(FORTUNE Magazine) – SHORTLY BEFORE stepping down as chairman of Ford Motor, Philip Caldwell talked candidly with Charles Burck, a member of FORTUNE's board of editors, about the lessons the auto industry has learned in the past few years and about the challenges ahead. Caldwell ended his career with a flourish, presiding over a $1-million extravaganza in Hollywood in late January to introduce the new Ford Taurus and Mercury Sable--midsize replacements for some of the company's last relics of the pre-oil-shock era. He could take still greater satisfaction from the company's performance since the bleak days of the early 1980s, when some critics wondered whether Ford had a future. Ford earned $1.9 billion in 1983 after losing $658 million the year before --the biggest one-year turnaround from loss to profit in business history. Last year's earnings roared to almost $3 billion. Ford also gained two points of market share in the U.S., its biggest increase since 1968, though its 19.2% of the total domestic market is still well below the 25% it held in the early 1970s. Excerpts from the interview: On how much credit for the improvement goes to cost cutting and how much to a stronger market: The results don't fit into neat bins. Increased volume has been important, but we could have operated in the black in 1983 even if there had been no increase. On where the blame lies for Detroit's predicament of the early 1980s: Everybody put some dirt in the carburetor. I wouldn't have started to answer this way a few years ago, but I think the most decisive factor was that we let quality slide. Pride in work was allowed to deteriorate, and I suspect there was an undue effort to command quality rather than to earn it by paying meticulous attention to details. Regulatory burdens also put us under tremendous pressure. Those regulations were not inappropriate, but they were effectuated in a very clumsy and costly way and were frequently contradictory. But I don't think the industry can be criticized for seeming to overlook the trend toward small vehicles. The volume wasn't there before the oil shocks. On when Ford first began to view the Japanese as a major threat: In 1977 we concluded that the Japanese auto industry had a capacity of eight million units, against its domestic market of five million, and planned to increase its capacity rapidly to 12 million. Henry Ford and I went to see Bob Strauss, when he was the trade negotiator, and suggested that there was the basis for a considerable confrontation. Now we have a huge problem on our hands, and we don't have any solution in sight. On the Japanese cost advantage: The gap is in the $2,500 range, according to our most recent numbers--as big as it's ever been. On the importance of the dollar-yen relationship to that figure: Let me give you a rule of thumb: a movement of 10 yen has a $100 effect on the cost of a subcompact Japanese vehicle. So if the yen goes from 230 to the dollar to 250, there's a $200 advantage to the Japanese. The other big problem, though no one planned it that way, is that our tax policies are not competitive with those of Japan or any other country that has a value-added tax, which--unlike U.S. taxes--isn't imposed on products that are exported. All told, currency and taxes account for almost half the Japanese cost advantage. On the justification for import restraints: If we were on--and I hate to use this phrase all the time, but I can't think of any other one--a level playing field, that would be one thing. But we're not, and until we get there, you are forced to take steps you'd rather not. We haven't even talked about the unseen increase in Japanese imports. Whatever happens to quotas this year, probably 500,000 Japanese vehicles will be assembled in the U.S. with, let's say, half their components imported. That's like importing 250,000 vehicles we didn't import before. By 1987 there will probably be a million, equivalent to 500,000 imports. Taking these into account, you could easily get an automotive trade deficit with Japan of $27 billion to $28 billion. We're living beyond our means--we aren't able to pay with goods we can sell. On solving the dollar problem: The most important thing by far is the deficit, and that ground has been plowed so many times there's not much point in talking about it. One part of the deficit worth looking at in a broader context, though, is that we are paying a disproportionate share for protecting the rest of the free world. That will have to be addressed. What's wrong, for example, with a use charge for deployment of our Navy to make sure the oil lines from the Middle East to Japan are kept clear? On Detroit's efforts to meet Japanese quality and cost standards: Let's take quality first. Measured by what we call things gone wrong, our cars have improved by some 55% and our trucks by 50% since 1979. On the cost side, Ford's North American breakeven point has been reduced by some 40%, and we've lowered our worldwide operating costs by more than $1 billion a year. It's interesting that our Louisville assembly plant, where we make Ranger pickups and Bronco II vehicles, is our fastest line, producing 75 an hour. Yet we know of no one in the world who makes a better compact truck. So efficiency and quality go together. The thing I keep track of is the time and material it takes to make a component or a vehicle. Leave aside currency values and wage rates: just track the pounds and minutes, and you talk a common language around the world. And we have made substantial progress in reducing them. I will also be candid and tell you we have more to do. There has been a considerable amount of good will on the union side. What we call our employee involvement program does exactly what the words say: involve everybody so they make a contribution. For example, we share our manufacturing cost data with the union, and we are bringing labor in when we look at a new manufacturing concept. On changing restrictive work rules that hamper manufacturing efficiency: We have made considerable progress. Our newest experiment, at our Rawsonville, Michigan, plant, which produces various components, is a pilot agreement with the union local that will guarantee jobs. Part of the agreement is that there will be some significant changes in work practices. I hope we can expand this to other plants. I would also point out that Ford in the U.S. hasn't lost the production of a single car or truck due to a strike in the last five years. On GM's new Saturn subsidiary, which is supposed to bring radical changes to the way cars are made: I don't think Saturn is the discovery of the Holy Grail. I think it is just an organized, inch-by-inch review of the whole process to see if there aren't lots of little efficiencies that will add up to something important. That's sound, but we are going at it in our own way. If they know one thing we don't know, I will be very surprised. On offering fewer options to customers: An important part of our business is simplifying the product. The Taurus and Sable have some 1,700 fewer parts than their predecessors. One reason is that we're offering fewer decisions for consumers to make because we're collecting that information ourselves. Henry Ford's idea--give them any color as long as it's black--was another way of saying simplification. That was carried to an extreme, perhaps, and gave rise to General Motors. But somewhere in between those two is the balance we are looking for. ! On developing new cars faster to keep up with changing markets: A good deal of our activity has been directed at fundamental changes in basic design and manufacturing, which has tended to increase the time to develop a new car. Taurus and Sable took five years because they're all new except the tires. The same is true of the processes used to manufacture them. I don't see as many of those fundamental changes coming in the late 1980s, so I believe we'll be able to move at a more rapid pace. On the shape of the world auto industry in the 1990s: There may be consolidations and various forms of cooperation among competing companies, but there will be more companies all told. I don't see the rise of new large producers, like the Japanese, but rather niche producers from Korea and Taiwan. On Ford's plans to diversify: We're about 10% nonautomotive, and we have expertise to bring to bear in nonautomotive areas. It's not the right time to say something substantive, but we're very interested. BOX: INVESTOR'S SNAPSHOT FORD SALES (LATEST FOUR QUARTERS) $51.3 BILLION CHANGE FROM YEAR EARLIER UP 25% NET PROFIT $3.0 BILLION CHANGE UP 249% RETURN ON COMMON STOCKHOLDERS' EQUITY 32% FIVE-YEAR AVERAGE -2% RECENT SHARE PRICE $47.50 PRICE/EARNINGS MULTIPLE 3 TOTAL RETURN TO INVESTORS (12 MONTHS TO 2/1) 26% PRINCIPAL MARKET NYSE Explanatory notes: page 94