Why Lexus Doesn't Lead the Pack in China

Even after a series of embarrassing recalls last year, Toyota Motor's (TM) Lexus managed to remain the No. 1 luxury vehicle maker in the U.S.—a spot it's held for 11 years running. In China, however, it's an also-ran. Lexus sold just a fifth of luxury leader Audi's tally last year in the world's biggest car market. It also trails BMW and Daimler's Mercedes.

To bolster Lexus's standing in China, Toyota is turning to the feature that cemented its early success in the U.S.: extreme customer service. Showroom amenities such as cappuccino machines, Wi-Fi, Lego tables for the kids, and airport shuttles for busy executives dropping off their cars for servicing—now-standard touches among luxe brands in America—took root in Lexus's signature tan and black dealerships in the U.S. during the 1990s.

To learn the latest in consumer coddling, Toyota is embedding two Chinese managers at Lexus's U.S. headquarters in Torrance, Calif. They'll stay a year to learn all aspects of the luxury brand's operations, rotating through sales, marketing, and customer service. Then they'll return to instruct Lexus colleagues back home. "The U.S. is the most sophisticated auto market in the world, in terms of our capabilities," said Mark Templin, head of U.S. Lexus sales.

The same can't be said for Lexus in China; "nothing stands out from Lexus's service," says Maggie Lin, a 32-year-old owner of a decorative stones business in Foshan who owns an imported Lexus RX sport-utility vehicle and an Audi A6 sedan. "I don't feel there's anything special compared with what Audi has been doing. They are more or less the same." Although Lexus sales in China grew 61 percent, to 49,000 cars, last year, Audi sold 236,000, says J.D. Power and Associates.

Lexus is adapting its models to fit local tastes. "Consumer needs are not all the same in each market," explains Takeshi Uchiyamada, Toyota's executive vice-president for research and product development. "In China, within the Lexus lineup we're introducing smaller-engine cars favored by Chinese customers." Examples include the recently added IS 250 sedan and IS 250C convertible, whose 2.5-liter engines are much smaller than the 3.5-liter found in the RX SUV popular in the U.S. Lexus plans to sell a new entry-level hybrid Lexus, the CT 200h, later this year that will have sportier handling than Toyota's Prius. The model, promoted as the "darker side of green," will compete with BMW's 1 Series, the Audi A3, and Mercedes's B-Class models.

John Zeng, a Shanghai-based analyst for J.D. Power, says Toyota is at a disadvantage because it imports all the Lexus cars it sells in China. Importers pay a 25 percent custom duty and a 17 percent value-added tax. There's also a consumption tax, based on engine size, that can reach 40 percent. That can make Lexus prices too high for younger buyers, Zeng says. "Toyota insists on producing Lexus in Japan," he says. "But if you want to achieve the volume of your competitors, you have to follow your competitors' strategy. BMW, Audi, Mercedes—they are all focused on localizing production of their models."

Analysts say Toyota has been reluctant to entrust non-Japanese plants with the luxury brand because they want to control quality and protect intellectual property. The automaker is also moving forward cautiously after a year of recalls globally for problems including quality glitches in Lexus models. "Especially now, we're not going all out to go as fast as we can in China," says Karl Schlicht, head of the brand's global product and marketing division. "We've learned a big lesson."

Lexus's underdog status is partly due to its later entry into China. It opened its first dedicated showrooms there in 2005, after beginning imports in 1993. Audi, the favored brand of Chinese bureaucrats, is owned by Volkswagen, which entered the market in 1985.

Globally, Lexus sales have failed to take off in major markets outside of the U.S. In Japan, sales reached 33,400 cars last year, about half the company's original target when the brand was introduced there in 2005. By contrast, Lexus's U.S. sales rose 6.2 percent in 2010, to 229,329. While worldwide sales rose 12 percent, to 410,000 cars, that's less than a third of luxury car leader BMW's deliveries of 1.46 million cars.

Even if Lexus becomes China's customer-service champ, it may not lure more buyers, says Beijing Mercedes owner Wang Jun. "The Chinese market is still a seller's market," Wang says. "People pay more attention to brand reputation, quality, and price rather than dealer services."

The bottom line: To catch Audi, Lexus is improving customer care in China, where J.D. Power predicts luxury sales will triple by 2015, to 1.4 million vehicles.

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