Special Coverage

Toyota's Safety Crisis

It’s becoming ever more obvious Toyota Motor Corp., the world’s largest vehicle maker, is a victim of self-inflicted wounds, but how deep and disabling they are remains unclear, Tokyo auto analysts say.

The Japanese auto maker’s production and sales halt of millions of its top-selling models in North America, as dictated by the U.S. Department of Transportation, plus two massive recalls totaling more than 7.7 million vehicles in the region and more coming in China and Europe, is rocking Toyota to its foundation.

Adding to the company’s woes, five leading daily rental companies in the U.S. are withdrawing Toyota vehicles from their fleets and stopping sales of used vehicles. Several rival auto makers already are offering special deals to worried Toyota vehicle owners who might want to trade-in their cars, and Washington lawmakers want to question Toyota on how it is addressing the crisis.

Toyota blames the problem on gas-pedal defects that may be causing unintended acceleration, possibly resulting in as many as 275 crashes and 18 fatalities over the last several years, according to some media reports.

But some industry analysts in Japan consider the situation the result of too much ambition, too much global expansion too rapidly and too much cost-cutting.

“When Toyota was expanding in recent years, management may have thought their business model was more robust than it was, and it was stretched in ways that could not accommodate expansion,” concludes Chris Richter, a senior industry analyst with CLSA Asia-Pacific Markets in Tokyo.

The auto maker’s new and untested CEO Akio Toyoda, grandson of the founder, admitted as much when he took the helm last June. “I do not think we were wrong to expand our business to meet the needs of customers around the world, but we may have stretched more than we should,” he is quoted as saying.

The standard industry practice of sharing parts and platforms over a wide range of models has made things worse.

“When an auto maker increases the commonality of parts and platforms across many models, every mistake is amplified,” says Kurt Sanger, a senior industry expert with Deutsche Bank AG in Tokyo. “And if they have to have more local content, integrating new suppliers into their production system is a challenge.”

Says Kota Yuzawa, a senior industry analyst with Goldman Sachs Japan: “Toyota stumbled in North America because of the rapid production increases in 2007 and 2008 and the need to get multiple new local vendors.

“There have been no serious quality-control problems with vehicles made and sold in Japan, where Toyota has (a group of) reliable suppliers,” he points out. “But non-affiliated parts makers pose difficulties for the company.”

Damage control is under way. Toyota reportedly has devised a remedy for cars already on the road that dealers can implement, while its U.S. supplier, CTS Corp. of Elkhart, IN, has begun shipments of pedal replacement parts to the auto maker’s U.S. assembly plants.

A new electronic brake system Toyota plans to install on all of its vehicles will permit brakes to over-ride accelerators if both are depressed at the same time. But eliminating the backlog of replacement units dealers need to install is daunting. More than 2 million vehicles require the upgrade and no estimates have been given on how long this will take.

“Toyota has already taken drastic action, stopping product sales and production, to reassure the public and customers,” Richter says. “The company is doing the right things but has some fences to mend with customers. Toyota brands are built on a bedrock of product quality and enjoy a lot of loyalty, but customer patience is not infinite.”

At the same time, Tokyo analysts stress perspective is needed.

“The recall problem is spread over many (eight) models, so it’s been inflated,” Sanger says. “Toyota will restore quality standards, and the strength of their dealer network will keep them fighting hard for market share.

“The reaction of (General Motors Co.) and Ford (Motor Co.), offering special incentives to lure Toyota customers, is shameless. I wouldn’t think any CEO would be quick to point fingers. With the increase in commonality of parts and platforms, these problems can hit any maker.”

Recalls are not uncommon, and it’s possible to exaggerate their long-term impact on company sales.

“The concern about Toyota’s current problems surprisingly is not that overwhelming for the short term,” Sanger adds.

“The key question is what it does for Toyota’s longer-term market share and pricing power. Can the company continue to charge more for a Toyota because of its quality? This is more important than the $300 million or $400 million cost of a recall.”

At this stage, it’s difficult to measure with any accuracy how much the auto maker’s reputation for quality, reliability and safety has been damaged.

“Toyota’s reputation for quality has almost certainly taken a significant hit from this episode, and the effect on its sales, at least during the current quarter, is likely to be significant,” IHS Global Insight’s Aaron Bragman says.

“Only the numbers will tell,” adds Sanger. “The problem with quality issues is that they are not easily swept under the rug. The reminders keep coming back and reinforcing the message.”

Yuzawa reminds that despite a massive recall in 2008, Toyota gained U.S. market share in 2009, even though the increase was only a modest 0.2% rise to 17%.

But all agree the financial hit will be substantial, without touching on the many lawsuits that may materialize. Sanger estimates $450 million in lost revenues from a 1-week production and sales shutdown.

Koji Endo, managing director-Advanced Research Japan in Tokyo, tells Bloomberg he estimates the production and sales stop, plus the defective accelerator fix, may cost Toyota ¥100 billion ($1.1 billion).

To put this into perspective, Toyota reported an operating loss of ¥445 billion ($4.9 billion) in the fiscal year ending in March 2009, its first loss in 59 years.

The outlook for earnings this fiscal year is not nearly as bad as it could be. Although the auto maker is forecasting an operating loss of ¥350 billion ($3.8 billion), the Tokyo analysts are more upbeat.

“A few of us assumed Toyota would make a small profit this fiscal year, but the recall problems could eliminate this,” says Sanger, who foresees an operating profit of ¥450 billion ($5 billion) in the next fiscal year ending in March 2011.

Yuzawa is more optimistic. “I expect the company will break even this fiscal year,” he says. “At this point, I expect Toyota will earn ¥700 billion ($7.7 billion) operating profit in the next fiscal year.”

Says Richter: “I’m less concerned about the immediate financial consequences of how much the fix or the lost production is going to cost than I am about the impact on the brand image, since damage to that can be with (Toyota) forever.”

The rhetorical question now being asked in Tokyo is whether this damage, once the road dust settles, will prove to be a temporary black eye for Toyota or a more permanent injury.

At an annual industry conference in Traverse City, MI, last summer, President Akio Toyoda told attendees: “The severe drop in the economy and auto market has created some of the most challenging times Toyota has ever faced. I aim to take us back to what made Toyota successful for many years – making high-quality products at an affordable price.”

But that was then and times appear to be even tougher for Toyota today. The betting in Japan is although the world’s largest auto maker may be down, it most certainly should not be counted out.