HERE COME JAPAN'S NEW LUXURY CARS First out of the gate, Toyota's Lexus is as good as, or better than, more expensive German makes. But will American buyers forgo Teutonic mystique?
By Alex Taylor III REPORTER ASSOCIATE William E. Sheeline

(FORTUNE Magazine) – HIDDEN AMONG rice fields on the northern Japanese island of Hokkaido, Toyota's Shibetsu test track has been off limits to outsiders since construction started in 1982. Recently, Toyota Chairman Eiji Toyoda traveled to Shibetsu to check out three automobiles: Mercedes-Benz's 420 SEL, BMW's 735i, and Toyota's own new high-performance sedan, code-named F (for Flagship) One. After driving the cars at speeds up to 120 miles per hour, the diminutive 76-year-old chairman related his impressions through an interpreter: ''I found when comparing them that our car had a number of quite excellent merits.'' Chairman Toyoda is too modest. The car raises to a new level the traditional Japanese virtues of high quality and superlative engineering. It is also faster, quieter, and more comfortable than its West German competitors -- and dramatically less expensive. When it goes on sale in the U.S. in August as the Lexus LS 400, it will carry a base sticker price of $35,000, nearly $30,000 less than the Mercedes 420 SEL. The inside tale of how Lexus came into being is rich in lessons for anyone who yearns to develop up-market products. Getting the Lexus out of Toyota, whose forte is rolling out wheels for the world's millions, is like producing beef Wellington at McDonald's. Toyota had to target its customer precisely, create all-new management organizations, rethink components down to the tiniest screw, and invest more time and money -- six years and over $500 million -- than anyone had originally imagined. Despite obstacles aplenty, the product looks like a stunning success. Lexus is the leadoff hitter in what will soon become an entire lineup of Japanese superluxury cars -- those costing $35,000 and up -- aimed at American buyers. In November, Nissan will launch the slightly larger and more expensive Infiniti Q45. Mazda and Mitsubishi are said to be planning expensive new sedans. And next year Honda will begin selling the Acura NS-X, a pavement- ripping sport coupe with a projected $50,000 to $60,000 price tag. Their timing is terrible. U.S. car sales are the weakest in five years, and big-ticket imports are particularly troubled. BMW has been holding its own this year, but Mercedes is down 18%, Audi 21%, and Porsche 48%. ''I have no doubts about Lexus and Infiniti being ultimately successful,'' says Wall Street's best-known automobile analyst, Maryann Keller of Furman Selz Mager Dietz & Birney Inc. ''But I don't think this is a market conducive to instant success.''

Luring luxury-car customers is especially dicey for Toyota, which is vaulting over Cadillac and Lincoln in price and venturing onto turf traditionally occupied by the prestige German and British automakers. Its most popular car in the U.S. is the $13,500 Camry, and the limousine it sells in Japan looks more like a boxy Russian Zil than anything likely to excite passions in Westchester or Westwood. Though Toyota ranks No. 1 among Japan's automakers, having turned out four million cars and trucks in 1988 with sales | of $50.8 billion, it often trails Honda in engineering and Nissan in styling.

Big and conservative, Toyota does not get the respect among auto aficionados that Chairman Toyoda thinks it deserves. So in 1983 he challenged his engineers to ''develop the best car in the world,'' with Mercedes and BMW as the benchmarks. The unassuming chairman will not admit to a lust for star quality, ascribing his motivation to more mundane concerns. ''The people who have been buying our cars were moving up in life,'' he said recently in his modest Toyota City office, two hours from Tokyo by bullet train. ''We wanted to meet their heightened needs.'' Though the chairman did not give his engineers a blank check, they got whatever they wanted. If Toyota was going to aim for the top, the U.S. was the logical market. The Japanese did not start buying luxury cars until taxes on big autos amounting to 23% of the wholesale price were eased in April. Europe's car buyers are chauvinistic, and import restrictions make life difficult for the Japanese automakers. Toyota set out to do what nobody else had done: design a sedan that would travel 150 mph while carrying four passengers in relative quiet, comfort, and safety -- and without incurring the American gas-guzzler tax. Even though 65 mph is the legal limit in the U.S., Toyota figured Lexus owners would want to brag about outrunning radar. THOSE SPECIFICATIONS dictated breakthroughs in aerodynamics, noise dampening, suspension, and most of all, the engine. Development was put under chief engineer Ichiro Suzuki, 52, whose bookkeeper demeanor masks the drive of a Vince Lombardi. He devised a nine-stage process to reach each design target. It included: discussing how goals would be met, making continual follow-ups, and trying wherever possible to have it both ways. For example, Suzuki wanted the optimum solution -- the biggest engine with the least noise -- even though the two objectives are difficult to reconcile. ''Compromise was unacceptable,'' he says. ''We had to push the engineers to achieve the vision we wanted to create.'' Every great automaker from Henry Ford to Enzo Ferrari has started with a new engine, so that is where Suzuki put his emphasis. He ordered up a 32-valve, aluminum-block V-8 that would combine high horsepower with unusual operating efficiencies. Like most luxury carmakers, he opted for rear-wheel drive because it provides superior ride and handling characteristics, although it adds weight and subtracts interior space. When the first engine prototype was tested in 1986, it got only 20.5 miles per gallon under a complex formula that blends city and country driving -- below the 22.5-mpg hurdle for escaping the gas-guzzler tax. So Suzuki applied an all-purpose problem-solving technique that he calls ''thoroughgoing countermeasures at source.'' Simply put, it meant ripping apart every component and improving it until the design goals were met. To get a 1% improvement in engine efficiency, he replaced stamped steel valve lifters with lighter, stronger aluminum ones -- an industry first. Later he tinkered with the transmission, the alternator, even the tires. Lexus now escapes the tax. If engine building is hard science, interior and exterior design is squishy stuff, requiring different tactics. In April 1985, Suzuki dispatched 20 designers to the U.S. to find out what customers wanted. They visited dealers in half a dozen big cities, staged focus groups, and buttonholed car buyers. They discovered that Toyota had little chance of wooing 60ish owners of Cadillacs and Lincolns, much less drivers who had invested tons of ego and cash in high-priced German cars and would consider anything else a comedown. Lexus would have to go after younger buyers who aspired to the best Germany could produce but could not yet afford it. In August, 15 designers returned home and five stayed on to intensify their study of the natives in California, where Lexus expects to sell 30% of its cars. Working out of a rented house in Laguna Beach, they created three one- fifth-scale clay models of a simple and functional car, which they presented at headquarters in Japan. Top management turned thumbs down. In the end the designers made eight proposals over 18 months -- six months longer than scheduled -- before one was approved. The most controversial item was the grille, a mechanical redundancy now that air intakes are located under the front bumper of many automobiles. But Mercedes and BMWs still announce their presence with distinctive grilles, and Toyota's conservative bosses decreed that Lexus wear one to look properly luxurious. Designers were more successful in striking a midpoint between a high rear deck, which improves aerodynamics but looks ungainly, and a more graceful lower one. Meeting performance targets dictated building a slippery body. Air drag creates 50% of a car's resistance at 65 mph, and 80% at 150 mph. By reducing the drag coefficient from 0.35 to 0.29 -- lower than a Porsche 911's -- Lexus engineers cut fuel consumption at 120 mph by 17% and boosted the top speed by seven mph. Look quickly at Lexus and you see a Mercedes 300E with BMW undertones. Toyota officials, sensitive to copycat complaints, argue that similarities to other cars are inevitable, given today's requirements of passenger packaging and aerodynamics. Beyond the surface resemblance, in fact, Lexus has an elegant, sculpted body that has been refined in unexpected ways. For example, a single piece of chrome trim borders the side windows, eliminating seams. WORRIED ABOUT premature disclosure, Toyota waited three years to reveal the project to its U.S. subsidiary, Toyota Motor Sales USA Inc., based in a Los Angeles suburb. Executives there did not see an official design proposal until February 1987. By that time the Americans were already deep into their own consumer research. Among other things, they identified the median sales prospect as a 43-year-old male with a household income of $100,000. Existing Toyota dealers appeared inappropriate for Lexus since they were volume sellers; the executives wanted a more sophisticated approach in handling customers. In the spring of 1986 they recommended that a separate dealer network be created with new showrooms and new ways of doing business, following an approach that Honda was already pioneering with Acura. They wrote several volumes of regulations, ranging from showroom carpeting to mechanic training, but that did not deter 1,200 applicants for the initial 100 franchises. (None of the dealers are black; see following story.) The U.S. executives fussed over details in the design. They spent weeks poring over leather swatches and wood samples for the console surface. They requested -- and got -- an upgraded sound system that is tuned at the factory for either leather or cloth upholstery. And they vetoed such gadgets as a trip computer and a TV-screen instrument display. Clutter, they said. The name became a nightmare. Toyota uses computer-derived nonsense words such as Corolla, Camry, and Celica. After consultation with Lippincott & Margulies, a New York image consulting firm, U.S. officials came up with Lexus, Vectre, Verone, Chaparel, and Calibre. They sent the names to Toyota City in October 1986, with Lexus designated the favorite because they thought it connoted luxury. Toyota City okayed it along with a capital L logo. Two years later disaster struck. Just as the car was being readied for introduction last December, Mead Data Central Inc., owner of a computerized legal information service called Lexis, got a temporary injunction against the use of Lexus on the ground that Toyota had diluted its trade name. Executives frantically searched a computer list of 1.3 million possible substitutes. They came up with Luxor, which had the virtue of preserving the logo, as well as three of the letters that had already been die cast in metal. Just last January a federal appeals court lifted the injunction, and the car made its debut at the Detroit auto show with its original name. Nine weeks later the court threw out the Mead Data suit, reasoning that the car and the information service had sufficiently little in common to cause consumer confusion. While the name question was still up in the air, the head of the American Lexus operation jumped ship. J. C. ''Jim'' Perkins, 54, quit to go back to General Motors, where he had worked for 24 years, as head of Chevrolet. Officials in Japan congratulated Perkins for his ''great promotion.'' Two weeks later they picked Perkins's lieutenant, J. Davis Illingworth, 45, to replace him. Illingworth, an intense and efficient former Chrysler sales executive, picked up the program without a public hiccup. BACK IN JAPAN, Suzuki was getting the car ready for production. Prototype versions had been zipping around for three years, including cold-weather and high-altitude evaluations in the U.S. and Europe, and hot-weather tests in Saudi Arabia and Australia. In all, prototypes rolled up two million miles, twice as many as normal. That included thousands of miles with Suzuki at the wheel; he did not approve Lexus for production until he personally drove an uncamouflaged car from Los Angeles to Florida via Chicago. Toyota officials believe the success of Lexus will lie in how well it is made. Says President Shoichiro Toyoda, 64, the chairman's nephew: ''Our biggest challenge will be to have no defects and to build a reliable car that won't break down.'' Little thought was given to making the car at Toyota's Georgetown, Kentucky, plant, since it was 6,600 miles away from the engineers. So Lexus was installed in Tahara, Toyota's newest and largest plant, 20 minutes from Toyota City by helicopter. To integrate manufacturing into the vehicle development process, Suzuki created a uniquely flexible organizational structure. He established an FQ (for Flagship Quality) Committee to monitor work on each component. In the beginning design engineers ran the FQ groups. But as the project neared production, manufacturing engineers took charge, so factory specialists had the final say on quality issues. The FQ Committee succeeded both in improving the vehicle and in creating production efficiencies. Small example: Plant engineers saved 13% of the weight of a connecting-rod fastener by eliminating the nut and boring a self- threaded hole in the rod instead. Weight savings were crucial, and no change that added more than three-tenths of an ounce could be made without Suzuki's personal approval. WHILE WEST GERMAN luxury-car makers lay on hand labor to achieve quality, Toyota took the opposite approach. Avoiding the excesses that have snarled General Motors, it installed its most elaborate automation in the belief that only mechanized processes could meet Lexus's assembly standards. Manufacturing technology may well turn out to be Toyota's secret weapon. After visiting luxury-car plants in Japan and Germany, John F. Krafcik, a consultant to the Massachusetts Institute of Technology's international motor vehicle program, discovered that the Japanese already build higher-quality cars than the Germans with one-fifth as much labor. Industry sources have identified Toyota and Mercedes as the two luxury plants used in Krafcik's study. According to the report, Toyota has to fix only 5% of its cars after they leave the paint shop, vs. 35% for Mercedes. Lexus requires 40% to 50% more labor than a $25,000 Toyota Supra, the company's top-of-the-line sports car, partly because it has five extra quality-control inspections to find tiny flaws that might disturb persnickety owners. Eventually Toyota hopes to reduce the labor premium to 20%. Krafcik asserts: ''If the European producers cannot reduce their competitive disadvantage in manufacturing, then they must yield market share to their more efficient competitors over the long term, regardless of the current strength of their brand images.'' At the Tahara plant, workers got big doses of motivation. They took a pledge of dedication, created dozens of exhortatory slogans (Example: ''Let's maintain our No. 1 customer satisfaction rating'') and were told to check out competitive products. An eager employee was nearly arrested after he spent an hour inspecting Mercedes and BMWs in the parking lot of a nearby golf course. Production started on May 15, but snafus developed. Of some 320 cars scheduled to be built in May, only 243 were finished. One problem: smudges in the paint of dark-colored cars, caused by insufficient curing. Toyota's manufacturing boss, Setsuro Sekiya, who supervised the Lexus launch, still predicts that Tahara will be turning out 3,000 cars per month on two shifts by September, and 5,000 to 6,000 a month by January. Sekiya aims to make Lexus the world-quality champ as measured in defects per hundred showroom cars, the industry's standard yardstick. (A defect may be as small as a squeak or a rattle.) According to a new J.D. Power & Associates study reported in Automotive News, Mercedes is the highest-quality producer, with 103 defects, followed closely by Porsche, Nissan, Honda, and Toyota. The average for all cars sold in the U.S. is 153. Yugo, which scores a disastrous 557, comes in last. Sekiya already achieves 40 defects per hundred and hopes to maintain that. With the cars driving off the line in Tahara, the Lexus team in California revved up its campaign to prime the American public for the arrival of the most expensive Toyota ever. Displaying atypical chutzpah, the company staged the first press preview in the competition's backyard, flying U.S. journalists from such publications as Car and Driver and Road & Track to Frankfurt, West Germany, where they were given four Lexus cars to drive, along with several BMWs, Mercedes, and Jaguars. The five-day event, which combined low-speed motoring along the Rhine with Autobahn cruising at up to 150 mph, stirred national passions. German auto writers, uninvited because the car will not be sold in Europe until late next year, shadowed the tests, photographing the Lexus from moving cars and interviewing the journalists at rest stops. Lexus performed superbly, particularly in its uncanny quiet and stability at frightening speeds. But as the September launch neared, U.S. executives nervously watched auto sales deteriorate. Dave Illingworth knew that he would have 8,000 LS 400s to sell in the remainder of 1989. He was determined not to let the Lexus languish on dealers' lots and be branded a loser. Fortunately he had already begun a direct-mail campaign aimed at 250,000 prospective customers. Now he decided to authorize dealers to sell the cars as soon as they got them in August, one month before the official introduction. Dealers, who have invested $3 million to $5 million in new showrooms, fear that profits might be a long time coming. To boost income, they will also be / offering a $22,000 sedan called the ES 250. But it is derived from the run-of- the-mill Camry and carries none of the world-beating claims made for the LS 400. While each Lexus will likely command a full 20% markup, volume may be light for a while, and income from sales and service scant. With the official introduction date just weeks away, executives in both the U.S. and Japan are worried most about the one element they cannot control: whether Lexus can acquire the image it needs to succeed. As superluxury cars go, Lexus is a bargain. But as a new brand, it is a blank page waiting to be written on. Buyers who spend more than $20,000 do not want transportation alone: They are making a statement about their income, their taste, and themselves. What if Lexus doesn't make an appropriate statement? Will customers put value ahead of ego? With conspicuous consumption on the decline in the post-crash, post-Reagan era, that does not seem out of the question.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: JAPANESE OR GERMAN? WHAT THE BUYER GETS Lexus and Infiniti post impressive numbers in this comparison with two German rivals that customers would most likely consider as al ternatives. The Japanese cars' multivalve engines save weight and deliver superior acceleration. All four cars have rear-wheel drive.