Mighty Toyota's growing pains: the Japanese juggernaut must confront internal challenges.

The latest numbers give credence to a growing chorus of predictions that Toyota will capture 15 percent of the global auto market by 2015, dethroning General Motors as the world's largest automaker. Toyota expanded global sales by 9.9 percent for the fiscal year ended in March, finishing in a statistical dead heat with Ford and narrowing the gap with GM (see chart, facing page). It even defied the adverse effect of a strong yen and increased net earnings to $10.2 billion, making it inarguably the most profitable car company in the world.

[ILLUSTRATION OMITTED]

Toyota is gearing to expand its production capacity by 1.5 million vehicles worldwide by 2010. It is building a pickup truck plant in Texas that will open in 2006, and it will possibly build another one in Mexico or South America. That doesn't include expanding its Chinese joint ventures. To many, the 15/15 goal seems realistic. "Global manufacturing of 9 million units by 2015 does not look like a far-fetched number at all," says Credit Suisse First Boston auto analyst Koji Endo.

Toyota has been able to stage its astonishing assault on world markets by maintaining ruthless quality and cost controls. In addition to being the most profitable automaker, it consistently wins top quality awards from J.D. Power & Associates. To Toyota President and CEO Fujio Cho and other executives, the guiding principles have always been clear. They needed only to keep implementing concepts pioneered by the late blunt, flamboyant engineer Taichi Ohno such as kaizen (continuous improvement), just-in-time delivery and other elements of Toyota's "lean" manufacturing system.

But while the rest of the world fears Toyota, insiders are concerned about the company's ability to manage its growth and maintain the quality of its products. The company now has 260,000 employees in 26 countries. But it has not yet been able to develop the sophisticated decision-making balance between headquarters and local operating units that some Western multinationals have achieved. As a result, the company can either centralize decision making in Japan or allow it to devolve to U.S. or European managements. There seems to be little middle ground.

Even by Japanese standards, Toyota is famously insular, being headquartered in southern Aiichi prefecture and still dominated by the Toyoda family. That insularity leads to missteps: In mid-June, Toyota had to delete part of a U.S. television commercial for its new Scion brand that showed a character consuming peyote and then hallucinating. And in China, the company used the Chinese lion, one of the Middle Kingdom's most cherished icons, in ads for the sport utility vehicle Prado. The Chinese, mindful of Japan's wartime occupation, were outraged. The ad was withdrawn.

Another major issue inside the mighty Toyota is that the rapid globalization and production expansion has begun to strain its manpower supply. Cho told a small group of foreign correspondents earlier this year that Toyota's product quality remains high, but because of the demands to adapt products to local tastes, the company needs to design and manufacture vehicles that differ by region. As a result, "Everybody is becoming extremely busy," a condition that could lead to quality deterioration, he warned.

Toyota's success also has attracted higher levels of competition from automakers around the world. GM, for example, has been gaining against Toyota's North American quality performance. "Other makers are making great efforts at catching up with us--and the gap is narrowing," said Cho, who became CEO in 1996. "We must pay close attention to it and make more efforts to improve our quality."

Extensive computerization of the entire car manufacturing process, from design to production and distribution, is one of the methods that Toyota is adopting for quality control and cost reductions. But "the potential risk of too much computerization is that we might launch new cars that are not tested in actual driving environments, such as in high humidity and other conditions," one top executive confides. That might cause unforeseeable problems. He also noted "an explosive growth" of warranty claims for certain models, though they have not led to embarrassing recalls.

The twin goals of improved quality and cost reduction, coupled with the demand for raising productivity, are imposing pressures on employees and managers that they haven't experienced in the past. That pressure is what caught up with Toyota middle managers in charge of dealer mechanic training last December: To show off the superiority of their training courses, they cheated on a national auto mechanics exam by leaking answers to Toyota dealer mechanics so they could outperform rivals at Nissan. "Middle management is under incredible pressure," another insider says.

Suddenly, it seems, Toyota has a human capital problem. Over the past 70 years, Toyota's ground rule has been genba-shugi, or doing everything on the job, including worker training. It no longer can afford that luxury and has been obliged to begin classroom training of new workers, calling back skilled workers from the U.S. plants to Toyota City and using them as instructors, says Managing Officer Takashi Hata. Even so, he acknowledges, the company is experiencing labor shortages.

[ILLUSTRATION OMITTED]

In preparation for the start-up of the Texas pickup truck and other overseas plants, Toyota founded the Toyota Institute in January 2002, followed by a Global Knowledge Center at University of Toyota in Torrance, Calif., in July 2002. These two centers are designed to teach middle managers various elements of the "Toyota Way" manufacturing system. The company also opened the Overseas Support Center in July 2003 in Toyota City for training foreman-level line workers.

The company also needs more top people with international savvy, because centrally driven design decisions and management style are increasingly less effective. In everything from research to product planning, from manufacturing to distribution, the old model of making decisions in Japan and then rolling those decisions out with only minor modifications for regional tastes doesn't work as well as it used to.

The Riddles of Globalization

Cho recognizes that problem and has been trying to cope with it by rationalizing the decision-making process. In the first major management reform in years, last June he slimmed down the number of the company's board members from 58 to 27. This was aimed at helping the board make better decisions by allowing directors to exchange ideas in a smaller, more intimate setting. At the same time, he created the post of managing officer, the cadre of 39 senior and middle managers who handle day-to-day operations.

At this managing-officer level, the company has been able to increase the number of foreigners, including North American sales chief James Press, to five from last year's three. But it has not yet been able to place a single non-Japanese on the board of directors even though 60 percent of its sales are outside of Japan.

Top management is trying to solve that riddle. "Toyota is headed toward becoming a global company," says Cho. "We are encouraging locally hired employees to become senior officials of our local companies and ultimately manage them. We also are encouraging them to become managing officers while working as heads of local companies. This personnel plan is progressing as scheduled."

Likewise, Cho thinks Japanese employees with overseas experience stand a better chance of promotion, as already has been the case with a number of board members, such as Executive Vice President Ryuji Araki, Yoshimi Inaba, Akio Toyoda--and Cho himself, who built Toyota's Kentucky plant and has retained his surprisingly informal style.

But because it has been difficult for Toyota to integrate foreigners into its top management team, it has been necessary to yield surprising power to managers of the most important markets. Nowhere is this policy more apparent than its U.S. operations run by Press, who holds the title of executive vice president of Toyota's U.S. sales, and by Gary Convis, executive vice president of Toyota's North American manufacturing.

Some insiders say Toyota's American operations suffer "bureaucratization" of middle-level American management that reports to Press and Convis. It's hardly a surprise given that Toyota's first North American manufacturing operation, the joint venture with General Motors, New United Motor Manufacturing Inc. (NUMMI), marked its 20th anniversary this year, and 16 years have elapsed at its Kentucky plant. "NUMMI and Kentucky have succeeded, but now middle management there is aging and their shop talk there is shifting to retirement and pensions from kaizen and cars," frets a Toyota insider. "The American operations are rapidly becoming bureaucratic. Toyota's culture of holding debate with (and sometimes challenging) bosses is disappearing."

Some of the issues that Toyota faces have nothing to do with its existing automotive products. At the same time that Toyota veeps are taking the 15-15 goal seriously, members of the Toyoda family are eager to diversify into new businesses. Management is being asked to examine everything from the development and manufacturing of airplanes, motorcycles, pleasure boats, bicycles and humanoid robots to civil aviation, Formula-1 and other motor sports activities, housing construction, telecommunications and information-technology, medical and financial services, education and biotech.

Shoichiro Toyoda, the 79-year-old former president and son of Toyota Motor founder Kiichiro Toyoda, apparently thought the timing could never be better to showcase some of those new businesses than in a quasi-real world environment called the Aichi Expo 05, which will be held for six months, beginning in March 2005. Toyota and its group companies expect 14 million visitors to experience its futuristic vehicles, such as the bug-shaped i-unit personal mobility car; fuel-cell hybrid buses; and the Intelligent Multimode Transport System, a computer-guided system that enables unmanned buses to run in a convoy.

No Longer An Upstart Challenger

There seem to be at least two reasons for staging the expo. One is pure business. Global auto demand will continue growing, but automakers need to develop vehicles that consume less energy and cause less environmental damage. Toyota hopes to advance the i-unit, the compact one-passenger vehicle, and other exotic technologies to offer such solutions as allowing the use of vehicles that weigh far less than conventional ones.

But at another level, top management seems to be looking for ways to inspire a Japanese work force that has aged and is no longer as driven as it once was. The climate today is a far cry from the export boom era of the 1960s, '70s and '80s, when workers dedicated most of their waking hours to their companies.

To head off complacency, the company sponsors an annual foot race with 20,000 cheering spectators even though other Japanese companies have discontinued corporate sporting and entertainment events. Toyota also is offering more generous pay packages to Japanese employees than rival automakers. "By offering better-than-average benefits to employees, our hope is that employees can enjoy the sense of unity and belonging," says managing officer Hata. At the same time, Toyota is improving workplace infrastructure, such as expanding child-nursing facilities at manufacturing plants and hiring more handicapped people and women.

Add it all up and it's clear that Toyota is trying to cope with the problems of becoming a more mature multinational rather than being an upstart challenger. Cho is keenly aware of the challenges of managing a global company. "Toyota's weakness, if you will, is related to information," he says. "Many of our vital functions are concentrated in Toyota City. This could mean that we are late in getting wind of important information. In the IT age where information is abundant, we must be extra careful about what is vital information and what is not."

He also understands that maintaining the company's focus is critical. "I am not sure whether we can prevail or outrun our competition, but probably the important thing for us is to grasp the demands and needs of the marketplace, customers and society and reflect them in our products," Cho says. "I think that is the competition we have to fight." In the final analysis, the biggest challenge Toyota may face is itself.

Toyota Pulls Even With Ford, Aims For GM

Vehicle production in the four quarters ending March 31, 2004

Toyota  6.7 (millions)
Ford    6.7
GM      8.1

Source: Company reports

Note: Table made from bar graph.