(FORTUNE Magazine) – Canon is unlike any other Japanese company. It never established keiretsu-style relationships with suppliers or a main bank. Its chairman, Ryuzaburo Kaku, is a born iconoclast, best known in Japan as an outspoken critic of bureaucracy and corruption, long before such criticism became fashionable. This mahjong fanatic and survivor of the nuclear bombing of Nagasaki pioneered "radical" employment practices like a five-day workweek. He got the president's job by delivering a blistering critique of the company at a 1975 board meeting--not exactly in line with the Japanese concept of wa, or social harmony.

As a result, Canon and Kaku have always been viewed as outsiders by Japan's cozy establishment of business leaders and bureaucrats. But that doesn't seem to bother the gnomish 71-year-old, because his style gets results. Under Kaku's maverick leadership Canon has become a standout performer, one of the few companies today that has transcended Japan's long economic malaise. Among FORTUNE's Global 500, Canon has jumped from No. 866 in 1975, with sales of $400 million, to No. 63 last year with sales of $23 billion, ranking it ahead of rivals Eastman Kodak (No. 99) and Xerox (No. 75). In the past decade net profits have grown an average of 20% per year. Over the same period, return on equity has more than doubled, to a current rate of 9.6%--a performance way ahead of the 5.6% annual average return posted for Japan's major companies.

Canon's short-term-growth story is no less impressive. In 1996, the maker of cameras, copiers, and printers earned a record $865 million. financial analysts say its earnings grew a healthy 9% to another record in 1997. Kaku, now chairman emeritus, looks back on the past two decades with characteristic understatement: "We've seen 20 years of rapid growth and diversification. I'm satisfied."

But Canon is at the end of an era. For years it thrived by challenging and beating other technology leaders at their own game--like Leica in cameras and Xerox in photocopiers. Today, however, Canon is the technology leader in many fields. Says Canon director of product development Ichiro Endo: "Now we have reached a point when we have to set our own targets. There is no one else to follow." Kaku is handing over the company to a new generation of executives who must lead Canon into the unfamiliar, largely unmapped universe of digital networked systems. In this world, as Canon sees it, people will be able to create, manipulate, transmit, and print digital documents more cheaply and quickly than ever before.

What's not yet clear is whether Kaku's successors will be able to thrive in such an environment. The current president, Fujio Mitarai, a nephew of Canon's founder, has yet to demonstrate the marketing smarts and global demeanor of stalwarts like Sony's Nobuyuki Idei or Honda's Nobuhiko Kawamoto. Nor has Canon shown an ability to bring hot new products speedily to market--a weak point in a company where fussy engineers lord it over marketers.

The challenge is all the more daunting because the new terrain poses big risks as well as rewards. One fear is that networked office printers might cannibalize Canon's highly profitable copier sales. And the company must find ways to protect its lucrative ink-and-paper business. Fear of price cutting by clone ink-and-paper suppliers actually drove Canon's stock down sharply last fall.

Fortunately for Kaku, Canon has some time to find its way forward. After all, it is already in the top three--and more often than not No. 1--in most of its major business lines. In Canon's original product line, cameras, which these days account for just 8% of sales, the company is No. 1 in both single-lens reflexes and compacts, with a 34% and 16% share, respectively, of the U.S. market. In the copier business, which accounts for about a third of its sales, Canon is tops in both color and black-and-white midrange business machines. When it comes to the printer business, which accounts for about 30% of Canon's sales, the company is second only to Hewlett-Packard.

To keep those kinds of results rolling, Canon has adopted a two-pronged strategy. It will maintain profits in its core business by cutting costs, making its suppliers more efficient, and speeding up its product development. At the same time Canon needs to move into the digital age. To do this, it plans to cultivate alliances with companies that know the networking and computer world better than Canon. The company's vastly successful 12-year-old alliance with Hewlett-Packard--Canon makes the motors for HP laser printers--stands as a model (see box).

Canon's push into the digital market couldn't come at a more crucial time. At company headquarters just outside Tokyo, the fear is that some of Canon's current products could go the way of the electric typewriter. Hewlett-Packard, for example, has launched a new marketing and product blitz aimed at replacing giant corporate copying machines with ubiquitous small printers. The effort is based on one terrifying insight (for copier companies like Canon) of the digital age: stand-alone copiers become a lot less useful when documents can be distributed by E-mail and made into hard copies at a nearby printer, as they already are at many companies today. In response, Canon is working out its own digital office-product vision, called ImageAnyware, which revolves around networked office printers with many PC-like functions.

As it struggles to cope with such rapidly shifting markets, technology is Canon's strongest suit, in a way few Japanese companies can boast. Its growth in the past has been fueled by a single-minded emphasis on high-margin products. For the most part, the company has stuck to patentable, category-killer technology in areas that it knows well, like optics, imaging, and printing. Each researcher is required to file for at least four patents every year. As a result, Canon regularly joins larger companies like IBM as one of the top five annual recipients of U.S. patents. This emphasis on R&D has translated into revolutionary products such as professional-quality autofocus cameras, the world's best miniature laser-printer motors, and remarkable photo-quality reproduction from ink-jet printers.

Unlike many major Japanese technology companies, such as NEC and Toshiba, Canon has steered away from next-to-no-margin commodity businesses like memory chips and PCs. Says Canon's Mitarai: "We didn't diversify into everything from fans to refrigerators the way others did. That's why today we make more money than a lot of Japanese electronics and technology companies."

The heart of the Canon technology empire is optics, which is where the company started more than 60 years ago when it tried to develop products to rival those of the big German manufacturers. After World War II, founder Takeshi Mitarai organized the small company around the slogan "Beat Leica," which it did, at least on price. Canon range-finder cameras, which closely resembled Leicas but were far cheaper, were a hit with U.S. occupation forces in Japan. For the next 30 years Canon was principally a camera company. Then in 1962, Mitarai decided that Canon should extend its optics expertise into office equipment. Xerox had created the device known today as the copier. It was an obvious gold mine and a challenge that fit with Canon's technological ambitions. But Xerox had surrounded its core science like a well-defended position on a Go board. "Aping" Xerox was not an option, because Xerox was not licensing its technology.

Canon engineers literally memorized every aspect of the Xerox patents to make sure that their own technology did not leave Canon open to any lawsuits. Over the next six years, Canon bet one billion yen--a whole year's worth of R&D expenditure--to create its own copier machine. In 1970 its NP-1100 photocopier rolled out.

No less valuable than breaking into the copier market was the lesson Canon took away on the technology front: It's far better to own your own patents. Unlike Xerox, Canon agreed to license its basic copier technology, and as a result it was quickly able to recoup most of its R&D investment. Today Canon consistently pulls in more than $100 million a year in royalties for its patents.

One critical area where Canon's technology drive has particularly paid off is ink-jet printing, which Canon claims to have invented. (Rival Hewlett-Packard stakes its own claim to the invention.) As the official Canon story goes, in 1977 researcher Ichiro Endo (today the company's director of product development) accidentally touched a needle full of ink with a soldering iron. The ink inside heated up suddenly, increased in volume, and spurted forth. Eureka! the basic principle of the ink jet was discovered.

As recently as two years ago, lasers looked like the future of printing. But a series of breakthroughs at Canon and HP has suddenly transformed ink jet from a balky, low-resolution printing technology into a stunningly affordable, very high-quality color printer for the masses. According to International Data Corp. (IDC), 12.4 million ink-jet printers were sold in the U.S. last year (vs. 2.9 million laser printers), and by 2001 that number will jump to 22 million (vs. 2.6 million laser printers).

President Mitarai is a conspicuous supporter of Canon's bubble jet effort, one of the company's top R&D priorities, because he sees a huge potential in three areas. One is new uses for the ink-jet technology, like a giant $1 million Bubble Jet machine Canon recently sold to a textile printer.

More promising still is the market Mitarai expects to develop as the digital-camera revolution takes hold, and consumers decide to print out pictures at home from their PCs. The new BJ-7000 series printer, which retails for $399, produces stunningly good-quality photo prints on plain paper. This spring Canon will release a version of the printer that works with a new Canon digital camera to provide prints direct from the camera without a PC acting as the go-between--a natural for Canon with its printing and camera expertise. "We expect a photographic revolution to take place," says Mitarai. "Currently, the digital-camera market is limited to PC users. But today there are 30 million traditional cameras sold. If there were a direct print-from-the-camera system, there would be a quantum leap in the market for digital cameras."

But selling millions of printers and digital cameras is the least lucrative part of the story. Canon hopes to steal a march on Fuji and Kodak by building a huge business around the sale of specialty paper and ink cartridges ("consumables," in the trade's lingo) for its bubble jet printers. Canon's margins on those products are 50% or more, vs. around 10% on the printers--among the lowest of all its products. Many of Canon's consumables are--guess what?--patent protected and "recommended" to make Canon printers work their best. In the next year or two, Canon expects half of its revenue in the ink-jet line to come from consumables. In the U.S., Canon is already negotiating with outlets like supermarkets and drugstore chains to sell Canon printer cartridges the way Kodak and Fuji sell film today.

It's a great vision that has analysts jazzed about Canon's prospects, but there is still a lot of nail biting. Last fall, for example, Canon's stock took a major hit when Xerox and Hewlett-Packard got in a legal scuffle over Xerox's right to sell laser cartridges labeled with the HP LaserJet trademark. The worry for Canon is simple: If Canon and Hewlett-Packard cannot protect their markets for ink and paper for their own printers, the fat margins they expect will turn to toast.

Another big question is whether Canon can execute quickly enough when it comes to getting new products on the shelves. In the first half of 1997, Canon lost ground because it was slow to get a new generation of Bubble Jet printers out the door compared with hard-charging HP and Epson. Says Keith Waryas, a market analyst at IDC: "Canon got comfortable and didn't look down the road at Epson coming on." Now Canon seems to have rebounded, and later this year it will introduce its first Bubble Jet printer designed in the U.S. for the U.S. market, code-named Captain America.

In digital cameras, too, Canon seems slow to roll. Mitarai argues that there is no money in digital cameras while the market is still so new, and as a result Canon has stuck with two models, the Powershot 600 ($699) and Powershot 350 ($499), which offer lower resolution than some newer models that Canon's competitors have on the market. There are no meaningful market-share statistics, but most analysts agree that Canon lags behind leaders like Casio, Sony, and Olympus. And Mitarai's vision of a camera-printer combo that does it all--no PC needed--is already on the market from Olympus.

So where is Canon? Busy making sure that its products--when they launch--will rock the market. Canon plans to launch new digital-camera models this year that include features like motorized zooms and manual controls, features largely absent until now from digital cameras. But senior Canon executives from Mitarai on down know that Canon has to move faster. One problem is getting the message through to Canon's fastidious engineers. Says Toru Takahashi, head of Canon's R&D and himself an engineer: "Engineers here used to think that they embodied what Canon was all about. I am trying to enlighten them with a more marketing-oriented approach, but they are slow to change."

One area where the company does have clearer priorities: cost cutting. Over the past few years Canon has been working hard to overcome its profit-slamming dependency on production in Japan. To view Canon's idea of the future of manufacturing, one need only step inside the clean room of its "mother plant" in Oita, a city on Japan's southern island of Kyushu. There a line of about 80 workers clad in Canon-issue gray slacks and two-tone polo shirts assemble the sleek Canon Elph, a popular new compact camera. They handle screws and parts so tiny that a carpet knotter would be impressed, but they won't be working on the Elph much longer. Seventy percent of the production has already been shifted to a Canon factory in Taiwan. Much of the rest will soon be in the hands of women on the line in Kyushu who wear long robes and Islamic-style head scarves in place of the standard Canon-issue uniform. Visiting from Canon Opto, a manufacturing subsidiary in Malaysia, these women will spend six weeks in Oita learning the fine points of Elph assembly before going home to teach what they learned to their co-workers. Then the Oita factory will go to work on another new line of Canon cameras.

At Japanese mother plants like Oita, Canon divisions initially assemble the latest printers, cameras, and copiers, and their engineers fine-tune the products and assembly procedures. Once sales pick up, the company increasingly moves production offshore. Ten years ago 10% of all Canon's production was abroad; today it's over 28% and rising.

Hisashi Sakamaki, who oversees Canon manufacturing, says he learned important lessons from U.S. companies' mistakes as laid out in the 1989 MIT Press book Made in America, by the MIT Commission on Industrial Productivity. "The key for us," he says, "has been to figure out how to benefit from production overseas without losing our capacity to develop production at home. Most American firms rushed abroad and lost that knowledge."

Saving money is one thing; leading the company into an uncharted future is something else entirely. That is where President Mitarai, a 23-year veteran of Canon USA, will have his toughest test. "I want to move closer to American-style management," he says, "to speed up decision-making."

The challenge for Mitarai will come in the vision department. Can he help Canon identify ways to cash in on the networked world of business machines? When Canon this fall took its first major pass at that question with the unveiling in the U.S. of Canon's ImageAnyware--"smart" printers with some PC-like abilities, including E-mail--analysts were not overwhelmed. Some felt intelligent printers may not be what the market wants.

Hewlett-Packard is moving ahead with a less ambitious, more customer-oriented marketing campaign that demonstrates simply how printers are a cheaper alternative to copiers in the workplace. Says Keith Kmetz, a research manager at IDC: "ImageAnyware is more future oriented, and it's great technology. The challenge for Canon is to develop a practical marketing strategy based on ImageAnyware. I haven't seen that yet." But at least Canon made clear that it is not sitting back waiting for someone else to come up with the answers.

It's no wonder, then, that Canon's headquarters today feels like a restless, uncertain place. There is a gnawing anxiety that Canon needs to branch out into some new category of technology. Sober engineers like Endo, Mr. Bubble Jet, insist upon worrying. "We still have to build a new technology pillar for the future," he says. "I feel we are entering a tough period."

By contrast, most analysts who follow the company dismiss the notion that Canon needs a major new breakout technology to be a long-term winner. Canon is in businesses so fertile with partners so strong, they argue, that its profits should remain in great shape for the foreseeable future. A bit of worrying, however, may be just what this maverick company needs to chart its own course through the largely undefined digital world.

REPORTER ASSOCIATE Cindy Kano