Honda Gets It Right

| About: Honda Motor (HMC)

One of the things that really irritates me about the U.S. public markets - and the mind-set of many U.S.-based institutional investors - is an emphasis on short-term results. There are inherent, structural, perverse incentives for corporate executives to do things that maximize short-term results to the detriment of long-term shareholder value. And this is a shame, for investors, executives and the economy alike.

Every so often I read a story that flies in the face of this approach, providing an example of a company or companies that eschew short-term thinking and instead choose to take the long view. And I know, I KNOW, this is the right thing to do. I just read one of these stories, and surprise, surprise, the company mentioned is not a U.S.-based enterprise - Honda Motor Company (NYSE:HMC).

In general, Japanese corporations have done a better job focusing on long-term benefits than their U.S. counterparts, particularly in the capital-intensive industries like autos and steel, and the results have been  predictable. But in this case, Honda is bringing their long-term thinking onto U.S. shores, insisting that cars sold into a foreign market are largely made of parts produced in that market. And if this means working with local suppliers in order to up their game to achieve Honda's high standards, then so be it. And if it costs a pile of money in the short-term but stands to create a strong, financially stable partner in the long-term, that is the price of playing the game the right way. I respect this so much, it is hard to put into words. Anyway, here are some interesting elements of the story.

Two years ago the walls were closing in on Anthony Chopp and the other employee-owners of Northwest Tool & Die. The tiny Walker, Mich. manufacturer had just racked up a $1 million loss on $10 million in revenues. It had $5 million in bank debt and owed $1 million more to vendors. Its customers, auto parts suppliers, were ailing. They were turning to low-cost tool shops in Japan, Korea and China for the dies they use to stamp sheet metal into sculptured steel parts for automobiles. "It was a pretty bleak picture," recalls 42-year-old Chopp, who was thrust into the chief executive's job in the midst of the crisis.

Today Northwest is thriving, even as much of the tool-and-die industry continues to deteriorate. Northwest's savior was of a most unlikely sort: Honda Motor. The Japanese automaker took Northwest under its wing, teaching it to more efficiently design and manufacture while steering millions of dollars in new business to it--even though its prices were 50% higher than any of a number of Asian suppliers. Today the new manufacturing techniques have brought Northwest's tool prices to within 15% of the low-cost Asian competitors.

"We took the long view that by working together we could make them competitive," says Timothy Myers, a purchasing executive for Honda of America.

Crazy like a fox, Honda has always been a quirky company driven as much by principle as by economics. It believes in building cars in the markets where they are sold--half of its global sales are in North America--and using locally produced tools, as well. So it made sense to rescue an ailing U.S. company, says Myers. When the tool supplier is situated nearby, he says, communication between engineers is better and cheaper, leading to improved manufacturing and fewer quality problems. "If everything is sourced overseas and shows up in a crate, we haven't really learned anything," says Myers. He has not forgotten that in 2002 a port strike on the West Coast delayed the shipment of important tools needed at a factory in Ohio for the launch of the Honda Element.

One point I plainly disagree with is the author's statement that Honda has been "driven as much by principle as by economics," somehow weakening the economic rationale of their actions. While that may be the case in some decisions made by the Company, that certainly isn't the case here. I believe the decision to prop up a local supplier, teach them how to become competitive, and have them effectively integrated into Honda's production process is manifestly rational from an economic perspective. Honda is creating a stable, local, high quality supply of parts. It is investing in the U.S., something that will endear it to labor unions, local, state and federal governments. It is greater vertical control over its production process without taking on the fixed costs. This is startlingly smart and something that flies in the face of what the U.S. automakers have been doing with their suppliers, namely, squeezing them as hard as possible in order to reduce their cost structures. Yes, lower costs are better, but not if it creates a financially unstable supplier. It can cause labor unrest. It can sour relations with government entities at all levels. In short, it is taking the short view. And it stinks.

Honda is so pleased with its progress that it is adding two North American tool shops to its comanagement program. American companies account for 41% of the tool-and-die business on Honda parts, up from a third before.

Northwest exited bankruptcy court in July 2006. It reported $12.5 million in revenues and a 6% pretax profit margin for the year. Honda accounts for 40% of that business, up from 20% before the bankruptcy. Chopp is aiming for sales of $25 million and a 10% margin within two years. He has won business from new customers, including big Ford and Chrysler suppliers. Its workforce has gone from 46 to 74.

And Chopp is sharing what he learned from Honda with other toolmakers in Michigan, who have formed a coalition in an effort to stop the industry's decline. "If you're not changing, you're headed for extinction," said Chopp. "We started to change too late, and it almost killed us."

So, you can see how Honda's actions have a salutary effect on several constituencies:

  • Honda, for the reasons mentioned above;
  • Northwestern, the tool-and-die maker assisted by Honda, because they have a new chance at life;
  • U.S. auto makers, who have a financially healthy, high quality supplier of parts that they are sharing with Honda;
  • The U.S. tool-and-die industry, to whom Northwestern's lessons are being disseminated through a trade coalition;
  • Consumers, who will get a steady supply of the cars they demand;
  • Employees in the U.S. tool-and-die industry, who won't lose their jobs; and
  • U.S. taxpayers, as employed people generally pay more taxes than unemployed people.

The losers in this story? None. Except that it just shines a bright light on the innovative, long-range thinking of Honda versus the U.S. automakers. And that, as a U.S. business professional, is hard to stomach.

HMC 5-yr chart:

honda chart