Tough Times for Japanese Component Manufacturers

Since the first half of this year, Japanese parts companies have been under unprecedented pressure, both from large parts companies that have long served automakers such as Toyota and Honda, and from smaller Tier 2 suppliers, who are experiencing huge pressure on revenues and costs. This is a difficult time for Japanese parts companies and another inflection point in the reshuffling and reshaping of the entire industry.

Shizuoka Prefecture, which has the highest concentration of auto parts companies in Japan, has been the site of a statistic by the Shizuoka Institute of Economic Research that the supply of auto parts here accounted for more than half of all Japan's territory in 2018, serving customers from almost all of the car manufacturers in the East.

After World War II, Shizuoka's parts industry boomed, with the coastal city of Hamamatsu spawning well-known companies such as Yamaha, Honda, and Suzuki. It was only a few years ago that the Shizuoka government realized that an electric revolution was coming and they set up the Future-oriented Automotive Research Institute to support local manufacturers in their transition to electric vehicle components.

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"We need to wake up the majority."

The head of the institute, Eiji Motsuki, had told Bloomberg in an interview six months ago that long before the Japanese government announced the carbon neutral timeline, they had realized that the sudden change in the industry was in fact wrapped in a crisis. There were already large component companies that were ahead of the game, but the majority of small and medium-sized local manufacturers were still asleep at the wheel.

Easier said than done.

Many of the small and medium-sized suppliers are in fact making very small profits, and it is difficult for them to have enough capital to make the transition or to cope with the risks if they encounter external uncertainties. This is inextricably linked to the sourcing strategies of Japanese customers, whose powerful automakers have become accustomed to pressuring upstream component suppliers to lower their purchase prices and demand the same quality and yield guarantees.

Tough Times for Japanese Component Manufacturers

Management consultancy Arthur D. Little predicts that as many as 300,000 jobs could disappear in Japan if the auto industry moves to electric vehicles across the board, equivalent to around 10% of all current auto-related jobs.

According to the Tokyo Institute of Commerce and Industry, there are currently around 7,500 Tier 1 suppliers and 15,000 Tier 2 suppliers in Japan. The next step in the change and fracturing of the entire industry, with layoffs and manpower reductions, will gradually trickle down to parts suppliers.

Since the first half of this year, Japanese parts companies have been under unprecedented pressure, both from large parts companies that have long served automakers such as Toyota and Honda and from smaller Tier 2 suppliers, who are experiencing huge pressure on revenues and costs. This is a difficult time for Japanese parts companies and another inflection point in the reshuffling and reshaping of the entire industry.

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01 Electronic Components: Increased Risk of Inventory Inflation

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The Nihon Keizai Shimbun recently conducted a statistical survey of eight major parts companies, including Murata Manufacturing, Nidec, TDK, and Nitto Denko, and found that inventory assets for April-June 2022 have reached 3.1 times sales and that the entire inventory of Japanese electronics parts companies, as a whole, is in a serious state of backlog.

A value of 3.1 times is not a good sign, and this is the first time in the past two years that ending inventory assets have exceeded the April-June 2020 period (2.9 months) when demand plummeted due to the new crown epidemic. In addition to the blockade in Shanghai, China, and other places due to the Omicron virus, slowing smartphone shipments and restricted car production have also suffered headwinds.

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Murata Manufacturing has now reduced its start-up rate, and these companies may face a deep production adjustment if final demand continues to slow.

The April-June financial reports of these eight parts makers have also come out recently, with cumulative sales up only 2% from January to March, compared to a 17% increase in inventory assets, 2.7 trillion yen (equivalent to 136.6 billion yuan) from a year earlier.

A major factor in the inventory buildup was the lockdown in Shanghai and other places due to the Omicron virus and the city lockdown. Japanese manufacturer Alps Alpine (ALPSALPINE), which produces electronic components and in-vehicle information equipment, and its director Tetsuya Kodaira analyzed the supply of automotive parts, saying that the shortage of packaging controls and semiconductors had led to a reduction in the production of new vehicles and that the company had also made substantial losses, excluding the impact of exchange rates.

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On one side, the supply chain level shortage is still intensifying, the Russia-Ukraine conflict, the new crown epidemic and rising prices of raw materials are the main factors; on the other side is the economic downturn, the long-term sluggish demand level, the deceleration rate is larger mainly smartphones, computers PC and other products.

U.S. research firm IDC made estimates, that global smartphone shipments in April-June than the same period last year fell 8.7%, the U.S. research firm IDC's estimates show that global shipments of smartphones in the April-June quarter than the same period last year fell 8.7%, PC decline of up to 15.3%.

Under normal circumstances, July to September is a critical period for Japanese component manufacturers to kick into high gear and go all out for the year-end business battle, but in the midst of the economic downturn, component production has slowed significantly this year.

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Market demand in the second half of the year will have a direct impact on the survival of component manufacturers. The most important concerns around supply and demand in the coming months are the new Apple mobile phones that will be launched this autumn and the expected boost in new car consumption. If there is a new wave of production in the second half of the year, it will also be a long drought for parts suppliers.

If you compare them side-by-side, Apple's smartphone shipments are more robust than those of other brands, with Hong Kong-based research firm Counterpoint showing that Apple's April-June shipments were only 5% lower than the same period the previous year. However, it is difficult to judge whether the new products coming to market in the second half of the year will be able to replicate the success of the past, against the backdrop of a continued rise in unit prices.

Tough Times for Japanese Component Manufacturers

On the other hand, the global new car market has slowly recovered, although production of cars is still constrained and capacity cuts by manufacturers such as Toyota continue. TDK, a supplier of automotive electronics, has reported that its orders have recently started to slowly increase.

In recent years, the electronics components industry has worked to reshape its product mix, flexibly adjusting its supply to the home appliance, PC, smartphone, and automotive sectors. In a climate of slowing growth in the PC and smartphone business, more and more suppliers are targeting new business areas such as electric vehicles.

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02 Auto Parts: Denso and Aisin Seiki Lead Declines

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Recently, Denso, Toyota's largest parts supplier, released its results for the first fiscal quarter (April-June) of FY2022, with profits falling by as much as 41%.

Due to the continued impact of the semiconductor chip shortage and New Crown Pneumonia, coupled with rising raw material prices and high logistics costs, major customers such as Toyota will see a reduction in production. On this basis, Denso's forecast net profit for the fiscal year 2022 (April 2022-March 2023) is expected to achieve 378 billion yen, a downward revision of 56 billion yen, and a 43% year-on-year increase.

Denso director Yasushi Matsui revealed that their automotive customers will all experience varying degrees of production reduction difficulties this year because of chip shortages and difficulties in parts supply due to the Shanghai epidemic blockade. Denso had previously expected that orders would be reduced by around 5% per month, but actual production, which fed into the April-June period, fell by around 22%.

Pressure on the supply chain side may ease in the second half of the year, but the business performance from April-June shows that orders will also decline by around 10% from July to September. Director Yu Nishida of Tokai Rikka recalled that customer orders were down by around 20% from the original plan, particularly for Toyota, which produced 2.12 million units globally in April-June, down 6% from the same period last year.

Of course, the fall in the profit dimension was also related to the rise in logistics and raw material costs. Denso achieved cumulative sales of 1.41 trillion yen in the last fiscal quarter, up 4.3% year-on-year and a record high. However, because of the depreciation of the yen, as well as higher raw material prices and logistics costs, operating profit fell 40% to ¥63.6 billion in the April-June period.

Also recently, a number of Toyota's component suppliers have been releasing their latest financial results for the last quarter, and with the exception of Toyota Tsusho, all of the companies have reported more severe quarterly losses than in the same period last year. Several companies, including Aisin Seiki, Toyota Boshoku, Toyota Synthetic, and Toyota Auto Loom, saw their profits fall in the April-June quarter.

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Shinichi Iwamori, director of Toyota Boshoku, admits that the company is struggling at this stage to maintain employment and cope with the reduction in production by its customers. Once the automaker suddenly reduces the production of new vehicles, they as suppliers will also be forced to adjust production, with many employees being idled, plus logistics efficiency is also deteriorating and the risk of inventory is increasing.

"The situation in Ukraine also brings uncertainty, the yen will continue to depreciate and logistics costs will continue to rise." Aichi Steel vice president Motoshi Nakamura believes the second quarter was tough for parts suppliers, but the industry as a whole will continue to be under pressure in the second half of the year.

Shigekazu Kato, director of Aizen Industries, which mainly produces parts for car engines and other components, told Yahoo Finance that the price of raw materials such as resin and aluminum rose in the April-June period just past, directly bringing the company an operating loss of 1 billion yen.

What makes them feel anxious is that raw materials and other factors may put pressure on the cost loss of 3 billion yen in fiscal 2022, with a much greater negative impact than previously expected.

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Indeed, times are getting tougher for Japanese component companies, these days. Because of difficulties in semiconductor supply and logistics, Japanese automakers, including Toyota and Nissan, are experiencing new challenges on the production side, directly affecting the orders and volume of business from key upstream suppliers.

Almost most Japanese automakers are propping up fragile supply chain systems, especially with the Russian-Ukrainian war and the Shanghai blockade due to the Omicron virus, adding to the manufacturers' new vehicle production.

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03 When "Pressure from All Sides" No Longer Works

For decades, Japan's powerful automakers have had the usual deflationary tactic of pressuring upstream component suppliers to lower their purchase prices and demand the same level of quality and output.

In fact, at this crucial stage of the transition towards electrification and autonomous driving, those divisions that are less relevant to the "new four" business will also be slowly subcontracted out by the automakers, as in the case of Toyota, who have previously transferred their semiconductor and internal combustion engine segments to Denso.

This is why Toyota, with its lighter footprint, is able to invest its development costs in the core areas of value creation and profitability without fear, while the supply chain changes that are being made under the banner of "abolishing duplication of business" are in essence transferring the anxiety of profitability down the pyramid to the component suppliers, pressuring them until The essence of supply chain change is to transfer the anxiety of profitability down the pyramid to the component suppliers, pressurizing them until they are "drained".

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With global inflation hitting at this stage, will Toyota, Nissan, and other manufacturers once again open up the familiar script of cost shifting, leaving parts suppliers to bear more of the pressure of soaring raw material prices?

Interestingly, Toyota announced to the public at the end of July a decision to suspend price reduction requests to suppliers for the second half of the fiscal year 2022 (October 2022 to March 2023).

The last time Toyota asked its parts suppliers to reduce their supply prices was in June this year, in response to a reduction in the production of new vehicles due to a shortage of parts on the production side.

As has been the practice in previous years, Toyota negotiates with suppliers twice a year to reduce purchase prices, usually in April and October. However, since 2020, because of adverse factors such as the new crown pneumonia, Toyota's production costs have been increasing year on year and it has had to break with its usual practice of repeatedly reducing the prices of parts procurement.

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As is customary, Toyota will cut prices again in the second half of the year, but given the rising prices of raw material costs such as iron and aluminum, and the shortage of semiconductors and other key components affecting new vehicle production, Toyota has passed up the opportunity to shift cost pressures again -

because the cost pressures on parts companies have reached their limits.

It has long been Toyota's custom to work with parts manufacturers to control costs, but in recent years pressure on profits has forced the company to press its suppliers to "squeeze" purchase prices to the lowest possible level.

In previous years, the annual rate of reduction in component purchase prices was around 1%, but in the long run, the day will come when the bottom will fall out and suppliers will be unable to bear the pressure. So in recent years, Toyota has been allocating a portion of its revenue each year to support its supplier partners who have a mature model of cooperation but are weaker in terms of procurement prices, to overcome profitability challenges such as the New Crown epidemic.

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Bloomberg interviewed a number of component SMEs in Shizuoka six months ago, and the research showed that many company executives at the time did not have a strong sense of crisis.

In the view of many decision-makers in parts companies, traditional fuel vehicles are not going to disappear immediately and the transition from the fuel era to the electric era will take a long time. These SMEs are more focused on the present, as many businesses are more profitable in the short term, and laying out for the long term is instead risky and difficult to reap the benefits.

"We just need to focus on the business at hand."

This was the message most manufacturers fed back to Bloomberg. It's just that times are changing, far more rapidly than they anticipated, and after the tough times in the first half of the year, especially the special period of supply chain and procurement from April to June, I'm sure many parts managers have changed their previous thinking.

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