Why Toyota Is Becoming the World's Top Carmaker

General Motors and Toyota were once neck-and-neck when it came to developing high-mileage gasoline-electric hybrid cars. About a decade ago, you see, both firms had cracked the code on how to engineer a hybrid, and GM even had a running prototype. But the new technology was so costly that the automakers would have had to initially sell hybrids at a loss to build a market for them. The differing paths the two companies took symbolize why Toyota has become wildly profitable in the United States while GM has been losing its shirt in its home market. And why Toyota, riding GM's bumper, is likely to pass it this year to become the world's biggest car company.

To GM, selling hybrids at a loss didn't make business sense. So it took a pass. To Toyota, hybrids looked like a reasonable bet on the future. It developed the Prius, selling it at a loss for years (by all accounts except its own). Today, the Prius is eking out a small profit for Toyota in the United States. Vastly more important, it's the hottest hybrid on the market and provides a halo for Toyota, making it appear to be the world's greenest carmaker even as it rolls out gas-guzzling trucks. GM, meanwhile, is playing catch-up and defending itself from allegations that its Hummer SUV melts the planet. "We made a bad decision," GM vice chairman Bob Lutz now says. "Being known as the technology laggard is not conducive to selling automobiles."

In addition to taking different technological paths, Toyota and GM have taken different approaches toward expansion in the U.S. market. Toyota last week announced plans to build a $1.3 billion assembly plant, its eighth in North America, in Elvis Land: Tupelo, Miss. "No company since Henry Ford has grown production at the rate Toyota is," says economist Sean McAlinden of the Center for Automotive Research. GM, by contrast, is closing U.S. plants. It's also overhauling its models to make them more stylish and fuel-efficient. While GM achieved a surprising 3.4 percent increase in sales last month, its biggest expansion hopes hang on a possible purchase of money-losing Chrysler, whose problems are very much like GM's own.

What's at stake here goes miles beyond a battle between two automakers. After all, nearly 900,000 Americans work in the auto industry—the largest chunk still for the Detroit Three—and the car business accounts for nearly 4 percent of the nation's GDP. For the United States and Japan, GM and Toyota are trophy corporations that have been protagonists in a long-running national rivalry. The winner of this race could determine who drives the global economy in the 21st century.

You've heard plenty about the differences between GM and Toyota when it comes to jobs, carbon emissions, pensions and health-care costs. But it all boils down to a simple bit of math: Toyota makes cars for less than it costs GM, and it gets to sell them at a higher price than GM does.

It's taken 50 years for Toyota to reach this point—but, then, staying power and the "Toyota Way" philosophy of continuous improvement are what the automaker is all about. Since introducing the tinny, 60-horsepower Toyopet Crown in the United States (1957 sales: 288), Toyota has built a rock-solid reputation for producing reliable cars. It achieved that by investing in bulletproof quality, advanced technology and high-mileage engines. It developed a superefficient manufacturing method, known as the Toyota Production System, that relentlessly roots out waste and builds in quality. (Workers stop the line thousands of times a day to make sure no glitch gets through.) It is emulated the world over and slavishly copied by GM. Toyota didn't dump cars into airport rental lots just to keep its factories rolling, as GM did. The result: a virtuous cycle that gives Toyota models topnotch resale value. After three years, Toyota's models retain 52 percent of their value, versus 43 percent for GM, according to the Automotive Lease Guide. That's a big reason the Toyota Camry has been America's favorite car for the past five years, outselling GM's No. 1 car, the Chevy Impala, by 35 percent in 2006.

For its part, GM, like its Motown cohorts, went for a bigger-is-better strategy, boosting the horsepower and heft of its models over the past 20 years. Sales of those big rigs tanked when gas prices soared above $3 last year. GM also undermined the resale value of its models by overproducing them and giving them away at fire-sale prices. That flawed strategy wrecked GM's reputation, and allows Toyota to sell its cars at a premium of $1,600 apiece relative to GM, according to auto researcher the Harbour-Felax Group. Compounding the problem, GM gave its union workers generous benefits that cost the automaker $73 billion over the past decade. That's money GM could have spent making its models better than Toyota's. In fact, it's such a vast sum that it equals nearly 10 years' worth of R&D budgets, GM execs say. Health-care costs alone add $1,200 to the cost of each car GM builds in the United States. By contrast, Toyota's health-care costs are about $200 per car. The upshot: Toyota has a stunning $1,800 profit-per-car advantage over GM in the United States, says Harbour-Felax.

Toyota is reaping the benefits of an ambitious growth strategy it launched in 1995. That's when Hiroshi Okuda became the first non-Toyoda family member to run the company and did away with a tradition of "cooperative competition," which meant keeping a respectful distance behind GM. Instead, Okuda did the unthinkable: he went public with an audacious target to capture first 10 percent of the global car market, and then 15 percent. Toyota blew past both goals, achieving the 15 percent milestone last year, four years ahead of schedule.

Now Toyota is marshaling its most formidable asset: its phenomenal wealth. It's on track to make a record profit of $13 billion this year, most of that earned in the United States, where it now sells more cars than it does in Japan. As a result of its enormous profits, Toyota has $36 billion of cash on hand and a stock-market value of more than $200 billion. That's 12 times what GM shares are worth. And Toyota drives that money right back into its cars, outspending GM for the past two years. As a result, Toyota will replace 83 percent of its product line by the end of the decade— the most new models of any automaker, according to Merrill Lynch.

GM, meantime, is trying to reverse-engineer its losing approach. It's reducing its dependence on guzzlers by rolling out a parade of hybrids and crossover utility vehicles. Over the past year, GM has cut $9 billion in costs, much of it through a wrenching downsizing that eliminated 33,000 jobs. That helped GM earn an estimated profit of $2.5 billion last year, after losing $10.6 billion in 2005. GM is also boosting its budget for new models by about $1 billion this year. Execs are ratcheting up the rhetoric. "I don't view Toyota as an insurmountable obstacle that GM can't vanquish," says Lutz.

More significantly, GM is showing a new willingness to roll the dice in its dalliance with Chrysler. Neither GM nor DaimlerChrysler will comment on or confirm the talks. Buying Chrysler would keep GM ahead of Toyota in vehicles sold, maintaining the leadership GM established in 1930, when it shot past the struggling Ford Motor. But analysts still see Toyota leaving GM in its rearview mirror. Auto researcher CSM Worldwide projects Toyota will edge past GM this year and, by 2013, will be outselling the American automaker by a score of 10.7 million vehicles to 8.9 million. That would give Toyota a nearly 2 million-vehicle lead over GM—which is roughly the number of autos Chrysler sold last year, and it plans to cut capacity. So buying Chrysler would only forestall the inevitable. GM's Chrysler courtship highlights another telling contrast: GM often tries quick fixes, while Toyota is known for consistency and a long-term focus. No surprise, then, that Toyota won't be among Chrysler's suitors. "I cannot find any benefit from buying [Chrysler]," Toyota executive vice president Tokuichi Uranishi told NEWSWEEK. "No synergy."

Toyota is trying to shut out all the hoopla over its rise to the top. "What we are worrying about is if our employees become arrogant or complacent, assuming we are No. 1," says Uranishi. Already, Toyota is experiencing what a Cadillac ad once called "the penalty of leadership." "Toyota is on the front page for everything we do now," says Toyota's executive vice president Jim Lentz. Lately, that's included bad press for a NASCAR cheating scandal and, most painfully, negative news about a rash of recalls. Headquarters is so worried about the quality problems that Toyota chairman Fujio Cho made a public apology in Japan last summer, complete with a deep bow. Now Toyota's leaders are tapping the brakes on its runaway expansion and tightening the screws on quality. "Without quality," says Uranishi, "there is no growth for Toyota."

GM chairman Rick Wagoner, no stranger to bad press, feels Toyota's pain. "We are becoming more alike than different," he told NEWSWEEK. He contends that the two giants will reach equilibrium, staying within a car length (or two) of each other. And though he didn't discuss Chrysler with NEWSWEEK, he described an auto industry that will continue to consolidate. "There can be more than one winner," says Wagoner. "Look at the cola business in the U.S. It used to be a lot of players, and now it's down to just two."

Toyota, however, has no intention of letting up. Its steroidal new pickup truck, designed on a theme Toyota calls "the power of the fist," could be the knockout blow to Detroit's last bastion. An entire generation grew up with Toyota cars, from Corolla to Camry to Lexus, but traditional truckers spurned its pickups as wimpy. Now the new Tundra has been supersized and stuffed with a big V-8 engine. Toyota expects to double its pickup sales, thanks to buyers like Ray McCrary, who just traded in a three-week-old GMC pickup for a Tundra. "I'm one of those good ole boys who never thought about buying a Toyota truck because you thought it was a toy," says McCrary, of Memphis. "But after I drove that Tundra, I just had to have it. It handles like a car, but it's built like a truck."

Plenty of good ole boys are making those Tundras at Toyota's new $1.28 billion pickup plant, situated on a sprawling former ranch in San Antonio, Texas. There's a giant Lone Star over the entrance and a Texas flag flapping in the breeze. Inside, though, the Toyota Production System is hard at work. A traffic jam of honking "tuggers" pulls racks full of parts to the assembly line, where every 63 seconds a shiny new pickup rolls off. "A plant in Texas is a brilliant strategy," says Citigroup auto analyst Jon Rogers. "Toyota is putting their future customers to work." One of them is Bruno Garcia, 35, who stamps out Tundra body panels by day but drives home in a Ford pickup. "I was one of those guys who would rather push a Ford than drive a Chevy," he says. "But I'm going to buy a Tundra, and I'll try to convert my Dad as soon as his Dodge dies."

Completing the circle, GM's trying to go green while Toyota's making macho. GM has given the go-ahead to the 150-miles-per-gallon Chevy Volt plug-in hybrid that lit up the Detroit Auto Show this year. It's proceeding despite the fact that the batteries needed to run the Volt haven't really been invented, or at least perfected, yet. But GM R&D chief Larry Burns is confident the batteries will be ready in time for the Volt to hit the road in about four years. Burns now wishes GM hadn't killed the plug-in hybrid EV1 prototype his engineers had on the road a decade ago: "If we could turn back the hands of time," says Burns, "we could have had the Chevy Volt 10 years earlier." Just like that old prototype, the Volt won't generate immediate profits. But times have changed. "We're the underdog now," explains GM VP Mark LaNeve. "So you're more willing to take risks." Better late than never.