Imagine that you are a manufacturer who has taken the lead in market share in your top market. Your leading competitors have either declared bankruptcy, or need government assitance to avoid it. You have built market share based on reliability and quality. You are reaping the rewards of your reputation. Well, Toyota just learned the hard way that the shiniest reputation can be tarnished quickly.
The stock market's recent reaction to the Toyota recall and suspension of production related to problems with accelerators in eight models shows the importance of reputation management, especially for companies such as Toyota, which has long had a reputation for safe, reliable vehicles.
The stock market's recent reaction to the Toyota recall and suspension of production related to problems with accelerators in eight models shows the importance of reputation management, especially for companies such as Toyota, which has long had a reputation for safe, reliable vehicles.
Toyota Motors (“TM”) was at a one-year high on January 18, 2010 (in US$ 91.78). In mid-September 2009, an investigation faulted the floormat in a Lexus causing the accelerator pedal to stick, killing 4 people. Dealers were initially instructed by Toyota corporate to inspect floormats for proper installation. By the end of the month, Toyota issued a consumer safety advisory notice instructing owners of 4 million vehicles across seven car models to immediately remove the floormats on the driver’s side altogether. From its price of $83.78 on September 1, 2009, the stock declined $9.54 to annual low of $75.07 (see Chart 1 below).
This 11% drop in just over one month was significant, and could be attributed to the recall. In November (just before Thanksgiving), Toyota announced a fix to the accelerator problem, which would addressed by a modification to the shape of the gas pedal. By the end of 2009, the stock had regained its value back in the mid $80’s. Note the spike in news stories surrounding price drops. In August 2009, there were 6 news stories per day about Toyota (according to MarketWatch). On Sep 14, when the investigation results of the accident that killed 4 in California were released, the number of stories spiked to 12. From the Dec 2009 average of 5.5 stories about per day the last week of January has seen 62 and 81 stories on certain days.
Academic Study Finds Loss in Reputation from Auto Recalls.
Nicholas Rupp, an economist at East Carolina State University, conducted a study in 2004 on automobile safety recalls from 1973 to 1998. Rupp used regression models to estimate the indirect costs of a recall, which included the automaker’s loss in goodwill or reputation .
Rupp found that critical systems components such as airbags, exhaust and brakes were the most costly, and had the most impact on shareholder value. Another significant factor was the age of models recalled, as models on the road longer had a higher potential for the problems to surface. Additionally, initial recalls cost more than subsequent ones on the same model. Rupp also found that companies with the highest financial stability, as indicated by Moody’s bond rating, had the most to lose.
(Rupp, Nicholas, East Carolina University “The Attributes of a Costly Recall: Evidence from the Automotive Industry” Review of Industrial Organization, 2004)
Corporate Reputation is a Long-term Asset
A product recall can have several negative effects on a company’s financial results:
1) Actual product recall costs
2) Interrupted production/sales costs
3) Litigation/settlement costs
4) Decreased reputation/goodwill (resulting in sales decline even after problem is fixed)
The value to a damaged reputation is difficult to estimate. However, the other components of the loss in market capitalization can be estimated, mainly for the purposes of calculating the value that investors implicitly assigned to Toyota’s reputation, and currently have discounted.
Actual product recall costs
Currently there are approximately 6 million vehicles that are being recalled. There are estimates of $25 for parts plus labor to correct the issue. Conservatively, $100 per part and four hours of labor ($400) were used to arrive at $3 billion to actually correct the vehicles.
Interrupted production/sales costs
In February 2008, Toyota sold 174,000 vehicles in the US. In 2009, that number decreased to 109,000. November 2009 and December 2009 had increased 9% and 32% respectively over the same months 2008, resulting in an upwards sales trend in late 2009, which was set to carry into 2010 (reflected in the high stock price of $91.78 on January 19). Let us assume that February 2010 sales for Toyota would have been 150,000 vehicles absent the January recall. The eight models recalled account for 58% of Toyota’s US sales. If the entire month of February’s production was halted, the immediate lost sales to Toyota would be 87,000 vehicles at a margin of $1266, for an estimated immediate lost production/sales profits of $110 million.
Litigation/Settlement Costs
In fall of 2009, a class action lawsuit was filed against Toyota related to problems with the accelator pedal and floormats. It cited 16 deaths and 243 injuries had occurred as a result of these problems. A $5 million estimate for a wrongful death settlement/award, and $10 million average for an injury is somewhat arbitrary, but a reasonble estimate. If we assume that five times as many lawsuits crop up as a result of the negative publicity, the total estimate for liability/settlement of claims could be $12.55 billion.
Lost Reputation/Goodwill
Of the total $22.12 billion in Toyota’s market capitalization lost at the end of February, the categories described above are displayed in Chart 2 below:
Recall Cost: 3.0 billion dollars
Litigation Cost: 12.55 billion dollars
Initial Lost sales: 0.11 billion dollars
Reputation Loss: 6.46 billion dollars (22.12 – 3.0 - 12.55 - 0.11)
"Moving Forward"
In the current economic and political climate, Toyota has a tall order to repair its reputation. Bankers have been the villain for the last year, with conflicting perceptions with executive bonuses and TARP funds. Prior to that, executives of the Big 3 U.S. automakers were raked over the coals over their use of executive jets as they came hat-in-hand to Washington for bailout funds. With all the division in Washington over healthcare, and the mid-term elections, nothing can unite both sides of the aisle like a common foe. Expect both parties to trip over each other to make political hay at Toyota’s expense. Already, the UAW and Teamsters have piled on, protesting the closing of Fremont, CA plant jointly operated with GM, which was actually a casualty of the GM bankruptcy. Toyota may find the price of success is a bigger fall from grace. Their public relations strategy in the coming weeks and months could make the difference in a short-term loss and long-term one. Reputation can be lost more easily than it is earned, but it is possible to salvage if risk mitigation policies have been put in place ahead of time, and quickly put into action.
Tom Nolan
