Are U.S. Auto Exports the Growth Industry of the 1990s?
The United States has become the most desirable location in the world to build cars. Despite the revival of the Big Three, new entries continually appear, with two European makers, BMW and Mercedes-Benz, setting up plants in the United States. At the same time, cracks are apparent in the vaunted Japanese manufacturing system. Exports to Japan are growing, albeit from a small base, and imports from Japan continue to plummet, having fallen in volume terms every year since 1986.1 Chrysler and Honda produce right-hand steering vehicles in the United States for export; Ford, Saturn, and Toyota have announced plans to do the same. Among parts producers, eighty American parts firms have representation in Japan, and there are more than two hundred U.S.-based, Japanese-run plants that are also potential exporters. Driving this reversal are two fundamental shifts in our relative competitiveness: a reformation of American manufacturing management and the tripling of Japanese labor costs in U.S. dollar terms. These changes, of course, extend beyond the U.S auto industry into many sectors of manufacturing and affect our position relative to the European Community (EC) as well.
Evidence of Reversal
In 1981, Japanese automakers raised car prices in the United States by as much as 25 percent. The Big Three responded by raising prices too. Market shares shifted rapidly, as imports made inroads on the Big Three. The Japanese earned high profits; indeed, Toyota earned the moniker “Toyota Bank” from the horde of cash it accumulated. The Big Three automakers were at best able to stem their hemorrhage of red ink.
In 1992 and 1993, Japanese car companies again raised prices in the United States, with increases averaging 12 percent to 13 percent. The Big Three followed suit but with hikes only half as large. Market shares again shifted rapidly. This time around, however, the Japanese are trying to staunch the flow of red ink, while the Big Three — particularly Chrysler — are pulling in profits. Likewise, American producers are eating into Japanese market share, which dropped from 36.1 percent of the car market in 1991 to 32.3 percent in the first half of 1993.
Why the change? One reason is that this time it is Japan that is in the grips of a steep recession, rather than the United States. Sales within Japan began falling in 1991 and were still declining in June 1993. Recovery is likely to be slow. The external environment is also hostile; the EC has negotiated quotas based on market share, while the Big Three are still pushing antidumping and tariff cases. But the real problem is much more fundamental: the Japanese industry is critically dependent on exports, and Japan has lost its competitiveness (at least with respect to North America). In 1981, Japanese firms had a lower cost base and were better managed than the Big Three. Now these two gaps have been either closed or reversed.
U.S. Management Reformation
The 1980s saw the start of a management reformation in U.S. manufacturing, as competitive pressure from Japan forced firms to consider new ways to run their businesses. This was particularly apparent in the auto industry. In Japan, the market has long been competitive; there were as many as twelve passenger car producers in the early 1960s, of which eight survive today. Furthermore, these firms began as poor-quality, high-cost producers — in the mid-1950s, even 40 percent tariffs were insufficient to stem imports. These problems focused attention on the factory. In contrast, in the United States during the early postwar years, the market was dominated by a single firm, General Motors (GM). That has now changed. Following the 1973 oil crisis, imports from Japan and Europe captured a sizable share of the market, although they have now fallen from a peak of 27 percent of the car and light truck market to 16 percent in the first half of 1993. Meanwhile, new entrants, primarily Japanese “transplants,” have moved into domestic production; they now account for 19 percent of output in the United States and Canada. In 1992, Honda produced 563,000 cars in the United States and Canada, almost surpassing Chrysler’s 573,000 units.2 In 1973, the North American market was dominated by the Big Three and AMC, with imports holding a small share. Now there are fifteen producers, with two German companies set to enter, while imports account for a sizable share of the market. From a tight oligopoly, the North American market has become the most competitive in the world.3
Part of the turnaround is due to the presence of new producers, but competition has also engendered change at the Big Three. They have now closed the gap in car quality, while Ford is an exemplar of productivity and Chrysler sets the world standard for new model design and engineering. (GM still lags severely in productivity, hampered by low capacity utilization.) In addition, there has been tremendous change in the U.S. parts sector. More than two hundred plants are now run by Japanese firms, either on their own or through joint ventures, and, what is less well known, an almost equal number are now run by European producers. Existing parts producers are being forced to improve or exit. The management gap is thus closing throughout the whole industry.
The other gap concerns costs. In the 1970s, Japan was slightly behind the U.S. auto industry in productivity, but its labor costs were far lower, resulting in a large net cost advantage.4 Since 1985 alone, however, between wage hikes and the appreciation of the yen, labor costs in Japan have virtually tripled in dollar terms, whereas productivity growth has stagnated or even declined. Meanwhile, inflation has been checked in the United States, with labor costs up only 25 percent since 1985. Furthermore, in contrast to Japan, case studies of individual firms suggest that large productivity gains will be realized as the U.S. recession ends and capacity utilization improves. The bottom line is that Japanese labor costs for the auto industry as a whole were half those of the United States in 1985; I estimate that, at ¥108 per dollar, they will be 20 percent higher in 1993.5
The Japanese have faced challenges before — the yen appreciation of 1971, the oil crises of 1973 and 1979, the yen appreciation of 1985 to 1986 — and each time they bounced back stronger than before. Productivity increased rapidly after earlier shocks, when, for example, just-in-time (JIT) systems spread upstream to parts suppliers in the mid-1970s. However, this time there is no rabbit to be pulled out of the hat. The industry in Japan is saddled with excess capacity, car dealerships that on average are losing money, and a proliferation of models and options that have at least temporarily added weight to a formerly lean production system. Recovery is likely to await the end of the decade, and a realistic scenario is actually one of steady decline.
The most fundamental problem in the Japanese industry is an undue reliance on exports. For the industry as a whole, over 40 percent of output is exported, and one in ten of the vehicles made in Japan is destined for North America. At certain firms, exports account for over 60 percent of sales. But car exports to the United States have fallen from 2.6 million units in 1986 to 1.4 million units in 1992. During this time, the Japanese moved up market. Previously, their primary export was subcompacts, but exports in 1992 included 257,000 luxury cars. During much of this period, revenues in dollars thus continued to grow, but now even that has reversed, while the fall of the dollar means that yen revenues are down sharply. With the renewed competitiveness of U.S. production, Japanese attempts to raise prices in the United States have resulted in sharp sales declines. If the yen continues to remain at the ¥108 level or stronger, then the Japanese industry will be faced with 10 percent excess capacity almost overnight — although in the short run, rapidly growing markets in Asia, the Middle East, and Latin America will soak up some of the excess.
These problems have been accentuated by two changes. During the “bubble” economy, domestic sales exploded, and the auto companies sought to match near-insatiable demand with a car for every taste. Models and options proliferated, up to eighty steering wheel varieties for one car. The “platform team” approach to vehicle development facilitates integration among vehicle subsystems and helps to maintain the cohesiveness of the design concept in the final product. But it also severely limits coordination of engineering across products. Indeed, the independence of development teams means that engineers are in effect encouraged to engage in their penchant for designing unique parts and engineering solutions, rather than to aim for commonality.
Runaway innovation proved to be antithetical to lean production. The burgeoning of options and parts increased development costs and added to tooling expenses. But it also magnified the difficulties of suppliers trying to produce under JIT systems.6 Few options were ordered in large amounts, so parts makers had to cope with an extreme number of setup changes. This made it impossible, on average, for them to raise productivity fast enough to offset the rapid increase of labor costs stemming from the booming economy. Indeed, their labor costs were increasing faster than those of the automotive assemblers. In addition, the expansion in automotive consumption added more vehicles to already clogged roads. Particularly for Nissan and other firms based in the Tokyo-Yokohama region, this meant a sharp rise in transport costs, as fewer trips per day translated into more trucks and more drivers carting parts. The combined effect is that the share of parts and materials purchases increased each of the last eleven years, eroding profit margins despite the boom in sales.
This labor shortage, which peaked in late 1991, hit manufacturers of all types. It was viewed at the time as a side effect of the “bubble” economy. In fact, however, all the boom did was accentuate the impact of a slowdown in the growth of the labor force, as the sharp drop in birth rates following World War II made its influence felt. Combined with a shift in social attitudes — factory work is now looked down on — this brought a qualitative change in the industrial workforce as well. Many firms relied on immigrant labor. At large plants, it was not unusual to find signs duplicated in Portuguese for the benefit of the Japanese-Brazilians who were granted visas in order to fill vacancies. Smaller plants utilized illegal workers. Despite Americans’ perception that Japan has a stable labor force, the Japanese auto industry has always relied on seasonal and temporary workers. But this reliance reached new levels in 1991, limiting managers’ ability to motivate workers and maintain the training levels that support the complicated production mix and quality control methods of lean production.
The automotive assemblers have eliminated seasonal and temporary workers, and presumably many of the guest workers from overseas have now returned home. However, depending on the depth of the industry’s current adjustments, these problems may arise again in a few years. But in the interim, the required adjustments are very large. First, over 40 percent of capacity in recent years has been devoted to exports. At current exchange rates, exporting to the United States is not profitable, except in high-margin niches. Yet the U.S. market still accounts for one in ten cars produced in Japan. The competitive advantage is less severe vis-à-vis the EC, which is the largest vehicle market, but the Japanese industry faces explicit trade barriers there.
Second, the erosion of export markets comes on top of a dramatic expansion of capacity. In the past year, three new assembly plants have opened in the Northern Kyushu area, which, along with new plants elsewhere, add about one million units in new capacity. Parallel additions took place in parts production, with 128 parts firms locating facilities in Kyushu in 1990 and 1991 alone. Another forty-odd firms opened plants in the depressed Northeast (Tohoku) region. Extrapolating this rate to other regions, the net effect is that, during the boom years, 360 parts firms made significant increases to their capacity within Japan. Some of this activity reflects a long-standing trend to move to outlying regions — Nissan’s largest production base is now in Kyushu —but much was due to the combined effect of a boom and low interest rates. This lured firms, large and small, to expand at an unwarranted rate — and with engineers in charge, many plants will prove to have excessive levels of hard-to-operate automation.7
Two factors are saving the industry from what might otherwise be disaster. One is that, in the aggregate, exports continue to do well. The past five years saw an astounding growth of automotive demand in Asian and, to a lesser extent, Latin American markets. Already vehicle consumption in Southeast Asia (including Australia and New Zealand) is over 1.2 million units, and production exceeds 900,000 units. China, Hong Kong, and Taiwan account for another 1.6 million units of demand and 1.3 million units of production. The Japanese exported over 600,000 vehicles last year to Asia, which they dominate, helping the industry to maintain production volume. Even the vehicles made in other Asian countries contribute to the Japanese industry, as most of them rely on imported parts. But neither of these are as profitable as were exports to North America. Ultimately, Japanese production must decline as producers in Thailand and other Asian countries increase the range of activities they undertake. Furthermore, other foreign producers — notably those based in North America —are unlikely to remain oblivious to the growing Asian markets, and Japan’s weakened competitive position should enable them to garner a share of the region’s imports. But that shift is still several years away.
The second mitigating factor is the trend toward a shorter workweek. Cutting actual time worked from 2,300 hours per year to 1,900 hours is the equivalent of a 17 percent reduction in output, or two million units a year. (This, however, will exacerbate cost pressures.) Additionally, many plants built in the early 1960s are small and inconveniently located. The drop in sales will let firms shutter some of these older facilities and shift workers to other plants. Already Nissan has announced the closing of it Zama plant, after reaching agreement with its union that all workers who do not accept early retirement will be transferred. Other plants in the industry have eliminated shifts.
Of course, the sales decline at home and abroad is not uniform among companies or among different plants of the same company. Some will be able to scrap facilities or reduce hours smoothly; others will fail. Isuzu has already withdrawn from passenger car production, while Daihatsu has ceased exports to North America. Others face mounting losses. Likewise there is turmoil among parts producers and an opening in the barrier between the Nissan and Toyota supplier keiretsu.8 And for workers in those firms that do not successfully adjust, the location of most Japanese auto production in regions with a diversified economic base will ease their transition into new jobs.
Opportunities for U.S. Firms
The natural reaction for many U.S. firms is to gloat over the problems in Japan. They should, however, realize that this represents in part a fundamental shift in American competitiveness. Companies face new opportunities at home and abroad. Over the next several years, the auto industry is poised to become a major exporter, although automotive imports will continue at levels higher than in the 1950s and 1960s. Where is the greatest potential for change, and what will be required to meet it?
For automotive assemblers, many firms in the United States, Japan, and Europe face a mismatch between their production strengths and their distribution networks. Given the weakness of the dollar, virtually any plant that can produce at full capacity in the United States is cost competitive. However, product tastes differ among markets. In the early 1990s, the Honda Accord, for example, was successful in the United States but never sold well in Japan. Minimally, U.S. manufacturers need to ask what export markets want and explore how best to adapt current vehicles for overseas markets or even whether to develop new vehicles. The increase in production of right-hand drive vehicles is an encouraging sign that automakers are becoming more sensitive to these needs.
Furthermore, only some firms have overseas distribution networks in critical foreign markets. Chrysler and many of the Japanese transplants have weak channels in Europe; the Big Three are virtually absent in much of Asia. A priority is to deepen existing channels and establish new ones. In Japan, BMW set an example by developing its own very successful channel. Ford has now purchased additional equity in Mazda’s Autorama channel in Japan, and GM has shifted to Yanase, the strongest existing import specialist. Chrysler, meanwhile, is concentrating on Europe.
Direct entry, however, is not the only route. Within the United States, there is an increase of relationships among original equipment manufacturers, with Ford assembling minivans for Nissan, while GM has discussed producing pickup trucks for Toyota. Within Japan, this trend is even stronger. Isuzu’s exit from car production has left room for others to sell cars through its dealer-ships, while Isuzu can sell light trucks to others, such as Honda, that lack anything in that segment. There are newly formed ties among Honda, Mazda, and Isuzu, and Nissan and Isuzu, in addition to those that have long existed between Nissan and Fuji Heavy Industries (Subaru) and between Toyota and several firms (Hino, Daihatsu). This formation of alliances for specific products will likely increase in the future, particularly given the turmoil that is occurring in Japan and that will soon arise in the EC as national barriers break down.
U.S. parts firms face both greater challenges and greater opportunities. Because their labor cost advantage is so great, the transplant producers — including, in the future, BMW and Mercedes-Benz — face tremendous pressure to source parts from firms in North America. Many U.S parts firms, however, are ill-positioned to meet this demand. Historically, the car development process was highly centralized within the Big Three, and parts firms produced primarily to blueprint, leaving them very weak in product engineering and design skills. But the “virtual corporation” has long been dominant in Japan, where parts producers are integrated into the development process. Honda, Nissan, and Toyota are gradually expanding their technical centers in the United States, with the goal of eventually having stand-alone operations. But, even for these firms, much of the work is still done in Japan, and other firms have only a small engineering presence abroad. It is thus important to at least maintain representation in Japan and ideally to have some engineering capabilities there in order to be able to sell to the Japanese-run plants in the United States. Representation abroad is, of course, even more important for firms that hope to export to Japan and to the EC.9
The U.S. automotive industry is not alone in rapidly becoming a competitive force in global markets. Integrated steel production in Japan faces similar cost pressures, while much of consumer electronics production has already been shifted to other parts of Asia. Already two of Japan’s leading export industries in the past, textiles and shipbuilding, have largely disappeared. Japan’s imports of textiles now exceed its exports: Japanese apparel imports top $10 billion. Korea now dominates shipbuilding, NEC is relocating all of its own color television production in Thailand (it also purchases sets from a Korean OEM producer), while most “Japanese” VCR deck production occurs in Southeast Asia. Indeed, while in 1980, manufactured goods accounted for only 23 percent of Japan’s total imports, the proportion rose to 51 percent in 1991.
Thus, while the automotive industry is important in and of itself, it also provides an important case study for other areas of manufacturing. The maturation of the Japanese production system — the end of productivity miracles — and the maturation of the population with consequent high wages and a strong currency will continue to weaken the competitive position of many Japanese industries. The position of U.S. manufacturers at home, in third-country markets, and even within Japan will be affected. Managers must focus on these trends to help formulate their strategy for becoming effective players in world markets.
1. This and other data on the North American market are drawn from various issues of Automotive News. For background on Japan, I rely on Nikkei Kogyo Shimbun.
2. Chrysler, however, also produced almost 1.2 million trucks, including 548,000 minivans.
3. Including Canadian operations, these are: the Big Six producers (GM, Ford, Chrysler, Honda, Toyota, and Nissan) and the eight second-tier producers, Auto Alliance (formerly Mazda, before Ford’s recent equity purchase), Diamond-Star (Mitsubishi), NUMMI (Toyota-GM), Saturn (GM), SIA (the joint venture of Subaru and Isuzu), CAMI (Suzuki), and the near-moribund Hyundai and Volvo operations. BMW and Mercedes-Benz are both set to enter.
4. M.A. Fuss and L. Waverman, Costs and Productivity in Automobile Production: The Challenge of Japanese Efficiency (New York: Cambridge University Press, 1992).
5. For details of this estimation, see:
M. Smitka, “The Decline of the Japanese Automotive Industry: Causes and Implications” (Cambridge, Massachusetts: MIT International Motor Vehicle Program, paper, June 1993), p. 27.
6. Historically, the most important aspect of JIT is reducing inventories in order to highlight bottlenecks in the production system and hence focus engineering attention on systemwide productivity. But in Japan, with small plants and few warehouses, it is also a scheduling and logistics system, and it is in this aspect that costs are rising.
7. For an extended discussion of this and other problems facing the Japanese industry, see:
R. Johnson and M. Maskery, “Rx for Japan,” Automotive News, 17 May 1993, pp. 1, 18–20.
The same issue also contains a series of articles on General Motors. See: P. Frame, “Smith Remakes GM for Today’s World,” Automotive News, 17 May 1993, pp. 1, 22–23.
8. In fact, from the beginning, Toyota and Nissan have shared about one-third of their suppliers. Others were small local suppliers for whom geographic constraints mattered. It was only for the few parts firms in which Nissan and Toyota had substantial equity that the taboo was meaningful.
9. For more on the relationship of car producers and parts firms in Japan, see:
M. Smitka, Competitive Ties: Subcontracting in the Japanese Automotive Industry (New York: Columbia University Press, 1991).