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Monday, March 15, 2010

The Humbling of Toyota

Business Week

A combination of high-speed global growth and ambitious cost cuts led to the quality lapses that have tarnished the once-mighty brand. How it all went wrong

Toyota Motor has always been fanatical about frugality, and for many years that was good for both the company and its customers. This is a Japanese carmaker that routinely turned down the heat at its employee dormitories during working hours and labeled photocopy machines with the cost per copy to discourage overuse. Its engineers collaborated with suppliers to extract cost-savings without compromising quality. Yet by the middle of the last decade Toyota's virtue had become a vice.

So say current and former auto executives who are trying to grasp how Toyota, with its gold-plated reputation for engineering excellence, slipped up on such a scale, with 8 million cars recalled due to mechanical failures linked by U.S. regulators to 51 deaths. Before company officials knew that runaway acceleration was causing crashes, one of these executives says, a simple manufacturing process would sometimes ignite small fires in a component as a direct result of corner-cutting. It was just one early sign that the focus on cost reduction had gone too far.

Those production mishaps occurred in 2006, a year after company President Katsuaki Watanabe boasted about having squeezed more than $10 billion from global operating costs in the previous six years—this despite an impressive run of profit growth and global market share gains in the middle of the last decade. Then Toyota pushed even harder for more cuts. It asked suppliers to design parts for its Camry midsize sedan that were 10% cheaper and 10% lighter. The company's top U.S. executive, Jim Press, warned his bosses in Japan that vehicle quality was slipping, according to a slide presentation U.S. Senate investigators unearthed in their sudden-acceleration probe. But his warning had no apparent effect.

The redesigned Camry brought out in 2006 had an embarrassing flaw in its headliner, the fabric and composite lining that covers the inside roof of the car. Under pressure to cut costs, the lead Camry supplier, Toyota-affiliated Toyota Boshoku, chose a carbon fiber material that hadn't been approved by Toyota engineers, according to an executive who worked on the redesign. The headliner is made by compressing layers of materials together using a certain amount of heat to mold it. In this case, the carbon fiber required so much heat that the headliner would catch fire.

Toyota fixed that problem, but when a North American parts supplier interested in working with the automaker did a teardown of a 2007 Camry, its engineers were surprised by how much the traditional Toyota craftsmanship had been watered down by years of nips and tucks. The padding in the ceiling of the car, though compliant with safety regulations, had been thinned out to save money. A tray for sunglasses used a flimsier type of plastic than previous models. "It was a bare-bones car at that point," says one executive who declined to be identified for fear of harming business ties with Toyota.

Toyota insists its focus on cost hasn't hurt consumers. "It's not true that by reducing cost you automatically reduce quality," said Jim Wiseman, Toyota's vice-president for North American corporate communications. "Every automaker has to stay competitive relative to price."

True, but probably not with the intensity Toyota brought to cost-cutting and rapid expansion under three successive presidents: Hiroshi Okuda (1995-1999), Fujio Cho (1999-2005), and Watanabe (2005 to 2009). Toyota executives will spend years mopping up after their mess.

At last count, the company faced 109 class actions and 32 individual cases filed in courts in the U.S. and Canada. (In a well-publicized incident on Mar. 8, the owner of a 2008 Prius lost control of his car on a California interstate highway and had to be rescued by police.)

As grave as the current troubles are, they are symptomatic of a larger problem at Toyota: It got carried away chasing high-speed growth, market share, and productivity gains year in and year out. All that slowly dulled the commitment to quality embedded in Toyota's corporate culture.

"The root cause of their problems is that the company was hijacked, some years ago, by anti-[Toyoda] family, financially oriented pirates," Press charged in a recent interview with Bloomberg News. Once the highest-ranking American at the company, with a seat on the board of directors, Press left in 2007 to join Chrysler as vice-chairman and president, but departed from there after last year's bankruptcy. The financial pirates, he said, "didn't have the character necessary to maintain a customer-first focus."

The embodiment of character at Toyota, as any new engineering hire there learns, is a man named Taiichi Ohno, the innovator widely credited as the genius behind the Toyota Production System. With a handful of other executives during the 1950s, Ohno developed a set of in-house precepts on carmaking efficiency that later evolved into such concepts as lean manufacturing and just-in-time inventory management. Ohno's ideas not only changed the auto industry, they changed late-20th-century manufacturing. At their core was an attention to detail and a noble frugality that shunned waste of every kind. As Ohno's concepts were handed down to successive generations of Toyota executives, however, the purity of the message appears to have been slowly lost.

The traditions of the company began to change in 1995 when family elders, led by then-Chairman Shoichiro Toyoda, tapped Okuda to take over the company from 68-year-old Tatsuro Toyoda, who had been waylaid by a stroke. The company was widely thought to have lost its edge, and Okuda (a black belt in judo) was just the sort of hard-charger to help get it back.

In jobs ranging from accounting and purchasing to international and domestic sales, he was a nonstop manager who liked to test-drive every Toyota under development. He also could be impolitic. In 1995, Okuda called his Detroit rivals "stupid" for trying to import bulky cars ill suited to Japan's narrow side streets.

Toyota needed Okuda's in-your-face approach. Glacial decision-making and poor execution were resulting in major mistakes. Toyota stuck with conservatively styled sedans when everybody in the U.S. and Japan wanted the more daring, off-road stuff. It also botched some key product launches. It introduced the T100 truck in the U.S. with an underpowered engine, and a 1995 redesign of the Corolla for the Japanese market fell flat.

Okuda and his team started turning things around on the product front while embarking on one of the most aggressive overseas expansions in automotive history. Between 1995 and the end of 2009, Toyota roughly doubled, to 50, the number of overseas plants and manufacturing facilities in North America, Asia, and Europe in a bid to improve its market responsiveness and sidestep potential trade disputes about car exports from Japan. This coincided with a massive product rollout that penetrated new categories ranging from the boxy Scion xB to the one-ton Tundra pickup to the hybrid Prius compact. In the U.S., Toyota gained market share at "a kind of speed no other carmaker has ever experienced in the past," said Koji Endo, an analyst with Advanced Research Japan in Tokyo.

By the late 1990s the Corolla sedan and the 4Runner and RAV4 sport-utility offerings were all selling well, and plans were under way to invade Detroit's cash-cow minivan and large pickup truck categories. In the all-important North American market, Okuda spent big to double total vehicle capacity, to 1.2 million units, by 1998. To launch the Sienna minivan, he expanded capacity at Toyota's Georgetown (Ky.) plant, already the production base for its Camry and Avalon sedans.

Early in Okuda's tenure as president there was a lot of talk about grabbing a 10% share of the global auto market. By the time he moved up to the chairman's job in 1999 to make way for Cho, the goal was 15%. Cho was less flamboyant than Okuda and studied law at the prestigious University of Tokyo. Yet early in his career Cho became fascinated with the Toyota Production System and mastered its best practices. (He put that knowledge to use in 1988, supervising the launch of the Georgetown plant.) Cho often talked about the "criticality of speed" in product development cycles and the importance of responding to changes in the marketplace. Ohno's precepts were beginning to morph into something he might not have recognized.

By 2003 a lot of things were going right at Toyota. Profits were booming, and in November of that year it enjoyed a market capitalization of $110 billion—more than that of GM, Ford, and DaimlerChrysler combined. (Today, despite its troubles, Toyota is valued at $132 billion.) In the U.S. it had finally pieced together a strong lineup of high-margin SUVs, once the profit sanctuary of U.S. automakers, ranging from the $19,000 RAV4 to the $65,000 Lexus LX470. Meanwhile, the Prius was starting to take off, creating mass market interest in eco-friendly cars.

At the same time, Cho, Okuda, and other top executives were pushing ahead with a program dubbed CCC21 ("Construction of Cost Competitiveness for the 21st Century") that had been started in 1998. In implementing CCC21, no detail was too small. For instance, Toyota designers took a close look at the grip handles mounted above the door inside most cars. By working with suppliers they managed to cut the number of parts to five from 34, which helped cut procurement costs by 40%. The change slashed the time needed for installation by 75%—to three seconds. "The pressure is on to cut costs at every stage," Takashi Araki, a project manager at parts maker and Toyota affiliate Aisin Seiki, told BusinessWeek at the time.

By mid-decade, when Watanabe, a trained economist, became president, Toyota had incredible numbers to share with Wall Street analysts. On the job as Toyota's chief executive for less than three months, Watanabe told New York's financial community at a Sept. 12, 2005, meeting in Manhattan that CCC21 had wrung out more than $10 billion in savings over six years. "Under CCC21 activities, which I led, Toyota realized cost reductions of more than 200 billion yen ($2.2 billion) a year on a consolidated basis," he said.

It wasn't enough. Next up was what he called an "aggressive version of CCC21," dubbed Value Innovation, which promised more savings by making the entire development process cheaper and faster, further trimming parts, production costs, and time to market. Toyota had managed to slash the time it took to bring models into production once a design was final to about 12 months, compared with an industry average of between 24 and 36 months.

A credit bubble and soaring home prices in the U.S. had Americans buying Camrys and Lexus SUVs in droves. Toyota raked in $55 billion in operating income during its fiscal years running from 2006 to 2008. Shares traded in Tokyo (Toyota also has stock listed in New York and London) shot up 112% from mid-2005 to February of 2007.

Yet during these hyperspeed growth years there were signs of trouble. That's when Press, Toyota Motor's top U.S. executive, warned his bosses that quality was slipping and that regulators were stepping up scrutiny.

Reports of more serious problems started to get the attention of U.S. regulators far earlier in the decade. The National Highway Traffic Safety Administration opened eight investigations of unintended acceleration of Toyota vehicles from 2003 to 2010, according to Safety Research & Strategies, a Rehoboth (Mass.) group that gathers data from NHTSA and other sources for plaintiff's attorneys and consumers, though the carmaker's problems only became widely known to the public this year.

Toyota's fortunes, and that of the entire industry, took a nasty turn starting in late 2007 as the financial crisis hit and oil prices spiked to $145 per barrel in July of 2008—a combination that brought on the global recession that later pushed GM and Chrysler into bankruptcy. Last September, at a meeting with Toyota investors in Tokyo, Akio Toyoda, who succeeded Watanabe in June 2009, said an annual goal had been to boost global sales by as many as 700,000 vehicles a year, more than three times the previous increase, according to a former executive who attended the gathering. The accelerated production had outstripped the abilities of company engineers and led Toyota to outsource more development work to suppliers.

On Feb. 24 of this year, the grandson of company founder Kiichiro Toyoda said during testimony before a congressional committee: "I fear the pace at which we have grown may have been too quick....Priorities became confused, and we were not able to stop, think, and make improvements as much as we were able to before."

Toyoda and other top executives have vowed to fix the sudden-acceleration problems and other quality lapses that have surfaced in so many of its models. In a bid to win back customers, Toyota is offering incentives such as no-interest loans and discounted leases, which may reignite sales. Still, Toyoda and his team will be spending many months trying to absorb a painful lesson about what happens to a great company when ambition gets too far ahead of tradition.