Toyota European Exposure: Currency Risk and Manufacturing Strategy

Introduction: Toyota's European Market Challenges

Toyota Motor Europe Manufacturing was the only Toyota subsidiary experiencing losses when CEO Hiroshi Okuda requested, in January 2002, a proposal to reduce and eliminate those European losses. Toyoda Shuhei was the newest President of Toyota Motor Europe Manufacturing at the time. Despite Toyota dominating the Japanese market and leading the world in units sold, it ranked only eighth in sales in Continental Europe. In 2001, only twenty-four percent of automobiles sold in the European market were manufactured by Toyota. One of Toyota's biggest strategic missteps was its prolonged delay in moving manufacturing for European sales to Europe itself.

Much like the rest of the world market, Toyota was experiencing financial strain due to slowing global sales and compressed margins. Sales in America were greater than those in Europe in 2001, which helps explain why, during a period of budget constraints, Toyota chose to direct its finances toward the American regional market rather than its European one. American sales were far more promising, and as a result Toyota continued investing in domestic manufacturing facilities within America, which produced sixty percent of North American Toyota sales in 2001.

Though European sales were not as strong as American ones, Europe ranked second only to America in foreign market units sold, with roughly 634,000 vehicles sold in 2000. During this period, Toyota Motor Europe Manufacturing expected to see an increase of 166,000 units sold by 2005. Despite this projected growth, fiscal year 2001 saw financial losses for Toyota Motor Europe Manufacturing of approximately $82.5 million.

Currency Exposure and the Euro-Yen Exchange Rate

It is understandable that Toyota would be hesitant to invest further in its European market after anticipating growth but experiencing a loss. European sales were meager, and the company posted losses for fiscal year 2001, while Toyota sales were growing more rapidly in America. As most of the world faced budget pressures, Toyota had to decide where to allocate its resources. Logically, Toyota had two options: pursue a more aggressive marketing strategy in Europe or concentrate on its more profitable markets. It would likely have continued to deprioritize Europe had it not been for the remarkable success the Toyota Yaris — a small vehicle with a 1,000cc engine — achieved with European consumers.

One significant reason Toyota suffered losses in its European division was the continuing decline in the value of the euro. In late 2000, Toyota Motor Europe Manufacturing announced that it would be unable to produce a meaningful profit for the next two years. As shown in Exhibit 2, the euro continued to fall against the Japanese yen throughout 1999 and 2000. It was not until 2001 that the euro began to correct itself, and even then it remained quite weak. This meant that European purchasing power against the yen was severely diminished.

Although the Yaris had become popular in Europe, it was determined early on that the vehicle would be manufactured in Japan and then imported to Europe. With nearly seventy-five percent of European Toyotas being produced overseas in Japan, the cost of purchasing a Toyota rose for European consumers because prices had to be converted from Japanese yen to euros. Toyota was thus forced to decide whether to absorb the loss resulting from the exchange rate differential or raise vehicle prices for European consumers. Toyota chose to absorb the loss, which generated shrinking and, ultimately, negative margins in both its Japanese and European markets. Understanding foreign exchange risk is central to evaluating why these losses occurred and how they might have been mitigated earlier.

Conclusion: Path to Profitability in Europe

With the struggling economy of the early 2000s, Toyota experienced losses alongside many companies across various industries. With its European operations generating losses rather than profits, Toyota was compelled to reassess its entire European strategy. Waiting so long to move Yaris manufacturing to Europe — rather than establishing European production from the outset — caused substantial financial losses due to the exchange rate differential between the euro and the yen. The prospect of the British pound joining the European Monetary Union was shown to be neither likely nor realistically beneficial for Toyota's profit margin.

To generate the greatest possible profit, Toyota should redistribute its European plant locations more evenly across the continent. The plants that remain in operation should focus on producing small, fuel-efficient vehicles that appeal to European consumers. By pursuing this strategy, Toyota Motor Europe Manufacturing should be positioned to achieve a sustained and improving profit margin over the long term.