Toyota's European Operating Exposure - Case Study Example

Toyotas European Operating Exposure Table of Contents Introduction 3 Toyota’s Need for extending its operations for Europe Market 3 Implications of GBP joining the European Monetary Union 7 Problems facing TMEM and solutions 9 Short term problems 10 Long Term Problems 10 Recommendation 12 The measures that can be recommended for Toyota Europe in resolving the issues of the continuous increase in the operating loss of the company is that Toyota have agreed to continue with its operating loss in Europe and transfer its market share profit and goals above the margin and then considering on the aspects of continuing with the present operating and pricing policy of the company. The value of euro has fallen significantly against the Japanese Yen and British pound but it has improved its situation in the present scenario since Euro have been able to increase its value to some extent as compared to the previous years (Hampson, 1999). 12 Conclusion 14 References 15 Bibliography 18 Introduction The operating losses of Toyota in Europe in the year 2009 have risen to around 9.9 billion yen and the loss was due to the operating exposure of Toyota which was due to the change in the value of euro in consideration with the Japanese Yen. Toyota has already faced significant loss within Europe for their sales due to the change in the value of euro. Toyota operates in the automobile industry and it is very capital extensive in nature. It is considering on the economies of scale. Toyota sold only 26% of its cars in Europe which was manufactured in Europe and it is considered as the second largest foreign market for Europe. The sales of Toyota in European market are considered as second largest as compared to North America. Toyota has waited for longer period of time in moving and transferring its manufacturing in Europe. Toyota’s Need for extending its operations for Europe Market Toyota’s manufacturing in Europe was the second largest in size of market after North America. North America production facilities accounted for more than 60% of its total sales unlike in Europe where it accounted for 25%; the rest was imported from Japan in 2000-2001. TMEM incurred operating losses to the tune of ¥9.897 billion, owing to the depreciating euro. The rising yen added to TMEM’s operating loss. 75% of its total Europe sales were imported from Toyota Japan. Its cash flow margin started to fall owing to its high import bill. Its cash flow position worsened for the period 1999 to 2001. The exchange rate stood at ¥110/€ throughout 2001. Prior to 2001 euro weakened and witnessed a continuous fall till 2001, when it stabilized (Srivastava, 2008). Figure 1: TMEM flow of business operation The above figure represents the flow of business operations of TMEM. TMEM imported value added automobile components and manufactured cars from Toyota Japan that stood at 74% of the total European sales while the rest was manufactured in its European production facilities in UK, Portugal and Turkey. The production facilities in Europe imported component parts from Japan that added to its transfer pricing problems. The rising yen led to low competitive advantage as Toyota Europe had to import at a higher price and still defend its Europe Market. Its competitive pricing resulted in high operating loss for the period 1999 to 2000 (Eiteman, 2007). Figure 2: Japanese Yen per Euro 1999 - 2001. Figure 3: GBP per euro 1999-2001. The above figures are representative of the spot exchange rate of Japanese yen per euro and British pound per euro for the period 1999 to 2001. From 1999 onwards euro started to fall against the Yen and GBP widened its operating loss. It was difficult for Toyota to immediately correct its operating loss as it was a negative externality that affected its cash flow position. It waited till the Euro adjusted with Yen and GBP. It was not possible for Toyota Europe to start local production of automobile components and build facilities to support its European sales as this would require substantial time (Kazmi, 2008). It was difficult for Toyota to build new manufacturing facilities in its second largest automobile market i.e. Europe in a span of one to two years time. It waited for the exchange rate to adjust itself so as to recover the already incurred loss. Though eventually it recovered as the Yen per Euro stabilized at 110 in 2001, still GBP per Euro was rising at a slow rate (Liker, and Franz, 2011). TMEM was also dependent on Toyota UK for its intermediate components that was used in the European manufacturing facilities. It had two plants one in Turkey and the other in Portugal. Eventually Toyota built its new plant in France in 2001, owing to the rising demand of its new model ‘Yards’. It was rolled out in the year 2000 and accounted for the sale of 180000 units in the same year. The emerging market for Yards in Europe gave Toyota an incentive to build its production facility in France. This move was also taken by Toyota to prevent further loss in its operations. Though the loss margin could not be eliminated totally, but it managed to reduce it as it still had to import value added components from UK and Japan (McFarlin and Sweeney, 2014). The currency exposure was the main problem that led to the delay in moving its manufacturing facilities in Europe. It would not be wise for Toyota Europe to set up new production facilities as it would halt the current productions. In order to continue its current business operations in Europe it also started to build its manufacturing plant in France. Moreover it was the problem of transaction exposure that was facing Toyota Europe. Owing to the stabilization of the exchange rate, Toyota planned to increase its European sales from 634000 to 800000 by 2005. It also rolled out plans to increase its manufacturing capacity and expand its operational facilities by 25% (Bowhill, 2008). Toyota was left with no option other than wait for the currency rate to correct for itself; else it would result in high losses which were to be capitalized, resulting in lower profit margins. Toyota Europe was well aware of its current dilemma and thus it made a press release where it mentioned about its decreasing profitability that resulted from rising Yen and British Pound (Kenʼichi, 2005). Implications of GBP joining the European Monetary Union Toyota Europe faced exchange rate risk that led to high operating loss for the period 1999 to 2000. The rising Yen and GBP against the Euro led to decreasing cash flows of TMEM that reduced its profitability. Toyota Europe, a subsidiary of Toyota Japan used to import manufactured cars and automobile components from Japan and UK to meet the demand of the European market. 76% of total Europe auto sales were contributed by importing manufactured cars from Japan. Though the Euro stabilized against the Yen in 2001 and stood at ¥110/€, still it was weak against the GBP (Basu and Miroshnik, 2000). The exchange rate stabilization of the Yen did help Toyota to bridge its cash flow gap, but the weak Euro against the GBP added to its problem as it was dependent on its UK facility for intermediate auto parts. If GBP were to join the European Monetary Union, it would allow Toyota Europe to gain competitive cost advantage as it would reduce the exchange rate differential. This would reduce not only the imported component part but also the final price of its product (Hiriyappa, 2013). Though Toyota Europe imports are highly dependent on the price of Yen, still GBP joining the European Monetary Union would positively impact its cost of production in various ways. It would allow free flow of capital and labor, reduce transaction costs, reduce exchange rate risk and reduce adjustment pressure. From the above though capital and labor mobility would help Toyota in reducing its high cost of capital and labor owing to uniform or pegged exchange rate. It would allow Toyota to sell its products in UK market as well as import value added components at comparable rates (Kolb and Overdahl, 2009). Supply of low cost labor across UK and Europe would also benefit Toyota from procuring skilled labor at competitive cost. The advantage of labor and capital mobility will have less impact on its problem of operating losses, but transaction costs, exchange rate risk and adjustment pressure would directly benefit the company in mitigating its problem of rising GBP. Transaction cost would be reduced to a great extent as Toyota Europe depends on Toyota UK for intermediate component parts for final production. Weak Euro against the GBP would increase its cost of production, resulting in reduced profit margin. Having a uniform currency i.e. if GBP would join the European Monetary Union, Toyota would then import auto parts at the same rate if it produced the same in Europe (Hill and Jones, 2007). It would not have to create provisions and hedge against exchange rate risk, unlike under flexible exchange rate system where it would have to make provisions for the rate differential i.e. weak or strong euro. Though Toyota Europe would enjoy competitive advantage to a certain extent as mentioned above, still much of its problems would still persist as its major imports of automobiles and component parts were made from Japan. Thus, GBP joining the European Monetary Union would help reduce Toyota’s operating loss by a small margin, but will not help it to eliminate it completely (Rochon and Rossi, 2006). The integration of GBP and Euro is quite unlikely owing to various inherent challenges. Both the markets have different characteristics, business cycles, business verticals, and quality of labor, fiscal and monetary policies. Monetary integration is highly dependent on the product market for UK based companies. Currency integration is dependent on the number of countries in a continent. GBP joining the monetary union would not benefit UK to that extent unlike Europe which will benefit European companies from greater cost advantage. A monetary union is most likely between countries which witness extensive trade. Its aim is to reduce the transaction cost between these nations. European countries experience more trade amongst its neighboring nations than in UK (Henry, 2011). This prohibits GBP from joining the European Monetary Union. The monetary and fiscal policies also greatly differ between UK and Europe. The interest rate policy of Europe is inappropriate for UK owing to the housing structure and income level. UK mostly uses variable rate mortgages to finance the housing sector which is quite different from the European rate financing. It would be beneficial for considering inclusive currency when countries in the union have identical economies in respect to its trade whether it is import dependent or export dependent (Donald, Waters and Waters, 2006). The GDP growth and inflation rate is another critical factor that influences the formation of monetary union. Various Foreign Institutional Investors take advantage of the currency fluctuations to arbitrage their earnings. Foreign exchange is nowadays considered to be an alternative investment class, thus currency integration would eliminate the opportunity for the FIIs to clock high returns. FIIs positively and negatively affect an economy in which it trades (Baldwin, Skudelny and Taglioni, 2005). Problems facing TMEM and solutions For Toyota Europe, I would categorize the problems facing it on the basis of external and internal factors. TMEM faces internal problem of increasing its operational capacity to meet its local demand. The global imports of manufactured automobiles and spare parts account for 76% of Europe sales. This influences high levels of transactional costs for TMEM which reduces its competitive advantage. Externally it was exposed to exchange rate risk that affected its cash flow position. It incurred ¥9.897 billion operating loss for the period 1999-2001. The Japanese Yen and GBP rising against the Euro further aggravated the problem. Its operating loss margin widened. I strongly feel that owing to lack of hedging against the rising Yen and GBP has led to high operating loss for TMEM that corroded its earnings. It could have used derivatives like forwards and future contracts with Toyota Japan to minimize the impact of rising Yen against the Euro (LiPuma and Lee, 2004). Currency swaps or back to back loans would also result in reducing the exchange rate risk that resulted in such operating loss (Porter, 2008). With the help of back to back loans the company would share either currency for a specified period and a specified rate. At the end of the period the currencies would be swapped back, thus giving the borrowing company i.e. Toyota Europe the leverage when the Yen and GBP rose (Wintzer, 2007). As for its internal problems, it requires domestic internal facilities that would reduce the dependency on the imports from Toyota Japan. It should focus more on local procurement and producing intermediate auto parts that would aim to eliminate the currency risk (McIvor, 2005). Short term problems TMEM in the short term was exposed to the exchange rate risk where the rising Yen and GBP weakened the Euro, making Toyota Europe’s imports of intermediate components and automobiles dearer. Following the currency fluctuation TMEM witnessed deteriorating cash flows that affected its overall profitability. It could not eliminate the exchange rate risk totally, but had to eventually absorb the shocks that further aggravated its operating margin. It had to wait till the Yen corrected itself. As witnessed in 2001, when the Yen stabilized at ¥110/€ the operating loss was reduced as compared to its earlier levels. Long Term Problems The value of euro have fell simultaneously and continuously as compared to British pound and yen , the amount of profit have reduced and the flow of cash into the business have decreased significantly which creates a situation in which Toyota finds itself very hard in remaining competitive. Toyota manufacturing strategy has created a long term problem (Amasaka, 2002). The British associated with the European Monetary union have eliminated the currency risk that have existed between Europe and UK but not the risk between Europe and Japan. The North American operation of Toyota has been transferred to the manufacturing sector of North America. The current decision for manufacturing a new European product was targeted for production of the car named as Yars in Japan. But this strategy did not seem to be a good strategy since it will adversely affect the exchange rate movements and the fall in the value of euro have adversely affected as there was a percentage change in the value of euro between the periods of January 1999 to the period of July 2000.Toyota has created constraint in the movement of its manufacturing units into the regional and the local markets (Daisuke, 2010). Toyota has experienced no profit since last two years which affected its productivity and the operating loss of the company have increased to a high level. The assembly of the parts was made in Japan but expensive value added in UK. The decrease in the value of euro against both Japanese yen and British pound has lead to the generation of long term problem of remaining competitive in the market (Fang and Kleiner, 2003). Recommendation The measures that can be recommended for Toyota Europe in resolving the issues of the continuous increase in the operating loss of the company is that Toyota have agreed to continue with its operating loss in Europe and transfer its market share profit and goals above the margin and then considering on the aspects of continuing with the present operating and pricing policy of the company. The value of euro has fallen significantly against the Japanese Yen and British pound but it has improved its situation in the present scenario since Euro have been able to increase its value to some extent as compared to the previous years (Hampson, 1999). The British establishing its relationship with the European Monetary Union have eliminated the currency risk that existed between Europe and UK and now since UK have joined the European Monetary Union therefore it will reduce or eliminate the variation in the currency between Euro and British pound. The other measures that can be adopted is that Toyota can adopt a strategy of continuously absorbing its Yen based increase or rise in the cost by selling it in Europe at a lower margin by taking into assumption that the market will not be able to bear the change or the movement in the exchange rate in case of the medium and long term sales. Toyota is required to move its content of the automobile industry into the manufacturing operations that existed within the European Monetary union and not within the United Kingdom (Muffatto, 1999). The significant operations of Toyota have created a problem and the problem will continue to exist for the time period in which UK will stay away from the European Monetary Union. The value of the pound when measured and a valued against Euro on the basis of the rate of stability it has been observed that the rate was found to be changed in the period between 2000 and 2001 which did not signify or indicated well for the operations or the manufacturing that was carried out in UK and sold in European market. In order to mitigate its fluctuations in the exchange rate Toyota since it is a big automobile manufacturing company operating throughout the world has to adopt the strategy that is mostly adopted by the big manufacturing company. Toyota is required to consider on transferring its cost structure and manufacturing business within the European Monetary Union and not considering or transferring in UK as well as in Japan. Toyota is also required to focus on its suppliers in order to settle all its bills that are related to the minimization of currency in case of risk exposure and therefore assessment of the rate of exposure is required to be stable and constant which will facilitate the investors or the business in minimizing the loss of Toyota. Toyota is required to measure and recognize the change or the verification in the value of the currency that has resulted from the changes in the future operating cash flow of the company that has been caused due to the unexpected change or modification in the exchange rate of the company. The operating exposure is measured in terms of the potentiality and profitability of the company and it affects the market value, net cash flow of Toyota due to the change or fluctuations in the exchange rate movement. The operating exposure measurement is required to be adopted by Toyota since it affects the competitive position of Toyota and the effect or the fluctuations in the movement of the exchange rate generally affects the competitive advantage of the company which is very difficult to measure. Since the operating exposure contributes for a large part in the total exposure of the company. Toyota is required to manage its operating exposure risk that is required to manage and measure its future cash flow exposure as well as it is required to deal with its liability exposure. Toyota can also focus on introducing and establishing new divisions for managing its economic as well as its foreign exchange risk and it is required to diversify its operations and it can also select low cost production or manufacturing sites The Company is required to utilize its cash flow for minimizing the difference in the cash flow of the assets and liabilities and the forecasted changes that have occurred due to the fluctuations in the exchange rate. Conclusion Toyota is considered as one of the largest automobile industry of the world and the process of manufacturing that is carried out by Toyota is very complex and critical and it is engaged in capital intensive industry. As most of the automobile industry desires to carry out its operation by enjoying economies scale, Toyota also wishes to enjoy economies of scale in its manufacturing and production of Toyota and therefore it has shifted its manufacturing from the local and regional market. But the problem that was encountered by Toyota in its manufacturing process due to fluctuations in currency therefore Toyota is required to adopt the strategy of operating exposure management in which it can anticipate by influencing the change in the exchange rate that is expected in the future and also the unexpected change in the exchange rate of Toyota on the future cash flow. Toyota is required to focus on the strategy in such a way that it can improve its profitability and growth trend in the future period of time. References Baldwin, R., Skudelny, F., and Taglioni, D., 2005. Trade Effects of the Euro: Evidence from Sectoral Data. ECB Working paper Series. Basu, R.D. and Miroshnik, V., 2000. Japanese Foreign Investments, 1970-1998: Perspectives and Analyses. USA: M.E. Sharpe. Bowhill, B., 2008. Business Planning and Control: Integrating Accounting, Strategy, and People. London: John Wiley and Sons. Donald, C., Waters, J. and Waters, D. 2006. Operations Strategy. 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