Collapsing pyramid: EV shift strikes at heart of Japan’s auto sector

Honda Motor’s announcement in June last year that it will shut down its powertrain production unit in the city of Moka, Tochigi Prefecture, in 2025 came as a surprise to Keita Aoki.

Japan’s second-largest automaker by sales had already declared that it would end production of brand new gasoline-powered vehicles by 2040 as part of its fight against climate change, so the head of Moka-based Aoki Symtech knew that this would happen eventually.

But it came much faster than Aoki expected.

“It’s an abrupt shift, as I was thinking that (the engine-related business with Honda) would probably not change for another decade,” says Aoki, whose firm has been providing parts for the Moka factory's engine production lines and maintaining them for more than three decades.

Although the transition from conventional gasoline-powered cars to their electric equivalents is proceeding quite slowly in Japan, the nation’s carmakers are set to accelerate their efforts over the next few years. As engine production is a core part of the Japanese auto sector, that will see many firms shift or downsize production, similar to how Honda plans to do so in Moka.

With such a transition and its related upheaval now appearing inevitable, it raises the question of whether the country’s auto sector — which consists of thousands of suppliers and millions of workers — will remain intact as a critical pillar of the Japanese economy.

Quite how that will play out remains to be seen, but what is more certain is that the electric vehicle shift will drastically reshape the industry’s structure and force a number of firms to overhaul their business strategies.

Stuck at the starting line

Battery-based EVs are a niche choice in the domestic market, accounting for only about 1% of brand new cars sold last year.

The figure is significantly lower compared with other nations such as the United Kingdom and European Union, with their rates standing at 11.6% and 9.1%, respectively.

Considering the current situation, “the pace of adoption for battery-powered EVs and plug-in hybrid vehicles is overwhelmingly slow,” says Hirotaka Kanno, a partner at Deloitte Tohmatsu Group.

One of the reasons why EVs have not sold well in Japan is because of the high popularity of hybrid vehicles, which accounted for about 40% of new passenger car sales last year. At the same time, Japanese carmakers have not yet introduced many EV models.

That is beginning to change, though, with more options debuting on the market this year: Toyota launched its first mass-produced EV model — the bZ4X — in May, while the Nissan-Mitsubishi alliance rolled out electric minivehicle models this summer.

More EV models are expected to hit the market over the next few years.

While Japanese carmakers have mostly been taking a wait-and-see approach, foreign firms are taking advantage of the EV transition to challenge the dominance of domestic automakers in the Japanese market.

China’s BYD, which topped Tesla to become the No. 1 EV seller globally in the first half of this year, announced earlier this year that its passenger EVs will debut in Japan in January.

Meanwhile, South Korea’s Hyundai Motor re-entered the Japanese market earlier this year for the first time since 2009 with the introduction of its Ionic EV model.

Japan’s status as an automobile powerhouse may even have been holding back its EV shift, some experts say. But now that change is finally in the offing, the very structure underpinning the sector is under threat.

Weakening structure

The Japanese auto industry is known for its pyramid structure, in which major carmakers sit at the top above several tiers of suppliers. Since this structure was established in the era of engine-powered vehicles, a hasty transition to EVs would be problematic for many firms that supply parts for such cars.

But with carmakers needing to give up on gasoline-powered engines sooner or later, that landscape is set to experience sweeping change. For some firms, the transition could be particularly tough — or even impossible.

“The EV shift is accelerating (globally) and is now irreversible. ... It will have a profound impact in our case,” says Hiroshi Otsuka, who heads Musashi Seimitsu Industry, an Aichi Prefecture-based manufacturer that produces parts for engine transmissions.

In turn, this shift could represent a serious problem for Japan, as the auto industry is a backbone of the economy.

In 2019, the value of the auto sector’s shipments totaled ¥60 trillion ($405 billion at current exchange rates), or equivalent to about 19% of that of the overall manufacturing industry. The value of auto exports last year, meanwhile, was ¥15 trillion, amounting to about 18% of total exports.

The number of employees working for the auto industry was about 5.5 million in 2020, or roughly 8% of the nation’s entire workforce.

Underpinning the threat to the current auto industry pyramid is its reliance on traditional production customs.

One of the strengths of Japan’s auto sector is its craftsmanship based on close coordination between carmakers and suppliers, especially with regards to engine-related systems, Otsuka says.

He pointed to the example of gears — even if his firm makes them based on design specifications, they often don’t work perfectly. As such, the carmaker and his firm need to work together to make painstaking adjustments as part of the finishing touches.

But since EVs don’t have engines, they don’t require this level of refinement, with the manufacturing process more like the simple assembling of parts seen for electronics products.

As a result, “I believe the pyramid structure will be changed for sure,” Otsuka says.

Making the change

Alarmed by the looming demise of engine manufacturing, some suppliers have been attempting to keep up with the EV shift.

If all vehicles became electric next year, the company would lose more than half of its sales, Otsuka says. But the company, which has been a first-tier supplier for Honda, has been moving quickly to prepare for the electric era.

For Musashi Seimitsu, that means doubling down on the parts that will still be needed to meet the demands of the new era.

In terms of parts, even if engines are expected to be phased out, the company will be able to produce components for EVs, such as differential gears that help cars turn smoothly.

“Our company has been manufacturing gears for more than a half century ... so we have a lot of advantages,” Otsuka says.

But still, adaptation is a must, as specifications differ. Otsuka explains that gears in EVs are put under greater stress, meaning they need to be tougher.

Also, since EVs are loaded with batteries that weigh hundreds of kilograms, it is essential that their gears are lightweight.

“Production of gears for engines may diminish, but we will increase gears for EVs,” Otsuka says. “We are very much focusing on this strategy now.”

Supply chain relationships within Japan’s auto industry are often long-standing and deep-rooted, but the absence of established EV supply chains is allowing firms to stake out new opportunities.

Musashi Seimitsu, for example, has long been part of Honda’s supply chain, but is now working on a number of business projects with various automakers.

“We don’t decline any of them, so we’ve been actually really busy,” Otsuka says, adding that the next five years will be an important period in which to promote itself as a key supplier for EV-makers.

The EV shift is also prompting some companies to look beyond the auto sector altogether.

Aoki Symtech plans to continue being a supplier for carmakers, but it has also taken advantage of its automated production technology to enter the food manufacturing business.

“We will continue to have the auto business as one pillar (of revenue), but we don’t want to depend only on that,” Aoki says.

With more people eating at home amid the pandemic, and food production firms consequently needing more workers but not necessarily being able to find them, Aoki’s thoughts turned toward automation in this sector.

“When I first saw automated food production lines, there were actually quite a lot of tasks handled by people, even though they’re called ‘automated,’” Aoki says. “This would be unacceptable in the auto industry.”

Aoki says cultivating business in the food industry has been quite successful, and sales have increased several times over.

In the past, Aoki Symtech relied on the auto sector for about 80% of its total sales, with Honda being its primary client, but the rate has now fallen to below 50%.

“We have found a silver lining in food production and are now wondering what can be another pillar of our business,” Aoki says.

While suppliers such as Musashi Seimitsu and Aoki Symtech have been eagerly seeking ways to survive the paradigm shift, there will be other smaller manufacturers within the pyramid structure that will struggle with the EV transition.

“The impact of the EV shift on suppliers will be tremendous,” says Kanno of Deloitte Tohmatsu. “There are highly skilled engineers who have been making engines or intake and exhaust systems, but if cars no longer need those, (affected suppliers) will face an issue of how they should make the best use of their talents.”

According to an estimate by consulting firm Arthur D. Little, about 680,000 people work for auto parts suppliers, but the EV shift could see about 84,000 jobs cut by 2050.

In addition, growing pressure on manufacturers to make investments to achieve carbon neutrality will place an extra burden on some smaller suppliers, Kanno adds.

To cushion the impact of the EV shift, in August the government launched support services for small and midsize suppliers to facilitate their efforts to renew their business models, while at the same time also offering subsidies.

Auto industry no more?

Given the auto industry’s pyramid structure is unlikely to be maintained — with firms downsizing, splintering off or dying out — the sector’s future as a pillar of the Japanese economy is being called into question.

For Kanno, the shake-up and inability of various suppliers to keep up with the transition means the auto sector — at least as it is currently understood — probably won’t remain a backbone of the economy.

But a more optimistic view is that nontraditional players will expand into the sector in response to the rise of new technological trends, such as connected vehicles and autonomous vehicles, as well as the ongoing process of electrification.

Carmakers themselves are stressing the importance of integrating software, as artificial intelligence is critical to self-driving cars, which themselves will allow drivers to enjoy improved in-vehicle entertainment.

The recently formed alliance between Sony and Honda symbolizes this trend.

“In terms of software, we will need to have a fresh way of thinking,” Yasuhide Mizuno, a Honda executive who is also chairman and CEO of the joint venture, said at a news conference in October. Indeed, it was Sony’s strength in software and content, such as music and video games, that prompted Honda to partner with the conglomerate.

Thus, the auto industry is expected to see an influx of new entrants in the coming years and decades.

“When including all these players, I think the auto industry will still be the pillar industry in Japan,” Kanno says.

But the nature of that pillar will be very different, with the evolution of cars further blurring the boundary between the auto sector and other fields.

Companies such as Tesla were quick to get ahead of the game, Otsuka says, adding that Tesla’s elimination of the word “Motors” from its company name in 2017 highlighted this trend.

“It’s quite possible that people will no longer call it the auto industry in 20 years,” Otsuka says.