The Connection Between Currency Exchange Rates And Cars

When most Americans evaluate the global aspects of the auto industry, the issue of currency exchange is rarely discussed. However, currency exchange rates are of pivotal importance to all automakers. What follows is a simplified illustration of currency exchange and how it can impact profits.

See how currency exchange rates impact the auto industry

Hopefully, it will be more interesting than it sounds!

Let’s start with the basics – the approximate costs and profits in an average $20,000 vehicle.

Vehicle production costs as a percentage of MSRP

The percentages above are based on Toyota’s 2005 financial statements, one of the most profitable years in the history of modern vehicle manufacturing (Toyota made in excess of $12 billion in 2005). This is the best-case scenario – most  auto manufacturers earn much less than 6% profits in a typical year.

Now, let’s toss currency exchange rates into the mix. We’ll assume that it’s 2008 and that we’re Toyota, a company building a car in Japan and selling it in the USA.

Ground Rules:

• Vehicle MSRPs change very little during the course of the model year – if they change at all. As a result, the net revenue is essentially fixed for the model year.
• Production costs do not drop during the model year.
• We’ll use actual currency exchange numbers from 2008.

Taking our costs (about 80% of the MSRP) into account, we set the MSRP for the 2009 model year at $20,000, expecting that we’ll earn about $1,000 in profits. We start making our 2009 model-year cars to sell in the USA in late July 2008, knowing that it takes 60 days to produce and transport them to the US. As is the standard industry practice, once the car is delivered to the dealership we’ll call it “sold” and collect our money. Here’s how the year will go.

How exchange rates can impact profits on imported or exported cars. Click the image to see a larger version.

Oanda.com has a nice tool for finding historical exchange rates and is the source of our exchange rate data.

As you can see, the exchange rate that we based our MSRP on in July 08′ has changed dramatically during the course of the model year. Since the car we make in Japan is produced in Yen and sold in US dollars, we’ll have to exchange our dollars for Yen in order to get our cash back. Unfortunately, because of rapidly falling exchange rates, our MSRP is far too low in this example to earn a profit for most of the 2009 model year. In actual fact, Toyota lost nearly $9 billion dollars last year largely because of the declining dollar.

Items to keep in mind about currency exchange rates:

• Rarely do exchange rates change this dramatically this quickly.
• Auto manufacturers have some mechanisms for sheltering themselves from the full brunt of these currency exchange rates.
• This exchange phenomenon can go both ways. U.S. automakers who were exporting vehicles during the same time period greatly benefited from the decline in the dollar, and in years past importers like Toyota have earned quite a bit as the dollar gained strength.

Bottom Line: Currency exchange rates can greatly impact profits, and the best way to reduce their impact is to produce vehicles in the market in which they’re sold. Look for Toyota to shift more production from Japan to the US in the coming years.

Be sure to read our article Where Do Toyota Tundra Profits Go? which addresses the common notion about the Toyota Tundra that “all the profits go to Japan.”

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