Who is Number One?

Auto sales are not the only measure to assess an auto OEM's relative health. This piece from the Detroit Bureau lays it out:

• GM slid to third when it comes to units sold for the first half of 2014. And focusing on just the most recent quarter, the Detroit maker fell to fourth when it comes to gross revenues.
• GM reported gross sales of $39 billion for the April to June quarter, noted Autoline: Detroit Editor John McElroy, putting it well behind Germany’s multi-brand Volkswagen AG, at $68 billion. That was well ahead of even the industry’s leader from a unit sales standpoint, Toyota, which managed a still-hefty $62 billion in revenues.
• The big surprise was Daimler AG, which managed to nudge past GM with $42 billion in second-quarter revenues. GM, in turn, managed to squeak past the Euro-Asian Renault-Nissan Alliance by just $100 million.
• Ford Motor Co. delivered $37 million in revenue, with fast-growing Korean siblings, Hyundai-Kia reporting $33 billion. The newly merged Fiat Chrysler had combined revenues of $31 billion. Rounding out the list of major global plays, Honda revenues came in at $29 billion, with BMW in the industry’s 10th spot at $26 billion.

The Decline of the Japanese Auto Industry

Here are three graphs, pulled from a talk I gave at UMTRI in the spring. The Japanese auto industry – that is, manufacturing and retail inside Japan – faces permanent decline.

Two trends interact. First, due to demographics Japan's population is in decline, and so is the number of licensed drivers. I don't have statistics on the latter, but I have used Census data and population projections to calculate the potential number of licensed drivers. (In Japan you can't get a license as young as in the US, and after age 70 it becomes increasingly hard to get your license renewed.)

Second, the vehicle mix is unfavorable. From the production standpoint, exports are important, but the data show that the market isn't increasing, has more low-value vehicles and is very volatile. The third graph is the domestic parc, which is what matters for dealers. Here the story is even worse, while full-sized cars rose in share along with incomes, that process has ended. Instead what we see is a decline in mid-size car sales (compacts in the US context) and their replacement by "kei" minicars.

Here are implications, as I see them.

1. Over time dealers will face extraordinary pressure. That will be accentuated by the geographic aspect of population decline, because population will fall more and age faster in rural areas where car ownership is highest. Rural areas are already distinctly older than the major urban areas (Tokyo-Yokohama-Kawasaki-Chiba, Osaka-Kyoto-Kobe, Nagoya, Hiroshima, Fukuoka-Kita Kyushu, and Sapporo). Their potential market is literally dying off. Dealerships in Japan are also unable to sell across prefectural boundaries, so better-run dealerships can't use the internet to extend their geographic market to offset local decline.
2. Manufacturers will face a smaller market. They have a large number of distribution channels – not including trucks, Toyota has six channels: Daihatsu, Netz, Corolla, Toyopet, Toyota and Lexus, with lineups that overlap and cannibalize each other. (Dealerships are also multi-point, with sales points each trying to buy business from other parts of the same dealership, while the strong players in used cars are independents such as Gulliver.) Rationalizing production and model mix and distribution will be traumatic, as we've seen with the efforts of GM, Ford and Chrysler in dropping multiple brands.
3. Suppliers will have an even harder time. Small Japanese suppliers were slow to internationalize. Even worse, when I've visited suppliers in Japan for engineering presentations – and in sharp contrast to similar visits in the US and France – I've been the only non-Japanese in the room. That hurts in two ways.
   • First, there just aren't that many would-be engineers graduating from Japanese universities. Without international staff they simply won't be able to stay in the game. Honda and Toyota have huge engineering operations in the US that can handle the entire vehicle development process. As far as I can tell, that's not the case with most Japanese-headquartered suppliers.
   • Second, in order to serve their customers on a global basis, suppliers need to have the same global capability. Some will finesse that by being acquired by foreign firms, and thereby globalize their engineering. Others will prove unable to build a global engineering and manufacturing presence because they've been slow to delegate decision-making and build capabilities and staffing outside Japan. They will steadily lose market share to firms with HQs outside Japan. Indeed, my scanning of industry news (in English, Japanese and [less frequently] German) supports that. Toyota is turning more and more to the big US/Europe based global suppliers, because their own "keiretsu" suppliers can't support Toyota's global footprint.
   • Now this is a third bullet, but is speculative so I won't claim it as a 3rd point. My belief is that because of the two factors above Japanese suppliers lag in technology. Casual empiricism turns to the body of finalists in the Automotive News PACE competition, who are chosen on the basis of successful innovation. Japanese firms are largely absent. [Mea culpa: the competition is entering its 20th year, and I've been a judge since the start.] Not having a truly global mindset, not having the bulk of engineers in Japan able to use English as a working language, means that Japanese suppliers are behind the eight ball in technology. Sometimes it's better to be a bit behind where you can learn from other's mistakes and simply not invest spend money on "advanced concept" R&D that leads to dead ends, the "bleading edge" thing. OEMs also want second sources, so even firms that have reasonable intellectual property know they won't have a monopoly. Still, my judgement is that being second source is less profitable. And being second-source based on production in Japan is a losing proposition.
4. Japan, as a geographic entity, is already a shrinking part of the global industry. Of course the growth of the BRICs and ASEAN means the same is true of the Euro zone and of NAFTA. My belief is that slow internationalization will accentuate the impact of a shrinking domestic market. That's particularly good new for non-"Japan" suppliers.

In the 1980s the US industry feared that domestic firms would disappear under the onslaught of Japanese "keiretsu" suppliers. That's not what we see if we look at the top 100 suppliers today.

Honda as Japan's Exemplar

...Make where you sell, and that's not Japan...

For a while the impact on the auto industry of 3/11 – the earthquake and tsunami – and then the Thai flood garnered headlines. Lately the headlines in Japan have been politics, politics, and more politics. First there was the US election and the leadership transition in China – Japan's #2 and #1 trading partners. Then there are the upcoming elections in Japan and Korea. These have embroiled the auto industry, too, because of the attempt of various parties in China and Japan to wave the nationalist flag, with much of the fallout hitting bilateral Japan-China auto trade. All this has pushed more mundane news – the transition of the domestic Japanese auto industry – out of the headlines.

So here are two snippets, both using Honda as a foil, though these are more general issues.

First, there's the story – Alan Ohnsman at Bloomberg – that Honda will become a net exporter from the US. Why? – because they're ceasing Accord production in Japan. Of course Nissan is already bringing in the March from its plant in Thailand; Mitsubishi has also begun imports from there. But the yen is cutting into the attractiveness of production in Japan, while the domestic market is small: make where you sell, and that's not Japan.

Second, Honda has now moved into second place in sales for January-November 2012, with 701K units. Meanwhile Nissan, the one-time national champion, ranks fifth. (In third and fourth are Daihatsu and Suzuki; Toyota dominates with 1.55 million units, over twice Honda's level.)

What though is Honda selling? It turns out their success -- and that of Daihatsu [a Toyota subsidiary] and Suzuki -- is due to the growth of the "kei" (minicar) segment, vehicles with engines 360cc or smaller. In the full-size segment Honda is a distant 4th, more-or-less tied with Mitsubishi (29K vs 27K units) but far behind Nissan and Toyota. Indeed, in that segment Honda remains behind the importers BMW and Mercedes (at 32,000 and 33,000, respectively). But in compact cars they were second only to Toyota, and Honda sold enough "kei" to move them to the #2 position.

	Passenger Cars
	Standard	Small	Mini	Total	Trucks	Buses	Grand Total
Toyota	719,229	700,743	30,549	1,450,521	138,574		1,592,957
Honda	28,598	376,402	264,876	669,876	30,531	-	700,407
Nissan	186,042	224,609	117,382	528,033	91,317	1,460	620,810
Daihatsu	175	2,605	514,912	517,692	117,783	-	635,475
Suzuki	2,469	80,790	416,705	499,964	132,866	-	632,830
Mazda	81,212	61,204	39,253	181,669	24,305	-	205,974
Subaru	92,821	3,957	31,144	127,922	35,623	-	163,545
Mitsubishi	26,534	28,652	45,156	100,342	31,679	-	132,021
Others	181,382	30,867	19	212,268	1,804	64	214,136
TOTAL	1,217,756	1,396,773	1,349,335	3,963,864	663,013	10,399	4,637,276

Now domestic sales – cars, trucks and buses – peaked in 1996 at 7.1 mil units; in 2012, the level will be about 5.4 million units, down almost 25% despite the rebound from the depressed levels of 2011. So no one is doing well, and population aging means a declining number of licensed drivers. Things will not improve. But the mix is becoming bimodal, too. Full-sized cars are fine, quite possibly hitting a new peak of 1.5 million units (triple sales in 1990, during Japan's bubble). The shift is from compact cars to minicars. The former peaked in 1990 at 3.8 million units; 2012 will see sales of 1.6 million units. At the same time, minicars will hit 1.6 million units, up from 0.8 million in 1990. The market is thus split about 1/3rd each, but the shift is one that leaves a less rich product mix.

	Full	(share)	Compact	(share)	Mini	(share)	Cars Total	Trucks
1990	467,490	(9%)	3,839,221	(75%)	795,948	(16%)	5,102,659	3,639,909
1995	889,260	(20%)	2,654,291	(60%)	900,355	(20%)	4,443,906	2,403,825
2000	770,220	(18%)	2,208,387	(52%)	1,281,265	(30%)	4,259,872	1,686,599
2005	1,271,349	(27%)	2,089,992	(44%)	1,387,068	(29%)	4,748,409	1,085,904
2012 - Nov	1,318,462	(31%)	1,509,829	(35%)	1,459,996	(34%)	4,288,287	395,377

...mike smitka...

...tariffs are 0% on vehicles shipped from Mexico...

Honda is building a full-sized assembly plant (200K units per year) as is Mazda; Nissan is adding a 3rd plant. Part of that is driven by the strength of the yen, at ¥81.3 per US$ on 17 November; the US is the biggest source of profits for the auto industry, so sourcing vehicles for the US market from a non-yen location is important. [The Euro is also strong, to which anyone who has traveled there on a dollar budget can attest. So while VW has operations in Mexico, here I focus on the Japan angle, because I'm teaching a course on the Japanese economy.]

But why Mexico? Logistics costs are high, because most vehicles will likely be exported and because the local supplier base is not as deep as in the US midwest (hence parts must be imported). So while quality is high and wages are competitive, it's not a priori a natural choice.

The answer lies in free trade agreements: Mexico has been more aggressive on that front than the US (and Japan). As a result not only can vehicles be shipped tariff-free to the US–0% from Mexico versus 2.5% on cars and 25% on trucks shipped from Japan. Ditto Europe–tariffs are 0% from Mexico versus 10% on vehicles shipped from the US or Japan. (I have not researched whether Mexico has similar aggreements in Latin America.)

Now Japan could offset some of this were it to negotiate more free trade agreements. (It has one with Mexico.) But that's an awkward process, and has yet to join the biggest pending agreement (TPP, Trans Pacific Partnership). The reason: farmers, whose political clout is disproportionate to their share of the economy, and whose clout over time has led to subsidies and tariffs that allow rice farmers to remain in business despite costs that are multiples of those in other large producers. So removing protection for rice would drive most farmers out of business. In Japan, it's the "3rd rail" of electoral politics.

While we didn't hear anything about the economies of Canada and Mexico, our two biggest strategic partners, in the recent (and unlamented) US political cycle, this movement clearly benefits NAFTA and thus the US. Do higher wages in Mexico harm us? No! And while we might rather have the jobs in the US, we do pick up additional parts business. If we're going to import vehicles – and economies of scale mean that many will still be built in but a single plant globally – then better Mexico or Canada than Japan or Europe!

...mike smitka...

Bad News for Toyota? – the Detroit 3 are Back

...the Detroit 3 are returning to the midsized-car segment...

I'm tossing out back issues of Automotive News to try to fit into a corner office with more windows but less shelf space. I know, crocodile tears for this academic with his shelf-filling collection of books and journals. Anway, one headline caught my eye: "What can save the Detroit 3? Cars!" [a John K. Teahen, Jr. editorial from Sept 18, 2006, p 16].

The context was the near-exit of GM, Ford and Chrysler from the car market, which decreased monotonically from 89% of their sales in 1965 to 35% in 2005, while (correspondingly) trucks went from 11% to 65%. Now admittedly trucks were incredibly profitable on a unit basis, while small cars were a necessary evil, intrinsically unprofitable but needed for CAFE (the Corporate Average Fuel Economy mandate). But the decline at the Detroit 3 was disproportionate to the shift towards light trucks in the over US market.

One point is that ambitious designers, engineers, and senior managers all want to be associated with halo the ka-chenk of good bottom-line vehicles. Teahen argued that the Chevy Impala remained a potential money-earner, with hoped-for sales a bit above the 296,000 of 2006. In fact, on a platform basis, output was higher – 500K – reflecting the multiplication of nameplates that were in fact the same basic car, but the implication of the editorial was that it wasn't making much money. And even with the shift of the overall vehicle market towards light trucks, such sales pale besides the 1-plus-million mark hit of 1965. GM wasn't putting its heavy hitters on car projects.

I've argued before on this blog that Toyota lavishes undue attention on the Prius and on the Lexus marque, again reflecting the status of these projects within the company as a whole. Reputedly Toyota's working to correct that bias, devoting more effort to the 2012 version launched in December 2011. Time will tell if it is better executed and better selling.

Today, however, the Detroit 3 are a factor. They have very different cost structures, with the removal of the millstone of legacy costs from around their neck, a function of the aging of workers "retired" under pre-2007 restructurings, the impact of the VEBA and (for GM and Chrysler) additional costs shed under bankruptcy. Labor is no longer a fixed cost. They thus no longer need to maximize revenue [which for you economics junkies is also implied by the low marginal price of labor]. Instead they can aim to make money from cars. We see that in reduced incentives, reduced fleet sales -- that is, higher prices -- and a normalization of residuals. (I can't speak of leases -- I lack knowledge and suspect that option continues to suffer from the aftershocks of the financial upheaval of 2008-9.)

What does that imply for those who remain focused on cars, particularly Toyota, Honda, and Nissan? On the one hand, they ought to benefit from less discounting. On the other hand, they are hurt by reinvigorated Detroit 3 products. The latter, I believe, dominates: from Toyota's perspective, they have two new, heavy-weight competitors in GM and Ford (and in some product categories, a 3rd in Chrysler), and while Hyundai has been around for a while, sales of the Sonata are only now such as to represent a major slice of the mid-size segment of the Camry and the Accord. If you've become a bit sloppy dare I say arrogant? the sudden appearance of new competitors can be very painful.

My prediction thus is that Toyota (and Honda) will resort to greater discounts and higher fleet sales. That should be good news for new car buyers. (Car renters will have greater choice, but price may not budge much, better residuals will work against higher initial acquisition costs for Enterprise and their rivals.) But since Toyota relies on exports from high-yen Japan for Lexus and (to a lesser extent) the Prius, they've taken a major hit to profits on that front. I'll leave it to financial analysts to pour over segment results of the major players, particularly Toyota, to see if the new competition means their US profits take a hit as well.

Mike Smitka

comments welcome, here or via email!

Japan's Headlines: China not Clunkers

Mike Smitka

The top headline in the Nikkei today (Aug 7th) was neither their recession, nor their pending general election (and the potential change of government). It was July car sales in China, up 64% from from 2008 to roughly 1.1 million units. That's above the clunker-driven 1.0 million level in the US, and (as the percentage increase suggests) out of synch with sales doldrums during the past couple summers.
Part of the reason is that, despite the American perception of China as an economy dominated by exports, it's a country the size of the continental US, and that huge domestic expanse is peopled by 1.3 billion would-be consumers. The Chinese government is determined that they will be consumers. To make that happen, the government is providing plenty of domestic stimulus, unhindered (at least in comparative terms) by domestic banking problems, and with little of the pointless tax cuts and other fluff that bolstered the price tag of the "stimulus" package passed in the US. The ongoing construction of a national highway system provides plenty of room to speed things up (reversing the policy stance of a year ago, when the fear was inflation).
There are also vehicle-specific policies with bigger environmental implications than the US program that gets rid of a few seldom-driven¹ "clunkers." Their tax breaks and and scrappage incentives (that include provisions to help rid rural roads of smoke-belching 3-wheelers), was implemented in a timely manner in January 2009. The focus is small vehicles, those with under 1600cc engines, with no loopholes to subsidize the purchase of trucks (unlike the US "clunkers" program). And if you visit Shanghai or Suzhou, while you'll find the roads filled with scooters and motorized bikes, the noise level is a fraction of what it used to be: they're electric, driven by batteries. The garages of condos include outlets to plug them in at night, enough to power the daily commute. But diesel fuel in China is still sulfur-laden, so the next-best alternative, a clean-diesel powered vehicle, is not yet an option there -- as was the case until two years ago in the US. So China can't (yet) follow the European option of small, clean and very-long-lived diesel powered cars.
Now the China market is profitable for the moment, and important to global firms. GM has actually shifted its international operations HQ to Shanghai, anticipating its sales there to top 1 million units in the near future; VW already sells over 1.0 million units a year. Accordingly everyone is pouring on capacity and dealers.
This may be a "bubble" of sorts. Already the shift towards smaller vehicles makes it less of a gold mine than a year ago on a per-vehicle basis. Meanwhile, the number of players is mind-boggling: not only are all of the major international players in the market (VW and GM have the top two spots) but there are still 80 local players. Yes, 80 -- because local governments support their "favorite son" firms. If you visit China, watch how the make of taxis varies as you move from city to city. The government is pushing for consolidation, and a couple of the bigger players have bought up a couple small ones. Others have quietly exited. But consolidation has been policy for years and years, and still there are 80 firms! Unless push comes to shove, Beijing has all too little clout at the local level, and this is just one example.
Lots of players ultimately means little profit. GM, Toyota and their rivals are jointly placing a big bet that that does not happen until they've been able to recoup their investment. However, that's a game of "chicken" and at the moment no one wants to blink and ease off on the throttle. I smell a bloodbath in the making, red ink puddled all over balance sheets. That may be 3 years away, but it will happen.
Meanwhile lots of incumbents remain due to (local) government largesse. A couple will turn out to have been well run and innovative, though at present they are still woefully lacking in engineering sophistication. In the background Beijing -- not the locals -- is making a big push towards electric vehicles; ditto battery technology. So a few local firms are likely to focus on electric vehicles (not nightmarishly complex hybrids), and in a market where drivers don't expect to go hundreds of kilometers at a stretch, there will be a local market (unlike in the US). The transition in drivetrain technologies may allow a couple global players to emerge out of the current plethora of small, high-cost producers.
Note that this has strong parallels with the Japanese case. There government policy also pushed for consolidation, and it also failed to accomplish that. Now the early post-WWII market did have about 30 players, and without local government support [Japan's is not a decentralized political system] or other deep pockets half of them soon exited; Toyota and Nissan both picked up with an extra factory or two in the process. The bottom line however was a market with a dozen firms, no dominant firm or even a "Big Three" that could mute competition. In Japan, it was improve efficiency or fail, and in the end that gave birth to Honda and Toyota.² Japan's auto industry succeeded because industrial policy failed; the same, I suspect, will prove the case in China.³
Notes
1. Unfortunately the mandatory "CARS" survey that is part of the US "clunkers" program doesn't ask how many vehicles were owned. It does ask how many miles were driven the previous year -- as far as I can tell, no data from that question are yet available. Not surprising: most dealers haven't been able to get their "clunker" deals approved, much less gotten a check.
2. There are of course other Japanese firms, but only Honda, Toyota and Suzuki remain autonomous. Nissan is controlled by Renault, Mazda is de facto controlled by Ford, Fuso is owned by Daimler, Nissan Diesel by Volvo Truck, Toyota has purchased Hino and Daihatsu outright and has a large stake in Subaru/Fuji Heavy and Isuzu, and MMC has survived through the inexplicable largesse of its creditors and of Mitsubishi Heavy Industries.
3. I have only cursory knowledge of India. In contrast, I began studying about China in 1971, and while I ultimately became a Japan expert (more practical at the time), I've followed (and taught a course on) the Chinese economy for over 20 years, and have visited the country repeatedly.