Tuesday, April 24, 2012

BOSS Article Part Four

Following after the jump is part four of the seven part BOSS article on Honda and its current problem. The link to the TOV forum discussion thread is BOSS article Part 4 TOV thread



Unable to Gain “Control” in “Treasure Chest” Emerging Markets

The Disappointing New Civic

Until the 1990s Japan, Europe and the U.S. were called the big three auto markets in the world, but as these markets matured the emerging markets of China, Asia and Central/Latin America are expanding rapidly in today’s auto industry. Among Japanese manufacturers, Honda is known as heavily depended on the U.S. market, and as such the company is shifting its course toward expanding shares in developing markets by reducing its dependence on the Americas and industrialized nations.

In August 2011, Consumer Reports having strong influence over American consumers trashed the new “Civic” released after a full model change in the spring, saying that the compact sedan “could not be recommended given its poor handling, ride comfort, brake performance and interior quality.” As a result, Honda rushed to implement major improvements ahead of schedule.

One primary cause of the setup that invited harsh criticisms was the order by President Takanobu Ito to cut more cost when the development had already made far progress, which led to unreasonable compromises. Why did he make such a decision? One source at Honda familiar with the situation explains as follows:

“It’s not that Honda will ignore the U.S. market, but the underlying assumption is that the company’s key battleground will shift to emerging counties in earnest.

Following the collapse of Lehman Brothers, the purchasing power of low- and middle-income earners is dropping faster than we think in Japan. To appeal to the users who would buy a Civic, the price must be lowered significantly. Honda’s idea is that, if the U.S. no longer generates as much profit as before, we should make and sell cars only to the extent of maintaining the status quo in the U.S., while diverting the management resources such as development and production technologies to tapping the emerging markets.”

The new Civic became a compromised setup in favor of cost reduction, not because Honda tried and failed to unreasonably increase the profit margin, but because it made a proactive decision to provide a safe car for the U.S. market that stopped expanding and to keep the share. It received a low mark from Consumer Reports only because the focus distributions were not correct.

Given the nature of Honda as a company, it is only natural that the company wants to shift its focus to emerging countries. The U.S. is like the second mother to Honda, serving as an important production hub and development hub. However, Honda’s business operations are clearly oriented toward developing users in emerging countries and developing countries.

Honda boasts the largest share in the global motorcycle market, producing more than 150 million units in cumulative total worldwide. The low-cost bike “Cub” series created by Founder Soichiro Honda is utilized as business bikes by all user segments including the low-income group. Honda also sells many affordable products that contribute to progress of civilization, such as ATVs (one-passenger or two-passenger four-wheel bikes), outboard engines, generators and small agricultural machinery.

“In India, for example, customers who buy a generator have relatively high income and can afford a car. There is also an element of brand loyalty in that users of a Honda generator also buy a Honda car. In developing countries, we see many cases where an owner of a low-cost generator or agricultural implement steps up and buys a motorcycle or car as his economic situation improves. It is one strength of Honda to be able to approach markets that are still small but present a growth potential in the future.” (Person in charge of power product sales at Honda)

In the 2000s Honda began reinforcing its emerging country strategy. The current model of Japan’s best-selling basic car “Fit” was released in 2007, where various ideas were incorporated in the new car development stage to cut cost, such as significantly reducing the use quantities of expensive materials not readily available outside industrialized nations. This was to eventually enable the model’s production in developing countries and emerging countries.

Furthermore, in 2011 Honda released the low-cost compact car “Brio” targeting users in emerging countries in Thailand and India. It is a ultra-low-cost model, sold for around 1 million yen in Thailand and 700,000 yen in India. “When I saw the real thing, the price was several hundreds of thousands of yen cheaper than the Fit, but the design was more appealing. Despite its compact body, the interior was spacious, probably to cater to the need to carry many passengers in emerging countries. Local R&D staff developing other models liked the car and asked us to import it right away because they wanted to buy the car themselves.” (Source at Honda R&D)

The current basic overseas strategy of Honda is to expand the lineup of low-cost models such as this one and gain shares in emerging countries where the market size is expected to increase by 20 million units to 30 million units over the next 10 years.

Despite its focus on emerging countries, Honda is not treading a smooth path when it comes to the company’s overall overseas strategy.

The biggest challenge is to strategize its course in industrialized markets such as Japan, Europe and the U.S. Honda has large production facilities in industrialized countries and regions such as Japan, North America and Europe. It is inefficient to export complete body units or CBUs for emerging countries from high-cost factories in industrialized countries, and Honda must obtain a certain level of share in each region in order to raise the utilization ratios of local factories.

However, it is becoming increasingly difficult for Honda to gain control in industrialized markets such as North America where the company has been traditionally strong.

The greatest risk is in the European market, including Germany having Autobahns or motorways with no speed limits, where average car speeds are the fastest in the world. Given the speed limits of 100 kph and 110 kph on national highways, which are equal to the speed limits of expressways in Japan, naturally European users are the most critical of cars in the world.

Honda is losing out in this European market in terms of sales. Honda’s share in the 187,000 units sold in Europe in 2010 was a little more than 1%, far behind Toyota who sold 600,000
units, Nissan who sold 400,000 units and even Suzuki who sold 195,000 units.

South Korea’s Hyundai Group is one Asian manufacturer in a contrasting position to Honda. Including the sales under its sister brand Kia, Hyundai has sold 620,000 units and has become the top-selling Asian automaker for the first time, surpassing Toyota. One executive of Honda comments on this dismal state: “ The European market is shrinking and no longer profitable, just like the U.S.” However, this is like eating sour grapes. Being ignored in Europe where car performance is evaluated against the strictest of standards is only negative for the brand image and there’s nothing to be positive about.

Luxury Cars That Don’t Sell

In the Japanese market Honda is not doing too bad, thanks to the healthy sales of hybrid cars helped by the environmental tax incentives. However, the majority of selling models are low-margin compact cars, and with the recent strength of Nissan, Honda’s ranking in overall sales including Japanese K-class cars is dropping from the previous high levels.

Among the industrialized nations, Honda is doing relatively well in the U.S., but this market is not without concerns. Hybrid cars, which are recognized as a symbol of advanced technology and contribute to enhancing the brand image, are not selling at all at Honda and Honda is falling far behind Toyota in this segment.

In 2009, Honda’s second-generation “Insight” and Toyota’s third-generation “Prius” were launched around the same time and went head to head. In the U.S., the Insight was priced differently from Japan, or around 5,000 dollars cheaper than the Prius, but Honda’s hybrid still suffered a crushing defeat to the Prius. The Prius has been enjoying constant sales of over 10,000 units a month, except during the time its production was affected by the earthquake. In stark contrast, sales of the Insight are less than 1,000 units.

The Civic Hybrid that underwent a full model change in 2011 is another complete failure, selling far less than 1,000 units per month as initially planned despite its expensive, high-power lithium ion batteries because performance-wise it is far inferior to the Prius.

Gaining power in the U.S. market by casting a scornful gaze at struggling Honda is Hyundai. Hyundai debuted its first hybrid model “Sonata Hybrid” this summer and received a spotlight when it sold more than all Honda hybrid cars combined. The Hyundai Group is increasing sales by using the high won-dollar exchange rate as a weapon, and closing in on Honda in total unit sales.

The size of unit sales is not the only concern of Honda in the big three industrialized markets. Another concern is the low-margin, high-volume sales structure where the majority of selling models are low-margin compact cars and luxury models that make sense to be manufactured in industrialized nations are not selling at all.

In the summer of 2010, a newspaper reported that Honda was “suspending the development of a new generation of its luxury car Legend” immediately before the mid-year press conference by the president. President Ito denied the report by saying it was “false” during the press conference, but the Legend (known as the Acura RL overseas) is suffering an extreme sales slump around the world, selling only 100 to 200 units a month even in the main battleground of the U.S. Given that sales are virtually zero in Europe and Japan, there is actually a call to shelve the model. “It makes no sense to include this model in the lineup. If we can’t make a truly good car, we might as well scrap it.” (President of Honda’s new car sales company)

Strong Rivals Appearing One after Another

The “Accord,” which is supposed to be fighting against Audis, BMWs and other middle-class luxury sedans, is suffering a terrible sales slump.

If the current situation continues, where only low-margin mass-market models are selling, Honda will have to stop producing in industrialized nations, although its brand name will probably survive. To prevent this from happening, Honda must go at making luxury cars again. However, there is little hope as “The top management has half given up, selfishly deciding that the era of luxury cars has passed.” (Source at Honda)

As for the battle in emerging countries, however, there is no guarantee that things will go smoothly as envisioned by Honda. Global auto giants such as Germany’s Volkswagen and the U.S’s GM and Ford are starting to introduce attractive low-cost models one after another by targeting emerging countries.

For example, the compact car “Up!” exhibited by Volkswagen at the Frankfurt Auto Show allows the manufacturer to build different models for industrialized countries and emerging countries by changing the quality of parts while maintaining the same shape. The new car even raised an alarm in one Toyota executive who said, “Given the fairly low cost, this car will be a tremendous threat in emerging countries.”
Having obtained a top-three share in China, Hyundai is also expected to enter the emerging markets by using the know-how of low-cost car development gained in China as a weapon. “ASEAN (Association of Southeast Asian Nations) countries are traditionally pro-Japan and the superiority of Japanese cars including Honda probably won’t change in the near future. However, European and U.S. manufacturers are gradually stepping up their offensive in other regions. If they gain momentum in these other regions and eventually enter Asia, we don’t know what will happen.” (Above executive from Toyota)

Honda was quick to introduce its emerging country strategy by actively attacking its strong segments. In a sense, however, the strategy is a way to “escape” from industrialized nations where Honda has been experiencing a series of failures in the high-margin luxury car business which is essential for any company operating in these countries.

If Honda remains too confident about its strengths, it may be forced to only defend itself when rivals that have been gradually gaining power eventually close in on the company’s stronghold. We anxiously wait Honda’s next move.

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