While a majority of the luxury automakers are pouring in investments in China to boost the local production, Toyota Motors (NYSE:TM) seems to be content with exporting Lexus vehicles from Japan at least for the moment. Selling luxury cars is pivotal to any automaker’s profitability since they have fatter margins compared to conventional cars.
Recently, Mercedes announced its decision to invest $2 billion in China to raise the local production. The German automaker feels that producing cars locally will make them more affordable which should boost its overall sales. Furthermore, even GM got approval from the Chinese government to build a $1.3 billion plant with a capacity of 150,000 units to manufacture the Cadillac cars locally.
Imported cars are levied a 25% tax, making them more expensive compared to those produced locally. On top of that, there is a value added tax (VAT). All the taxes and duties imposed on foreign manufactured cars inflate the final price of the vehicle making it unaffordable for even the upscale customers. Lexus sold 49,000 cars in China in 2012, only a fraction of 236,000 vehicles sold by the market leader Audi. 
While it is true that Audi and BMW have been in China for much longer than Lexus, a higher price tag prevents automakers from targeting customers in the interior regions of the country where people are more price sensitive. Most of the sales currently take place in cities and urban areas on the east coast. Audi and BMW on the other hand have a better market coverage within China and is one of the reasons why these companies have performed so well in the country.
Going forward, the luxury car market in China is expected to outpace the overall automotive market. A report by McKinsey released earlier in the year projects the Chinese luxury car market to reach 2.25 million by 2016 and to 3 million units by 2020, making it the biggest luxury car market in the world. 
There are two major reasons that discourage Toyota to produce Lexus cars locally in China:
a) A weak yen which encourages Japanese companies to export their products from Japan.
b) Tensions between Japan and China have lowered the popularity of Toyota in China and made the sales forecast unpredictable.
Although exporting from Japan is beneficial for the automaker since the yen has now weakened, a plethora of taxes limits the volume of the company. The yen has depreciated nearly 25% against the dollar in the last nine months after the new Japanese PM stepped into the office.
But what if the yen appreciates back a few years down the line? After all, it’s not all that unlikely that a different BoJ (Bank of Japan) governor might agree completely with the monetary policies of the current administration. Toyota then will neither have the advantage of a weak currency nor the benefit of high volumes.
Furthermore, it has been a year since tensions first sparked between China and Japan due to ownership over the disputed islands, but the impact is evident on the sales until now. Usually, it takes about 30,000-40,000 units of sales of a particular model for the production to be economically feasible. However, in such an uncertain environment, it becomes all the more difficult for the automaker to pledge investments into the country. But such huge is the size of the Chinese market that no automaker can ignore to maximize the size of its operations. This is a conundrum that is difficult for Toyota to solve.
We have a $119 price estimate for Toyota, which is about 5% lower than the current market price.Notes:
- Lexus Faces Difficult Challenges in China, July 13, 2013, lexusenthusiast.com [↩]
- China on track to become globe’s top luxury car market, March 7, 2013, nbcnews.com [↩]