Drastic change: future of the Japanese automobile industry
The key to survival is building new business models

January 14, 2009 Eiji Kawahara

An unprecedented sense of crisis is now growing among the automobile industry of the world. In the second half of 2008 alone, leading Japanese manufacturers have lost the whole three-years’ worth of profit increase(i.e. 1.25 trillion yen achieved by Toyota Motor Corporation and Honda Motor Co., Ltd. alone)due to the recent changes in both volume and lineup of sales.

Foreign exchange rate fluctuations also contributed to the significant drop in profits. (Toyota and Honda enjoyed 900 billion yen profit increase in the past three years due to the favorable effect of foreign exchange, but the same factor caused 1.25 trillion yen decrease in profits for the two companies in the fiscal year 2008 alone.) On the other hand, during this growth period, fixed cost continued to swell until ballooning out of proportion to the shrinking sales amount. (Fixed cost was the factor that increased the expenses of Toyota and Honda by 1.1 trillion yen in three years.)

As you can see, the automobile industry is in a state of great shock that would turn conventional wisdom upside down and hamper people's steady efforts based on that. To recover from this shock and resume evolution during the period of transition for the next development, the auto industry should take on a big challenge which it has never experienced before, to solve short- and long-term issues.

Optimization is required in the field of production, development and sales

For a while, it is necessary to make optimization of the swollen system the first priority to escape from the present critical situation and to secure profits and cash flow. Reviews would be necessary not only for the system of production where downsizing is already in process, but also for those of sales, development and back-office sections. At the same time, it is important to secure flexibility for the future growth opportunity in each field.

In the production field, in addition to the downsizing of the whole production capacity, the various methods which have so far undergone improvements in the field site should be evolved into approaches a few steps ahead.

Examples of the above-mentioned approaches are as follows: introduction of FMS (Flexible Manufacturing System) and the flexible treatment devices of body line (e.g. “GBL: Global Body Line” of Toyota)corresponding to that, the system that reduces complexity and space of Multi-Model Production in the assembly line (e.g. “SPS: Set Parts Supply” of Toyota), and the module method to outsource each special process. In such case, a top-down reform of the production system from scratch might be necessary for an effective way of innovation.

As for the development field, it is necessary to try to evolve further the innovation that was achieved during the 1990s, which has created outputs effectively by developing a mass production platform to support flexible model developments.

Specifically, selection and focus should be implemented over the resource, theme and process of development, and we should consider the way to optimize them (e.g. mixture of self-manufacturing and outsourcing). Thus, it would be possible to assign resources for offering the products that really meet the needs of the market, while reducing costs.

For sales as well, it is getting more and more necessary to reform the old sales system that was built according to the concept of “Distribution (supplying products for all those who need them),” and that is only effective in a period of growth when supply is unable to satisfy demand.

Considering that, through this recession period, consumers’ sense of value toward cars would change and the character of products themselves would change in developed countries, it might be necessary to reconsider the original meaning of the distribution channel mix i.e. what kind of sales model and sales system could respond to consumers’ sense of value effectively, with the lowest cost, in each area.

Shifting from enhancement of production capacity to the next generation technology in progress

Priority areas for investment vary according to the times. During the 1990s after the collapse of the bubble economy in Japan, as “simultaneous recession in the three regions: Japan, U.S.A., Europe” was under way, each manufacturer’s production was growing at a sluggish pace. Improvement of efficiency and cost reduction were significant tasks for the management.

One of the big strategic areas for investment in this period was the development of a “platform of flexible mass production.” It was the incessant investment of low-cost products with high quality based on this platform that supported the high growth in the 2000s.

During the next stable period of growth, the number of cars Japanese manufacturers’ produced worldwide drastically increased; the leading three companies alone produced ten million in 2000, then as many as 16 million in 2007. The driving force of the market in this time was the overseas markets; plants were built one after another overseas. Thus, it can be said that the priority area for investment in this time was “enhancement of production capacity.”

Considering the period after the current transition, heavy investment for the “next generation technologies” that will support future growth seems to be essential. According to this idea, merely developing many kinds of products and producing many cars is insufficient. The development investment competition for the technologies (e.g. rechargeable battery) with a wide range of potential applications, which are to be the core of the next motorized society, would spur the real evolution of the future car.

The purpose of the flexible platform is to achieve economy of scale through in-house standardization and commoditizing. On the other hand, the next generation technologies have potential to win dominant status across the boundaries of company and industry, as the technologies to support mobility.

Drastic change expected from consumers’ sense of value

Through the transition period, consumers’ sense of value may change. Auto manufacturers should anticipate this change and supply appropriate products. If ideas for realizing such products cannot be generated through the conventional way of thinking of the existing auto manufacturers, start-up manufacturers and other industries can be acceptable as advisers, especially for the ideas involving innovation of technology.

An example of the above-mentioned consumers’ new sense of value may be the ultra low-price car “Nano,” which will be released this year by the Indian manufacturer Tata Motors Limited. Specialized in basic car performance, and at extraordinarily low prices: about 2,500 dollars for the basic model, the market response to this product (to be unveiled in 2009) will be very interesting.

If, triggered by a product like this which is much safer than bikes, the value of “simple” cars becomes recognized widely, Nano might lead to creation of new markets and give great impact to the existing markets, just like “NetBooks” that are rapidly growing in the PC industry with prices as low as fifty thousand yen, or “PNDs (Portable Navigation Devices)” of the car navigation system industry.

It may be necessary for some product segments to move away from excessive quality. Reconsideration of the quality of global specifications would be needed as well.

It is also certain even for electric cars that are regarded as the representative of the next generation technology, that the various specs that have delineated conventional car performance will lose their meanings and that the features that consumers are particular about will change. Many people still remember that similar phenomena occurred when digital cameras first appeared and while the process of digitalization of home electrical appliances was in process, resulting in great change in the structure of competition.

Thus, as consumers’ sense of value changes, marketing approaches should be reviewed as well. In concurrence with the change of values expected from products, the value placed on communication channels would change. With further penetration of network media, new communication points for text, pictures/figures, and videos would appear and demonstrate their advantages such as interactivity, immediacy and community-oriented nature.

Furthermore, due to the change of commodity characteristics, the set of values auto manufacturers can provide to consumers may change. Products in certain segments would gradually lose their advantages as hardware, while their brand value as a symbol including messages such as design, etc., would be enhanced. Then, the need for the “investment for brands” that would go beyond the present form would increase.

The whole auto industry may undergo a seismic change, just as the electronics industry once did

In the auto industry that is facing a big turning point, business models may be changed on a large scale. Currently, most players in the business system such as auto manufacturers, parts manufacturers and dealers can hardly make profits continually.

To achieve long-term development of an industry, efficiency should be improved based on the business models and yield profits to repeat investments for growth. Developing business models to maintain growth is essential for the current period of transition.

As for other industries, we find the example of Dell Inc., which created business models for the personal computer industry. The company started selling low priced products over the Internet in 1996. By using many general-purpose parts with high cost performance according to economy of scale, Dell succeeded in keeping the prices of its products low.

The company realized low cost distribution and marketing as well by introducing the build to order system (i.e. without keeping its products in stock) and non-store selling, resulting in increasing its market share with prices 20% lower than those of its competitors’ products with the same specifications. (During the five years between 1996 and 2001, Dell’s share of the international market rapidly expanded from 4% to 18%.) In addition, the company secured its profits by adopting the system in which the standard of the prices of low-end models (with basic specs) is half of that of competitors, while the prices go up depending on the highly-flexible options which are selected and added by consumers.

Now, we can find various ongoing changes and evolutions in other industries. Although few of them can be directly applied to the auto industry, it might be possible to introduce some of them as elements. As I mentioned in “Challenge to the Optimal System,” it would be natural if, in the process of optimizing self-manufacture and outsourcing, many companies started to try systems such as fabless production, in which certain products are manufactured in the facilities of other companies.

Open architecture will be promoted due to modularization, etc.

Together with changes of consumers’ sense of value and business models, the product architecture of the automobile, which has been changing slowly while keeping its core untouched, may change as well.

As the change of automobiles is “electronics-oriented,” and considering the trend of the electronics industry, it is likely that “open-architecture” will be promoted in the field of car manufacturing.

With this structure, by assembling modules with standardized interface, variation of products is achieved and the standardized parts to be assembled realize a high cost performance due to economy of scale, allowing the manufacturer to secure an overwhelmingly strong position and profits in the market.

Of course, in the case of automobiles, since an integrated design is required for the elements that physically implement the basic performance: “Run, Turn, Stop,” the possibility of a major change is not high. However, if something like a standard chassis were developed, the open architecture would be applied even for the above-mentioned elements, in relation with the body to be assembled with the standard chassis.

In conventional car design, monocoque construction has been applied for the purpose of weight saving. As a result, integrity has been essential for the car assembly process. However, in the case of the chassis with complex electrification, even that assumption may be undermined.

One characteristic of the car industry is that what is already obsolete in other industries is still surviving as the norm. For example, in this industry, most resin parts are more expensive than metal parts for the reason of safety and heat tolerance. Besides, digital parts are more expensive than analog parts for the same reason.

However, in many other industries, these cost relations have already traded places. With the change of product architecture, the rate of the parts with a trend similar to other industries might increase.

In other industries, there are many examples showing that although some products share similar article characteristics and values for consumers, their costs are quite different. The difference between quartz clocks and analog clocks is one of those examples. Another example is electric scooters. While the prices of products manufactured and sold in Japan range from several hundred thousand yen to nearly a million yen, the prices of the Chinese-version products, more than ten million of which have been manufactured so far, are several ten thousand yen.

Although their performances are not the same, the disparity between the basic characteristics of the two nations’ products is not significant. The number of made-in-China electric scooters which were produced in five years between 2001 and 2006 rapidly expanded from about 0.5 million to 12 million. When such a product trend occurs, it might be necessary to reexamine fundamentally where we can find the source of additional value for consumers, from a viewpoint other than the existing one. Low-cost design at the development stage should be implemented with a new approach beyond the existing level.

Industrial strategy to avoid being exploited is needed

In such a large turning point, the auto industry, as one of the key industries of Japan, would be forced to change its whole strategy.

Although it is important to reduce costs and review the existing system to secure near-term earnings, it is in a time of recession like the current one that investments toward future growth are really required. Whether or not you can survive depends on how carefully you can build a scenario for the future and, based on that, how effectively you can invest in the priority areas.

If only a limited effect is possible from the efforts of individual companies, governmental aid for strategic investment by the whole auto industry might be necessary to maintain and develop Japan’s competitive power in the international market.

Especially, assuming that the world is moving into the trend of electric cars, however much Japanese manufacturers may have the advantage of basic technology currently, there is no telling that, once a conversion of business models including infrastructure occurs, they could secure their positions to make profit forever.

This is easily comprehensible by assuming a structure similar to the cell-phone industry, where the manufacturers that continuously develop and produce handsets and bring them to the market can hardly make profits, while companies like Qualcomm Incorporated, as both a carrier and a developer of system software, can continue to make stable profits.

In addition, in the automobile industry we might see the same structure found in the PC industry, where Intel Corporation makes profits while PC manufacturers are in a predicament. If the above-mentioned keys to profits were taken over by other countries while Japan is still keeping conventional industries, Japanese industries might fall into a position of being exploited as a mere “producer.”

You should prepare from now on so that, when the growth period provided by new technologies arrives through the current recession, you can secure a position in the industry that can add the most important value for consumers.

Moreover, I hope the Japanese automobile industry will contribute to the worldwide innovation as a renewed industry from Japan, with the leadership offered through intra-industry cooperation or international cooperation including emerging markets, instead of merely involving the cross-industry strategy inside Japan. I also would like to make my humble contributions for that.