Lexus' Big Test

Can it keep its cachet--and appeal to the young?

Deep inside Toyota Motor Corp.'s (TM ) headquarters campus 250 kilometers south of Tokyo lies a dome-shaped building that's more fortress than workshop. It's surrounded by tall trees, has no windows where snooping eyes might peer in, and metal detectors at the doors scan visitors and employees alike for hidden cameras and cell phones. Why all the paranoia? Inside, technicians tinker with high-performance engines. Designers plot out new bumpers, headlights, and door handles on powerful computers. And artists painstakingly carve full-size clay prototypes of the cars of tomorrow -- everything from next-generation Camry sedans to outlandish concept vehicles with featherweight bodies in a riot of funky colors.

The car that has Toyota's engineers really jazzed is the best-hidden of the bunch. Some company insiders call it by the nickname "Project Mount Everest," and Toyota expects the car to hold its own against coupes such as the $141,800 Aston Martin DB7 Vantage and the $113,250 Mercedes-Benz SL55 AMG. The low-slung beauty is said to feature a V10 engine derived from the V12 used in Toyota's Formula One race car. Its nose looks something like a Corvette, and its gracefully sloping tail sports trim lines that accentuate deep wheel wells. The elegant hot rod could be introduced as soon as the Tokyo Motor Show in the fall, most likely as the flagship of Toyota's luxury marque, Lexus. The expected price tag: close to $150,000.

Wait a minute. Doesn't Grandpa drive a Lexus? And isn't the brand better known for solid luxury bargains than for heart-stopping performance at prices as high as the Himalayas? Right on both counts. And that's Lexus' biggest problem. The median age of Lexus buyers is 52, four years older than that of Mercedes-Benz and nine years older than BMW'S, according to Toyota's own figures. Despite attempts to launch sportier fare in recent years with the $30,000 IS 300 sedan and $62,000 SC 430 convertible, Lexus doesn't have the pizzazz that attracts the young, wealthy buyers car companies love. Just ask Steve Glenn. The 38-year-old Los Angeles entrepreneur looked at a Lexus sedan but says it felt "too old and staid.... It's like a grown-up car." He settled on a $50,000 Audi TT convertible.

So Lexus is looking to blow the lid off the high end of the brand with Project Everest. Officially, Toyota denies its very existence. But several company officials, including one board member, confirm that Toyota is working on the high-powered sports car. A prototype has completed cold-weather road testing in Canada and was scheduled to log some miles in the heat of the Australian desert. While it's still possible that the car could be marketed as a successor to the Toyota 2000GT of the late 1960s, it's likely to do more to help Lexus than its downmarket cousin. Toyota doesn't expect to make a lot of money on this exotic offering. But merely having it in the lineup adds an aspirational quality to the Lexus brand that burnishes its premium image.

Besides, Lexus needs the juice. Today, the only Lexus that even barely passes the macho test is the SC 430. Although the two-seater boasts a 4.3-liter V8 engine with 300 horsepower, it packs a five-speed automatic transmission -- instead of a racier manual six-speed. "Lexus needs more sportiness, and something that's above and beyond the ordinary," says Shinzo Kobuki, chief of the brand's planning division.

Lexus isn't exactly in trouble. The marque has grown from a novelty a decade ago to the leading luxury brand in the U.S., selling 234,000 cars such as the RX 300 SUV and ES 300 sedan last year -- up 4.5% over 2001. Resale values are sky-high, and Lexus is a consistent winner in vehicle quality ratings. But it's starting to get a few dings and scratches. While Lexus' sales remain strong, BMW pulled ahead of it in the U.S. market in January and February. The brand once undercut rivals on price and outdid them on service but has lost its uncontested lead in both categories. Now that Lexus has been established as a luxury leader, prices have crept up to about the same level as its chief rivals. And customer-service scores have edged down as Lexus dealers strain to take care of their rapidly growing customer base. "We are no longer the upstart, the newcomer," says Denny Clements, a Toyota vice-president who serves as general manager of the Lexus division in the U.S.

Those are trends Toyota can't ignore. Lexus' profits and revenues are a closely guarded secret, but North America -- where 90% of the cars are sold -- accounted for 39% of Toyota's record $126 billion sales in 2002. More important, the U.S. market made up to 82% of the company's $5 billion profit last year, estimates Credit Suisse First Boston Corp. The high margins earned on Lexus cars in the U.S. make it Toyota's single most profitable business unit by far -- which means that if the brand starts to skid, the whole company could end up with a big dent in its bottom line.

Toyota recognizes the problem. The carmaker has hired New York brand consultant Siegelgale to help reposition the marque's conservative image over the next decade. In fact, the new hot rod was originally scheduled to be introduced in 2005, but Toyota wants to push that up by two years in order to breathe some new life into the Lexus brand. Luxury buyers increasingly want a sportier ride and more power -- and Lexus comes up short in both areas. "If you look at what's happening in the industry, there's a feeling that we've missed the boat," says one former Toyota official.

Without more horsepower in its stable, Toyota fears Lexus could become downright dowdy in the minds of car buyers -- even regular folks without $150,000 to blow on a set of wheels. When customers buy luxury, they're not simply buying transportation. They want to join an exclusive club, and the value of that membership drops as more people sign up. With 1.6 million Lexuses speeding down U.S. highways, the club has a lot of members now, and most of them are buying what Toyota terms "near luxury" models such as the ubiquitous RX 300 sport-ute or the ES sedan. Toyota is keenly aware of what happened to Cadillac after General Motors cranked up production in the 1970s and 1980s: The brand's image sank. "We can ill afford to grow at a rate that does not sustain the Lexus experience," says Lexus chief Clements.

What's more, Lexus is no longer the obvious choice for luxury-loving tightwads. The original LS sedan in 1989 sold for some $10,000 less than a comparable 300 E Mercedes and boasted a higher top speed, quieter cabin, and better fuel economy. These days, the 4.3-liter LS 430 starts at nearly $55,000, about the same as a 5.0-liter E-Class Benz, its closest competitor. That's partly due to a stronger yen, but the Lexus threat also forced the Germans to cut costs and sacrifice margins to get more competitive. Lexus' early pricing strategy "changed the rules of the game," says BMW Chairman Helmut Panke. "Everyone in the industry learned from that experience."

At the bottom end of the luxury market, Lexus faces savvy upstarts that have cloned its bargain-luxury strategy. These days, Lexus' $31,500, 3.0-liter ES 300 doesn't look like much of a deal when compared with rivals such as the $27,000, 3.5-liter Infiniti GS sedan. And while critics rave about the firm, BMW-like ride of the IS 300 sports sedan, many knock it as too plasticky to deserve a Lexus badge. They say it should be stripped of its luxury veneer and branded a Toyota model the way it is in Japan.

Even Lexus' reputation for sterling service is starting to tarnish. Time was, buyers loved the putting greens Lexus installed in showrooms and the roses offered with tune-ups. Today, Lexus sales per dealer are among the highest in the industry; that's great, but it means buyers no longer get quite the white-glove treatment they once did. Last July, J.D. Power & Associates ranked General Motors' Saturn division and Nissan's Infiniti ahead of Lexus in customer satisfaction with dealer service. That shocked Lexus, which had taken top honors for the previous five years. "The survey provided an opportunity for us to reflect," says Takashi Sakai, vice-president for operations at Lexus headquarters in Torrance, Calif.

The reflection has led to changes that address the brand's shortcomings. Lexus is giving its 199-dealer network a boost by opening more satellite service centers and equipping most of its 3,000 salespeople with Palm Pilots so they can punch up customer data on the spot. And the brand is playing up its high-tech edge. Check out the swiveling headlights on the new RX 330 SUV, which trace the vehicle's path as it rounds a corner. The GX 470 SUV offers rain-sensing automatic windshield wipers. And in 2004, Lexus plans to offer a gas-electric hybrid SUV that gets 35 miles per gallon.

Such changes may not be enough, though, for Lexus to enter the rarified realm of truly global luxury brands. To get there, Lexus must balance the need for continued growth and the right model mix with the risk of diluting the brand. A first step will come next year when Toyota starts selling Lexus-branded cars in Japan for the first time. And a new super-sportster should give the brand's image a lift.

Europe may prove a much harder nut to crack. Today, Lexus has zero traction on the home turf of its toughest competitors -- Audi, BMW, and Mercedes-Benz. Toyota's luxury cars lack BMW's legendary driving performance or the classy heritage of Mercedes-Benz. And Lexus hasn't quite figured out how to please finicky European drivers. The brand's flagship LS sedan, for instance, has just one choice of engine, compared with the five grades available for an E-Class Mercedes or the 10 variations for the upscale S-Class. A diesel engine wouldn't hurt, either. "European car buyers are a conservative lot who know what they like," says Tetsuo Kubo, president of automotive market researcher Fourin Inc. "They're harder to please than Americans."

Doing all that is a tall order in a market that never stops changing. But if Lexus reinvents itself, it will be doing so from a position of strength. The brand has handily outsold Infiniti and Honda Motor Corp.'s Acura and has mostly kept ahead of Mercedes-Benz in the U.S. Scaling Everest? Toyota could easily spend its money elsewhere. But heck, a company with $17 billion of cash in the till could buy the whole rock if it wanted to.

By Chester Dawson in Tokyo, with Chris Palmeri in Los Angeles

— With assistance by Christopher Palmeri

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