. was a minuscule $481, compared with almost $2,000 on a Mercedes and almost $3,000 on a Ford. This is also why Subarus today retain their value better than any other brand, according to a TrueCar analysis. “They have been the fastest-growing brand … and the most disciplined brand,” Krafcik says.

Jeff Schuster, a senior auto analyst at the Michigan-based consultancy LMC Automotive, says any increase in inventory would threaten the company’s “cult status.” In other words, Subaru may be growing so quickly and selling so many cars precisely because it doesn't sell that many cars. “It’s the this-isn’t-a-Toyota appeal,” he says. “And it’s a balancing act. Do you lose what the Subaru brand is if you chase volume and broaden your lineup?”

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).

After that kind of result, most executives would take a victory lap—bankroll a reckless race car or at least splurge on a famous headliner to make an appearance at one of the auto shows. Doll, however, is hunkered down near a hotel Starbucks, carefully making last-minute edits to his annual address to dealers. When asked about his remarkable success of late, he shrugs, cracks a wry grin, and offers the koan of a car guy who has seen both boom and bust: “Profit in this business is all temporary; eventually it just has to be redeployed.”