Toyota's Cost-Cutting Drive: Making the Tough Choices

Toyota Motor (TM) is no stranger to cost-cutting. In recent years the automaker has slashed expenses by as much as $3.3 billion annually by implementing thousands of changes suggested by employees and keeping a tight rein on spending. But now, with global auto sales in a tailspin and Toyota expecting its first loss in 70 years, the push for frugality is entering overdrive: Last fall, the company formed an "Emergency Profit Improvement Committee" to ferret out an extra $1.4 billion in savings this year.

When the need for profit improvement reaches emergency status, apparently nothing is sacred. In Japan, the company is shedding 5,000 temporary workers and is likely to cut production by as much as 40%—450,000 cars—over the next three months. According to reports in the Japanese media, Toyota is considering shedding 1,000 permanent workers in the U.S. and Britain. Toyota says nothing has been decided and that it does its utmost to preserve employment, but, if it happens, it will be only the second time since 1950 that it has trimmed permanent staffers.

No saving, it seems, is too small. Workers are being encouraged to take the stairs rather than elevators, to save electricity. The heat in factories has been turned down, so workers are now wearing extra sweaters to stay warm. And on Jan. 19, Lexus engineer Takayuki Katsuda and two colleagues drove from headquarters in Toyota City to Tokyo for the Japan launch of the Lexus RX sport-utility vehicle. Though the trip took four hours, vs. 90 minutes on the Shinkansen bullet train, they saved about $300 in train fares. "We're facing a once-in-a-hundred-years crisis," Akio Toyoda, a scion of the founding family, who will become president in June, told reporters on Jan. 20.

Even the announcement of Toyoda's promotion got hit by the cost-cutting drive. When he was introduced to the media, the company didn't rent a hotel ballroom as it normally does for such events. Instead, Toyota simply cleared a few Priuses and Corollas from a Tokyo auto showroom on the ground floor of its offices and brought out folding chairs.

Beyond the Downturn

Reflexive cost-cutting is a time-honored response to crisis at Toyota, but some of the current problems can be blamed on un-Toyota-like moves on the part of senior management. Sure, every automaker on earth has been hurt by the downturn. But the breakneck speed of Toyota's expansion in recent years, its continuing reliance on production at home, and slower decision-making as it has grown have all aggravated Toyota's woes.

Since 2001 the company has added production capacity of around 500,000 vehicles every year, building new assembly plants from China to the Czech Republic. After winning praise for its foresight in developing the Prius hybrid, Toyota opened a huge Tundra pickup plant in Texas in late 2006, just months before the subprime crisis exploded. With Toyota having invested so much in new factory space, some company watchers reckon the automaker needs to keep its plants busy 80% of the time to make a profit, higher than the 70% level preferred by most Japanese rivals. Toyota doesn't give figures on capacity utilization, but current President Katsuaki Watanabe has spoken recently of the need to be profitable even with volumes of 7 million. The company sold 8.9 million vehicles in 2008. As a result of the capacity glut, Toyota has put on indefinite hold a partially constructed new plant in Mississippi that was scheduled to make Highlander SUVs but was switched to the Prius.

In years past, Toyota was far more prudent when expanding into new markets. In China, for instance, it initially lagged Honda and Nissan, only surpassing them as the best-selling Japanese automaker there in 2007. As recently as 1994, Toyota made just 1 million vehicles a year overseas. In 2008, it made 4.3 million.

Growing Pains

Analysts say the rapid expansion made sense when it was planned. Until recently, Toyota was struggling to meet demand, and since it takes years to build plants and develop new models, there's always a chance that there won't be buyers for cars built by a new factory. Yet Japanese papers report that some top Toyota brass, including influential retired executives such as former President Hiroshi Okuda—a strong advocate of aggressive expansion outside Japan—urged slower growth. Toyota declined to comment on the reports.

The impact of the strong yen, another drag on profits, can also be linked to Toyota's expansion. One reason Toyota has built overseas plants was to reduce its vulnerability to the currency's rise, since shifts in exchange rates matter less when cars are built in the markets where they're sold. Yet even though Japanese car sales have been falling for years, it still made 4.9 million vehicles in Japan last year—53% of its total production, and more than half of those were shipped overseas. In North America, where Toyota has six plants, it imported 42% of the cars it sold there in 2007, vs. 25% at Honda Motor (HMC) and Nissan Motor (NSANY).

That's fine—and highly profitable—when the yen is weak and global demand is strong. But it leaves Toyota vulnerable when those factors reverse. Toyota "couldn't have avoided the effects of the global slowdown, but foreign exchange, that's an avoidable thing—it just depends on where you build stuff," says Christopher Richter, an analyst at CLSA Securities in Tokyo. In the financial year that ends in March, the impact of the strong yen is set to cost Toyota almost $10 billion.

Others say Toyota, which last year overtook General Motors (GM) to become the world's biggest automaker, has grown too unwieldy. With dozens of factories worldwide, it's harder for Toyota to react to changes in the market, so its response to the current crisis was slower than some rivals', says Koji Endo, an analyst at Credit Suisse (CS) in Tokyo. "Deciding which shifts and models are to be cut and what programs have to be implemented takes time," Endo says. "It's a lot more difficult when you are making 8 or 9 million vehicles than for a company making a million." Adds Ashvin Chotai, managing director at consulting company Intelligence Automotive Asia: "The challenge for Toyota is now to create an organization structure that is more responsive both in terms of decision-making and action."

Help from Ample Resources

That's not to say Toyota will suffer as much as Detroit's giants. With some $20 billion in cash and a solid balance sheet, the company has ample resources to ride out the storm. And with the level of attention Toyota pays to the details of planning and manufacturing, the company has cut in half the time it takes to develop a new engine or launch a new car under current chief Watanabe, says Jeffrey Liker, a professor of industrial and operations engineering at the University of Michigan. "Compared with their competitors, they are incredibly well placed," Liker says.

And Toyota watchers are confident that Toyoda, who has been groomed for the top job for decades, has the right credentials and character to steer the company onto safer ground. A former member of Japan's national field hockey team, Toyoda got an MBA at Babson College near Boston and then worked in London and New York as a banker and consultant.

He joined the carmaker in 1984, and after some initial ribbing about his princely background, he has thrived. He launched a successful e-commerce venture called, oversaw Toyota's operations in China, and managed a manufacturing joint venture with GM in California. Last year, Toyoda took on the task of reinvigorating sales in Japan, a market that has been in decline for years. "He has put in the time to learn the ropes and has not been given any special favors because of his name," says Alberto Lapuz, a vice-president at researcher J.D. Power & Associates (MHP). "Many senior board members point to him as 'one of us,' which is the ultimate compliment."

Toyoda may also help Toyota overcome its image for reliable but somewhat dull cars. An amateur racer, Toyoda fought to keep the Lexus LF-A sportster from being sidelined. It made its debut in May at the 24-hour endurance race in Nürburgring, Germany. And in November, Toyoda got behind the wheel for an exhibition run at the Fuji Speedway in Japan. Now, he says, he's ready to roll up his sleeves and confront the "heavy responsibility of navigating Toyota through an unprecedented crisis."

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