(FORTUNE Magazine) – OF ALL the hortatory slogans kicked around Toyota City, the key one is kaizen, which means ''continuous improvement'' in Japanese. While many other companies strive for dramatic breakthroughs, Toyota keeps doing lots of little things better and better. Consider the subcompact Tercel, the smallest Toyota sold in ^ the U.S. The car contributes modestly at best to profits. Even so, Toyota has made the 1991 model faster, roomier, and quieter than its predecessor -- with less weight, equally good mileage (32 mpg on the highway), and, remarkably, the same under-$8,000 price for the basic four-door sedan. It's $100 cheaper than GM's new Saturn and as much as $1,600 less than other competing models. One consultant calls Toyota's strategy ''rapid inch-up'': Take enough tiny steps and pretty soon you outdistance the competition. By introducing six all- new vehicles within 14 months, Toyota has grabbed a crushing 43% share of car sales in Japan. In the just-ended 1990 model year, it sold more than one million cars and trucks in the U.S. for the first time -- strengthening its position as No. 4 to the hard-pressed Big Three. Californians buy more Toyotas than Fords, Chevrolets, or any other make. Another half dozen new Toyotas are due in the U.S. in the next 12 months, including a sporty two-door based on the Tercel, a V-8-powered coupe version of the top-of-the-line Lexus, and bigger, more Americanized editions of the bread-and-butter Camry and the upscale Cressida. The magnitude of these accomplishments may surprise anyone who thinks of Toyota mainly as a builder of competent sedans, renowned more for reliability than pizazz. The company simply is tops in quality, productivity, and efficiency. From its factories pour a wide range of cars, built with unequaled precision. Toyota turns out luxury sedans with Mercedes-like quality using one-sixth the labor Mercedes does. The company originated just-in-time mass production and remains its leading practitioner. In short, Toyota is the best carmaker in the world. And it keeps getting better. Says Iwao Isomura, chief of personnel: ''Our current success is the best reason to change things.'' Extensive interviews with Toyota executives in the U.S. and Japan demonstrate the company's total dedication to continuous improvement. What is often mistaken for excessive modesty is, in fact, an expression of permanent dissatisfaction -- even with exemplary performance. So the company is simultaneously restructuring its management, refining its already elegant manufacturing processes, planning its global strategy for the 21st century, tinkering with its corporate culture, and even becoming a fashion leader. Toyota is putting to rest its reputation for fuddy-duddy design. Its Sera, a glass-topped minicoupe with gull-wing doors, is this year's fad favorite in Japan. The jellybean-shaped Previa, a hit with U.S. buyers, proves that minivans can be stylish as well as utilitarian. The $44,700 Lexus LS400 has become the first Japanese car to show that prestige doesn't have to wear a German or British nameplate. After only 14 months on the market, it outsells competing models from Mercedes-Benz, BMW, and Jaguar in the U.S. Japanese buyers have to wait a year to park one in the driveway. Leading this juggernaut is President Shoichiro Toyoda, 65. Only 5 foot 2, this unlikely samurai is a grandson of the founder of Toyota's predecessor, Toyoda Automatic Loom Works, started in 1926. (Toyoda means ''abundant rice field,'' inappropriate for a carmaker, so the company changed its name in 1936, three years after it got into the auto business.) A Ph.D. in engineering who enjoys being called ''Doctor,'' Shoichiro Toyoda has worked at the family company since 1947 and succeeded his second cousin Eiji, now 76, as president in 1982. The whole family owns less than 1% of the company's stock, worth some $450 million. (The Ford family's holdings amount to 8% of their company's common stock and 40% of the voting stock.) Though relatives abound on the Toyota payroll, none seems likely to succeed to the presidency. At an age when many American executives have one foot on the golf course, Shoichiro Toyoda keeps driving his company ahead. In recent months he has ripped out two layers of middle management, stripped 1,000 executives of their staffs, and reorganized product development, putting himself in charge. He explains, ''We felt we suffered from large-corporation disease. It had become extremely difficult for top executives to convey their feelings to our workers. So we embarked on a cure. We have a saying: 'A large man has difficulty exercising his wits fully.' We wanted to recertify that customer satisfaction is our first priority.'' Globalization is a close second. Toyota is tightening its grip on Southeast Asia, making inroads in Latin America, and mobilizing for an assault on Europe from a new assembly plant in Britain. Any day now it will announce plans for a third U.S. assembly plant. No. 3 among the world's automakers since 1978, Toyota could sell nearly five million vehicles worldwide in 1990 (vs. about eight million for General Motors and six million for Ford). It is well on its way to its goal of six million cars and trucks a year by 1995. Global expansion and waves of new models haven't dented Toyota's profitability. It made a net profit of 4.7% on sales of $64.5 billion in fiscal 1990, which ended June 30. Toyota enjoys the highest operating margin in the world auto industry, according to Gerard Paul of New York's Sanford C. Bernstein & Co. In Japan it earned a healthy 9% profit in fiscal 1989, vs. 8.4% for Nissan and 6.5% for Honda. Toyota netted 2.9% from U.S. sales, partly because its new Georgetown, Kentucky, plant wasn't running at capacity. (Ford made 4.3% from North American auto operations last year, while GM earned a scant 0.7%.) Japan's No. 1 automaker is so rich that it makes more money on financial investments, including lending to other companies, than it does on operations. Jokingly known as the Bank of Toyota, it sits on $22 billion in cash -- enough to buy both Ford and Chrysler at current stock prices, with nearly $5 billion to spare. For years Toyota was the most conservative of Japan's automakers. Its heart remains in congested, provincial Toyota City (population: 327,000) in Japan's industrial belt. Four of Toyota's five car assembly plants are there, along with factories for nearly 140 of its parts suppliers and company housing for thousands of employees. Top executives work out of a flat-roofed three-story structure smaller and less prepossessing than a typical U.S. high school. The lobby is tiled in vinyl. Silver-plated cigarette boxes shaped like cars dot the conference tables. Lately competition for Toyota's soul has started coming from Tokyo, 300 miles to the northeast. While Nissan and Honda are headquartered there, Toyota has shunned the bright lights and high prices of the capital. But in the past year it opened a design center in Tokyo to feed back data on fashion trends, as well as the world's biggest new-car showroom -- a five-story, high-tech display where nearby office workers can kick tires as well as eat lunch. A fleet of four helicopters shuttles executives back and forth from Toyota City. (Toyota's only company plane -- prop-driven -- is based in Long Beach, California, to serve the U.S. sales operation.) Like chrysanthemums in a rock garden, other signs of a new Toyota are popping up. A few executives -- though not Dr. Toyoda -- have traded in their blue sack suits for tailored double-breasteds and designer ties. Beige colored jumpers have replaced the traditional blue uniforms for the women who serve as receptionists and offer visitors orange juice and hot washcloths. Toyota today appears more open to outsiders, even boastful. The company distributes reprints from the Harvard Business Review praising product development methods like Toyota's. Says Satoshi Nakagawa, a research manager: ''The mood is definitely different. There is a feeling among the younger engineers that they can take things on their own and change them. That wasn't there before.'' After years of leaving technological innovation to Nissan and Honda, Toyota is moving to grab the lead. Between 1984 and 1989, R&D spending tripled from about $750 million to $2.2 billion. Rather than develop flashy consumer items such as four-wheel steering, the company concentrates on practical manufacturing technology -- for example, new ways to stamp sheet metal. Toyota spends about 5% of sales on R&D, a slightly higher percentage than GM or Ford. Many automakers, notably Honda, exude dedication and purpose. But Toyota is 2 1/2 times the size of Honda -- and functions even more efficiently because of its unparalleled mastery of kanban, the just-in-time system conceived by Eiji Toyoda and perfected by legendary production boss Taiichi Ohno. In appropriating Ohno's ideas in the early 1980s, Detroit used just-in-time only to manage the delivery of parts to the assembly line. Toyota builds its entire production process around just-in-time. It aims to manufacture only what is needed, when it is needed, and in the quantity needed, whether it's a water pump or a complete car. With traditional mass production, parts and finished cars are turned out in large batches and pushed downstream, ending up in inventory on dealer lots. Under just-in-time, parts and cars don't get built until orders move upstream to request them. Japanese dealers use on-line computers to order cars directly from the factory. Thomas Hout, a vice president of the Boston Consulting Group who spent six years in Japan, says the system works like airline reservations: In placing an order, the dealer essentially reserves a portion of factory capacity. Rather than wait several months, the customer can get his built-to- order car in a week to ten days. That leads to savings all along the line. The factory can balance production and stay in touch with shifting demand; the dealer keeps almost no inventory. Under Toyota's management, just-in-time has produced remarkable results. The company makes 59 passenger-car models from 22 basic designs. Ford, which sells about a third more cars, produces only 46 passenger-car models. Using data collected by the International Motor Vehicle Program at MIT, professor Michael Cusumano estimates that Toyota needs only 13 man-hours to assemble a car in its best plant, vs. 19 to 22 hours for Honda and Nissan. Ford performs about as well as Honda and Nissan; GM lags behind. Toyota's high-volume family cars -- Corolla, Camry, and Cressida -- all rank tops in their class for assembly quality, according to the latest ranking by J.D. Power & Associates, the automotive research and consulting firm near Los Angeles. Like all great ideas, just-in-time sounds simple. But Ohno spent 20 years perfecting it. Toyota's system is fed by a network of suppliers whose competence and close ties to their parent are the envy of the world. Toyota owns two suppliers outright; 228 others produce everything from jigs and molds to general contracting services for new plants. The suppliers also perform more R&D than American ones. That fact, along with higher productivity, helps explain why Toyota's payroll looks so skinny, with 91,790 employees vs. 766,000 at GM. To feed its superb production system, Toyota reorganized product development in February. A council headed by Toyoda took over long-range product strategy. Under him were placed 240 members of the product planning division, arrayed in three groups: small front-wheel-drive models (for example, Tercel); big rear- wheel-drive cars (Lexus); and trucks. The reorganization was driven by changing marketing requirements. Back in the 1950s, U.S. automakers turned out cars in one size -- big. Today full-line manufacturers produce five basic sizes (mini, subcompact, compact, midsize, and full-size), with several variations of each (two-door, four-door, three- and five-door hatchback, fastback). ''We have learned that universal mass production is not enough,'' says Kazuo Morohoshi, head of Toyota's Tokyo Design Center. ''In the 21st century, you personalize things more to make them more reflective of individual needs.'' The winners will be those who target narrow customer niches most successfully with specific models.

TO MANAGE each new model, Toyota created the position of chief engineer and gave him unusually broad responsibilities: He has charge of everything associated with the development of a car. First he determines its physical dimensions and suitability for its potential market, then how it will be made and who the suppliers will be. He even helps design marketing strategies and talks frequently with car buyers. In January, for example, the Tercel's chief engineer will travel to Boston, Chicago, and Florida with six assistants to find out what dealers and owners like about the 1991 model -- and to begin planning the 1995 version. Besides getting the cars out, the chief engineer has to stay on top of social, political, and environmental trends. Toyota is grappling with issues that will affect future models, including fuel economy, alternative fuels, exhaust emissions, recyclability, highway congestion, and safety -- both active (antilock brakes, traction control) and passive (air bags, reinforced bumpers). While it is behind Chrysler in adopting air bags, Toyota should catch up quickly.

The chief engineer system differs sharply from Detroit's product development practice, where a new-model boss has narrowly defined responsibilities and limited power. The Detroit chief usually works under specific instructions from the product planning and marketing departments. Even if he stays with the project through the manufacturing launch, he almost never has direct contact with dealers and customers. Toyota's system has many advantages. Speed is No. 1. Toyota takes a new car design from concept to showroom in less than four years, vs. more than five for Detroit (and seven for Mercedes-Benz). That cuts costs, allows quicker correction of mistakes, and keeps Toyota better abreast of market trends. Gains from speed feed on themselves. Toyota can get its advanced engineering and design done sooner, says Yoshio Yunokawa, a manager of corporate R&D, because ''we are closer to the customer and thus have a shorter concept time.'' Teamwork also accelerates the process. Product and manufacturing engineers work closely together under the chief engineer, so factory machinery gets developed in tandem with prototype testing. Typically prototype testing leads to changes in the car that require alterations in the assembly line. Since Toyota completes the two processes simultaneously, no last-minute changes stall the production plan. The Toyota system also drives down factory tooling costs, the biggest chunk of any development budget. Tools and machinery can account for about three- quarters of the $1-billion-plus required to design a new model and ready a plant to build it. Among the highest-cost items are the custom-designed dies that punch out each piece of frame and sheet metal, and the big stamping presses that hold them. Donald Smith, a researcher at the University of Michigan, estimates that Toyota designs and manufactures dies and presses for one-half to two-thirds less than the Big Three. Here again, just-in-time cooperation is critical. Car engineers design parts with the body engineers, the manufacturing engineers, and the stylist so they can be made with about 35% fewer strokes of the stamping press, by Smith's calculation. Fewer strokes mean lighter, less expensive dies, lower operating costs, shorter shutdowns, and reduced maintenance. Body panels that emerge from Toyota's stamping operation are as precisely cut ''as the works of a Swiss watch,'' says Smith. In some competitors' plants, he adds, ''I've seen people force panels into compliance. If the parts are not consistent, the welding guns have to operate almost like C-clamps to force the parts together. Toyota parts usually just lie in the fixtures and require no force from the welding guns.'' Because of model proliferation, Toyota needs twice as many dies as it did ten years ago. So it has automated the die manufacturing process. Computers drive numerically controlled machining tools that cut dies faster and more accurately than mechanical methods can. Giant cranes carry die castings to the machining tools and retrieve the finished dies. The whole system can run for ten days without human intervention: The plant can make dies ''lights out'' while workers are on holiday. Using Pascal's law describing the behavior of fluids under pressure, Toyota has adapted a remarkable stamping process to make the production of small- volume niche models more efficient. In this flexible press system, the bottom half of the metal die is replaced with -- of all things -- water. A fender, say, gets stamped between a curved metal die and a tankful of water, which serves as a smooth, flexible bottom die. The system cuts die costs by nearly one-third, improves yield, and reduces piece costs by 18%. Toyota says it makes a better fender because the die is more accurate and can bend the metal more than conventional two-piece dies. Drawbacks: The forming process takes 80 seconds, vs. three to five seconds with conventional dies, and finished pieces must be dried. On the assembly line, Toyota's guiding principles shine through the grit and haze. Quality is defined not as zero defects but, as another Toyota slogan has it, ''building the very best and giving the customer what he wants.'' Because each worker serves as the customer for the process just before his, he becomes a quality-control inspector. If a piece isn't installed properly when it reaches him, he won't accept it. His first act is to alert his supervisor by tugging a rope that turns on a warning light. If the problem isn't corrected by the time the next piece comes down, he can stop the line by pulling the rope a second time. Toyota's Japanese workers also perform feats of agility never seen in a U.S. factory. In the 50 seconds or so it takes for a car to pass their station, they climb inside the front and rear passenger compartments to install electronic equipment or interior trim. One man has to clamber into the trunk to affix a wiring harness. A few workers wear leather cushions belted around their waists to protect them when they sit down inside the car. Like all employers in Japan, Toyota faces a stringent labor shortage because of slowing population growth and a national reluctance to import workers. So it is trying to enrich assembly line jobs by ''making work more creative,'' says personnel boss Isomura. He adds: ''We want work to be pleasant and vivid for our employees, because when they grow, the company grows.'' Already a pioneer in quality circles, where workers discuss ways to improve their tasks, the company is working to eliminate what it calls the three D's: the dangerous, dirty, and demanding aspects of factory work. It is also investing $770 million over the next four years to improve worker housing, add dining halls, and build new recreational facilities. Single men live dormitory-style with shared bathrooms, while married workers with families qualify for their own small apartments. At least 24,000 Toyota employees in Japan live in company-subsidized housing. Across Japan, on average, there are 1.37 jobs available for every worker. The squeeze is even tighter around Toyota City, where the figure is 2.13. Toyota's assembly plants in Japan all run on overtime, with workers logging an average of 1 1/2 extra hours every shift (for which they are paid time and a half). Over the course of a year, Toyota figures its workers spend about 2,300 hours on the job -- the equivalent of more than 57 standard 40-hour workweeks -- vs. 2,200 for Nissan and only 1,960 at Honda. And that's not counting 25 vacation days. By 1993, Toyota wants to reduce the workload to 2,000 hours. It also wants to hire more women, who account for about 9% of all employees but do not work in the plants. To reduce overtime, Toyota is investing heavily in automation. Capital spending will rise 39% to nearly $4.2 billion for the current fiscal year, according to Automotive News, a trade weekly. In final assembly, where the car body is fitted with its engine, transmission, electronics, and trim, Toyota has added robots that apply adhesive to the windshields and drop spare tires into trunks. Still, only 5% of the assembly line jobs are automated, vs. 30% at some Volkswagen and Fiat plants in Europe (which has long experience with labor shortages). White-collar workers, who might otherwise have boarded the bullet train to shop for new jobs in Tokyo, are also getting a dose of job enrichment. Says Toyoda: ''We are still slow in movement. But we are making ourselves more attractive to younger people.'' Employees are being retrained to work with less supervision, accept more responsibility, and move projects along more quickly. Instead of getting up to ten sign-offs on a new program, in many cases they now need only three. But Toyota has not given up its longtime emphasis on decision-making by consensus. Says Junji Numata, who used to help out as a translator in the public-affairs department and now heads European operations: ''We still work together as a team. You can't just wave your flag and go.'' A NINE-MONTH training regimen for new white-collar workers provides plenty of opportunity to imprint the company culture. College graduates embarking on a Toyota career spend four weeks working in a factory and three months selling cars. They get lectures from top management and instruction in problem solving. Their supervisors make them keep reworking solutions until they produce one that's suitable. Developing cadres of independent-minded team players should serve Toyota well as it tries to develop integrated worldwide production. Until recently executives found it hard to leave the supportive network of suppliers and well-established manufacturing practices of Toyota City. Not until last year did the company set up Japanese plants outside its friendly confines. Toyota was especially cautious about starting U.S. production. It tiptoed in via a joint venture with GM in 1983 to build Corollas in Fremont, California. Its biggest problem was replicating just-in-time parts delivery. Since most auto suppliers are based in the Midwest, Toyota set up a warehouse in Chicago to accept deliveries, then shipped parts to California by train. Just-in-time was redefined from several hours to 3 1/2 days, but the discipline of the system was maintained. Toyota will add trucks to the Fremont operation in 1991, and is expected to expand its production further in 1996 by buying GM's share of the venture. With the California facility up and running (and Nissan and Honda already established in their own U.S. plants), Toyota in 1988 opened the Georgetown, Kentucky, facility, where it will build 220,000 compact Camrys this year. Several hundred American supervisors went to Japan for training. The plant abounds with imported techniques, among them big electrical signs called andon boards that track daily production, signal overtime requirements, and identify trouble spots along the line. Individual workers have their own smaller versions that tell them, for example, whether they have attached a bolt tightly enough. Quality is high at Georgetown but productivity runs about 10% below Japanese levels. Toyota production boss Susumu Uchikawa blames the lag on U.S. suppliers, which he says aren't up to European standards, much less Japanese. To defuse political objections, Toyota buys American parts anyway. In some cases it keeps identical Japanese-made components on hand as insurance against defective American materials. By the mid-1990s Toyota could be selling 1.5 million cars and trucks in the U.S., half of them made in North America. It is building one of the world's largest test tracks on 18 square miles of Arizona desert; the proving ground should be ready by 1994. The company is also doubling the size of its California design center, which sculpted the exterior of the Previa minivan and the upcoming Lexus SC400 coupe, and is expanding its technical operations in Ann Arbor, Michigan, and Torrance, California. With five separate subsidiaries reporting back to Japan, Toyota's North American operation is overdue for reorganization. Some top U.S. executives have to make the 24-hour round trip between Los Angeles and Japan as often as nine times a year, frequently to discuss future product plans. Changes may be forthcoming when U.S. sales head Robert McCurry, 67, retires in three years. WESTERN EUROPE presents Toyota with a fresh set of obstacles. With Peugeot boss Jacques Calvet as their chief spokesman, inefficient European automakers are waging a protectionist battle to limit Japanese car sales until the next century. Some compromise will likely be worked out, but Europe still won't be / a pushover. French, Italian, and German buyers are more resistant to non- European cars than Americans are. Toyota has set up a design center in Brussels and is building a plant in Derbyshire, England, with a capacity of 200,000 cars annually. European boss Numata expects that Toyota will have only 3% of a 20-million-vehicle market by 2000, vs. 2.5% now. The smaller nations on the Pacific Rim provide a glimpse of Toyota's skills at operating overseas. These countries have some of the world's toughest local-content laws, but their populations aren't big or skilled enough to support integrated manufacturing. So Toyota put together a clever scheme to build carmaking expertise. This fall it started casting cylinder blocks in Indonesia, and it will soon begin making other parts in Thailand, Malaysia, and the Philippines. For now the parts are being shipped back to Japan, but eventually they will be assembled into cars at a more central location. Labor costs in Asia's less developed countries are one-third to one-fifth of Japan's, but workers require more intensive training and factories run more slowly. By 2000, Toyota expects to be operating one or two assembly plants in the region and selling one million cars and trucks annually in a 3.5 million vehicle market. Southeast Asia is a paradigm for how Toyota would like to operate in the future -- buying parts, building cars, and selling them around the world regardless of national boundaries. Dr. Toyoda has a plan for globalization, as he seems to for everything else. It has five steps. Toyota is on the cusp of step four, which calls for turning overseas operations over to local managers. In the final stage, perhaps in 20 years, the company ''optimizes its operations by planning and managing all of them from a global perspective,'' Toyoda says. That would mean turning the world into a giant Toyota City and establishing operations wherever they make economic sense. To pull that off, Toyota needs to loosen further the ties that bind its overseas operations to the home office, while making production function as smoothly in Thailand as in Toyota City. But having written the book on automotive manufacturing, Toyota appears well placed to update it with a new global edition. Momentum is clearly on its side. Thanks to kaizen and kanban, continuous improvement and just-in-time, Toyota's lead over the competition -- American, European, and Japanese -- keeps growing and growing and growing.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: WORLDWIDE CAR & TRUCK SALES TOYOTA STEERS FOR THE PASSING LANE Long No. 3 among the world's automakers, Toyota could go ahead of Ford in cars in 1993. It pumps out new models faster than anyone and keeps quality high, with fewer defects than any other manufacturer. Just-in-time production means fat margins and hefty profits. Market share has hit an all-time peak in Japan and is heading toward 8% in the U.S. Toyota is on the right road to sell six million vehicles globally by 1995.

CHART: NOT AVAILABLE CREDIT: SOURCE: J.D. POWER & ASSOCIATES CAPTION: QUALITY See above.

CHART: NOT AVAILABLE CREDIT: SOURCE: DRI/MCGRAW-HILL CAPTION: U.S. CAR & LIGHT TRUCK SALES PROJECTIONS WORLDWIDE CAR SALES PRODUCTIONS See above.

CHART: NOT AVAILABLE CREDIT: SOURCE: SANFORD C. BERNSTEIN & CO. CAPTION: AUTOMOTIVE OPERATING MARGINS See above.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: R&D EXPENDITURES See above.

CHART: NOT AVAILABLE CREDIT: SOURCE: JAPAN AUTOMOBILE DEALERS ASSOCIATION CAPTION: MARKET SHARE JAPAN See above.

CHART: NOT AVAILABLE CREDIT: SOURCE: WARD'S AUTOMOTIVE REPORTS CAPTION: MARKET SHARE U.S. See above.

CHART: NOT AVAILABLE CREDIT: SOURCE: ANTONY M. SHERIFF CAPTION: AVERAGE AGE OF MODEL LINES See above.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: INVESTOR'S SNAPSHOT TOYOTA MOTOR