Director writes: "Sounds like you are going to forego a massive buildup in size in favor of fewer, better units. I heartily concur."
This is the traditional Italian strategy, conducted largely because of a limitation of supplies and oil. I have discovered new force levels that meet the same criteria of oil and supplies, but gives Italy much more punching power.
Italy, generally, will fight with the forces available at the begining of the conflict. If you plan on small force structure, that's what you'll have for the remainder of the game.
I recommend Italy forgo motorized and mechanized entirely and instead build five full corps consisting of a General w/1tank+8inf, a Lt.General w/3inf, and a Mj.General w/1inf. For scouting and flanking Italy also needs 8 tank divisions. This will give Italy three full corps to take Alexandria in 1941, with two corps for continency's such as tackling the Suez Canal and later defending Tunisia in 1942-43 when the American's come calling. What was that Stalin said, "Quantity has a quality of its own."
Standard infantry is not sexy, I know, but Italy is a poor country. In later years, from '42-on, Italy will need to build naval bombers and interceptors just to maintain control of the Mediterranean Sea and protect their convoys, otherwise their ambitions for Africa will fail for lack of supply and reinforcements.
Italy's navy is not limited to port for lack of ability, rather due to a lack of oil. Therefore, to defend what it has, Italy must build up it's flack power and AA forces. Italy also excells at building and upgrading interceptors because they are relatively inexpensive and cover all the important areas of the Mediterranean.
Italy's lack of talent requires it to focus its research in select areas. Forget about navy technology or building capitol ships (such as aircraft carriers), when Italy builds ships it's destroyers and submarines because they're cheap and easy to replace. When things get tough, newly built units can be staged at Cantania, and Italy can run its transports between Cantania and Benghazi at night. Be sure to use picket subs or destroyers to make sure the coast is clear beforehand. Italy may also want to build a naval base at Cantania along with flack towers to protect the navy yards.
Italy needs to go the upgrade route by steadily building up professionalism of the armed forces. If you like sexy, build some paratroopers or air cavalry, but that's about the extent of it.
Note:
1) In later years Italy needs motorized artillery to bolster their land forces against American mechanized units.
2) For costal defence use militia with fixed artillery because they are cheap, easy to build, and don't cost much in the way of supplies or oil.
3) Italy's mountain troops are ideal for spearheading invasions and in jungle warfare for the central Africa campaign (if you become that successful).
4) Also, once you break down British resistance in Somalia, South Africa will easily fall to a single Italian Corps.