Leading Japanese supplier Denso Corporation is arguably the best performing large supplier in the world today. It is currently enjoying both rapid growth on overseas markets, particularly in Europe and Asia outside Japan, and is the second most profitable supplier (in absolute terms) in the world.
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Denso’s depth of know-how in automotive electronics positions it to grow strongly with the steady rise of automotive electronic applications, particularly in more complex safety and engine-related systems.
Japan accounted for 56.3% of Denso’s sales in its last financial year to 31 March 2004, but the election of Koichi Fukaya, with strong international experience, to President and CEO of Denso in July 2003 underlines the international ambitions of the group. Edmund Chew reports.
Financial performance
Denso was the world’s most profitable automotive supplier in 2003. Its operating margin of 7.4% for fiscal year ending 31 March 2004, gave it a profit of $1.79bn, about 20% more than the number two supplier in global absolute automotive profitability, Robert Bosch. Johnson Controls, the third most highly valued automotive supplier on the stock market, had operating profits of $879m in its financial year to 31 September 2003.
The 2003/4 fiscal year continued the group’s strong performance. Denso grew sales 9.8% in its financial year through to 31 March 2004 to ¥2,562bn ($24.2bn). Sales exceeded expectations during the course of the 2004 financial year due to higher Japanese production and continued growth in overseas sales, according to Nobuaki Katoh, CFO at Denso.
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By GlobalDataNet income for the group as a whole was down 0.9% in the full year to 31 March 2004, largely due to extraordinary income recorded in the previous year, relating to a change in government regulations on pensions in Japan.
Longer term the company is aiming to raise its return on equity (ROE) to 8% on a consolidated basis by fiscal year ending March 2006. That means the company must raise its operating profit margins from the current 7% to over 9% over the next two years. The improved ROE will partly be achieved by reducing the company’s issued capital base. Denso bought back six million of its own shares, equivalent to 0.68% of outstanding shares with its profits in late February, in early March. The company has approval to buy back up to 20m shares over 2003 and 2004.
Denso is also making a greater effort to source globally at key manufacturing facilities, and aiming to reduce its capital expenditure by improving efficiency and getting greater commonality between the operations. Overall it is looking to reduce capital expenditure by more than 30%. The company says that capital expenditures fell 11.6% in 2003 and around a further 8% in fiscal 2004.
Business focus
For a company of its size, Denso is relatively focused. Automotive accounts for more than 90% of sales and operating income across the company, and 80% of Denso’s sales are in its three core business areas – thermal products, powertrain control systems and electronics systems.
In 2001 Denso stopped making mobile phones and focused on its on-board information
systems business.
Denso claims to be global market leader in 18 automotive products and is looking to extend this across more product areas.
Denso’s growth has been largely driven by organic gains both from the success of its Japanese customer base, and above all Toyota, and also through winning share in its key product areas. However, the company has made a few major acquisitions. Denso acquired the rotating machines business of Magneti Marelli in 1999, and took over Magneti Marelli’s remaining share in another joint venture involving air conditioning and heat exchangers, including some front end module work in 2000.
In the climate control business Denso has benefited from the growth of fitment rates of air conditioning, particularly in Europe. Denso expects strong growth in air conditioning business in Europe. “In 2002, 11m air conditioning units were installed [in Europe], and we anticipate that number to climb to 15m units by 2005,” said Satoshi Watanabe, managing director in charge of Thermal Systems at Denso. While climate control is a relatively mature business, a major risk is the possibility of a switch to CO2 as refrigerant. This would require a high degree of investment on Denso’s part.
In the engine management systems business, diesel has been a fast growth area. Denso is pouring more than $100m into manufacturing facilities for its systems in Thailand and Hungary as well as Japan. Denso expects to make about 300,000 systems a year by fiscal 2005 in Hungary, and 250,000 a year in Thailand. Denso has also benefited from tighter emissions controls for trucks, and demand for more high performance in engine control units.
Denso is developing a diesel particulate filter in a move that parallels Bosch’s development of a capability in this area as the demand for diesel particulate filters is set to take-off. Denso is also heavily involved in Toyota’s fuel cell and hybrid work for the Prius-Denso developed a new scroll-type compressor with an integrated DC brushless motor and inverter. Prius requires an electrically driven compressor rather than a mechanical one. The development is much smaller and lighter than a conventional electrical compressor.
During the 2003 fiscal year Denso moved its intelligent transport systems (ITS) operations into a separate business segment, because of its growing importance. “Denso is looking to develop ITS into the third pillar of Denso’s product portfolio,” said Hiroshi Uchiyama, senior managing director at Denso, but ITS is well short of this at present. Denso produced 650,000 car navigation units in 2003, but expects to produce one million units by 2005. Denso is looking for sales from its ITS operations to exceed ¥1bn around $1bn in 2005.
Electronic toll collection (ETC) units are also expected to grow from 250,000 units in 2003 to one million by 2005. Denso’s ETC has benefited from Japanese government support and it has been producing automotive ETC systems since 2001. Executives say they are expecting the Japanese market for the systems to rise to three million units in 2004, 58% more than fiscal 2003.
International spread of operations
Japan accounted for 56.3% of sales in the financial year ending 31 March 2004, the Americas, north and south, accounted for another 21.7%, Europe 13.0% and Asia and Oceania 8.8%. Denso’s manufacturing footprint is well-balanced against its sales with only modest net exports from Japan, most of the net flow going to Asia followed by the Americas and Europe.
a) Europe
“Europe is the most strategic region for our further growth,” said Koichi Fukaya, president and CEO. In Europe Denso experienced an operating loss of ¥4.25bn in its financial year ending 31 March 2004, 7.2% higher than the preceding year. Start-up costs for plants in the Czech Republic and Hungary have added to its investment costs and new additions to the product lineup were detrimental to the operating profit in 2003/4.
Denso wants to move from around 17th largest supplier in Europe to be among the top ten by 2005 or 2006. Major opportunities for Denso are through the growth of air conditioning fitment
rates and diesel common rail systems, as well as navigation systems.
Denso’s Italian operations are the largest part of its European network. Denso has almost 4,000 employees in Italy within the thermal systems, starter alternators and small motor business that the company bought from Magneti Marelli. Denso is looking to transfer technology from Japan to the Italian operations to strengthen its systems capability.
The second largest concentration of Denso manufacturing facilities in Europe is in the UK, where Denso has 3,200 employees. Growth in the UK was spurred by the early development of the Japanese assembly industry.
Denso makes its diesel common rail systems for European customers at a plant in Hungary. Denso will raise the output of common rail high pressure direct injection systems at its Hungarian plant from 300,000 a year to 700,000 a year from late 2004. In addition to the products for the Toyota Avensis and Isuzu it already produces, Denso will supply Ford from 2005. The plant is near full capacity and Denso would look to expand if it won further contracts, say Denso executives.
In navigation systems Denso believes that the European market will move from 1.5m units in 2003 to about three million units within five years. Denso already supplies Jaguar and sees significant opportunities to grow further; the market in Europe is still undergoing major change as OEMs work to establish the optimum man-machine interface and functionality. Denso’s experience in Japan’s more mature navigation systems market and foothold in Ford leave it as well placed as any of its competitors to meet that growth.
b) Asia
Denso has a strong presence in ASEAN. In Thailand it has 2,500 employees and has been manufacturing electrical components and air conditioning systems since 1972. Most recently the company established
a joint venture with Kyosan Denki to manufacture fuel pump modules, and for production of diesel common rail systems for pickup trucks. Denso is supplying the systems to Toyota’s south east Asian plants from July 2004.
Denso also has over 2,000 employees in Indonesia, almost 2,000 in Malaysia, and recently has been expanding its operations in Vietnam. Denso has been in Vietnam since 2001 and has manufactured TGV actuators and air flow meters since 2003 and added EGR valves and other components to the product line in April 2004. Denso Manufacturing Vietnam also opened a design centre for engineering services in July 2003, working on components for Japan as well as application design assimilation. It expects to have 460 employees in Vietnam by 2005 and sales of $45bn (¥5bn).
By the end of 2003 Denso had seven operations in China, despite the relatively late entry of the Japanese OEMs, and in particular the Toyota group, into the Chinese market. Manufacturing operations in China included air conditioners, alternators, ignition coils, electronic control components and wiper washer systems. Denso also has a small software development facility in Shanghai.
c) The Americas
Denso has 11,000 employees in the US manufacturing a broad range of products. The company is “experiencing exceptional business growth in the thermal products division”, said CEO Koichi Fukaya.
Denso has big opportunities for growth from the efforts of Ford, General Motors and DaimlerChrysler to widen their traditional supplier base, and bring in alternative suppliers to raise the level of competition facing former in-house businesses, principally Delphi and Visteon. Denso competes directly with the former component operations of the Big Three in several key areas – such as air conditioning, navigation systems and engine control units.
In the first three quarters of the 2004 financial year (to 31 December) Denso reported higher sales to General Motors in particular, and Denso won its first contract to supply air conditioning systems to Ford in autumn 2003. Total sales in 2003/4 were up 3.2% to ¥558bn ($5.3bn) although operating income fell 11.9% to ¥24.8bn ($234m).
The company announced in mid-2003 that it was establishing a sixth thermal products business manufacturing company in North America in Osceola, Arkansas to produce car air conditioners and heavy equipment radiators. Denso is investing $35m in the facility, which will employ 500 people by 2008, and Denso has noted that Arkansas is well placed to ship directly to expanding OEMs in the region.
Research and Development
Denso’s development capabilities are central to its market position and growth, and the company’s capabilities are highly regarded. Denso is one of the few suppliers, alongside Bosch and Delphi, to have the capability to produce some of its own semi-conductors, for example.
Denso aims to spend around 8% of sales on research and development. Its basic research is undertaken at Denso Research Laboratories in Japan with local research facilities primarily in the US and Germany to meet local market needs, as well as R&D sections in production applications in each major business segment.
Denso has also invested heavily in diesel technology. It is not an obvious investment for a company that primarily serves a market that is not interested in diesel technology for passenger car applications – Japan – and whose second biggest market – the US – has not so far taken up the technology for light vehicles. Denso’s decision to make the expensive attempt to develop and launch its own technology in this area, in the absence of high volume demand for the product from its traditional core customers, is a measure of the global ambitions of the company in its core business areas. Denso has chosen a high performance solution and was the first supplier to launch a high pressure direct injection diesel system operating at 1800 bar.
In air conditioning systems, Denso is working on a CO2 based system. Last year the European community proposed a new refrigerant regulation to reduce emissions of hydrofluorocarbons (HFCs). “These stricter environmental regulations bring us an opportunity to grow,” said Denso executives, “however, we have to carefully watch industries’ opinions and movements regarding the substitute, R-134a.”
Denso is also working on integrated safety systems. It is offering a radar-based pre-collision avoidance system on the Lexus LS 430 and the system is a first in an area that major competitors such as Valeo, Bosch and Continental expect to become increasingly important in the next few years. Valeo describes this area as the “seeing and be seen”; Bosch describes it as the “sensitive car”, but basically it is the integration of pre-collision assessment systems with braking operations.
Integrated safety systems build on Denso’s strengths in a broad range of electronic applications. For example, it already makes airbag actuators and has now developed a system that tightens passenger seat belts and activates brakes to reduce speed where collision is unavoidable.
Denso also has a minority (20%) stake in ADVICS, the brake system Toyota affiliate formed to develop complete braking systems.
In navigation systems Denso has a joint venture with Bosch for the development of the technology behind next generation navigation systems, expected to come to market in 2006 or 2007.
In addition, in early 2004 Denso formed a joint venture with Toshiba corporation for the development of a multi-operating systems environment for car navigation systems. Their approach provides a single shift support for both micro-ITRON and Microsoft Windows Automotive.
The two companies have also developed a technology to operate the macro media flash player on car navigation systems. Software allows background images to be displayed on the car navigation systems, while the radio or CD is playing.
Modules and Systems
One of Denso’s relative weaknesses is its position in modules. Denso makes front-end modules in Europe for Fiat and also the front-end module for the Daihaitsu Copen in Japan, but it is handicapped
in its interest in developing more complex assembly modules by the lack of interest at its major customer, Toyota.
Relative to other air conditioning and electronics suppliers, Denso is under-developed in its module integration capabilities in areas such as the cockpit – despite having more content in that area in navigation, air conditioning and instrumentation than almost any other supplier.
Denso is very interested in cockpits according to Fukaya, but so far it has not found a partner. Toyota is interested and Denso is supporting the development of Toyota cockpits, said Fukaya. Fukaya said that Denso can make progress with air-intake modules, combining intake manifolds, air flow sensors and filters. Air-intake modules, which Denso has also developed for a North American OEM, are one module that Toyota has expressed an interest in.
Denso executives say the development of a modular capability is important to the company’s long-term success. They stress, however, that for it and its customers, the critical ingredient is the ability to rethink the way a module functions or is assembled – it is not particularly interested in modules that are just assembly operations. For the Daihatsu Copen, for example, Denso integrated sensors and managed the front-end’s wind flow performance to enhance the functionality of the products. Denso is looking for similar additional functional benefits for its air conditioning area with cockpit modules. “We need to offer more ideas,” said Fukaya.
Outlook
The 2004 financial year progressed better than Denso expected and the operating margin continued to improve, driven strongly by a 24.5% increase in operating profit in Japan, the result of
higher production volume and cost reduction measures. On the downside the yen’s appreciation against the dollar has slowed the growth of its North American businesses and the operating margin has fallen. Also the threat of a continued strong yen will hamper direct exports from Japan and force Denso to accelerate its internationalization.
Denso is now forecasting fiscal 2005 sales of ¥2,580bn ($24.3bn), an increase of just 0.7%, and net income of ¥118bn ($1.1bn), up 7.2%. The company has benefited and will continue to benefit from the success of the Toyota Group. Toyota owns about 24% of Denso. Toyota has forecast record sales of over seven million units in 2004.
But while the Toyota link is undoubtedly a strong net advantage to Denso, it does have its downside. The company has been relatively slow to develop its capability in some fast growing module areas, and has had to work hard to catch up in the fast growing diesel engine control systems business that the Japanese OEMs initially underestimated. Denso is pushing hard to overcome these constraints.
Changes to the management system will see a reduction in board directors from 32 to 13 and the creation of 24 new non-board managing officers in June 2004. This should shorten decision making time and speed up internal operations.
SWOT Analysis
STRENGTHS
- Strong position on vehicles of parent company Toyota, which is expected to be one of the best performing mass and luxury carmakers in the next decade
- Strong position in electronics, also set for rapid growth
- Mature market position in North America where major customers are looking for alternatives to traditional suppliers
- Strong position in ASEAN
- Proven competence at developing industryleading technologies
- Strong market position in navigation systems and electronic toll collection, as well as other intelligent transport system elements
WEAKNESSES
- Capability to develop systems and modules is restricted by parent Toyota group’s limited interest in these areas
- In powertrain controls Denso is number three or four in fast-growing diesel engine systems
- Only has a minority 20% share in ADVICS, giving it a weaker grasp on key technologies for driving control and safety than rivals TRW, Bosch or Continental
OPPORTUNITIES
- Toyota’s commitment to technology leadership and its strong growth possibilities in the high performance luxury area give Denso the chance to lead in establishing capabilities in integrated vehicles systems linking communications and driver safety and control
- Thermal systems are a relatively mature area, but they demand a high level of investment if industry switches to CO2 as a refrigerant
THREATS
- Small motors business in ASMO for washer systems, power windows and automotive blowers may be threatened by growth of lowcost manufacturers in Asia.
- Slow growth prospects for core air conditioning business
- Limited growth prospects for development of heat exchanger sector and relatively small market position in one potentially key direction of development for radiator systems – the front-end module.
Q & A Koichi Fukaya, president and CEO, Denso Corporation
Koichi Fukaya has been President and CEO of Denso Corporation since July 2003. He was interviewed by Edmund Chew and Colin Whitbread of SupplierBusiness.com in April 2004.
What is Denso’s key competitive strength?
I believe our customers most appreciate and value our R&D capabilities. We work with car manufacturers in the very early stages of product development, even at the conceptualization stage. Car manufacturers expect tier 1 suppliers to be an R&D partner, and Denso is one of a few suppliers that can provide such values. R&D capabilities are key to Denso’s growth. That’s why we invest about 8% of consolidated sales in R&D.
In what product areas do you see the fastest growth prospects in North America?
Our focus is on air conditioning, navigation systems and components for engine management systems. The air conditioning market is moving away from components supply to system supply. I see this as
a great opportunity for us to grow our business in that field, as we are the only supplier capable of system development with technologically advanced components. The navigation system market also will grow.
In addition, I see a lot of potential for common rail systems.
How do you see developments going in Europe?
We are expecting business expansion in Europe compared to North America or Japan. The most challenging area is the diesel engine system, including the common rail system. Another area is air conditioning,
because the installation ratio is going up so much. Another area is navigation or information systems. We want to focus on these three areas in Europe.
Who are your main targets in Europe?
The Japanese carmakers in Europe are one target for us, of course, but on the other hand, for diesels European auto makers are our main target.
What share of the high pressure direct injection diesel market do you expect to have in two or three years time?
We have a specific business target, but we are not disclosing it publicly. What I can say, and want to say, is that the diesel common rail system is one of our most important products for Europe. And our common rail technology is more advanced.
Denso is loss making in Europe. Where do you see the priorities for that? Where is the problem?
So far the European business is loss making, but this loss is a very healthy situation I think. The loss is caused by recent investment in land and factories, but, for example, the Czech plant is just starting production. They do not need any more investment, so I think we can solve this loss situation in a short time. But if we do acquire more
new business, that may require more investment.
Does your relationship with Toyota prevent you from gaining contracts with other European business potential?
No. Toyota is a kind of father to Denso, but it is very open and Denso is free to approach any other company. They always recommend us to other companies and never prevent Denso from winning other customers.
In the past you have used some acquisitions in Europe to help grow your business. Is that likely in future?
So far we have no idea or no plans to acquire another company.
What was the reason for your joint venture with Bosch Blaupunkt on navigation system technologies?
The core development required so much money and manpower that we decided we wanted to develop it together. Then using this core we want to create another navigation system independently, either Denso navigation or Bosch navigation. We are partners in this project, but on the product side we will be competitors.
What are the prospects for front-end modules?
With front-end modules we can showcase our capabilities in systems and modules. In the future, we expect front-end modules to cover safety technologies. Those may include adaptive front lighting systems and collision warning systems.
Denso has already started production of front-end modules in Japan for Daihatsu. Daihatsu accepted our ideas for our new front-end module because it has additional functions such as better space management. Denso also has a lot of experience on thermal control – how to control the flow of the air and so various functions were added. Just assembling the components is not acceptable. Additional functionality is the key.
Any other modules that you are working on?
Air-intake modules – intake filter, intake manifolds and air flow sensors. Cockpit modules are very interesting, but so far we have no business, just developments.
What kind of changes in the way that Denso works do modules require?
We must shift from specification-oriented thinking to concept-oriented thinking. Then we have to develop and make products with new value. Because of our advantages in developing core technologies and
components, Denso can and will create such systems and modules.
