Monday, May 16, 2005


The latest love affair in the auto industry between GM and Toyota is striking for its contrasts. GM is burdened by its health care and pension liabilities, first quarter losses in excess of a $1 billion, junk status debt, and a stock price at a 10 year low. Toyota however is humming along like a new Prius, with a “reported $2.8 billion in profit in the same quarter and commands an edge in the market for environmentally-friendly hybrid vehicles.” However, the market is abuzz with talk of cooperation between GM and Toyota ranging from Toyota’s sharing of its hybrid technology to cooperation in fuel cell technology and the Japanese car-maker raising prices to help floundering American competition. Is Toyota really being altruistic here? Will this partnership revive GM?

The biggest reason cited for Toyota’s overtures has been the possible return of Japanese car bashing of late 70s and 80s. Most analysts agree that these fears are overblown. According to Walter McManus, “Ultimately, U.S. consumers are consumers first and citizens second. Most people don't really think about where their vehicles are made.” So what else could be driving this cooperation? Toyota and Japan are heavily dependent on the US economy and will do whatever is necessary to maintain sales in this country. Another potential answer, according to Lindsay Brooke of CSM Worldwide, is that by combining efforts the industry giants would “have a lot more clout with other decision-makers and could help get government and industry more involved.” Given the expense of developing fuel cell technology, the real reason may be based in simple economics as the Japan Times reports, “Joining hands in development would benefit both automakers by reducing costs, which would bring down prices and make the vehicles more affordable for consumers.” The story on hybrids is also put down to pure economics of Toyota wanting to spread technology development costs over more units. Are the arguments for cooperation the complete picture or is there more to the economics of these deals?

We do agree with analysts that fears of an anti-Japanese car revolution are remote since the scenario has changed significantly since the 80s. Toyota has taken preemptive steps to alleviate potential domestic tension including joint ventures with US automakers and developing US plants. In Kentucky, where Toyota has one of its main US production facilities, Japanese firms have 35,000 employees. In addition, perceived value of Japanese cars significantly outweighs their prices in the markets and it would be difficult for patriotism alone to overcome the surplus, as stated by McManus. Continued outsourcing of products to China and success of Wal-Mart underscores this change in American consumerism. More importantly the drivers of the unrest in the 80s, Unions have been significantly weakened in their position as monopolistic suppliers of labor by globalization and, thus, do not pose as much of a threat. Overall economics and politics dictate against the much publicized backlash.

How about the economics of fuel cell technology? Will that help GM in the long run? Based on data in EV World, fuel cells are currently extremely expensive costing more than 50 times as much as an internal combustion engine to produce power and wearing out 5 times as fast. There are also significant technical issues with fuel cell today that makes Toyota predict that fuel cells will not be available for 25 years. Hence, Project Apollo would help share the development costs of the fuel cells and help the companies create value faster and cheaper. But who will capture the value created? In terms of engineering, Toyota is years ahead of GM in fuel efficient technology for small cars as is evident from their position in the hybrid market where used Toyota Prius sale for a premium and may adapt fuel cell technology for its cars faster than GM can. Thus, while they would be sharing costs, Toyota will capture more value from the partnership.

What about the hybrid technology sharing? Will the Toyota technology get GM purring in a market that is growing by 960% a year? It is important to note that Toyota came up with the proposal for hybrid sharing. Sharing of fixed development costs of the hybrid engine and reducing vehicles costs could have been a motivation for Toyota but it wasn’t the only one. If hybrids are the cars of the near future, how could Toyota maximize its benefits from this phenomenon? The best scenario for Toyota is to be the sole supplier of the hybrid engine, which is the core of the product, and dissuade competition from developing. Hence, this offer is a way to weaken the GM-Chrysler partnership on hybrids and maintain the Toyota-Honda duopoly in hybrids where Toyota today is the only manufacturer supplying hybrids to other car companies. Can GM use any of its learning curve in the heavy vehicle hybrid segments to counter Toyota’s power? Bradley Berman, Editor in Chief of states “I can't help but think that it relates to GM's overall strategy as it relates to hybrids," he said. "They started with buses. They start with the biggest systems and test them out. I'm giving them a break here. They test it in fleets where you can get good data back. But do you do that and then leapfrog into vehicles that do millions in volume?"

So what is really going on here? Toyota seems to be playing a shrewd game that it stands to win in every state of the world. Even on price increases, GM stands to lose more since it faces greater price elasticity of demand, as evidenced by deep promotions needed to sell GM vehicles, as compared to Toyota. Hence, the unequal partnership with Toyota may end up hurting GM in the long run, given Toyota’s superior technology and pricing power. Improving the value to cost margins, better design and quality, cost cutting, and partnerships with an equal like Chrysler is the only way GM will get into the black, not subsidizing Toyota’s fuel cell research.

Robert Cummings Drew Dekett Debasis Rath


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