Japanese play the risky game of removing content
Soaring yen puts pressure on profits
LOS ANGELES -- With the yen at a record high against the dollar, Japanese carmakers are finding new ways to squeeze profits from vehicles they export to the United States.
Consider Lexus' redesigned GS 350, which arrives in the United States in February. To cut costs, Lexus is using asphalt spray instead of laminate sheeting on the underbody for noise suppression and recycled plastic instead of virgin for the protective cover beneath the engine.
It is carrying over the old six-speed transmission instead of matching the seven- or eight-speed transmissions that competitors offer, and is no longer offering a V-8 engine option.
Endaka -- surging yen -- is back, and so is the risky game of removing content from vehicles. With the Japanese yen surging to just 75 to the dollar, the old "build 'em where you sell 'em" philosophy no longer is enough.
To avoid price increases, as they hustle to increase North American plant capacity, Japanese automakers are using lesser-quality materials or removing features that once were deemed essential.
They're rethinking which features should be standard and which should be optional. And they're withholding some new technologies and deleting some products altogether.
The risk: Will shoppers and owners feel they're getting less for their money?
The past year has seen a particularly painful currency swing for Japanese automakers, who already were wringing their hands in August 2010 when the yen hit 85 to the dollar. But they still held out hope that it would return to a more comfortable level of around 100.
Today, at 76 yen to the dollar, Japan's automakers are making hard decisions about expanding production abroad, cutting back exports from Japan and reviewing how to price and equip their vehicles. Executives say that is preferable to raising sticker prices.
John Mendel, American Honda's U.S. sales chief, describes the current situation as "squeezing costs from a rock."
Yoshihiko Kanamori, chief engineer for the GS 350, says he scrambled to hit "cost-down" targets, while adding safety and telematics features and upgrading many visible features.
"We also had to select some specifications that should not be visible from the customer's point of view," Kanamori said through a translator. "The current-generation GS hybrid and V-8 have variable gear ratio steering, but for the new-generation, only the F-Sport model has it. The rest have the basic steering package."
Because the GS 350 is built in Japan, largely with Japanese components, the strong yen is a huge burden. So Kanamori knew it would be difficult for any GS 350 sold in the United States to generate profit.
Did the cost-down targets mean he couldn't engineer the car he wanted?
"There were no items omitted that I would like to have, but with this exchange rate we will have to raise the price," Kanamori said.
Engineer Yoshihiko Kanamori: Scrambling to hit “cost-down” targets
'Almost the same'
Regarding the asphalt-spray technique, he said: "The cost is lower, but the performance is almost the same."
To Lexus engineers who want their vehicles to outdistance the luxury competition, "almost the same" is virtually an admission of defeat. But compromises have to be made.
Toyota reported an operating loss of about $425 million for the April-September fiscal first half. The March earthquake was a factor, but exchange rates accounted for a $1.7 billion swing in the wrong direction. Satoshi Ozawa, an executive vice president, warned that Toyota's domestic operations were on pace to break even next year -- but only if the dollar rises to ¥85.
Mendel says "de-contenting is not an option," but adds that some "wow" features won't be included in a Honda if they have no concrete customer benefit.
"Look at these ballyhooed self-parking systems," he says. "It's very cool technology, but it's probably not the best use of $2,000 worth of technology on a Civic or Pilot, especially since it's useless in many states because you don't parallel park.
"Instead, we look at technology like iPod connectivity, Pandora and Bluetooth," Mendel says. "We didn't do it because it's nice to talk about. We did it because that's what customers are asking for and it's relevant technology. We asked the question when the yen was at 115, and we're asking it again at 77."
The profit pinch
In November 2010, every dollar earned by a Japanese automaker in the United States returned about ¥83 in revenue. This year a dollar equaled about ¥75.
A Japan-made Toyota Prius III, one step up from the base model, carries a sticker price of $24,520 and an invoice price of $22,825. Toyota doesn't disclose the wholesale price that the Japanese parent receives for the car, but $21,000 is a reasonable guess.
Last year, using that assumption, the parent company booked ¥1,743,000 from that sale. This year just ¥1,575,000. In dollar terms, that's a $2,240 cut in revenue. Meanwhile, the cost to build a car in Japan has not gone down.
Endaka, the sequel
This isn't the first time Japan's automakers have grappled with a surging currency, or endaka.
In the mid-1990s the yen soared from 110 to the dollar to 84 in 14 months. Japanese automakers rushed to increase local production and cut costs in ways they hoped customers wouldn't notice, such as not painting gas tanks. And, for the first time, they began removing features from cars.
As the yen slowly returned to more manageable levels, many of those practices were kept in place, and profitability soared. But most of the cost-cutting methods adopted back then have become ingrained -- such as increasing local production. In fact, as the yen has strengthened, some Japanese automakers have even seen their local-build percentages fall.
Of course there are ways a strong yen can help automakers. Raw materials are cheaper to import to Japan. And although the yen is at all-time highs, it is not as painful in real terms as in the 1990s endaka because of deflation in Japan over the past decade. Thus, labor and other fixed costs aren't as high.
But exports must be profitable for a company like Mazda that assembles in Japan more than 80 percent of the vehicles it sells in the United States. And Mazda knows from experience that removing contenting is the kiss of death.
During the 1990s endaka, Mazda product planners compared options and features from the 626 sedan against competitors such as the Honda Accord, Toyota Camry and Mitsubishi Galant. If one competitor didn't have a feature, that feature got the ax on the 626.
"Everything left -- vanity mirrors, cigarette lighters, sunglass holders," said Robert Davis, Mazda's executive vice president of U.S. operations. "We tried the de-contenting route, and the reaction from our customers was very negative."
The Camry case
The redesigned Toyota Camry that debuted in 1997 had far less content than the previous model, reflecting pressure to slash costs. The preceding Camry was so rich in content that some Toyota executives considered it too good for its price point.
But the reduced content didn't hurt sales. The Camry rang up four consecutive years as America's best-selling car. But with the redesigned 2002 Camry, the pendulum had swung back to a bigger car with more content.
No large-scale axing is going on at Mazda these days. Still, some content has had to be chopped to save money. Davis insists it is "behind the scenes."
For example Mazda has stopped installing rubber mats on top of vehicle floor carpeting at the factory.
Another strategy is making optional features standard, then raising the vehicle's price.
Davis said: "A piece of equipment that was optional and becomes standard -- and you can raise the price equal to the value [in the customer's eyes] -- that's generally more profitable than the cost."
For example, the 2012 CX-5 with automatic transmission will have standard aluminum wheels because the perceived customer value is very strong.
"Compared to the steel wheel on a base model, you're able to enhance the brand, help residual values, and it ends up allowing you to get a little revenue and pricing power," said Jim O'Sullivan, CEO of Mazda North American Operations.
"If you can get $100 in revenue for a part that costs $10, that's an easy decision," O'Sullivan said.
Jim O’Sullivan: Revenue and pricing power
Midcycle is tough
Product planners say it makes little sense to switch components in midcycle, and virtually impossible to change materials such as seat covers once a model is on the market.
Making changes while a product is in development is much easier. A Mazda r&d executive said that some active-safety advancements had to be held back from next-generation products because the return on investment is much lower than it is for, say, a 40-mpg engine. Once the safety feature is a market standard offered by bigger players, the costs come down and Mazda can afford to install it.
If all these tactics to cut costs aren't enough to offset the strong yen, does it mean some Japanese automakers are "dumping" cars -- selling them here at a loss just to maintain volume? Executives deny that, but also admit that most of their imported product lines were meant to be profitable at a much lower yen-dollar ratio.
"The yen is the biggest challenge we face," says Mark Templin Lexus Division general manager. "But we have to price against the heart of the market. We don't expect the yen to stay at 76. We're seeing smaller margins than we're used to -- or no margins. But we'll stop producing cars if we're going to lose money on every car."
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