Toyota Works to Keep the Wow in Hybrids

An experimental plug-in version of the Prius hybrid on the move in Detroit.

For a company that hates to gamble, Toyota put a big stack of chips on the table when it decided, in 2003, to build pickup trucks in Texas. After debating the move for years, the Japanese automaker broke its own rules in order to plant a flag in the heart of truck country, hoping a Texas-built Tundra would earn the all-American cred needed to invade the one bit of automotive turf still dominated by its domestic competitors. The San Antonio plant would be a logistical stretch, far from other Toyota facilities that would provide engines and expertise. Instead of piggybacking on existing supplier networks, Toyota would have to build a costly new parts hub. By the time trucks started rolling off the line in 2006, the project seemed more like a public-works boondoggle than the kind of lean operation Toyota is famous for, with costs ballooning to $1.3 billion—60 percent over budget.

It got worse from there. Toyota ended up introducing the new Tundra (city gas mileage: 15 mpg) just as gas prices were beginning their ascent toward $4 per gallon. The housing meltdown and slowing economy have further constricted sales, since builders and contractors are prime pickup buyers—in flush times, anyway. So far this year, Toyota is 25 percent below its goal of selling 200,000 Tundras, and the San Antonio plant is running well below capacity. "The timing on that looks horrible," says David Magee, author of How Toyota Became #1. "Toyota makes plenty of mistakes. They're not flawless."

Yet no car company stands to gain more than Toyota as skyrocketing gas prices and the eroding economy batter all the automakers. Despite missteps like the Tundra, Toyota's renown in the car business borders on mythic: It had the vision, after all, to introduce the Prius hybrid back in 2000, when gas was a mere $1.50 a gallon and most American car buyers cared more about cupholders than gas mileage. Toyota sold 181,000 Priuses last year and can hardly meet demand. The company now offers six high-mileage hybrids—more than any other automaker—and has more on the way. That's helped Toyota remain steady while sales have plummeted at the Detroit automakers. Toyota now sells more cars in the United States than Ford or Chrysler, and it could catch up to General Motors before long.

So with gas prices bursting through the $4 threshold—on their way to $5, perhaps, or even $6—the elemental question in the car business is: What will Toyota do? And Toyota, for its part, is trying to figure out which of the cars on the drawing board could be another Prius—and which another Tundra.

Just like drivers, Toyota's planners wonder where gas prices are heading. A recent Goldman Sachs report drew gasps by predicting that oil, currently trading at roughly $125 per barrel, could hit $200 by 2010. Such a "superspike" would result in gas prices well above $5 a gallon, a scenario Toyota planners generally agree with. But after that, prices could drift back down as new sources of oil begin to come online.

The next question is: What will consumers do? When gas prices passed $3 per gallon—once considered a psychological and behavioral tipping point—drivers were surprisingly blasé, with only modest changes in car-buying patterns and driving habits. But $3.50 seemed to mark a more painful threshold, and with gas now at $4 in much of the country, a rout seems to be on. Sales of the biggest vehicles have plummeted more than 20 percent so far this year, and the only segment where sales have risen is compact cars. Some SUV owners can't even get rid of their big haulers without losing money; since nobody wants a used SUV that gets 15 mpg, it makes sense for many owners to simply hold on to their big gas guzzler and gird for $80 fill-ups.

Puzzle. But Americans are very reluctant downsizers, and every automaker knows what happened after the oil shocks of the 1970s: Drivers flocked to small cars—then abandoned them when gas got cheaper. Instead of riding that boomerang again, this time the automakers are racing to develop have-it-all technology that will be appealing if gas drifts back to $2 and essential if it rises to $6. They're also dealing with tough new government gas-mileage requirements and consumers accustomed to getting more, not less, car for their money. "I've never seen so many uncertainties," says Mike O'Brien, who oversees Toyota's U.S. product planning.

Yet for Toyota, uncertainty is good news, not bad. Oracular vision may be part of Toyota's success, but its real strength is that it has the financial resources (2007 profits: about $15 billion, more than GM's entire market capitalization of about $10 billion) to play many hands at once—and thus the luxury of waiting until the last minute to decide which are the surest bets. That has helped Toyota guess right more than most of its competitors—and provided a hedging strategy to fall back on when it guesses wrong.

Toyota's lead on hybrids, for instance, is an obvious advantage in a world of $4 gas. But it's almost an accidental success. Even Toyota had doubts about the Prius when it debuted, giving it a meager U.S. sales goal of just 15,000 in its first year. That's why Toyota was working up plans for a beastly new Tundra at the same time and enlarging—not shrinking—other popular vehicles like the Highlander SUV and the Camry sedan. Gas was cheap, after all, and big cars like the majestic Chrysler 300 were an affordable luxury. The Detroit Three were making a profit of $15,000 or more apiece on some of their largest vehicles.

Now, as the market for big cars collapses again as it did in the 1970s, Detroit is scrambling for a backup plan. GM just announced that it's closing four plants that produce big trucks and SUVs, part of a permanent about-face toward smaller vehicles. It may even sell the rough-and-ready Hummer brand. Toyota is taking some lumps, too, with a projected 27 percent drop in profit in the coming year, mostly because of a flagging U.S. economy. But Toyota also has a ready stable of right-size vehicles, like the Corolla and RAV4, and the budget Scion lineup, that have already helped push the company's U.S. market share to about 18 percent, a record high. That's just 2 percentage points behind leader GM.

Hybrids are still a relatively small portion of Toyota's portfolio—but the biggest opportunity to break away from the pack. Hybrids get better mileage than conventional cars because they have both a gas engine and a battery-powered motor, with computers that toggle between the two in the most efficient manner. Some hybrids, like the Prius, are tuned for maximum gas mileage, while others, like Toyota's Lexus rx400h, are speedy performance cars with gas mileage that's just a notch higher than that of conventional competitors.

Virtually all the big automakers now offer one or two hybrids, with plans for more. Toyota plans to roll out more hybrids, too, but it's also weighing snazzy new features to maintain its dominance in the sector. "We want to extend the 'wow' of the hybrid," says O'Brien, the company's top product planner. One likely feature of the next-generation Prius, due next year, is a dashboard button that allows the driver to run the gas-electric powertrain purely on battery power—perhaps for a couple of miles of driving—before the batteries hit a depletion point and the gas engine kicks back in. That's just the kind of feature that appeals to "hypermilers" who compete to see who can get the best mileage out of their hybrids.

Beyond hybrids, the race is on for new alternatives to gas engines that can be mass-produced. And every automaker craves the rewards that would come with finding solutions to America's dependence on foreign oil. The next step in that direction will most likely be a "plug-in" hybrid with batteries that will be rechargeable from an ordinary power outlet at home. On current hybrids, the batteries draw recharging power mainly from the gas engine—and gas, of course, is expensive. Power drawn from the electrical grid could cost the equivalent of $1 per gallon—and plug-ins could also go further on a charge than today's hybrids.

The stakes are huge: The automaker that seizes the plug-in market could dominate for years. And already GM has targeted the pole position on plug-ins, with the Chevrolet Volt, due in 2010. It wasn't long ago that executives at GM pooh-poohed hybrids as overcomplicated technology that was too expensive for ordinary consumers. Toyota clearly proved otherwise, which a humbler GM now admits. "Ever since Toyota assumed the mantle of technology leader," says GM Vice Chairman Bob Lutz, "there's been a certain class of buyer who wants to be associated with the best technology. In that sense, every Toyota has a little bit of Prius in it."

The Volt is supposed to be GM's Prius—an iconic breakthrough car that helps propel GM, once the industry's proudest innovator, back to the front of the pack. It's a tall order, which GM acknowledges. The Volt supposedly will be a safe, reliable, mass-market plug-in that can travel 40 miles on a single charge before a small engine kicks in. If it works, its fuel economy could be the equivalent of 100 mpg. And GM insists the car will have a sticker price of $30,000 or less. The current Prius can go only 1 or 2 miles on battery power alone, so the Volt would represent a multifold improvement on the state of the art. And nobody has yet fielded a lithium-ion battery of the sort the Volt would require.

Plugging in. Toyota has answered GM in its usual understated way. In January, President Katsuaki Watanabe gave a bland speech in which he announced that his company would field a "significant fleet" of plug-ins available to commercial customers, matching GM's 2010 target date. And Toyota recently announced a new plan to team with Panasonic in Japan to mass-produce its own lithium-ion battery. The chase car on its tail seems to be driving Toyota to move faster. "For the first time, they're seeing a reinvigorated challenge from GM," says powertrain analyst Kevin Riddell of J. D. Power & Associates.

On the surface, Toyota's strategy is admittedly less aggressive than GM's. Instead of the kind of game-changing breakthroughs that some GM executives are hinting at, Toyota plans to introduce a plug-in that's an incremental improvement on the Prius. "Think of it as a Super Prius," says Bill Reinert, Toyota's national manager for advanced technology. Its maximum range on battery power alone might be 10 miles, not the 40 GM is promising. But Toyota does plan to leverage its reputation for reliability. "Our plug-in will be excuse-free," Reinert insists. "It will be able to meet a 150,000-mile warranty without being subsidized." Some analysts think the Volt, by contrast, might be such a technology stretch that GM will have to bear a big portion of the actual cost if it holds to a sticker price of $30,000.

Toyota's 2010 prototypes most likely will be built on the same platform as the next Prius, due in spring 2009. At some point within the next five or six years, the prototype will be ready for prime time, and the Prius plug-in will move from test fleets to the consumer market. In some families, the Prius is already the equivalent of a beloved pet, and here's one more idea that could endear the car to its owners: equipping it to function as an emergency generator. Once a plug-in is equipped to draw power from the electrical grid, through a household outlet, it's also able to put power back in. "There's enough power in a Prius battery to power a 1,200-square-foot house," O'Brien points out. So with a few modifications, a Prius could keep the lights on and the refrigerator running if a storm knocks out the electricity for a few hours or even a day or two.

Like its competitors, Toyota is also investing more research into diesel engines, turbocharging, direct-injection fuel systems, and other ways of improving a car's efficiency. Such technologies tend to be expensive but make more sense as gas prices rise. Combining direct injection with a turbocharger, for instance, is one way to get more power from a smaller engine—and improve fuel economy without asking buyers to cram themselves into a smaller car. And it could accelerate a trend toward smaller engines. "I can easily imagine deleting the v-6 from the Camry lineup," says O'Brien.

Toyota's scientists sound less optimistic than its competitors about ethanol and other biofuels, pointing to unresolved problems like the acreage of arable land required to produce feedstocks and the cost of technology for converting other material to fuel. GM, by contrast, has invested in an ethanol start-up, and it already builds thousands of "flex-fuel vehicles" that can run on the stuff. That's a simple assembly-line conversion, however, and if the fuel becomes widely available, Toyota could easily build as many ffvs as it chose.

Down the road, hydrogen fuel—which could be cheaper than gasoline or plug-ins and generate better mileage still—might offer the most promise of all. Toyota, GM, Honda, and others are all investing heavily in fuel cells in the hope of spearheading a genuine energy revolution. It will still take years to perfect the technology and build a nationwide network of fueling stations. But "there appear to be emerging pathways for solutions on fuel cells," Reinert says. For the time being, O'Brien credits Honda—which plans to lease a real-world hydrogen-powered car to a few customers beginning this summer—with having the lead. "Honda has a better overall product," he says. "We're more about powertrains right now."

While designing the car(s) of the future, meanwhile, Toyota may still shake up its lineup to strengthen its position in a market that changes by the day. "Toyota is a small-car leader," says author Magee. "Anybody who knows Toyota knows they're going to plow everything they've got into the areas where they're strongest." And if the seers are wrong and gas prices drop back to $1.50 per gallon, then building that plant in Texas will probably look like a brilliant move after all.