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While many economist stress the importance of competitive markets, it is often overlooked that firms are an alternative mode of resource allocation and utilization, and it matters a great deal how firms are organized. Organization can bestow a significant competitive advantage, the history of business is full of it.

Fordism and Talyorism
The most famous examples come from the car industry, where Ford (NYSE:F) perfected an already existing system of mass production based on interchangeable parts and the assembly lines (an idea imported from slaughterhouses) set the work pace. The division of labour was taken to extremes on the principles of Talyorism.

Taylor's principles of "scientific management" grappled with the fact that craft workers had more knowledge about the work process than management, a situation which they were able to exploit (by shirking). He divided tasks to bare minimum components, taking Adam Smith's pin factory to extreme. He measured carefully (with the famous stopwatch) what time each task would take, and the resulting knowledge would be used to the advantage of management.

The knowledge monopoly of craft workers was broken and with the assembly line setting the work pace, human labour was reduced to simple repetitious tasks over which the workers had little control. This state of affairs is immortalized in Charlie Chaplin's film Modern Times.

However, the extreme specialization turned out to be such a boost to productivity that Ford cold afford to pay double the wages compared to other manufacturers, creating mass consumption as the natural extension of mass production. This is not the place to discuss the strengths and weaknesses of the model, they're merely examples of how organizational innovations can confer competitive advantage.

The Toyota Production System
The peculiar circumstances in which the rebuilding of Toyota (NYSE:TM) in the aftermath of the Second World War took place made copying the Fordist mass production model impossible. Not only was the Japanese car market way too small, there was heavy competition with a myriad of other car manufacturers present.

This meant that production lines had to be able to switch easily between models, something which required a considerably more flexible and involved workforce, as production lines couldn't be dedicated to a single model and had to be able to switch frequently. Add to that some of the ideas of US quality guru Deming, who argued that quality control had to be build into the process, preventing errors from happening, rather than repairing faulty products after they have been produced (or worse, after they have been sold).

The just-in-time inventory management system evolved into a collaborative ecosystem with suppliers and, by reducing waste, exposed process weak-points for improvement, providing another powerful way to improve the processes.

There were three ways in which processes were continuously improved. Statistically, through total quality management, involving workers to have a "second job" in the form of going to the root of problems and suggesting process improvements to prevent them, and by JIT inventory management, removing buffers to expose weakness in processes.

This became quite a powerful paradigm of manufacturing. It is worthwhile to understand the nature of the competitive advantage this system afforded Toyota to consistently out-compete most rival car manufacturers. It is so deeply baked into organizational routines and culture that much of it is tacit and collective knowledge, which is quite difficult to reproduce.

In the 1980s, Toyota city became something of a pilgrimage for car executives the world over, and the fact that Toyota didn't have any problem with visiting executives from competing companies shows how sure they were of their advantage and the difficulties other companies would have in reproducing the system. Organization can be a powerful competitive advantage.

While many Western car manufacturers have been closing the gap (and Toyota itself has run into a little headwind, most likely from overextending the model a bit in a dash to become the biggest car manufacturer in the world), it still exists, and the fact that it has been the benchmark for the good part of three decades says a lot.

Toyota's shares closed at $68.62 on Thursday. Lets look at some numbers from Yahoo:

  • Market cap: $107.6B
  • Sales $225.9B
  • Cash $41.9B Debt 150.7B
  • Profits are expected to hit $1.94 per share, rising to $7.20 next year (this year was particularly bad for Toyota)
  • It has a P/E of 41.14 and a forward P/E of 9.53
  • Price/sales is 0.47 and price/book is 0.82

If one compares that with Ford, whose shares closed at $11.59 Thursday:

  • Market cap $44B
  • Sales $134.1B
  • Cash $20.6B Debt $95.1B
  • EPS this year of $1.87, falling to an expected $1.58 next year
  • The P/E is 6.95 and forward P/E is 7.34
  • Price/sales is 0.32 and price/book is 7.18

General Motors (NYSE:GM) shares closed at $22.17 on Thursday. Some metrics:

  • Market cap $34.7B
  • Sales $149.2B
  • Cash $32B Debt $11.7B
  • EPS this year is estimated at $3.93, falling back to $3.79 next year,
  • it has a P/E of 4.85 and a forward P/E of 5.85
  • Price/sales is 0.22 and price/book 0.96

Volkswagen:

  • Market cap 52B euro
  • Sales 150.6B euro
  • Cash 26.7B euro Debt 63.9B euro
  • EPS 3.17, forward EPS not determined
  • Price/sales 0.34
  • Price/book 0.9

You see that on most metrics, except price to book, Toyota is substantially better valued than its most important rivals. However, despite it's organizational advantages, it has a rough time with a number of high profile recall cases (even if some of these turned out to be not their fault) and the Tsunami disrupting supply chains.

What's more, the US car manufacturers not only have adapted a significant amount of the Toyota production system, they've shedded a lot of fat in their state-led restructuring efforts and as a result, they've won some domestic market share back from the Japanese.

Further, Toyota (like other Japanese manufacturers) is plagued by the inexorable rise of the yen, not only against the dollar but now also significantly against the euro. So we see some chances in US car manufacturers, especially as the US market is also likely to grow faster than the other developed markets. It has the oldest fleet (average of 10 years) and the fastest population growth, even if unemployment is still very high.

While Toyota has had a formidable competitive advantage that brought it (briefly) to be the biggest car manufacturer in the world based on a unique organization and practices, the competition has slowly been catching up. But don't count it out yet, it still remains one of the most formidable companies in the world.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: EDITORS Please add tickers GM, F, and Focal ticker: TM as somehow the selection in your beta new editor page doesn't work

Source: Toyota Vs. Ford: Organization For Competitive Advantage