The Impact of the Toyota Recall

How will the recent mass recall of Toyota cars affect the demand for these cars in the short and long run

Toyota Motor Corporation was founded in 1937 as a spinoff from Toyota Industries and ever since it has thrived to reach to the point where it is now the world's largest automobile maker by sales. Toyota's success is based on its reputation of having good quality reliable cars at reasonable prices. In the last 12 months though, due to some car faults, Toyota's reputation as producing reliable cars was malformed.

At the worst time ever for the company, due to the economic crisis, (according to the Guardian, Toyota reports the worse results in its history in May 2009) the company is faced with another great cost. According to BBC News "Toyota Motors says its massive vehicle recall could cost it up to $2bn (£1.25bn) in lost output and sales." Top gear commented that even though this is a heavy cost it is still bearable for a company as big as Toyota.

Demand

To realise the possible impacts in both the short and long run of this costly recall, some economical theories must be explained. The most important factor that any company depends on is the demand for that commodity. A general definition for demand is the relationship between the quantity of a commodity a consumer is willing and able to purchase at a given price. The factors that affect demand differ from product to product, but in our case the main factors are the price, quality, prices of substitutes, income and consumer size.

Before we go in depth with all the factors, a graph showing a shift in demand will be helpful to visualise the effect of each factor.

This graph represents a negative shift in demand. The change from D1 to D2 means that people are less willing and/or able to purchase the good at any given price.

As mentioned before price is a factor of demand, which means that a change in price will have a direct change in demand. It won't necessarily shift the demand line to the left but definitely cause a movement on the demand line. Cars are not a cheap good, as the consumer will use a high percentage of his income to purchase it. Therefore, the higher the car price, the higher that percentage value is and it might cause the consumer to turn to a cheaper alternative. Income and price are linked together in this scenario, as briefly shown previously. That price to income ratio has 2 factors. The price of the commodity, which the company can alter, but it cannot have any influence on the income of its consumers. The recent crisis in the economy made people unsecure about their jobs and left thousands of people unemployed or degrade to a less paid job. This results to the price to income ratio to be higher and putting consumers off the idea of purchasing a car at this period of time.

Moving on to the issue of quality, consumers expect the highest quality when they purchase anything. If there are any indications that the quality is not of satisfactory level, then people would not want to purchase that certain commodity. When consumers try to make a decision, that decision is based on a comparison of the price and quality of the product between different substitutes. Since in our case Toyota is not the only the player in the car industry, customers will definitely look at competitors prices and even though they might be higher, they will trust the company more due to the lack of company flaws. Lastly demand for a commodity depends on the customer base. Obviously the bigger the consumer base, the more demand that product will have.

Market Structure

The car industry is an oligopolistic one. Oligopolistic market is a term given to a market which is dominated by a small number of large organisations. It actually comes from a mixture of Greek words that mean small number and sellers. The small number of organisations within the market causes high barriers to entry for any other new competition.

There are only a handful of organisations dominating the car manufacturing industry. These include Toyota, GM and Honda. These companies have been in the industry for many years and achieved large economies of scale. Even though billions were spent on research and development, now they all enjoy operating on a large production scale, which effectively leads to profit maximisation.

As mentioned earlier, there are high barriers to entry, due to several reasons with the main one being the sunk cost. Meaning the cost required to start a car production company. The long established reputation of other manufacturers though makes it even harder to compete even if the sunk costs can be paid for.

Price elasticity of demand (Ped)

Price elasticity of demand is the term used to see how demand changes with a change in price. If there are available figures, you can use them and you would usually get a result from -1 to +1 (even though most times the figure is negative due to general inverse correlation of demand and price). The closer the value is to either ends of the range, the more dependant the demand is to the price. When the value is 0, it is said that the products price elasticity of demand is perfectly inelastic. Meaning that the demand does not change with price changes. The closest real life example is cocaine, as addict will pay anything to get their dosage.

The Ped depends on various factors, which resemble the factors mentioned for demand. In addition to the number of substitutes and competitors and level of income, Ped also depends on the rationalisation of the consumer. By rationalisation I mean that the consumer will think twice for a product such as a car. Cars are becoming a necessity in the modern world, but taking into account the lower income levels now, a consumer will rationale if a car is a need or a luxury at the moment. There are several substitutes for cars, from bicycles to buses and underground trains. This might change the consumer's opinion whether the car is a need or just a desired luxury.

Putting the theory in action

Car manufacturers have recalls more often than one would think. Always at a much smaller though. Mercedes for example recalled one model of theirs, redesigned it and put it back in the market without causing any damage to its reputation. Of course, in Toyota's case we are talking about nearly 9.1 million cars worldwide (according to a Toyota spokesman). How did a car giant like Toyota let this happen then?

Unfortunately errors are bound to appear in any business, due to various factors. The company has fallen victim to a manufacturing flaw