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Watanabe Risks Toyota Quality to Press Cost Cuts as Steel Rises



June 23 (Bloomberg) -- Toyota Motor Corp. President Katsuaki Watanabe's cost-cutting obsession began in 1964, when he oversaw the company's cafeteria. He reduced waste by polling workers on their favorite dishes and issuing tickets to track servings of curried rice.

``People thought it was strange that a guy was taking data in the kitchen,'' recalls Watanabe, 64, who took the helm of the world's most profitable carmaker a year ago today. ``There was so much waste, so I saw there was clearly room for improvement.''

That thrift has helped Toyota's shares rise almost 50 percent since Watanabe became president. With more spending reductions planned, he now risks compromising the top-rated quality that's helped Toyota gain on larger General Motors Corp., says investor Atsushi Osa. Rising steel and rubber prices also threaten four years of record profits.

``Watanabe has done a great job so far because he's put the company on track to boost production globally even as it cuts costs,'' says Osa, who helps oversee $4.1 billion at Sumitomo Mitsui Asset Management Co. in Tokyo and wouldn't disclose whether he owns Toyota shares. ``His challenge now will be to maintain Toyota's quality as rising costs force him to cut back even more.''

Under Watanabe's austerity campaign -- based on the concept of ``kaizen,'' Japanese for continuous improvement -- Toyota aims to reduce the cost of engines and related components by an average of 30 percent starting next year by reviewing designs and sharing parts among models.

Steel, Rubber Prices

At the same time, raw-material costs are squeezing profit margins. The price of iron ore, the key ingredient in steel, will rise 19 percent this year after a 72 percent surge in 2005, according to the benchmark set by Brazil's Cia. Vale do Rio Doce, the world's No. 1 iron ore exporter. Natural rubber prices on the Tokyo Commodities Exchange have risen 48 percent this year.

Such increases added more than 100 billion yen ($868 million) to costs in the year ended March 31, Senior Managing Director Takeshi Suzuki told reporters May 10 at Toyota's earnings press conference in Tokyo. He didn't provide details.

That's made it harder for Watanabe's austerity push to get results. Toyota reduced expenses by 130 billion yen in the year ended March 31, less than the 160 billion yen in savings it achieved during the previous year and the 230 billion yen it recorded two years earlier.

``The biggest risk ahead of us is higher material costs,'' Watanabe said at the news conference. ``What's important is that we plan, develop, produce and sell the best vehicles in the world while still cutting costs.''

Catching GM

Toyota shares have gained 48 percent to 5,870 yen in the 12 months since Watanabe took office, beating a 31 percent gain for the benchmark Nikkei 225 Stock Average. The stock has fallen 12 percent since April 13, tracking a decline in the Nikkei, on concern about rising oil prices and higher borrowing costs in the U.S., Japan's largest export market.

Toyota, the maker of the Camry sedan, the U.S.'s best- selling car, may overtake Detroit-based GM as the world's No. 1 automaker by sales as soon as this year, says Koji Endo, an analyst at Credit Suisse Group in Tokyo who rates Toyota shares ``outperform.''

So far, Watanabe has maintained the quality ratings that have helped Toyota grab market share from GM and Ford Motor Co. in the U.S., the company's biggest market. The carmaker dominated J.D. Power & Associates' annual consumer survey of automobile quality published this month.

Top-Ranked Quality

Toyota models such as the Corolla compact car, Lexus SC 430 luxury sedan and Highlander sport-utility vehicle topped more than half the categories in J.D. Power's Initial Quality Study, which measures design and production flaws in the first 90 days after sale. Toyota's Iwate assembly plant in Japan was the world's top-rated factory by the Westlake Village, California- based market researcher.

The company has led Consumer Reports magazine's annual list of the best new cars and trucks for the past decade. The company's models were the top pick 34 times between 1997 and 2006, beating Honda Motor Co.'s 27 and Ford's eight. The Highlander gasoline-electric hybrid SUV and hybrid Prius hatchback were chosen this year.

Even so, the relentless focus on costs may be resulting in production glitches, says Yasuhiro Matsumoto, an analyst at Shinsei Securities Co. in Tokyo.

He blames the strategy of sharing more parts among models for the October 2005 recall in Japan of 1.27 million vehicles, including Corollas and RAV4 SUVs, to fix defective headlights. It was Japan's biggest one-time recall.

Recalls

Last month, Toyota recalled 987,262 vehicles worldwide, including Corollas and Prius hybrids, because of defective steering shafts. That followed the October 2005 recall of 1.53 million Hilux Surf SUVs and LiteAce and Town Ace wagons to repair steering defects -- the automaker's biggest-ever international recall, says Toyota spokeswoman Ai Ishitoya.

``There's no doubt that the main reason for the big recalls is because Toyota is sharing parts,'' Matsumoto says. ``To a certain extent, it's inevitable.''

Watanabe himself says he's concerned about quality.

``Toyota's quality has made us what we are today, so we can't afford to let it slip,'' he said at the May 10 news conference. He said he planned to name a senior managing director in charge of vehicle quality, a new position, to avoid future mistakes.

In his latest savings campaign, Watanabe -- known to colleagues as Mr. Kaizen -- plans to group engines, brakes and steering systems into modules that eliminate unnecessary parts, and to simplify designs for components such as brakes and stereos.

`Big-Company Disease'

Toyota is redesigning the Corolla, its best-selling car, with 1.3 million sold worldwide last year, to make the engine block 30 percent cheaper. The same method may be extended to every new Toyota model starting next year.

Toyota previously redesigned molds for Camry engines, cutting their cost in half to $1,000 through a program Watanabe developed known as ``Simple Slim.''

In September 2005, Watanabe required the managing officers who report to Toyota's top 26 executives to start flying business class instead of first class on overseas trips, while lower- ranked managers and their deputies now fly economy instead of business on some flights, says Toyota spokeswoman Shiori Hashimoto.

``We have to get rid of the big-company disease,'' says Watanabe, who has never had a posting outside Japan.

He honed his focus on savings in 1995, when he was named general manager of corporate planning and supervised production, says Credit Suisse's Endo, who has covered Toyota for 20 years and usually meets one-on-one with Watanabe once a quarter.

1 Trillion Yen Saved

The yen had surged to an all-time high of 80 to the dollar, reducing the value of Toyota's overseas sales. Watanabe and other executives were charged with finding ways to streamline production and save money, Endo says.

They bought vehicles made by European and South Korean carmakers, disassembled them and examined every part to see if rivals were using components more efficiently. They found room for improvement, spurring Watanabe's push to reduce the number of parts that go into Toyota cars, says Endo, who has known Watanabe since 1992.

As head of purchasing, Watanabe achieved 1 trillion yen in savings from 2000 to 2005 by reviewing the cost of 173 components -- ranging from headlights to horns and steering wheels -- and sharing them among models.

``He invented a new way to cut costs,'' Endo says.

U.S. Gains

Toyota increased its U.S. market share to 15.8 percent last month from 10.4 percent five years earlier. During the same period, GM's share fell by 5.2 percentage points to 22.8 percent, and No. 2 Ford's dropped 3.4 points to 18.6 percent.

As Toyota expands further, Watanabe can't take high quality ratings for granted, says Norihito Kanai, a Tokyo-based analyst at Meiji Dresdner Asset Management Co., which oversees $2.5 billion in equities and doesn't disclose specific holdings.

``Toyota will need to pay more attention to quality because it's embarking on its biggest global expansion at a time when it has to cut costs,'' Kanai says. He says he doesn't expect Toyota's ratings to slip because Watanabe has proven he can reduce spending without compromising quality.

Watanabe, whose father came from a wealthy landowning family in Toyota City, joined the company in 1964 after earning a degree from Tokyo's Keio University, where he was a tenor in the university choir. A father of three adult daughters, he has headed departments ranging from procurement and business planning to public relations.

Karaoke Singer

In 1996, he was assigned to run the Motomachi plant near Toyota headquarters. He says he split workers into teams of five to 10 that were graded on their performance in areas such as avoiding accidents and keeping the factory clean. He set a target for each team to raise its ranking by one notch within a year, and personally checked on their progress.

A former Nagoya Philharmonic Orchestra president who enjoys singing Japanese folk songs on karaoke, Watanabe practices hands- on leadership that motivates employees to meet his targets, says Shin Kanada, a senior managing director whose duties include government relations.

``Watanabe has been very proactive,'' Kanada says. ``He always wants to know where the plan is, and if we say it's on schedule to be completed next month, he'll ask, `Why not this month?'''

Watanabe has also fostered better communication with his managers than his predecessor, Fujio Cho, who became vice chairman last year after six years as president.

Faster Decisions

He holds monthly meetings with Toyota's eight executive vice presidents, who oversee areas ranging from the company's China unit to quality control, says Executive Vice President Takeshi Uchiyamada, who heads production. Cho, 69, didn't hold such meetings.

``Everyone says what they want to say,'' Uchiyamada says. ``The speed of decision-making has become much faster because it used to take a lot longer for issues to be reported to top management.''

Department heads are encouraged to criticize each other's performance so they can discuss how to solve problems, Uchiyamada says. Watanabe keeps his mobile phone turned on and always answers colleagues' calls, according to Kanada.

Credit Suisse's Endo says Toyota's leader may struggle to replicate his first year's performance in the coming year.

``This will be a challenging year for Watanabe,'' Endo says. ``He'll have to show that Toyota can absorb rising raw-material costs without letting quality decline.''


Last Updated: June 22, 2006 17:03 EDT
 
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