Toyota wants big price cuts: Won’t get them

by SR on September 17, 2012

Denso (6902) operating profit margin by quarter (%)

The pressure is on

On 14 September the Chubu Keizai (‘Chukei’) economic daily newspaper – which is based in Aichi prefecture and has excellent local contacts with the Toyota group – ran a story saying that Toyota will ask its parts suppliers for a 3% cut in prices for the October 2012 to March 2012 period. That’s a 3% cut compared to the first half, so pretty substantial. The article notes that the stronger yen is making life difficult for Toyota and that the company wants its parts suppliers for help. But, as the Chukei comments, the parts companies are pointing out that they too are suffering from the stronger yen and that “negotiations will not be plain sailing”.

  1. We had the same story 6 months ago. As the Chukei itself says, this is the third 6-month period in which Toyota has asked for steep price cuts. Indeed, there was an almost identical article in the Chukei on 17 March 2012. The size of the purported price cut (3%) and the conclusion (difficult to implement) were exactly the same. And the story belongs to a 10-year long tradition of “oh no, Toyota is crushing its suppliers!” articles. I remember a particularly melodramatic story on Bloomberg in February 2005 that cleverly avoided any specific predictions but talked about the “China price” and implied that Toyota would use Chinese competition to extract concessions from its Japanese suppliers. The reality was that Toyota’s parts suppliers had three great years during 2005-2008 and that Chinese auto parts companies are still marginal suppliers at best, even in China.
  2. Yet auto parts companies are enjoying high margins. And yet for the past several quarters the auto parts suppliers have seen rising profitability. The chart at the top of the page shows the quarterly operating margin of Denso, just to make this point. If it were not for the strong yen, margins would have hit a record in the past two quarters. Aisin Seiki has an even more impressive chart. In this post I reviewed the April-June quarter results for 40-plus Japanese auto parts companies and it clearly showed that the Toyota parts companies are doing well and the Honda suppliers not so well. So if these price cuts are real, why aren’t Toyota supplier margins lower?
  3. That’s because the headline figure is misleading. The answer is that price cuts of the level suggested in the article are not real. The actual price cut is no doubt substantially smaller, probably in the region of 2% annualised. That’s high in a historical context and does represent a concession from the parts suppliers. Nevertheless, it’s nothing like the annualised 5-6% figure implied by the Chukei article. I suspect that these price cut negotiations are part of Toyota’s public relations campaign to get the Japanese authorities to try harder on behalf of Japanese industry in the form of working towards a weaker yen.
  4. It’s true that not all suppliers get the same treatment. A company like Denso is a very different proposition to some little metal-basher that has two factories employing 50 people in Aichi prefecture. Denso and other tier-1 suppliers – those that supply largely assembled sub-systems and components directly to Toyota – add value through design and innovation. A tier-3 supplier than bends metal strips into a predetermined shape for a tier-2 company has no say in the system design and adds little value. Dozens of companies can perform such work. However, even within the same company there is much variation. Products such as alternators are relatively low-value add and so Denso will have to compromise more on the price of such a product than, for example, an engine control unit or a millimetre-wave radar system.
  5. Toyota planning 10 million units in 2014. It’s a common misconception that Toyota only has to click its fingers to get immediate concessions from its supply chain. The reality is far more nuanced – if it were not the case, Toyota’s margins would be far higher and the margins of the auto parts suppliers would be far lower. Toyota is making a big push for product and will probably start running into capacity issues outside Japan in 2013; another Chukei article suggests that Toyota plans to hit 10 million units of production in 2014 compared to 8.87 million in 2012, and that figures excludes Hino and Daihatsu.
  6. Motivated suppliers needed for success.. At such a time, Toyota would be foolish to discourage its suppliers from giving Toyota their full attention. Low margins and harsh terms of business are not motivating. Sure, suppliers can’t ignore Toyota, but the level of commitment they offer can and does vary. For example, Denso will admit that it doesn’t compete aggressively for low-margin electrical parts business at Toyota because, well, it’s not very profitable. This is a reasonable, rational and indeed normal approach, even in Japan. Nobody likes to not make money, right? So while Toyota will persuade, cajole, lean on and even gently bully some of its suppliers, it has to keep one eye on planned expansions in China, Brazil and India. Even Toyota can’t succeed without support from its parts guys. And Toyota understands that better than most business journalists and sell-side auto analysts.

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