1. Federal Reserve Bank of Cleveland Symposium on Inflation
Chuck Brown
Vice President - Accounting & Finance
Toyota Motor Engineering & Manufacturing North America
May 30th, 2014
Good Morning.
My name is Chuck Brown.
I am Vice President of Accounting & Finance for Toyota Motor Engineering & Manufacturing North America.
In addition, I have been serving as the Chair of the Cincinnati Branch of the FRBC since Jan
It is a distinct pleasure to be a part of this panel discussion today.
I will try to shed some light on the impact of inflation on pricing decisions within the U.S. Auto industry.

2. What “pricing” means for Toyota
How do we create competitive prices which:
Reflect the consumer’s idea of value and are based on marketplace demand
Support Toyota’s sales goal (volume, product mix, etc.)
Provide profitability for dealers, sales & marketing companies, and manufacturing companies & TMC
Help us to maintain long-term prosperity for all of our stakeholders
Are fair to the marketplace and society
What does pricing means for Toyota?
For us, pricing is not just about numbers or mathematics. It is more than just a matter of what we want the price of a vehicle to be.
We need to create competitive product prices which reflect consumers’ idea of value and meet market demand.
At the same time, prices should be set at the appropriate level to ensure that we achieve our sales volume and product mix targets.
It must provide profit and prosperity for Toyota and our key stakeholders, such as dealers, in both the short and long-term.
Lastly, our price should be fair to everyone in the marketplace and society.
So, our challenge is how to develop a vehicle price that supports these goals and also Toyota’s philosophy.

3. Pricing Philosophy Factors
Consumers
Manufacturers
Pricing needs to take into account certain factors from three points of view. Consumer, Manufacturer and Society.
Our pricing needs to reflect the combined elements from these three perspectives to make sure our prices are competitive and appropriate.
Society

4. Pricing from the Consumer Point of View
Tangible Value
Basic Performance (Horse power, fuel economy, etc..)
Standard Specifications and Options (A/C, audio, etc..)
Size, Utility
Intangible Value
Brand (Lexus vs. Toyota)
Status (S Class vs. E Class)
Environment (Hybrid, Diesel, etc..)
From the consumers point of view, we believe competitive pricing does not necessarily mean the lowest price. Consumers judge the price based on their understanding of monetary value.
Consumers view value in two ways; Tangible and Intangible.
Tangible value includes factors that we can actually measure and quantify such as:
Horsepower, fuel economy: these factors can be very important as tangible values. In addition, consumers value standard specifications and options.
Intangible Values are generally not quantifiable, but are still important.
Factors that impact public opinion and status such as:
Brand equity, reliability, and perception are all intangible values – but they must be considered when setting vehicle prices.

5. Price, Profit, & Cost Formulas for Profit Generation:
#1: Cost ＋ Profit ＝ Price
(Actual cost） （Required profit） （Expected Price)
#2: Price － Cost ＝ Profit
(Market price） （Actual cost） 　 （Profit as a result）
#3: Price － Profit ＝ Cost
（Market price） （Required profit） （Target cost）
This chart will explain the relationship between price, profit & cost.
Which formula do you think is the right formula for Pricing?
First, let me provide some history for your consideration.
During the 1950s thru the early 1980s, the U.S. auto industry was dominated by the Big 3 (GM, Ford and Chrysler).
Accordingly, the main pricing model used by the industry was #1. In essence, cost increases were passed on to the customer via increased prices.
When the late 1980s brought more competition to the market place, the pricing model changed to Market Pricing. Thus, manufacturers could achieve “required profits” only by controlling costs.

6. Price, Profit, & Cost Formulas for Profit Generation:
#1: Cost ＋ Profit ＝ Price
(Actual cost） （Required profit） （Expected Price)
#2: Price － Cost ＝ Profit
(Market price） （Actual cost） 　 （Profit as a result）
#3: Price － Profit ＝ Cost
（Market price） （Required profit） （Target cost）
In #1, the COST of the product determines what the price should be.
・This is the opposite of Toyota’s pricing philosophy and in the current highly competitive market environment, this type of approach is not feasible.
In #2, the PROFIT level is determined as a result of the price set less the actual manufactured cost.
・In this case, profit levels can fluctuate, as cost levels change so there is no stable profitability, or in many cases the company loses money
So item #3 is the pricing formula that dominates the auto industry today.
・Set the appropriate price primarily based on the MARKET
・Set the profit level which is desirable for the company in both the short and long term
・Develop the product to achieve the target cost
Toyota strongly focuses on #3 as our ideal pricing formula

7. General Price Changes
Automotive companies consider many factors when pricing their product, but the Market provides very clear feedback on appropriate pricing levels.
Price change vs. previous period
As depicted in this chart, no Original Equipment Manufacturer can “price” their way to desired profitability. During the seven year period from 2007 thru 2013, all manufacturers had pricing leadership at least once during a half year period. Interestingly, OE#3 held pricing leadership for 2 years, but had an abrupt reduction in price in the 2nd half of 2013 as outlined in yellow. This is a pretty good indication that the Market sets the price and all OEs must adjust accordingly.
As with any pricing action, the extent of the pricing adjustments depends on vehicle price elasticity, competitor movements, and other factors already mentioned during this presentation. In the recent past, inflationary pressure on key input costs such as steel, resin, aluminum, rare earth metals, etc.. has eroded automotive profits in the short term. Of course, a lack of profitability impacts cash flow to reinvest in future products so the downward spiral continues into the mid term if high inflation persists.
Thus, to achieve mid to long-term sustainable profitability, MANUFACTURERS MUST REDUCE THEIR COSTS rather than PRICING THEIR WAY TO PROFITABILITY.

8. Average Transactional Price
As this chart shows, truck prices, the purple line, have increased more rapidly versus passenger cars, the yellow line, during the 2008 thru 2014 period. Especially during the first 2 quarters of 2014, the trend is more pronounced where cars are flat but truck prices are increasing.
This again we believe is due to market dynamics.
The Average Age of vehicles on the road is 11+ years, but the average age of trucks is 13+ years so there is more “pent-up” demand for trucks.
Among other key factors is “segment loyalty” which is highest among truck buyers.
Source: PIN

9. Capacity Utilization
Another key factor which impacts pricing in the auto industry is capacity utilization. As this chart indicates, in 2007 the auto industry was at 80% capacity utilization, dropping to 50% at the height of the economic downturn in Since that time we have improved steadily with the improvement in the economy so that we hit 90% capacity utilization in 2013.
This is primarily due to the significant right sizing of the industry since capacity has moved from 12.9 million units in 2007 to a low of 11.0 million units in 2010 with a modest recovery to 12.0 million units in 2013.
Of course when you are running operations at or near capacity, you don’t need to incentivize sales nearly as much to move the metal so transaction prices continue to increase as noted in the previous chart.

10. Annual Sales Volume & Leasing Trend
Finally, this era of low inflation, low interest rates, and improving GDP has had a positive impact on demand for light vehicles. In particular, the volume of vehicles sold has grown dramatically over the last 5 years (from 10.4 million units in 2009 to million in sales forecast for this year) along with the number and percentage of vehicles being leased.
In essence, manufacturers can offer attractive lease rates when interest rates are low as we have experienced over the last 5 years.
In summary, moderate inflation with low interest rates are good for the economy and good for the auto industry.
Thank you for your kind attention.