Honda's Weak Spot: Europe

As losses mount in Europe, it's scrambling to get back in the race

Honda (HMC ) is hot. In the U.S., the Tokyo company can barely keep up with demand for models like the Acura MDX sport utility vehicle and the Odyssey minivan. Four of the top 10 best-selling cars in Japan are Hondas. Honda recently passed rival Nissan to become Japan's second-largest auto maker after Toyota (TM ). And Honda returned to the Formula One racing circuit last year after an eight-year hiatus.

But the road is not entirely smooth for the Japanese carmaker. Honda Motor Co. has suffered a serious breakdown in Europe. In fact, Honda's operations in the Old World are posting very un-Honda-like numbers. The company reported a loss of nearly half a billion dollars in Britain and the Continent for the year ended Mar. 31. Rivals Nissan Motor Co. (NSANY ) and Toyota Motor Corp. also logged losses, but Honda's were twice as big. That's dragging down overall operating profits. "Our biggest worry is weak sales in Europe," says CEO Hiroyuki Yoshino.

So Yoshino's managers have gone into overdrive to repair the European business. Their game plan includes launching an all-new car for the subcompact market, boosting capacity at two plants in Britain, heeding European calls for cars with diesel engines, and implementing a hard-nosed cost-cutting program that targets parts suppliers. Honda is confident: "We anticipate a very strong recovery in our earnings picture there," says Satoshi Aoki, a senior managing director for finance. Indeed, Honda expects to cut last year's European losses in half for the year started in April and break even the following year.

Honda has a reputation for tackling all of its challenges head-on. But the European problem, even against the background of record results in the U.S., underscores Honda's fragility. Although less than 10% of Honda's global volume--and far less revenue--comes from Europe, the region has outsized importance to Yoshino and his deputies. Why? Because Honda has no safe harbor if its sales in the U.S. begin to flag, as some analysts expect. The company earns some 90% of its profits in America, a far higher percentage than other Japanese carmakers. "Honda is the least globally diverse Japanese automobile manufacturer," says Chris Redl, director of equity research at UBS Warburg's office in Tokyo. "It's a minor problem for now, but with the U.S. market heading down, it could become a major problem."

Honda's struggles in Europe today are partly the result of a key strategic error it made when it started making cars in Britain in 1992. Company officials didn't foresee the huge runup in the value of the British pound against Europe's single currency, the euro, which made its cars more expensive than competing models manufactured on the Continent. Sub-par sales cut output in Britain last year to levels near 50% of capacity: It's impossible to make money at that production level. "Europe is definitely an Achilles' heel for Honda," says Toru Shimano, an analyst at Okasan Securities Co. in Tokyo.

So Honda is increasing purchases of cheaper parts from suppliers outside Britain and moving swiftly to freshen its lineup. Earlier this year, a remodeled and roomier five-door Civic hatchback with improved fuel efficiency rolled off production lines in Britain. To goose output at its British operations, Honda will start exporting perky three-door Civic sedans built at its newest plant to the U.S. and Japan this year. It also plans to export its British-made CR-V compact SUV to America to augment the Japan-made CR-Vs now being sold there.

Honda is also catering to Europe's new taste for smaller minivans by importing its Stream van to Europe from Japan (price: $17,000 to $20,000). Another important change is the addition of diesel-powered engines; their fuel efficiency is popular among Europeans, who pay high taxes on gas. "If we had a diesel engine, we'd sell more cars," says Jerry Moore, a salesman at a British Honda dealership in Kent. "About two out of every 10 people that come in say they want a diesel."

NEW SALVATION? To meet that demand, a Civic featuring a 1.7-liter diesel engine made by Isuzu Motors Ltd. in Poland will debut in Europe in November. And a diesel-equipped Accord sedan is due out sometime in 2003.

All of that will help, but Honda's big issue is the hole in its lineup: subcompacts. While 1-liter-engine cars sell poorly in the U.S., Europeans and Japanese can't get enough of them. "Honda does not have a product for Europe yet," says UBS Warburg's Redl. It missed out with its 1-liter Logo. "It didn't stand out from the crowd," Yoshino admits.

So the Logo is history, and Honda's new salvation in Europe, due to launch first in Japan on June 21, is an all-new five-door hatchback called the Fit. At 1.3 liters, its engine outpowers Toyota's competing Vitz-class line of cars. Honda says the sporty Fit also boasts a number of nifty features. The only one it would confirm, however, is that owners will be able to flatten all four seats, including the driver's, at the flick of a switch. Honda plans to start exports to Europe later this year. Yoshino says the company may also export the Fit to Europe from a third country, such as China, to undercut higher-priced rivals.

Will all these fixes be enough to repair the damage? Some skeptics think not, pointing to Honda's inherent competitive disadvantage. Japan's new No. 2 auto maker doesn't have the deep pockets that Toyota does, and thus cannot easily spring for a new factory on the Continent to offset currency-related losses. (The factory Honda just built in Alabama cost $416 million.) Nor can Honda depend on help from a local partner. Competitors Mazda, Nissan, and Mitsubishi are all working hand in glove with allies Ford (F ), Renault, and DaimlerChrysler (DCX ) in Europe. Undaunted, Honda officials cherish the company's reputation as a lone wolf. "Partners just bog you down," declares Michiyoshi Hagino, Honda's senior managing director in charge of global passenger-car operations.

But by going it alone, Honda loses the advantage that would come with platform sharing and joint-parts procurement. The company is in the midst of a three-year project to roll out some 20 models worldwide through 2002. As usual, Honda is pulling out all the stops to keep up with the competition; it will spend some $3 billion, or 5% of annual sales revenue, on R&D this year. But the Old World losses may crimp efforts to keep up the pace with Toyota, which boasts a war chest of $19 billion in cash, compared with Honda's $3.5 billion.

As May waned, the news only got worse for Honda. The euro hovered near year-to-date lows against the dollar, the yen, and, most ominously, the pound sterling. As long as sales remain firm in the U.S., Yoshino needn't be too concerned about that dripping sound from Europe. But if American demand shrivels in coming months and that half-billion-dollar loss swells to an even larger number, the pain in Tokyo will increase.

By Chester Dawson in Tokyo, with Carlos Tromben in Paris and Heidi Dawley in London

    Before it's here, it's on the Bloomberg Terminal.