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Monday, March 8, 2010

The Cost of Toyota's Problems

Toyota's problems have already proven costly; how large that total will be remains unclear. I provide a couple numbers here, and then note the intangibles that I can't even guesstimate. In addition, I point out that Toyota's problems may prove costly for the industry as a whole, not just for Toyota itself.
First, Toyota has noted that the direct cost of recalls is likely to come to $2 billion. Now a well-run recall program can improve customer loyalty, particularly if it is a voluntary recall. The current ones aren't, but dealerships can clearly be told "treat the customer well" and in fact have been given cash up front to do so. In any case, this is not a cheap problem.
But that's if Toyota's problems were merely limited to recalls. Instead it has a product mix out of center with the market (e.g., it's often on-idle assembly plant in Texas), an undue dependence on production inside Japan (fine when it was ¥120 per dollar, but not at ¥90), and poor sales in various markets. (I'll add a more extensive analysis of Toyota's problems shortly, already out in March 2010 issue of The Oriental Economist.)
Second, and the biggest loss to date, is the drop in market valuation. The peak was in February 2007, and most of the fall occurred before the recall crisis. But the decline is still from 137.15 to 77.8 at close today, or $93 billion.
Third is the loss born by current customers who have seen the resale value decline. Initial reports suggest this might be about $5 billion at $1,000 per x 50 million vehicles in EU and US. Now the decline can end up rather lower, but does this does suggest an amount in the billions.  
Fourth are lawsuits. This is an even rougher guesstimate, but with Toyota's deep pockets, every ambulance chaser is in the race. And there are a lot of accidents. Now how many are tied to defects? -- precious few. Even the California accident that touched off the whole brouhaha may turn out to have other causes -- why didn't he shift to neutral given plenty of time to stop panicking, will the brakes there show overheating, and so on. My hunch is there will be no evidence that would make an engineer suspect a defect. The issue however is what a jury will think. Lots and lots of accidents can be blamed on unintended acceleration. It may be that all of them are due to the driver's behavior. In the US there are counties (in)famous in the industry for courts that have always ruled in favor of accident victims. So $2 billion? -- I fear that's safe. [On 10 Mar 2010 AP Miami reported $3 as more likely.] I have no idea how to consider suits from shareholders and owners of vehicles; I don't know if there is much precedent to suggest that they are likely to lead to payoffs, uh, settlements by Toyota or if they merely garner publicity for a few litigation operations.
Fifth are lost sales: up front, from Toyota, those will come to 100,000 units. At $30,000 per on retail, given Toyota's attempt to move towards the rich end of the product spectrum, that's $3 billion. But that has a smaller impact on the bottom line. However, it hurts when it is prospective customers who are lost. Early reports (TrueCar.com) suggest that shopping behavior changed markedly. Those who do look at Fords and GMs will be pleasantly surprised by what they find. Not good for Toyota.
Sixth are discounts: heavy! Toyota is laying on extended-term 0% financing. Not the deal it might seem with interest rates low, but still a discount as long as you negotiate price first and financing afterwards. Ditto leases – of course there are the "money cost" and depreciation components that permit leases to underprice other options, and the $179-$199 per month are not bad if you don't overpay for the car. So let's say this all runs Toyota $1,000 a car on average over the next year. That's $1 billion. Chump change? – only if they don't stay on and increase. Given Toyota's excess capacity, that seems to me a strong possibility.
Now all this seem might like good news for everyone else. Don't bet on it. This is not the time when the industry wants to see yet more price pressure.
But I'm worried more about unintended acceleration. This strikes me as legal quicksand (or rather, a legal goldmine to litigators). No car company is without some level of NHTSA complaints. Disproving it after the fact is very hard, little physical evidence remains. Sure, filings correlate strongly with the age of the driver – and then there is the US diabetes epidemic, which in advanced stages damages the nerves in feet. Even if that proves less lucrative to the legal profession than asbestos, it will remain a constant headache.
So the cost is added safety regulation. Some of it is not an issue for particular companies, that have a software "brake override" of the accelerator already in their vehicles. It's hard to see what other directions legislation might take, but it might well include additional reporting requirements. If this lets manufacturers bolster the case that their vehicles are safe, everyone benefits. However most accidents remain that – the unfortunate outcome of chance events amplified in most cases by human error. Having more unexplained incidents in NHTSA's database could backfire by suggesting that all vehicles have life-threatening defects – with enough data, you can uncover a pattern even if there is no underlying issue. The industry may well find out which effect dominates, given the ability of the US legal system to provide large settlements to the victims of sufficiently horrendous accidents. I fear for the worst.

Mike Smitka