Mike Smitka on the Future of Japan’s Automotive Industry

Mike Smitka is emeritus professor of economics at Washington and Lee University, an undergraduate liberal arts college in Virginia. He has a BA in East Asian studies from Harvard and a PhD in economics from Yale University. Fluent in Japanese, he has spent a total of seven years in Tokyo, with shorter stays in China, Germany, and Korea. Since 1994, he has been a judge for the Automotive News PACE supplier awards. He is in the steering committee of GERPISA, an international network of academics who work in the auto industry.

Kaito Komoriya CMC '22 interviewed Dr. Mike Smitka on October 14, 2021.

Photograph and biography courtesy of Dr. Mike Smitka.

As the world rushes towards electric vehicles, Japan is focusing on the hybrid car market. What drives this strategic decision, and do you consider this a viable plan for Japanese automakers?

One of the dilemmas is that the push to EVs is something that comes from the political side and so what I should be asking as an engineer is, what is the quickest way to improve the fuel efficiency of vehicles? I believe this year is going to be about 80 to 85 million vehicles sold globally. If we want to reduce the carbon footprint of those 85 million vehicles, what's the quickest way to do it? That’s the mindset that Toyota uses in approaching this problem. The obvious answer is to push hybrid vehicles. There's no consumer pushback on hybrid vehicles, the technology is relatively mature, and there is a bit of a cost increment to having a hybrid vehicle. If you want to improve the fuel efficiency by 10%, you can do it very quickly with hybrid vehicles. Moving to battery electric vehicles, if you're looking at India, you basically get no incremental benefit from a battery electric vehicle, because they're producing electricity with dirty coal. By the time you factor in the carbon fee, transmission losses, battery losses, you're close to what you would get from a standard gasoline car. The end game is a pure battery electric vehicle, or at least something where the drive train does not have an internal combustion engine. But there are a bunch of intermediate steps that can be achieved very quickly, at a reasonable cost point that won’t result in customer pushback. That's the strategic approach that was being taken by the Japanese motor vehicle producers. Toyota does okay in Europe, but they are much stronger in the US and in Japan, and they do quite well in China. Then they do well in many developing countries. In those countries, China aside, battery electric vehicles are not going to go anywhere. No one's going to want to buy one right now. That's the logic of focusing upon hybrid cars. Toyota has close to a quarter century working with hybrid vehicles, as well as a quarter century working with pure electrics. When they're making these decisions, it's not because they haven't developed battery electric cars. It's because they understand both and they understand battery technology, probably as well as any car company globally. 

Is this a viable plan for Japanese automakers? That's more an issue of politics than anything else. If we look at battery electric vehicles, the capacity is not in place yet to provide batteries for all the announced vehicle projects. A hybrid is using a battery that is at the largest 1/3 that of a battery electric vehicle if you're doing a plug-in vehicle. From the supply chain perspective, as battery capacity gets built out, you can have a greater share of the fleet that would be pure battery electric vehicles, but the supply chain just isn't going to be there for the sort of scenario that some of the political regulators have in mind in Europe. China is looking at 2035, not 2030. The stock market though is rewarding Tesla and Nio with stupendous valuations for companies that are effectively selling the output of one Toyota assembly plant. That's a disruptive force. It's not because battery electric vehicles are clearly offering a consumer value proposition. It's because the Tesla effect is pushing boards of directors for the publicly traded companies to do that. In Europe, there's the Volkswagen effect from the emission scandals, where there is a huge push for Volkswagen to come out with electric vehicles because they can't be trusted to be honest with their emissions for the gasoline and diesel. Hybrid vehicles are to me what should be done.   

Is Japan’s push for hydrogen fuel cell cars a risky strategy? Do the refueling infrastructure, high cost of fuel cells, and other factors create unsurmountable obstacles for these cars to go mass market? 

The Japanese government, the Korean government, and the US Department of Energy, to some extent, have big hydrogen fuel cell programs. Hydrogen fuel cells have use cases, beyond vehicles. Static fuel cells are a very attractive intermediate stage where you have a lot of solar cell power generation. Even if electrolysis of water to produce hydrogen is inefficient, if the energy to do that is free, which it is in California, or you could even be paid to take the energy, then turning out hydrogen is highly desirable. Fuel cells allow you to store hydrogen and you've got a fuel cell stack when the demand situation changes. This becomes a very attractive use case.

For heavy duty trucking, the name of the game is the amount of weight you can pull, so every kilogram of batteries that you put in a truck is a kilogram less free, and then uptime. For those sorts of use cases, the limiting factor generally is weight, not space. Then the storage for hydrogen is not a problem. The fuel cell stacks are now very efficient, and the cost is way down. Fuel cells are good for heavy trucks, ships, potentially trains, but not so appropriate for passenger vehicles. In Japan, you've got taxis that have the natural gas tank in the trunk. If you're wanting to go to the train station or to the airport and the taxi pulls up, you can't get your suitcases because the trunk is filled with a fuel tank. That's the challenge that would be there for hydrogen fuel cells in passenger vehicles. But if you've got a trucking fleet from a fixed base and you’ve got forklifts and a big factory, those markets are growing. In fact, there already is a small market for hydrogen fuel cell-based forklifts. 

Yes, it's a risky strategy, and it's not just the storage. There's been no sudden breakthrough that is allowing hydrogen to be stored that would make it a good mix for passenger vehicles. The refueling remains a problem. If you've got trucks going to a terminal, then that's less of an issue because you're not needing to have refueling stations scattered all across the country, or in California, for passenger vehicles. It's a risky strategy in the sense that it's taking a while to drive down costs to make it commercially viable. There's a fairly big market there, and one where a pure battery-based strategy is not going to be commercially viable. So it's sort of a mixed response on why fuel cells make sense. They made sense for a range of use cases, and batteries make sense for a range of different use cases. I think looking forward, if you're looking at the transportation sector, depending on the use case, you want to have a different sort of fuel. You may have an electric motor, but for some use cases, you probably still want diesel.

How are Japanese automakers stacking up to American competitors (like Tesla, Amazon, or Uber) in the race for autonomous self-driving technology? 

The big players are, not so much Amazon, but Waymo, which is Google. You’ve also got Cruise, which is GM with Honda as a substantial minority shareholder. Toyota is calling theirs “Woven”, and they've got a set of different subsidiaries that are involved with that. Ford has their own system, again an alliance. In China, you've got a couple of alliances that are important. Most companies are doing this with a couple partners. There are a lot of competitors here. Toyota and Honda are certainly in place, and all of them have some have skin in the game. 

The problem is that the commercialization is not going to be very important short term. Waymo has taxi fleets on the road in Phoenix, and they have a second location in which they are now launching at a very low level. These are extremely expensive vehicles, and taxis are not a high-income business. It's not clear to me that there are going to be any profits to be made from autonomous taxis until maybe 2030, so we're a good decade away from that being commercially viable. On the other hand, you've got fixed route shuttles on the road now in many places. Passenger shuttles and freight shuttles are already commercializing. The aesthetics of a vehicle aren't important, they're not operating on highways, and they’re not operating at high speeds. Same thing is true in Europe.

To get back to the question, the market that's going to develop first are these fixed route shuttles. In Las Vegas going from the airport to the strip or the casinos, there are shuttles operating there now. It's going to be the over-the-road trucks that are operating on a fixed route. It may be partly on an expressway, but drivers in the heavy-duty truck side have time limitations. If they can have their time not driving, and the autonomous system can take over, that's a very attractive commercial proposition. With terminals, Long Beach is working with that. Agriculture is working with autonomous tractors and harvesters. Mining vehicles are quickly becoming autonomous. 

The intermediate step of completely autonomous vehicles is driver assist systems. Heavy duty trucks have lane departure systems. If you eliminate a few accidents, you drive down insurance rates, you increase uptime. That's a commercially attractive proposition for fleet users to implement various sorts of driver assist systems in the heavy trucks. For Toyota, which means Isuzu and Hino, this is where those systems are becoming commercially viable. But of course, if you get a Toyota passenger vehicle, you've got adaptive cruise control, you've got automatic emergency braking, I believe next year, it becomes mandated in Japan. It's one that drivers might not think of as an autonomous system, but it is taking over driver functions, and lowering accidents, lowering insurance premiums, but increasing repair costs, because the sensors are expensive to replace. What you mean by autonomous and that would be an hour long discussion to go through the different levels when they're relevant. Well, I believe the Japanese car companies are behind. They may not be viewed as being in the lead, but the companies that are really pushing this are the big Tier I suppliers because they have the potential offering sensor systems to multiple car companies. The LIDAR suppliers are selling to the Tier I suppliers who are then supplying to auto companies. Denso is heavily involved in the autonomous vehicle system, working with Toyota because they're the ones who are buying the lidars. Tier supplies are very important, and Denso is very much a player. 

How can the numerous Japanese automakers work together to adapt to technological disruptions in the automotive industry? How easily can smaller auto makers (eg: Mazda, Subaru, Suzuki, Mitsubishi) adjust to the technological disruptions in the industry relative to larger producers? 

As you know Toyota owns Daihatsu, they own Hino, and they've got a reasonably big stake in Isuzu and Subaru. Toyota is 40 or 50% of the domestic market in Japan. Mitsubishi is owned by Nissan, so really, they are making independent decisions there. Mazda has shifted, and Suzuki has shifted. Subaru is allied closely with Toyota. Suzuki is doing some things with Honda and some things with Toyota. 

For smaller car companies globally, all of these are challenges. The electric vehicle side not so much. The key cost for electric vehicles is the batteries. Car companies shouldn't be making their own batteries. They may be able to finance the battery capacity, but they may want to lock in place capacity because they're worried that if they rely on an outside company like CATL, which is the globally the biggest battery maker, then they might launch a vehicle and find out they can't get enough batteries to meet customer demand. But in terms of chemistry, car companies do not have the chemical engineering, the experience in making batteries and so on. The name of the game for electric vehicles is really batteries, and the car companies are all turning to outside supplies. Toyota has some of their internal manufacturing. GM is doing some internally. Volkswagen is doing some internally. BYD in China began as a battery company, they only entered making vehicles later. You've got some companies with footprints in the battery side. But basically, leave battery chemistry to companies where that's what they do. You’ve NIDEC. You've got Continental. You've got Bosch. These Tier I suppliers specialize in making electric motors. Again, a car company doesn't even have to do their own electric motor, which is one reason you've got so many companies in China launching EVs because they can really go to Tier I suppliers. The car companies need know how to integrate that into their vehicle, but they don't have to be doing the underlying sensor systems and the controls for the sensor. I've been in a rental Mazda that had adaptive cruise control, it had a heads-up display, it would tell me whenever I was going over the speed limit, which in Europe is very important. All of that is something that Mazda, a fairly small company, can buy from a supplier and integrate into a car company. 

There are challenges for the smaller car companies, but I think the gap is much smaller than is widely thought. One of the other challenges for a smaller car company is simply sheer scale. Toyota can launch a vehicle, and because they're selling in Europe, South America, South Africa, the United States, Canada, Mexico, India, they can have a model that is okay in any single market, but globally, it's nicely profitable. Mazda has a much harder time. Of course, Suzuki has an even bigger challenge because they don't sell mid-sized vehicles. Each car company has their footprint. The real question mark is the Renault-Nissan -Mitsubishi Alliance. If Renault and Nissan really part ways, Nissan is going to have a real challenge. They will have a very small footprint in Europe, and the challenge for Suzuki is they basically are out of the Chinese market. This issue can be a whole other interview itself. 

Is the government helping Japanese automakers adapt to market disruptions in substantial or unique ways? 

The Japanese government puts together discussion forums, think tanks, and groups. The latest one goes by the initials of MBD. My sense is that, while they can make it comfortable for companies to talk, they aren’t putting a lot of money into it. The Japanese government doesn't have the national lab network that the U.S. has. The Department of Energy has a very extensive technology infrastructure with research in batteries, research in the nitty gritty of electric motors, research into the full supply chain for semiconductors, the full supply chain for hydrogen fuel cells, from storage technologies to the hydrolysis or the other ways of making hydrogen and then the membranes for the electricity generation. The Japanese government doesn't have that. The Japanese government helps, but not really. It's at best setting standards and doing charging infrastructure. 

The Japanese government push for fuel cells is mostly indirect, subsidies paid to companies or industry consortia. Toyota is such a big presence, so the main challenge is making it comfortable for other companies to be in the room with Toyota. When it comes to charging infrastructure for electric vehicles, the government can do some things. They can work on trying to set standards. But in some ways for the Japanese domestic market, if Toyota says what we're doing that and makes it open, then mission accomplished. There's a standard that all the other automakers can adapt to. My sense is that the Japanese government is not a major player, though they certainly want to be viewed as being a big help. 

How are Japanese automakers adjusting to the global chip shortage both in the short and long term? 

The chip shortage is something that is partly because the chips are in low supply for everything. If you want to buy a refrigerator, you may find that you can't buy a refrigerator either. Some of this is when COVID hit, companies cancelled orders. At the same time demand of every motor manufacturer globally went through the roof. The shutdown for COVID turned out to be shorter time horizon than the industry anticipated. When they went to try to get back in the queue, they lost their spot. Then there was the fire at Renesas plant, there was the freeze in Texas that shutdown a chip plant. A chip can take three months from start to end in the production process. Something like a fire or a total loss of electric power can mean that stuff just get thrown out. And then you've got a huge backlog, which there's no way to overcome in the short term. This is something where getting information is a challenge. 

The actual purchasing is being done sometimes by Tier II suppliers of say a camera unit that's going to a Tier I supplier, which then goes to a car company. In the normal course of events, the companies have worked out chips ships they're using. They've made sure that they’re automotive grade, which takes specific manufacturing. An off the shelf chip probably can't be used in the car since a cell phone chip will shake apart. The thermal expansion that a car goes through, going from minus 20 centigrade to 50 Centigrade. A car chip then has to be created specifically for automotive even if the chip itself is the same. 

Some of that is that chips aren't being bought directly from big manufacturers like TSMC. They’re getting bought from a distributor that is holding these chips as inventory. They've got a sense of the inventory they need to be holding. But the car companies weren't getting a global picture of how much each inventory had going into these Tier II suppliers then going into cars. When COVID hit, it turned out, no one was able to consolidate the information anywhere in the industry. Essentially everyone was blindsided because in the aggregation we knew that there was a problem, but by the time that the problem was known, it was far enough along that it was very hard to recover. We're looking at shortages continuing for another few months into 2022, and depending on the product, perhaps in the summer 2022. One of the problems is the chip companies are seeing demand today that they didn't build into their capital expenditures until 2023 or 2024. 

In sum, there are a whole bunch of things that came together with this global chip shortage. No one really knew where the chips were. In the long term there's no problem. The short term is still very painful. It's easing a little bit, but we're really looking at another six months. Toyota looked pretty good for a while, but right now they're losing lots of chips but not necessarily profits. If you go to a new car lot, you'll find that there may be no cars on, almost zero. You're paying list price or above list price. That means that the car companies aren't needing to do any subsidized leases. The quiet rebates that might be going to a dealer but not directly to a customer, those are all gone. And the product mix, if they can only make a limited number of cars, they're making the ones that have the fattest profit margins. Even though there's a chip shortage, the car companies are going to be making very nice profits this calendar year and the first half of next year. The chips shortage is something that affects us as consumers. It causes wild gyrations in the used car market. 

Kaito Komoriya CMC '22Student Journalist

Julia.Roesler, CC BY-SA 4.0 <https://creativecommons.org/licenses/by-sa/4.0>, via Wikimedia Commons

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