(FORTUNE Magazine) – WHILE the Japanese chewed up the competition in small cars in the 1980s, European and American manufacturers of big, expensive automobiles all but dozed. They thought the special qualities of their cars and their loyal owner base made them impregnable. After all, heritage, breeding, and image cannot be manufactured on an assembly line. The notion of a Japanese Jaguar was unthinkable. Here comes the wake-up call. In the U.S. this year Honda's four-year-old Acura division is on track to sell nearly as many cars costing $20,000 and up as BMW. Together with Toyota's Lexus, which opened for business only last September, and Nissan's Infiniti, which is two months younger, they should outsell BMW and Mercedes-Benz combined. That's not all. Within the next 24 months the Japanese will introduce at least nine new high-priced models in the U.S., including an Acura Legend that's bigger inside than a Cadillac. By the end of 1990 Japanese nameplates will adorn more than 14% of the 1,178,000 upscale automobiles sold in the U.S., according to a market forecast by J.D. Power & Associates, the California-based automotive research firm. The Japanese have succeeded not by following Cadillac or Mercedes but by pioneering a new route to wealthy car buyers. They combine exceptional product quality, reliability, and value with superior sales and service. ''The Japanese have redefined the meaning of luxury,'' says Laurel Cutler, vice president of consumer affairs for Chrysler and vice chairman of the FCB/Leber Katz New York advertising agency. ''Their cars are not ultracomfortable, ultrafast, or ultracostly, and in fact the styling is boring. But they have perfect manners: They are totally trouble-free, care-free cars.'' With two dozen companies selling $20,000-plus automobiles in the U.S., upscale cars have become a strategic crossroads for manufacturers from three continents: for the Japanese because they must maximize the margins on vehicles they ship across the Pacific; for the Europeans since they have been nearly priced out of lower product ranges; and for the Americans because they need to subsidize the sale of small cars. In the 1989 model year General Motors made a factory profit (excluding overhead) of more than $9,000 on each Cadillac De Ville and Fleetwood -- nearly four times the profit on a Chevrolet Corsica, according to an internal company report. THE COMPETITIVE friction is greased by the growing number of customers who desire and can afford something more than ordinary transportation. Older, richer baby-boomers are still driven to expressing themselves through their purchases. While passenger-car sales are expected to grow only one to two percentage points a year on average through the 1990s, upscale models should make annual gains of about 10%. With rewards so rich, everybody wants to sell a ''luxury'' car. Chrysler runs commercials comparing its $18,375 LeBaron to the Acura Legend, which costs up to $31,490, and Chevrolet uses the L word freely in describing the 1991 Caprice Classic, which came out in April. While the $19,370 Caprice has many attributes of the traditional U.S. luxury car -- plush interior, power equipment, pillow ride -- true premium or upscale automobiles offer more than nice transportation. They are indulgent, sophisticated, and a little bit special. (Prices cited include all popular options but not destination charges, dealer preparation, taxes, or rebates.) In violation of every principle of luxury marketing, European and American automakers have begun using price as a sales weapon. Cadillac and Lincoln dole out $2,000 cash rebates. Jaguar advertises a $39,700 price leader, a four-door V-6 sedan that is $4,300 cheaper than last year's version. BMW repositioned two of its 1990 model lines by cutting sticker prices. Mercedes dealers, who ! command a 25% markup in good times, now eagerly dicker with customers. Seductive lease deals are available everywhere. For no down payment and $499 a month, drivers can slide into a $27,685 Audi 100, drive it for three years, and then turn it in. WITH LASERLIKE accuracy, the Japanese are burning away at the fastest- growing chunk of the upscale segment: midsize cars costing $25,000 to $40,000. That's the lane where the Acura Legend and Lexus LS 400 are overtaking such European models as the Mercedes 190, the BMW 325, and the Saab 9000CD. According to a forecast by WEFA Group (formerly Wharton Econometrics) of Bala Cynwyd, Pennsylvania, volume in this luxury range should jump more than 100% by 1995 to over 400,000. Honda moved in first in 1986 with the Acura Legend. With its V-6 engine and low-key styling, it was disparaged by competitors as little more than an overpriced Honda Accord. But Acura put its own spin on the luxury business by establishing a separate dealer network to give customers special treatment. It emphasized reliable performance and value rather than status and ego gratification. Acura sold 64,638 Legends last year, and its dealers have won the No. 1 ranking three years running in the annual customer satisfaction survey of 35 brands done by J.D. Power & Associates. Says John Schnapp, vice president of Temple Barker & Sloane, a consulting firm in Lexington, Massachusetts: ''People who buy the Legend see it as a complete, sensible package, with comfort, pleasure, and the sense of a good investment.'' They get the greatest luxury of all -- no hassles. Toyota's Lexus division took the Acura approach several steps further. Says John Casesa, a former Big Three product planner who follows auto stocks for the New York investment bank Wertheim Schroder & Co.: ''When the Lexus LS 400 first came out, people said it was a better value than a comparable Mercedes or BMW. Now they are saying flat out that it is a better car than a Mercedes or BMW.'' The LS 400, which costs $40,000, cossets driver and passengers in a warm, friendly interior. Lexus dealers strive for the same effect. When Lexus suffered the embarrassment of its first recall (for three relatively minor glitches), owners who lived more than 100 miles from a dealer could enjoy that rarest of treats: a house call from a service technician. The LS 400 has become the most analyzed car in automotive history. Engineers from Detroit to Stuttgart have stripped it down in search of its soul. When they couldn't find any evidence of technical shortcuts, some hinted that Toyota had created a $50,000 car for which it was charging an indecently low price. For the record, Toyota says it makes its usual (though unspecified) profit on the car. SALES OF a less expensive Lexus, the $24,000 ES 250, have been disappointing. Buyers perceive it, correctly, as a fancy version of Toyota's $19,883 Camry LE Sedan V-6. The record to date of Nissan's Infiniti division also proves that the Japanese do stumble occasionally. So far in 1990, Nissan has sold only 7,161 Infinitis in the U.S. -- less than half as many cars as Lexus. Infiniti arrived late to the market with fewer dealers, a somewhat more sophisticated flagship car with less pizazz (the $38,000 Q45), and a perplexing ad campaign. As the builders of commodious, six-passenger cars, Detroit's Big Three do not compete head on with the Japanese in the luxury market, and they continue to thrive. Chrysler, whose sales have slipped more than 16% this year, successfully reintroduced the Imperial after an absence of six years and has sold 6,783 for about $27,185 each (before a $1,000 rebate). Detroit's long- term prospects are less heartening. Its big V-8-powered cars don't appeal to buyers who learned to drive in Volkswagen Beetles and Honda Civics. Demand for these traditional models is expected to grow only 26% to about 620,000 cars by 1995, according to WEFA. Cadillac, the volume producer among upscale automakers (1989 sales: 266,899), has the most to lose. Temple Barker & Sloane not long ago invited current owners of less expensive GM cars to drive luxury brands from a variety of manufacturers. Japanese cars outscored Cadillac. Says John Schnapp: ''These are people who might otherwise be headed toward Cadillac, but they've had unsatisfactory experiences with Buicks and Oldsmobiles.'' The old line that the age of a typical Cadillac buyer is somewhere between retired and dead is only a slight exaggeration. ''Clearly we have to broaden our appeal,'' says John Grettenberger, the division's imposing, silver-haired general manager. Cadillac, which is changing designs more frequently and developing higher-horsepower engines to improve performance, has been struggling with the youth problem for a decade. The compact Cimarron flopped in the early 1980s, as did the shrunken Eldorado and Seville that came out in 1985. Even if a new teardrop-shaped concept car called Aurora clicks, it would take four years to get ready for production. Among American luxury makes, Lincoln is the success story of the decade. In 1983 it sold only one-third as many cars as Cadillac (see chart). But this year it passed the GM brand for the month of April, and executives predict it will move 235,000 cars in 1990. Lincoln generates disproportionately grand profits for Ford. John Krafcik, a former member of the automotive study group at the Massachusetts Institute of Technology who now works at Ford, points out that Lincoln builds all its cars at a single plant that consistently runs on overtime. Cadillac spreads production among three plants, one of which operates on only a single shift. Lincoln achieves its high volume at a price. Last year 35% of sales went to corporate and daily rental fleets, vs. 24% for Cadillac. Rental fleets can tarnish a premium image. Although they expose cars to potential customers, they dilute the appearance of exclusivity. Herds of Lincoln's new Town Cars ($33,000, fully equipped) decorate Hertz and Budget rental car lots. Under a current Budget promotion, they can be hired for $44.79 per day in some cities. By 1992 there will be a new Mark VIII, derived from the Ford Thunderbird, and the popular Continental will get a 32-valve, aluminum block V-8 to replace the current V-6. Both cars now sell for around $30,000. ''I'd be stupid to say we aren't paying attention to Lexus,'' says Lincoln's Texas-born general manager, Ross Roberts. ''But at $38,000 to $42,000, the LS 400 is playing in only 5% of the total U.S. market.'' MANUFACTURERS of high-line European cars are trying to regroup after seeing sales fall for three straight years. Productivity at some West German and British luxury car companies is so flaccid that, according to an MIT study by John Krafcik, Mercedes uses six times as much labor per car as Toyota. Inefficient model development means that some European manufacturers wait a decade or more before replacing an old model with a new one. Burdened by an out-of-date factory and an aging product line, Jaguar, Britain's last independent automaker, sold itself to Ford earlier this year for $2.5 billion. Sweden's Saab-Scania, which also found the cost of new models nearly unaffordable, sold a half-interest in its auto operations to General Motors for $600 million. ''Saab and Jaguar couldn't support enough new product development on their own to remain competitive,'' says John Wolkonowicz, an automotive consultant at Arthur D. Little in Cambridge, Massachusetts. ''These deals will make them both more viable.'' During this year's first three months, Jaguar sold a record 5,000 cars in the U.S. At Mercedes sales have stabilized at about 75,000 cars annually, after falling 10% in 1989. Mercedes's prices can be breathtaking. The base model SL roadster with a six-cylinder engine and a five-speed automatic transmission sells for $73,500; buyers who want the two additional cylinders on the same car pay $10,000 extra for the V-8 engine. Prices like that have not stopped customers from queuing up for as long as nine months to await delivery. BMW, strong in Europe and Japan, has faltered in the U.S. After peaking in 1986 at 96,759, U.S. sales fell to 64,881 last year. Intensive marketing, price cuts, and the introduction of the popular $41,500 535i failed to keep volume from tumbling another 13% this year. BMW is bookending its product line with a $19,990 four-cylinder 318i -- the least expensive car it has sold since 1985 -- and a $73,600 12-cylinder 850i. VOLVO IS NOT usually thought of as a luxury brand. But two-thirds of its sales come from $20,000-and-up 740s and 760s. Despite their reputation for value and durability, Volvos scored 12th out of 35 in J.D. Power's latest customer satisfaction survey. The company's sales are off 10% this year. Audi and Porsche have regained a bit of lost momentum after precipitous falls in the late 1980s. Several other proud marques have been reduced to boutique status. Last year in the U.S., Peugeot sold just 6,010 cars, Rover Cars' Sterling 5,907, and Alfa Romeo a mere 2,912. For all their troubles the Europeans keep chasing after American buyers. In June, Italy's Alfa began marketing a four-door sports sedan, the 164, that starts at $24,500. France's Citroen, which last sold a car in the U.S. 16 years ago, plans to come back in 1992 with a V-6- powered hatchback called the XM. Both companies could do worse than emulate Range Rover, another division of Rover Cars. From a dead start four years ago, it sold 4,822 luxury off-the- road vehicles last year at $43,100 each. While the Europeans and Americans pop out new models one at a time, muzzleloader style, the Japanese fire them out in machine-gun bursts. Lexus and Infiniti could introduce at least five more models in the next 24 months. Among them: an Infiniti convertible based on the $23,500 M30, a Lexus coupe similar to the LS 400, and perhaps stretched versions of the two flagship cars, the LS 400 and Q45. No official information about the 1991 model Acura Legend, due this fall, has been released, but marketing and security analysts say it will have more power (a 200-horsepower engine, up from 160 now) and a wheelbase that is six inches longer than the one in this year's car. That would make it bigger than a Cadillac De Ville axle to axle. Even though the new Legend lacks a V-8 engine and won't hold six passengers, it could become a popular alternative to Detroit's behemoths. The Japanese are also expanding their presence in the sporty luxury segment (1989 sales in the U.S.: 57,379). Mitsubishi is going after the $38,000 Corvette and the $45,000 Porsche 944SII with the $31,000 3000GT. Acura takes aim at the upper end of the Porsche line with the NSX, a $60,000 race car in street clothing. Small production (5,000 annually) means slim profits, but such speedsters add to an image and draw showroom traffic. Mazda, Japan's fourth-biggest seller in the U.S., is studying whether to follow its three larger colleagues into the upscale market. George Peterson, a California marketing consultant who follows Japanese plans carefully, believes Mazda is considering three larger models: a V-8-powered 929 S, an upgraded 626, and a U.S. version of the Japanese Cosmo coupe. Unlike other Japanese automakers, Mazda may decide to sell the cars through its existing dealers rather than going to the expense of starting a luxury distribution channel. IN REAL ESTATE and stocks, excess supply usually precedes a slump. The same may be true of upscale cars. J.D. Power & Associates forecasts that nearly two million luxury vehicles a year will be available by 1995 -- 400,000 more than the market can absorb. Since luxury goods are the ultimate deferrable purchase, sales might plummet if the economy hits a chuckhole or if currency fluctuations distort import prices. Jaguar's top U.S. sales executive, Michael Dale, likes to say, ''People have been driving luxury chariots since Ben Hur's day.'' But perceptions of luxury change. Now that the Japanese are winning with their own interpretation, Europeans and Americans must refine their visions -- or be left in the dust once again.

CHART: NOT AVAILABLE CREDIT: SOURCE: J.D. POWER & ASSOCIATES CAPTION: SHARE OF U.S. LUXURY CAR MARKET Already Japanese automakers account for more than one out of every nine cars sold for $20,000 and up. European marques have been the big losers.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: LINCOLN COMES ON STRONG Lincoln has been gaining on Cadillac for a decade. But last year one-third of Lincoln owners had names such as Hertz and Budget.