(FORTUNE Magazine) – The off-the-rack gray suit, tie clip, company button, and metal-rimmed glasses mark Yoichi Morishita, chairman of Matsushita Electric, as a prototypical Japanese salaryman. Through patience, hard work, and a visceral horror of anything that could be construed as flamboyance, Morishita has risen to the top of Matsushita, the consumer appliance colossus that generated $67.5 billion in sales last year. On a drizzly afternoon last April, though, as the modest Morishita scaled the final summit of his lifelong climb at Matsushita, he was hoping to drum up a bit of buzz. "You don't think we're boring, do you?" the 65-year-old pleaded as he prepared for the press conference that would announce his rise to chairman. Later that afternoon Tokyo's assembled journalists, who had treated the ascension of Nobuyuki Idei at Sony in 1996 like the coming of a messiah, rendered their brutal verdict: They buried Morishita's promotion deep in the back pages.

There's a reason Matsushita elicits such yawns. It is perceived--and rightly so--as a bloated and demoralized industrial behemoth (282,000 workers in 160 factories worldwide) that is resisting the kind of corporate restructuring that transformed American industry in the 1980s and is now cutting a swath through Europe. To catch up to global peers like Sony, GE, Philips, or Siemens, Matsushita will have to do what they've already done: buy components from cheaper suppliers, slim down its bloated middle-management ranks, get out of dud industries, and spin off divisions that can do better on their own.

So far, there's little evidence that Morishita is willing to make those hard choices. He does say that he wants to transmogrify Matsushita into an Internet powerhouse by offering consumers products that are all hooked up to the Web, from digital TVs to toasters to toilets. But unless this unhip CEO figures out a way to change the company's calcified culture, Matsushita and its famous Panasonic brand are bound to be lost in cyberspace.

Here's the problem: Making consumer electronic goods--still the heart and soul of Matsushita's business--is becoming less and less profitable. Sales of consumer electronics in Japan have dropped from $42 billion a decade ago to $20 billion now. So even though Matsushita's share of the Japanese market rose from 40% in 1989 to 76% in 1999, its sales fell by 2.4%. The situation outside Japan is also bleak. As appliance makers come of age in places like South Korea and China, they are causing a global glut in consumer goods. That, in turn, is hammering prices. And the pace of technological change has squeezed the profit cycle of each new product even as research costs have risen. "Making the old color televisions was profitable for us for 40 years," notes Yoshitomi Nagaoka, Matsushita's chief technology officer. "But making digital televisions won't be profitable for more than 15 years."

No manufacturer is immune to these forces. That's why Sony wants to either morph stand-alone consumer products like Walkmans and Camcorders into Internet-enabled gadgets or replace them with products that are basically sophisticated Internet toys, like the Music Clip, a portable music player that can download music from the Net. Matsushita's Morishita also has faith that nascent Net services will breathe new profitability into his gadgets. "The profitability of producing stand-alone hardware is diminishing," he notes. "That's why we don't want to make products, but [hardware] platforms that enhance their value through software."

Matsushita doesn't plan to go head-to-head with Sony on the Internet. Sony's Idei believes the Net will change the way people play. Morishita, by contrast, is staking Matsushita's corporate future on a more sweeping yet also more down-to-earth idea: that people will be willing to use the Net to change their mundane routines--how they cook, clean, drive, even go to the bathroom. "The big global trend we see is a ubiquitous Internet network in society arising in the first decade of this new century," says Morishita. On the basis of that idea, over the next year Matsushita will unveil a series of "smart" appliances, ranging from gizmos that are readily adaptable to the Net, like mobile phones and digital televisions, to such unlikely Net accessories as refrigerators and ovens. The idea is that these Net-enabled appliances will ceaselessly interact with one another within an all-pervasive broad-band Internet network.

Before the company can become a new-economy player, however, it must clean up some old-economy problems. Unless it restructures its sprawling operations, profits--down from $1.3 billion in 1997 to $923 million for the last fiscal year--will continue to drop. Unless it comes to grips with new distribution models like the Internet, sales will continue to stagnate. And unless top managers like Morishita devise creative ways to unlock shareholder value, its stock will continue to lag behind rivals like Sony.

So, yes, Matsushita is torpid, ungainly, and old-fashioned. But in a weirdly fascinating way, it captures in a nutshell all that is good, bad, and ugly about Japan Inc. For a long time now Matsushita has been good at thinking up and churning out cutting-edge products, like the world's quietest vacuum cleaner. And the company clearly gets it when it comes to technology and globalization. Yet when it comes to acting on its internal ills--or even seeing them--Matsushita (like most of Japan) remains paralyzed and resolutely blind. The company is about to launch daring Internet products that consumers may not even know they want, but its boldness in creating new devices is by no means matched by daring in the executive suite. All the cool gadgets in the world will not return Matsushita to the glory days of fat profits if it does not change its bloated management structure and archaic attitudes.

Unlike other Japanese corporate zaibatsu like Mitsubishi or Mitsui, which trace their roots to the warring feudal clans of 17th-century Japan, Matsushita is the Japanese equivalent of a garage startup. Its saga began in the industrial city of Osaka in 1918, when Konosuke Matsushita, an engineer at the local utility, got a better idea for an electric socket. He quit his job, set up his tools at home, and went to work. The socket he designed was technically superior, but because Matsushita couldn't produce it in bulk, he had trouble selling it.

Matsushita applied that lesson to his next invention, a battery-powered and bullet-shaped bicycle lamp. By pawning clothes to raise more cash for raw materials and working furiously with his wife to churn out the bicycle lamp in greater numbers, Matsushita was able to meet the big orders that came from bicycle shops. The lamp was a runaway success. Mass production became the industrial mantra that propelled the company's growth in Japan right through World War II, when Matsushita produced dry-cell batteries for radios and military equipment.

It wasn't until 1961, when the company opened its first overseas factory in Thailand, that Matsushita discovered the pent-up demand in Southeast Asia and other parts of the developing world for his radios, rice cookers, and other household goods. The company shed its provincial Japanese roots and became a truly global company, displaying a fleet-footedness and willingness to change sadly absent today.

By the early 1980s, Matsushita had become the world's biggest maker of consumer goods like televisions, videocassette recorders, and refrigerators. Today roughly half of its sales (as well as half of its employees) come from outside Japan. "Like water," the recorded narrative at the company museum in Osaka intones, "our founder believed electronic goods should be abundant and cheap for everyone." Matsushita also believed that tiny innovative touches were what endeared products like miniature vacuum cleaners or water-sensitive rice cookers to consumers.

Konosuke Matsushita died in 1989 at the age of 94, but his obsession with producing for the masses and ceaselessly improving products endures. The company he founded has lots of problems, but creating attractively priced, innovative products is not one of them. "We want to empower the nongeeks!" says Akira Kanda, Matsushita's multimedia director. Leave the gadget freaks to trendier companies. Which is not to say that Matsushita is afraid of delving into high tech. The difference is that Matsushita is applying technology to an array of humble household goods.

The centerpiece of the cyberhousehold Matsushita envisions is the digital television. Web TV isn't a concept original to Matsushita, of course, nor is Matsushita a market leader when it comes to digital television sales (Philips and Sony are ahead). But just as the PlayStation is Sony's gateway to the Web, Matsushita is betting its digital television will be its own Uber-gadget. "I don't think game machines are the best gateway to the Internet," says chief technology officer Nagaoka. "I see a more brilliant future for digital television than the PlayStation."

In Matsushita's cyberhousehold, the digital television will be not only the primary Net access device but also the bulletin board for all the information gathered from its other Net-enabled household devices. An old friend drops by to visit, say, when you're not home. The video camera installed in the doorbell will record her face and any message she may leave, and then shoot those images to the digital television. So the next time you turn on the tube, there she'll be, in digitized splendor. What if she's rushing for the airport and needs to get in touch with you urgently? No sweat. The digital television can transmit her image to the tiny screen on your mobile phone.

The television isn't the only household item Matsushita has endowed with Web smarts. Example: the forthcoming smart toilet. This is no ordinary john. It checks weight and body fat when you sit down. After you're finished, an optical laser beam measures the level of glucose in your urine. If you're in the diabetes danger zone, your results will be electronically sent from the toilet to a central database and then to your company's health insurer or your physician, or both.

Another futuristic household gadget Matsushita hopes to roll out soon is its smart refrigerator, designed not just to store food, but to obsess over it. If you suffer from calcium deficiency, say, and you're low on milk, the fridge will send an alert to the nearest networked grocery store for a delivery. The fridge will also talk electronically to your oven, another smart device from Matsushita, informing it what food is around, which it knows because nearly every store-bought food item will be tagged with a tiny microprocessor. By the time you get home, the oven will present you with a menu. Oh, and because the smart fridge knows exactly how much food it has at all times, it can adjust its temperature and electrical usage accordingly, saving 30% on energy costs while costing just $100 more.

The big idea behind the gadgets is to weave together the devices people use daily in a giant broadband network. Every appliance will be connected to every other via the Internet. When all information is pooled in a central household server, the appliances will be able to share, retrieve, and analyze data from one another. The server will also be connected to devices outside the house, such as the popular I-mode phone (which, not coincidentally, Matsushita manufactures for NTT DoCoMo).

Is such a smart home what people really want? Matsushita executives can unroll reams of research showing how the lifestyles of Japanese are growing so rushed and complicated that they will open their wallets for any product that will make their routines a little easier. The same holds true for consumers in Europe and the U.S., they say, though executives concede that such advanced products would be a tougher sell in countries like China. There Matsushita intends to emphasize cheaper, simpler goods.

Even so, as the rich world moves toward this networked future, Matsushita believes it has found a sweet spot. "Our unique strength is that we cover such a wide area of consumer goods," Morishita says proudly. All of which is fine. And true. And even--dare one say it?--exciting. There's just one thing. It's hard to see how Matsushita gets there from here, given its sluggish corporate structure, which even the magical powers of the Internet can't wish away. Morishita seems to have an inkling that change is necessary. "In order to provide solutions and services over the Internet, we have to create new business models," he says. But when pressed for more, he doesn't go beyond vague generalities.

Matsushita's devil resides in its details. For instance, the company's insistence on manufacturing most of its components sucks away cash. Components like flat screens for televisions, ultrathin keyboards, or semiconductors could be reliably and cheaply made in South Korea or Taiwan, as Sony, Motorola, and Philips have proved for years. Technology chief Nagaoka defends the practice this way: "Japan has a big legacy of manufacturing. To destroy it will be difficult." Moments later he sheepishly admits, "It is a weak point." For Matsushita lifers, the prospect of laying off workers at its semiconductor factories is a terrible thought: Morishita has no desire to be known as "Neutron Yoichi." But the larger fear is that of relinquishing control. In the Matsushita mindset, only Matsushita workers can be trusted to ensure the high standards of craftsmanship the founder famously instilled. Which is, of course, rubbish. Morishita, predictably, does not pay much heed to that critique. "We will continue to make key devices inside the company," he says calmly.

This "us vs. them" mentality has insulated the company from change. Unlike Sony, whose open and cosmopolitan corporate culture has been shaped by the hungry young talent it recruits from Japan's top schools, Matsushita has always gone to great lengths to create a flat and noncompetitive atmosphere, even shunning graduates from elite institutions like Tokyo University or Waseda. Graduates of such schools, it believes, are more likely to be disruptive. New employees, from the mailroom on up, undergo a four- to seven-month indoctrination, living, eating, and all too often singing the company song together. The emphasis is on conformity.

Not that it's meant to be. At the company museum in Osaka, founder Konosuke Matsushita is endlessly shown on a crackly black-and-white video, exhorting his employees to think and move independently of the company. Stirring sentiments, indeed. But the video closes by showing ranks of uniformly dressed men rising to their feet in applause and then enshrining Matsushita's call for revolt into a company slogan ("Act like owners!") that is mindlessly repeated before every major staff gathering. Conformity, not the founder's ideal of enlightened rebellion, saturates every level of corporate life, from the fashion of its employees (white shirt, a tree-shaped company button at the jacket lapel, eyeglass frames from the Eisenhower era) to the unvarying lunch menu at the executive cafeterias (cold fish followed by rubbery beefsteak). It is a land where the 1950s never ended.

Matsushita's attitude toward marketing also hails from the era of tail fins and bobbysoxers. Consumers, for example, love megastores that compete brutally on price. Matsushita does not. "We don't discount. Not just because we want to maintain the quality of the brand, but to preserve market order," frets Yoshihiro Fujiwara, a marketing executive. "Market competition is a good thing, but if there's too much competition, it will damage the whole industry." Does worrying about the preservation of market order--whatever that is--sound quaint from an enormous multinational? It should, but at Matsushita, such sentiments are routine. Matsushita's marketers have been forced to adapt to this brave new world by selling their products in megastores, but they clearly are not at home in it. Their discomfort shows up as shrinking profits on Matsushita's bottom line. For example, because Matsushita cannot gauge demand from distribution channels like megastores as accurately as it could through their old mom-and-pop stores, the company has tended to produce more goods than it can sell. Overproduction is an industrywide problem, of course, but it's especially acute at Matsushita where unsold finished goods piling up at its warehouses has reached alarming proportions.

The irony is that Matsushita could change if it wanted to. Just look at its star subsidiary, mobile-phone maker Matsushita Communications (MCI). Unlike its stodgy parent, MCI is not run in order to furnish squads of salarymen a monthly income. It outsources the manufacturing of components like its liquid-crystal-display screens, sells its products through a variety of channels, and keeps costs low enough to maintain operating profit margins at 9%. With a global share of 6% in the mobile-phone market, ranking it fifth (Nokia is first, with 27%), MCI is a comer in a red-hot industry. Its stock has quadrupled in value in less than two years.

So, of course, MCI is serving as a role model for Matsushita. Wrong. Asked whether Matsushita would spin off more subsidiaries, executives gathered in a conference room at MCI are mildly shocked. To the contrary, suggests Masaki Akiyama, the senior managing director, "There's now speculation that MEI [Matsushita] will retake control of MCI." Why would Matsushita consider such a weird step, which would almost surely kill investor enthusiasm for MCI? Silence and unease fill the room.

For decades Matsushita's blue-chip institutional investors have tolerated Matsushita's old-fashioned ways. But their patience at last seems to be wearing thin. As Japanese society ages, large pension funds like Sumitomo Life, which is a major investor in Matsushita, are looking for better returns. "The pressure is definitely on," says Allan Dwyer, vice president for equity sales with Nikko Salomon Smith Barney in Tokyo, "but it's being exerted in a very private, closed-door, Japanese way." Matsushita will have to act fast. With a price-to-book value of about 1.5 (Sony's is about six), such a cash- and land-rich company is a tempting takeover target, even in fusty Japan.

One thing is already clear: To get the company out of its rut, salarymen like Morishita will have to rethink the way Matsushita does business just as creatively as they are rethinking the kind of products Matsushita sells. Only then will the giant awaken and, perhaps, help rouse the rest of Japan Inc. from its long sleep.

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REPORTER ASSOCIATE Cindy Kano