Toyota Doubles Down on Japan

The village of Ohira is in Miyagi prefecture, 20 miles northwest of Sendai Bay, the stretch of Japan's coastline closest to the epicenter of the massive Mar. 11 earthquake. In recent years the area has become Toyota (TM) country, and car and car-supply plants dot the region. But in a year that has been hard on Toyota and cruel to Japan, Ohira has done O.K. In the Sendai Shiogama port, the tsunami crushed cars as if they were soda cans, scattered street lamps like lawn clippings, and left huge fishing trawlers beached on the docks among the blown-open shells of warehouses. Ohira itself, however, lies inland. Compared with the devastation along the coast, the damage the village suffered was mild: cracked walls, torqued pavement, a few utility poles listing to one side or the other.

Ohira, in short, was lucky, and not for the first time. The village has managed to escape much of the nation's economic stagnation, too. Unlike many Japanese towns, Ohira has good jobs to keep its young people from fleeing to Tokyo and Osaka. The population of 5,500 swells by more than 2,000 during the workday as commuters stream in. Oki Electric Industry, which makes servers and ATMs, has a factory in Ohira, as does zipper maker YKK. Corporate taxes account for 80 percent of the village's revenue.

It's Toyota that looms the largest, though. The automaker's Central Motor unit opened a plant here in January where 900 workers make Yaris compact cars. In the neighboring town of Taiwa, a wholly owned subsidiary called Toyota Tohoku makes brakes and suspensions. Taiwa is also home to a factory where Primearth EV Energy, a joint venture between Toyota and Panasonic, makes hybrid-car batteries. This island of job growth was only momentarily unsettled by the earthquake: Central Motors is in the process of transferring 400 more workers here from a plant near Tokyo, and the plant will soon add Corollas to its product line. Toyota Tohoku is going ahead with plans to build an engine factory next to its existing facility to meet the growing demand from the area's Toyota car plants.

To an extent, Ohira and Miyagi's dependence on Toyota reflects the nation's. The world's biggest carmaker is also Japan's largest company by sales and its biggest taxpayer. But what sets Toyota apart from other Japanese manufacturing giants, as much as its size and clout and cultural prominence, is its insistence on making things in Japan. Nissan, the next-largest Japanese auto manufacturer, makes just 30 percent of its cars in Japan. Honda, the third of the Big Three, makes only a quarter. By contrast, for Toyota the share was 60 percent in 2010, and half those vehicles were shipped abroad.

The Mar. 11 earthquake underlined one risk of concentrating so much production in a tectonically cursed nation. Even though Toyota's actual plants suffered little damage from the quake and tsunami, the power shortages and disruptions along Japanese supply chains hurt Toyota more than its Japanese competitors. Toyota's global output dropped 30 percent in March, while Honda's fell only 19 percent, and Nissan's actually increased, as its overseas plants were able to temporarily offset the drop at home.

By itself, an unprecedented natural calamity might not be an argument for Toyota to radically change its global strategy. But the company is also facing a pair of longer-term challenges: a shrinking domestic market and a stubbornly high yen that makes its cars more expensive outside Japan. Industry analysts say Toyota needs to speed up the process of moving overseas to stay competitive at a time when the chaos brought about by the earthquake and tsunami all but ensure it will lose its status as the world's No. 1 carmaker, for now in any case.

"For Toyota, economically it makes 100 percent sense to move their production in Japan overseas," says Koji Endo, an auto analyst at Advanced Research Japan. But that "obviously would pose at least a huge short-term impact in particular communities and a spillover impact on other industries as well," he adds. "It's probably not that big a problem for Honda or Nissan, but it's going to be a big problem for Toyota."

And yet in the wake of the disaster, Toyota has announced its intention to maintain its footprint in Japan. "[Chief Executive Officer] Akio Toyoda came here and told me personally that Toyota is not going anywhere," says Yuki Takahashi, the Miyagi official in charge of auto business development, in an interview in his office in the prefectural capital, Sendai. This vehemence is even more striking since the company revealed plans last year to cut a fifth of domestic production by 2015 and move more manufacturing to emerging markets.

Reflexively digging in now might seem a stubborn, even reckless stance for a company of Toyota's size and global reach. It might also just be PR. But the conflicting signals that Toyota has sent can be read as an illustration of how much its leadership is torn over moving more business overseas and the company's awareness of the stakes involved. Toyota, it turns out, has good reasons for keeping its center of gravity in Japan—some of them economic, some political, some institutional. The company's size brings added scrutiny to its decisions and pressure not to do anything that would cost Japan jobs. And being a truly Japanese car company is important for Toyota in ways that it is not for its rivals—it is woven through the company's famed corporate culture and the image it has assiduously cultivated among Japanese drivers and citizens. Taken together, these factors tie Toyota to its home country, even as economic forces pull it away. Understanding them helps explains how—and why—Toyota remains exceptional, and may only seem to be acting against its own best business interests by breaking with the competition and publicly recommitting to domestic manufacturing.

Toyota Motor was founded in 1936 by a young Japanese mechanical engineer named Kiichiri Toyoda at the behest of his father, the entrepreneur and inventor Sakichi Toyoda. The seed money was one million yen that the elder Toyoda had earned licensing his design for an automatic loom to an English textile company. More than the money, Sakichi Toyoda's legacy was a fervent faith in the abilities of Japanese engineers like himself. In his book Staying Power, Michael Cusumano, a professor at the Massachusetts Institute of Technology Sloan School of Management, contrasts Toyota with Nissan, which was founded around the same time. Both companies drew heavily on American and English car designs, but while Nissan simply copied those plans wholesale and imported engineers to direct operations, Toyota reverse engineered the foreign models with the help of Japanese university professors and auto experts. The company carefully adapted the designs and production methods to the Japanese market—a smaller one than the U.S. that lacked, at the time, the industrial capacity to make many key parts in bulk.

Cusumano argues that this focus on "ingenuity and self-reliance" remains a central part of Toyota's culture. It is a key to the legendary efficiency of the company's production and the until recently industry-leading reliability of its cars. The determination to reinvent rather than simply copy automotive expertise was the first step in a long and relentless effort to improve on vehicles and the processes of making them, even when both were already considered state-of-the-art. The goal was to produce cars in Japan that were, in Kiichiro's words, both "cheaper and better than foreign imports."

While its production methods are celebrated and copied throughout the industry, sales and marketing prowess had as much to do with Toyota's rise, especially in Japan. The company did everything possible to make its cars ubiquitous and familiar. Early on, it focused on recruiting as many of General Motors' (GM) Japanese dealers as it could, to provide a national network of dealerships. And in the 1950s, Toyota started buying up driving schools. "As more Japanese became affluent and took up driving, their first exposure was often to a Toyota car," Cusumano writes. "Many of these people became lifelong Toyota customers." Toyota passed Nissan in 1951 as Japan's largest carmaker. Today it commands half the Japanese market.

That hegemony drove Toyota's Japanese competitors to look to overseas markets, and then to start making cars overseas, both to bring down transport costs and to curry favor with the governments of those countries. Toyota, on the other hand, was more conservative about making the jump. Honda started manufacturing Elsinore motorcycles in the U.S. in 1979; in 1983, Nissan opened a plant in Smyrna, Tenn. Toyota brought production to the U.S. a year later but hedged its bets. The first American plant was a joint venture called Nummi (for New United Motor Manufacturing Inc.) in Fremont, Calif., where Toyota managers taught GM workers how to make cars "the Toyota way." For GM it was a way to learn about the legendary Toyota Production System—with its tenets of "kaizen," or continuous improvement; just-in-time inventory; and "jidoka," the idea that any worker is encouraged to stop the production line if he spots a problem. For Toyota, Nummi was a pilot project to find out whether that production system could in fact be adapted to American autoworkers and their unions.

Since then, even as Toyota has built multiple plants in the U.S. and other overseas markets, the company has kept the majority of its high-end production—the Prius and most of the Lexus line—at home. Cultural chauvinism could be part of this decision. Toyota's North American plants, after all, have exemplary records, and tend to lead regional quality surveys. In those same surveys, however, the plants judged to be the best in the world are still Japanese. The J.D. Power and Associates (MHP) initial quality survey, which identifies the factories producing the cars with the fewest defects and malfunctions, has chosen Toyota plants in Japan for its "platinum" award for best on the planet in 10 out of the last 15 years.

"There's no question that if you want to see the best Toyota production system in the world, you go to Japan. That's still the case," says Jeff Liker, a professor of industrial and operations engineering at the University of Michigan and the author of several books on Toyota. "If you want to see them making parts in true just-in-time, delivering every two hours with almost no inventory in the system, and the quality almost perfect, you'll see that in Japan. It's just a little bit of a different level." What it takes 1.2 workers to do in an American plant, he estimates, one worker does in Japan.

"They've kaizen-ed and kaizen-ed and kaizen-ed the jobs. There's so little waste, it's just remarkable," he says. "If you think about a really good drummer playing a solo, that's what these workers look like."

Toyota's Japanese plants also benefit from a dense, tight-knit network of domestic parts suppliers. Rather than shop around for the cheapest acceptable option as American carmakers have traditionally done, the carmaker collaborates closely with prospective suppliers to bring their quality up to the level it demands, and continues to work with them to improve quality and pare cost. And while the carmaker does pit its suppliers against each other in this quest, it rarely drops one altogether. The Toyota Tohoku plant in Taiwa, according to its managing director, Kozo Sakurai, worked with a small die-cast manufacturer in nearby Iwaki for three years before it began accepting their parts.

The result, in Liker's description, can seem more like a family—if a slightly autocratic one—than a web of commercial relationships. Smaller Japanese automakers also have their supply networks, or keiretsu, but because of its size, Toyota can offer exclusivity and demand greater loyalty. The strength of the bonds is such that, when Toyota's sole supplier of a crucial brake valve burned to the ground in 1997, the company was able to assemble a team of representatives from other suppliers in a war room with the blueprints for the part and, working feverishly, cobble together an alternate production line. The carmaker's plants were back up and running again in a mere five days, even though the process involved designing and producing new manufacturing equipment. Only afterward was there any talk of payment. It was, The Wall Street Journal wrote a few months later, "the corporate equivalent of an Amish barn-raising."

This unquestioned sense of mutual obligation is what gives Toyota faith that it can recover quickly from this latest disaster, and it is what the company may lose in moving overseas too aggressively. The decision to move more production to Miyagi—where wages are lower than in the Tokyo and Nagoya areas—can be seen through this lens. The shift allows the company to cut costs but still draw on a Japanese labor pool and network of parts suppliers who share the cultural assumptions that undergird the company philosophy.

Toyota has done its utmost to recreate a keiretsu network in the overseas markets where it now produces cars. And though it has succeeded in exporting the structures and many of the norms it cultivated in Japan, there have been shortfalls. Recent quality problems can be traced, at least in one instance, to a supplier: Because of rusting in frames provided by Ohio-based Dana Holding Corp., Toyota instituted a buyback program for its 1995-2000 Tacoma pickups in 2008, and defective Dana driveshafts led to a Tacoma recall last year. (The higher-profile recalls related to faulty floor mats and sticking accelerators, Toyota spokesman Paul Nolasco points out, were design problems, not production problems, and therefore unconnected to where the cars in question were manufactured.)

"Part of the reason that they have had so much difficulty with quality is precisely because they've grown very rapidly and spread all over the world," argues Wallace Hopp, a professor at the University of Michigan's Ross School of Business. "Their production base isn't as tight-knit as it once was." The recalls, he suggests, and the recent slippage of Toyota cars in quality rankings are likely to make the company more reluctant to move further production overseas. "When you hear Toyota say 'We're committed to Japan,' it's not just because they're altruistic and loyal Japanese citizens," says Hopp. "They're committed to Japan because they created a colossus there, and they want to take as much advantage as they can going forward."

Arrayed against this advantage are two forces: the high yen and the low Japanese birthrate. Right now the exchange rate is 80 yen to the dollar—two years ago it was 100 yen to the dollar, four years ago it was 120. Toyota estimates that every additional yen of appreciation against the dollar cuts 30 billion yen from the company's earnings.

Demographic trends look even less tractable. With one of the world's lowest birthrates as well as one of its lowest immigration rates, Japan's population is shrinking. That is not good news for large companies that hire Japanese workers or make money selling to the domestic mass market. And as the Japanese market shrinks, it makes less and less sense to keep making cars at home only to ship them overseas to where people are actually buying them.

"Five years from now, will a greater fraction of Toyota's manufacturing happen outside Japan than today? The clear answer is yes," says Sunil Chopra, a supply chain expert who teaches at Northwestern's Kellogg School of Management. That means, some analysts argue, not only building more plants overseas but shuttering them at home. "I think it makes sense for everybody, including Toyota, to close some capacity in Japan," says Endo of Advanced Research Japan.

None of these arguments have much traction with the company itself. While Toyota is pushing to build more cars outside Japan, it insists the new capacity will be to meet new overseas demand, not replace Japanese production. "[M]aking more overseas has not meant making less in Japan," Toyota spokesman Paul Nolasco wrote in an e-mail, declining to make an executive available to discuss the matter. "[N]ot only does Toyota not have plans to move production away from Japan, there are no collective worries of which I am aware that Toyota might possibly do so," he wrote.

Even if leaving Japan didn't run counter to so much of Toyota's history and culture, the company's size brings its own political pressure. Toyota directly employs over 70,000 people in Japan, and several times that if one counts subsidiary plants and dealerships and the parts suppliers it keeps in business. After Renault bought Nissan, the new CEO, Carlos Ghosn, closed five Nissan plants. "It didn't have so much of an impact on the Japanese market," says Endo. "If Toyota decides to close two or three, it would be a huge impact on the Japanese market and on the economy as a whole."

Toyota in Japan today is in a similar position to GM in the U.S. in the 1960s, when it, too, controlled half its home market. Companies that big and that iconic become more than just companies. They're expected to serve political and social and symbolic purposes as well. They become bigger targets. GM made some poor decisions, and its problems are not those of Toyota, but the company's decline, Cusumano argues, was partly preordained by its dominance. "The unions always targeted GM because it was the biggest kid on the block, and its agreements were much less favorable than the ones at Ford Motor (F) or even Chrysler. It would be under pressure from government regulators to maintain employment and contracts. Over time it hurt [GM's] ability to be competitive. Over time it wore them down," he says.

"The big question for Toyota," says Cusumano, "is how much of these social responsibilities can they realistically take on and still remain a pillar of the economy."

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