The troubles of Toyota

Akio Toyoda has the job of returning Toyota to his grandfather's core values of dependability and economy while fighting off the threat of aggressive rivals. Photo / AP

On a mild day in February, Toyota's honorary chairman, Shoichiro Toyoda, summoned 400 executives to the redbrick factory in Nagoya, Japan, where his grandfather had built weaving looms a century ago.

The managers filed in for one of the customary updates from Toyota's grey-haired, 84-year-old patriarch. What they got was anything but ordinary.

Two months earlier Toyota had forecast its first operating loss since Shoichiro's father began making cars in the same factory, now turned museum, in 1937. Then in January, about three months earlier than planned, the company announced that Shoichiro's son, Akio, would replace Katsuaki Watanabe as president.

Even with these signals, the managers were ill prepared for the normally reserved Shoichiro's litany of the carmaker's missteps and his dressing-down of Watanabe.

"How many times have you made a mistake?" Shoichiro grilled Watanabe, who sat silently among stunned audience members, according to a person familiar with the meeting.

Shoichiro scolded the president for being so anxious to boost sales and profits that he'd let Toyota emulate the now-bankrupt General Motors and Chrysler. Toyota had become addicted to big, expensive cars and trucks and had forgotten the customers' need to save money, Shoichiro said, according to the person's account.

Shoichiro wasn't just lashing out at Watanabe. He was railing against the threat to everything his family had struggled to create.

The Toyodas built their first car when Henry Ford was turning out almost one million a year in the US. During World War II the family opened drycleaning stores to get by. They adopted kaizen, the making of small and continuous improvements, to fine-tune manufacturing. They enhanced quality and squeezed costs to become one of the world's most admired companies.

Across the Pacific, Ford, Chrysler and GM were gorging on Americans' car lust. They failed to heed skyrocketing petrol prices, declining workmanship and escalating pay. Last year, with help from its petrol-electric Prius hybrid, Toyota pushed GM from its perch as the planet's biggest carmaker.

But now it's Toyota that is feeling the pressure. To avoid the four-decade decline that humbled GM, the Japanese company must fend off rising competitors and adapt to the global reality of slowing sales growth and shrinking profits, says John Casesa, managing partner of car industry consulting firm Casesa Shapiro Group in New York.

"If Toyota is unable to react to a changing world, it will risk its very existence over time," says Casesa, who has covered the industry for two decades. "If the company internalises the GM lessons, it can maintain its leadership."

Akio's challenge is to cut Toyota's dependence on luxury cars and branch out from US markets destabilised by easy credit.

In its race to top GM, Toyota splurged on enough new factories to make two million additional cars a year. Meanwhile, South Korea's Hyundai targeted small-car buyers in China, India and other emerging countries, where it sold 55 per cent of its vehicles last year compared with 31 per cent for Toyota.

"Toyota went from being a scrappy newcomer to becoming convinced the market was just there for them to take," says Maryann Keller, a car analyst and president of Maryann Keller & Associates in Stamford, Connecticut. "Toyota wrote the playbook and Hyundai read it: build great cars with great value, and people will come."

After reporting record net income of US$17.7 billion ($27.9 billion) for the fiscal year ended on March 31 last year, Toyota's earnings took a US$22.2 billion nosedive. The company ended the 2009 fiscal year with a US$4.5 billion net loss and says it expects to lose US$5.7 billion more in fiscal 2010.

Earnings won't recover for three years, even if sales rebound, since Toyota is still paying for its expansion, says Christian Takushi, a portfolio manager in Zurich for Swisscanto Asset Management, which owns 1.7 million Toyota shares.

"Toyota has overdone itself with capital spending because they really wanted to be number one," he says. "They're paying a high price."

Not all investors are so pessimistic.

"Toyota is among the best," says Wendy Trevisani, fund manager for Santa Fe, New Mexico-based Thornburg Investment Management, which held 17 million Toyota shares in March. "They make every effort to address problems as seen by current initiatives including management shifts. Their balance sheet remains strong."

Toyota's US$52 billion in cash and marketable securities give it a comfortable cushion, according to Moody's Investors Service.

Inside Toyota, some chalk up the recent stumble to the recession that has cut global car sales by 20 per cent since 2007. Shoichiro wasn't buying that excuse. He told employees at the February meeting that Toyota fell victim to hubris, according to the person familiar with the gathering.

Beginning in 2003, Toyota pushed to expand manufacturing capacity by 25 per cent to build 10 million cars a year. When Watanabe became president in 2005, he backed the growth plans and championed a US$1.3 billion pickup truck plant in San Antonio, Texas, calling it "a dynamic symbol of our bright future."

Watanabe, 67, sealed his fate by failing to predict that sales would plunge last year and not acting quickly enough to recover, people familiar with the situation say.

In October, 2 weeks after Lehman Brothers' bankruptcy deepened the global credit freeze, a key Toyota lieutenant, executive vice-president Mitsuo Kinoshita, said sales could rise to 9.7 million vehicles this year. But in May the company predicted it would sell just 6.5 million vehicles in the 2009-10 fiscal year.

"If Toyota can't adjust to a market that will be smaller, with less expensive cars, then somebody else will be heralded as the next great automaker," Keller says.

It's up to Akio Toyoda, 53, the first Toyoda in 14 years to run the company, to make sure that prediction doesn't come true. First, he'll have to guide Toyota through unfamiliar times.

"We're facing a once-in-a-century crisis," Akio told a January press conference after his appointment as president, referring to the recession.

In a nod to Toyota's new austerity, Akio spoke in the lobby of the company's Tokyo office instead of at the Palace Hotel or one of the other upscale venues of previous years.

"I'll try to make changes without being tied down by the past," he said, reading carefully from a script. "I will consider measures quickly."

Akio has been huddling in Japan with 11 department heads to discuss ways to slow Toyota's expansion without completely killing it. He's planning to appoint five executive vice-presidents in key regions such as North America. They'll handle product development, manufacturing and sales locally. The heads of these departments currently report to executives in Japan, which slows decision making.

"Toyota has been addicted to US profits these last five years," says John Shook, a University of Michigan management instructor and former Toyota engineer. "They've been slow everywhere else, particularly in China, where the growth is. Hyundai could be the big winner."

The reorganisation is just part of Akio's makeover attempt. On May 18 he unveiled the latest Prius to the Tokyo media. The newest version of the hybrid boosts fuel economy by 8.6 per cent, to 4.7 litres/100km. Akio said he hopes to quadruple hybrid sales to one million annually during the decade that starts next year.

"Our answer to how a car should be in the future is the new Prius," he said.

Then on May 23 he travelled to Germany to drive a 373kW Lexus sports car in a 24-hour endurance race, finishing 87th in the 170-car field.

Two years earlier, in a blog he writes for Toyota's racing unit, Akio said he admired Ulrich Bez, chief executive of Aston Martin Lagonda, maker of James Bond's preferred car. He praised Bez for competing in contests that underlings called too dangerous.

"Because such a CEO leads the company, Aston Martin is able to offer an emotional sports car," he wrote.

Cliff Cummings, who owns two Toyota dealerships in the foothills of the San Gabriel Mountains near San Bernardino, California, says Akio is starting to shake things up inside Toyota. He credits the incoming president with pricing a no-frills Prius at what Cummings considers a reasonable US$21,000, almost US$11,000 less than fully equipped models.

"Akio is taking Toyota back to its fundamental values of dependability and economy," he says.

Akio, who is fluent in English, learned Toyota's ways from the ground up. On October 30 every year he visits the Kosai, Japan, birthplace of his great-grandfather Sakichi, who received the family's first loom patent in 1891. During his freshman year in 1973 at Tokyo's Keio University, Akio spent six weeks at the Punahou School in Honolulu, which US President Barack Obama also attended.

Akio graduated from Keio with a law degree in 1979. Three years later he got a master of business administration from Babson College in Massachusetts.

Akio joined Toyota in 1984. After factory and finance jobs, Shoichiro, then Toyota's president, tapped Akio to make the Japanese sales office more efficient by cutting inventories of unsold vehicles. In 1996 Akio spearheaded a service called G-Book that uses mobile phones and web browsers to provide traffic updates to drivers.

By 2002 Akio was running Toyota's China unit. He headed purchasing in 2005 and moved to global sales in 2008.

Some suppliers and dealers resisted Akio's ascension to president, saying he'll have a hard time breaking from Watanabe.

"I don't think anybody sees Akio as a highly original kind of guy, but he's really earnest," says James Womack, chairman of the Lean Enterprise Institute in Cambridge, Massachusetts, which trains companies on the carmaker's methods for cutting production costs. "He's been in the Toyota system all his life. He doesn't know anything else but to go back to the basics."

Watanabe joined Toyota in 1964. He rose through the purchasing staff with a reputation as a cost cutter. From 2000 to 2005 he achieved 1 trillion ($16.5 billion) in savings by streamlining Toyota's use of 173 components, from headlights to horns to steering wheels. The savings helped pay for Toyota's new plants. By 2005 he was running the company as president.

Watanabe opened the newest factory in Woodstock, Ontario, on December 4. Three weeks later he delivered Toyota's second major profit warning - but even then avoided acknowledging that he'd made a strategic mistake.

"We should have arranged a little bit more kaizen when we were on a growth path," he told reporters. "On the other hand, many customers bought our cars, so it's really a difficult judgment."

Akio's quest to fix Toyota will take him to the scene of one of its biggest setbacks: a former cattle ranch in San Antonio.

Back in 2003 Toyota announced the factory in an effort to undermine Detroit's last great profit bastion: pickup trucks. The Texas plant opened in November 2006, just months before cracks emerged in the US sub-prime mortgage market and petrol prices began their rise. Timing was just one issue.

"There was a lot of non-Toyota thinking," says Shook, the former Toyota engineer. "San Antonio seemed kind of crazy."

Starting with its first US factory in 1988, Toyota built the Camry mid-size sedan and others that had first proved their popularity in Japan, Shook says. It designed each assembly line to accommodate many models. In Texas, Toyota broke these rules by dedicating a whole plant to the largest pickup the company had ever conceived, the Tundra. Toyota wanted to attract new buyers on their home turf, Shook says.

Watanabe authorised US$3 billion for the effort, a person familiar with the situation says. He planned to turn out 250,000 Tundras a year in San Antonio and Princeton, Indiana. Today, Toyota builds 100,000 annually, and only in Texas.

Toyota was challenging Detroit where it was strongest, says Eric Noble, president of research firm Car Lab in Orange, California.

As Toyota was learning the truck-building ropes, Ford redesigned its F-150 pickup. The new regular-cab F-150, with its 1375kg payload and capable of 11.76 litres/100km on the highway with the midsize engine, was an exemplary achievement in the same way that the Prius is Toyota's best, Noble says.

By comparison, the Tundra had a 900kg payload and got 13.8 litres/100km. Even better for Ford, the F-150 won a five-star safety rating from the National Highway Traffic Safety Administration compared with Tundra's four stars.

US carmakers are catching up in quality too. Chevrolet customers reported 113 quality complaints per 100 vehicles last year, compared with 104 for Toyota, according to J. D. Power & Associates, which tracks consumer satisfaction. In 1998 GM had seven times the complaints of Toyota.

On the luxury end, Hyundai is chasing Toyota's Lexus GS with its Genesis, a premium sedan that sells for US$10,000 less. Hyundai also is preparing to bring its top-end Equus to the US.

For the Tundra pickup, the killer was price, says dealer Cummings. Toyota charged US$29,568 for a typical Tundra in 2007 - US$4000 too much, based on what potential buyers told him, Cummings says.

"By charging too much, we forced customers to look elsewhere."

When Honda's retiring CEO Takeo Fukui looks at San Antonio, he says he sees a clear difference between Toyota and Japan's No 2 carmaker.

Honda builds factories in stages, adding the capacity to make 50,000 vehicles at a time, instead of 250,000 at once.

"Toyota makes big investments," says Fukui. "Our idea is to start small and grow. We consider ourselves a small company, and the idea of having extra capacity is very scary."

A foggy day in San Antonio proves Fukui's point about idle space - and shows Toyota's determination to learn from its miscues.

Dozens of Toyota workers, wearing green or orange vests that signify they're on temporary assignment, inspect unfinished trucks. These same workers cleaned parks and enjoyed yoga and pilates on company time when a sales drop forced Toyota to shut the plant for three months starting in August, and then to cut a second shift.

Ray Tanguay, executive vice-president for manufacturing in North America, sees a silver lining in the downtime. The company is using its kaizen process to build vehicles with fewer workers, aiming for more profit when sales pick up.

"We have to go back to our core values," he says. "This might well make us stronger."

Kaizen-sparked improvements are taking root in San Antonio. Production manager Dan Antis says employees studied everything from workplace diversity to how to hold a screwdriver.

When you're chasing volume, you don't have time to teach people," Antis says. "The kaizen we're capable of doing after the shutdown is endless."

Standing near the assembly line's end, team leader William Steubing says he wanted a better way to handle a 9kg plastic box that carries parts alongside unfinished trucks.

Initially, Steubing's team attached the box to metal frames holding the trucks. As the Tundras moved along the line, workers reached into the box for headlights and other parts. When they emptied the box, they'd lift it off the carrier and carry it back for refilling.

During the shutdown, workers designed a conveyor to do that job. Now, as a truck moves forward, the conveyor tilts up a corner of the empty box and snaps it off the carrier. The box falls on to the conveyor and rolls back for refilling. The change saves 11 seconds of walking per truck.

Steubing and his co-workers also got training in welding and metal cutting. Then they recycled old conveyors, spending US$2000 compared with US$90,000 that Toyota engineers had planned for a motorised conveyor.

These and more than 400 kaizen projects are making an impact. Defects that workers reported in an internal audit fell to 0.2 per truck from 1.2, comparable with Toyota's best worldwide. Productivity measured by trucks made per worker per day, not including temporary labourers, rose to 0.91 from 0.73.

Toyota's North American factories need to run at 70 to 75 per cent of capacity to break even, Tanguay says. They were at 60 per cent in March.

He says he's cutting hundreds of millions of dollars per year in costs. Starting in September, the North American factories will break even, he says. "If the market comes back, we're going to be in a very good position."

While money-saving kaizen improvements may help Akio on the factory floor, the recession has made strategic planning harder, says US sales chief Jim Lentz.

In his office in Torrance, California, adjacent to the I-405 freeway and its crush of thousands of cars, Lentz says he can't predict with certainty how many vehicles Americans will buy in coming years. Nor can he tell what kind of cars people will want or which technologies governments will allow.

Lentz takes out a chart based on Toyota's economic and consumer research. It shows that US car sales may rebound from an annualised rate of 9.6 million this year to 17.4 million by 2015. He draws a line showing that, conversely, sales could total 11.5 million in 2015 if the recession lingers. If that happens, Toyota may lay off full-time workers, not just temporaries.

Even with President Obama's push to lift fuel efficiency for new vehicles to a nationwide average of 35.5 mpg (6.6 litres/100km) by 2016, environmental challenges are hard to plan for. California's zero-emission-vehicle mandate means Toyota and other carmakers must build tens of thousands of electric cars, fuel-cell vehicles and plug-in hybrids starting in 2012.

"Product planning is riskier than ever," says Bill Reinert, Toyota's US manager for advanced technology. "You're betting five years out on whether the public will adopt very different forms of transportation."

Amid the upheaval Toyota is making concrete strategic shifts. It's building more compact cars and setting up factories in emerging markets and countries with large reserves of resources like oil, Watanabe told reporters in May.

It doesn't have much choice. Sales at the Lexus luxury unit had generated more than half of US earnings, with 12 per cent of sales, in the middle of the decade. Consumers' lust cooled when the average US price for regular petrol topped US$4 a gallon in July last year. During the first quarter of this year, Toyota's US pickup, minivan and SUV sales plunged 40 per cent. Lexus sales dropped 37 per cent.

The danger is that Toyota's moves toward smaller vehicles may cut earnings in half, even after the recession ends, says Koji Endo, an analyst at Credit Suisse in Tokyo. And nobody is sure how the price of petrol, which has fluctuated by more than US$2 a gallon in the past year, will affect consumer desires.

Even so, Toyota is banking on such cars as the iQ. At the New York Auto Show in April, a lime-green model of the micro-compact descended from the ceiling amid strobe lights and techno music. The iQ fits sideways in a normal parking spot, travels 100km on 3.6 litres and has nine air bags. Toyota sells the iQ in Britain for US$15,000.

Such premium small cars will help maintain profits as fuel prices rise, Lentz says.

Hyundai has already claimed some turf that Toyota is targeting with smaller cars. Along with affiliate Kia, Hyundai sold 4.2 million vehicles last year, more than half of them in emerging markets.

"Toyota faces an identity crisis," Casesa says. "Their spectacularly successful business model is not working, and they are undergoing profound internal change with the new president."

Shoichiro's retirement from Toyota's board last month means Akio may be the next Toyoda to speak to managers in the redbrick Nagoya factory.

By then, investors will have more signs of how quickly and thoroughly Akio has acted on Shoichiro's February warning about the dangers of emulating Detroit.

- BLOOMBERG

SALES STALL

Number of vehicles sold by Toyota worldwide (fiscal years)

2006-07 8.52m
2007-08 8.91m
2008-09 7.57m
2009-10 6.5m?