(FORTUNE Magazine) – Toyota's design research laboratory sits on a tree-shaded hill outside Tokyo, far from the company's noisy stamping presses and oily assembly lines. But the placid setting belies a revolution within. Toyota, the company that invented lean production and creates new models with incredible efficiency, has planned a thorough overhaul for what may be its biggest systemic weakness: the design of its vehicles.

This is big news for the rest of the world's auto companies. Although Toyota has long been recognized as the most proficient auto manufacturer--the one with the stingy cost base and the highly disciplined operations--its engineering-dominated culture has squeezed the creativity out of its car designs. Enthusiasts say that despite their vaunted efficiency, Toyota cars and trucks don't have soul. If the company can transform its design process to make the style of its vehicles as compelling as their value, life becomes immeasurably more difficult for every other automaker.

This preoccupation with style is part of a broader change working its way through the world's third-largest automaker. That change isn't happening quickly--Toyota doesn't do anything quickly--but it has permeated the upper levels of the company and is seeping down to everyone else. New ideas have begun moving from America to Japan instead of the other way around. More Americans (or Japanese who have spent time in the U.S.) are climbing the corporate ladder. And dollars, not yen, are fueling Toyota's worldwide expansion. The quintessential Japanese company is becoming more American.

The evidence of Toyota's Western tilt shows up in unexpected places. The company has sold more cars and trucks in North America during the past two years than it has in Japan, and the gap is getting wider. North America now contributes 70% to 80% of Toyota's global profits, thanks to a rich mix of high-margin sport-utility vehicles and Lexus luxury cars, as well as beneficial exchange rates. U.S. dealers say Toyota is the industry's most desirable franchise; one refers to his outlet as a "cash machine." What's more, the U.S. is beginning to serve as Toyota's global testing laboratory. Traditionally the company experiments with new concepts in Japan, then moves them to the U.S. after they have been thoroughly debugged. Now Lexus, which was introduced as a luxury brand in the U.S. in 1989, will move to Japan in 2005. And Toyota has launched another new brand in the U.S., Scion, aimed at younger buyers.

"Americanization is going on in every facet of our business," says Yoshi Inaba, one of the company's 14 senior managing directors. "I am trying to push that." Inaba, 57, who many people think could become the next president of Toyota, symbolizes the company's American tilt. He's a specialist in sales and marketing rather than an engineer or a manufacturing whiz like most top Toyota executives. He got an MBA from Northwestern's Kellogg School and spent eight years in the U.S., learning about the American market and polishing his golf game.

Toyota is making these changes at a time when it is minting money. For the six months that ended Sept. 30 its net income rose 23.2%, to $4.4 billion, on revenues of $69.7 billion, an all-time Toyota record that confirms its status as the world's most profitable auto company. During that time, Toyota made an operating profit of about $2,000 per vehicle. By comparison, widespread discounting led General Motors to make only $18 per vehicle and Ford to lose $197. Toyota's profits helped push its stock up 50% by mid-November, to $62 per share; its market capitalization of $114.4 billion is nearly triple that of GM and Ford combined. The company's outsized returns follow a stunning sales success: According to a forecast by Global Insight, Toyota is expected to pass Ford in worldwide vehicle sales this year--6.6 million to 6.4 million--to become the second-largest automaker.

To get a better feeling for the changes at Toyota, look closely at Inaba and the man he could succeed, president Fujio Cho. A genial person seldom seen without a smile, Cho, 66, rose through the ranks of manufacturing and made his reputation by opening Toyota's first wholly owned U.S. assembly plant in Georgetown, Ky., in 1988. Cho likes to say that Toyota's globalization dates to 1987, the year he arrived in America. He returned to Japan in 1994 and became company president in 1999. Exactly how long he will stay in the job is unclear. He has not set a retirement date and isn't obligated to.

Cho has placed American and other non-Japanese executives closer to the centers of power at Toyota. In June he made sales and marketing boss Jim Press and manufacturing head Gary Convis managing officers; they now rank among Toyota's top 62 executives. Both spend about one week a month in Japan. "Toyota has been globalized step by step," says Cho, speaking through an interpreter at a meeting with U.S. journalists in Tokyo. "We are trying to introduce American elements into the company. But a lot of people don't speak English very well, including myself, so that should change."

By contrast, Inaba had breakfasted the previous day with an American journalist and conducted an hourlong discussion entirely in English. It's no coincidence that Inaba's management style is a long way from Toyota's traditional consensus method. Colleagues say he is direct, even blunt. They also say he expects decisions to be made quickly and acted upon just as quickly. Inaba, who oversees American operations, is more candid than many Japanese executives and is willing to admit mistakes. One example: Toyota has backed away from head-to-head competition with Detroit in some segments because it feared political reprisals, like the taxes once threatened on imported luxury cars. Beginning with the Previa in 1990, Toyota needed three tries and 13 years to develop a minivan fully competitive with American models. Similarly it hit self-imposed speed bumps with its first two full-sized pickup trucks, the T100 and the Tundra, which were criticized for being underpowered and undersized. "We wasted--'studied' would be a nicer word--two generations of products," says Inaba. "Toyota has been cautious. Nissan has been bold [with its supersized pickup]."

Lest anyone draw the wrong conclusion from that surprising admission, Inaba declares that Toyota won't make the same mistakes again. "We are a different player than we were five to ten years ago," he says. "We are willing to get into any segment where the customer will benefit."

Toyota's success with U.S. customers begins with the appeal of its cars and trucks, which are prized for their quality and durability, ease of operation, and thoughtful features such as controls that are intuitive to operate. Since demand is high and inventories typically low, Toyota, unlike Detroit, sells cars with skimpy marketing incentives, which protects its margins and boosts resale prices. Toyota also consistently finds ways to return value to its customers. It slashed the engineering development budget for the most recent Camry by 30% to hold the line on prices. This year Toyota launched a longer, wider Sienna minivan that has a fold-flat rear seat and priced it $1,000 less than its predecessor.

Known for its plodding ways, this conservative company possesses a surprising knack for innovation. Toyota offers an option in Japan, called "intelligent parking assist," that takes the fear out of parallel parking. The driver pulls his car into position, then touches a computer screen. A sensor identifies the empty space, and the car does the rest: It turns the steering wheel and drives in reverse while a recorded voice delivers a play-by-play. No hands are required, though the driver must keep his foot on the brake to control the car's speed.

Parking assist isn't coming to the U.S. anytime soon because American customers won't pay $2,000 for it. But their resistance hasn't slaked Toyota's American-like appetite for risk taking. The company aggressively creates new market segments where first movers get a huge, if temporary, advantage. It pioneered the now fast-growing market for sport-utility crossover vehicles by introducing the compact RAV4 in 1996, then followed it with the Lexus RX 300 crossover and the midsized Highlander. More recently Toyota became the first automaker to develop a brand specifically for younger buyers. Launched in California in January, Scion is making its way east with two models, including the boxy but oh-so-hip xB, which is selling faster than expected (prices start at $14,165). Toyota expects to add a sports coupe to the Scion line and build volume to 100,000 cars a year, which would represent about 5% of its North American sales.

Toyota's boldest and most visible leap into the future has been with hybrid vehicles. It has sold some 127,000 since 1997--far more than Honda, the only other company making hybrids--putting Toyota within reach of its goal of selling 300,000 by 2005. Environmentally minded U.S. drivers, including a smattering of Hollywood celebrities, have bought more than 56,000 Priuses. Toyota's early move into hybrids has left American manufacturers in its dust. Ford has delayed plans to market a hybrid-powered vehicle until August 2004; GM won't sell a full-power hybrid SUV until 2007.

Hybrids use two engines--one gasoline, one electric--to increase fuel economy and reduce emissions. The battery-powered electric motor drives the car during startup and at low to mid-range speeds, which is when a gasoline engine burns the most fuel and produces the dirtiest exhaust. Once the vehicle is cruising, the gas engine kicks in to power the car and to recharge the battery. Despite rates of 60 mpg in the city--where the electric motor does most of the work--and 50 mpg on the highway, hybrids have been slow to catch on because early versions lacked power, and cheap gas made the savings from improved fuel economy minuscule.

That is about to change. In October, Toyota launched a second-generation Prius in the U.S. much closer to the automotive mainstream. It is larger inside and accelerates more quickly to 60 mph (though at a still leisurely 10.5 seconds). With a base price of less than $20,000 (same as the old one), it already has a waiting list. Toyota expects to sell 3,000 Priuses a month each in Japan and the U.S.--more if they can make them. "Early indications are this will be much bigger than we anticipated," says Inaba.

While Toyota has marketed the Prius as a car for the environmentally sensitive, the company will try to bring hybrids into the mainstream when it introduces a gas-electric version of the Lexus RX 330 next fall. The RX 330 will be propelled by a larger electric motor coupled with a V-6 gasoline engine that will give the vehicle real zip. Observers figure the Lexus will accelerate from zero to 60 in 7.5 seconds and still get 35 mpg.

Long established as the industry's leading manufacturer, Toyota continues to find ways to make its production more efficient. At its Takaoka plant, it has installed a simplified assembly process, known as the Global Body Line, which maximizes the use of common tools and reduces the number of production steps. Besides being incredibly flexible--Toyota can easily shift production among eight different car types--the system costs 50% less to install, changes over to new models for 70% less, and ramps up to full production in three weeks, compared with three months for the old system. It has also been installed in Kentucky and is being rolled out to Toyota plants around the world.

Despite their importance, neither new factories nor fancy hybrids will provide as much lift to Toyota's image as better design. Even Toyota loyalists complain that the company's production experts have squeezed the life out of new concepts to make them easier to manufacture. As other manufacturers improve quality and durability, Toyota must refashion its designs to stay ahead. "Our salespeople are not 100% satisfied with styling," says Cho. "[But] I think Toyota vehicles have become much better in design than our cars in the past."

Right now Toyota is focused on preparing Lexus for its 2005 debut in Japan. The Lexus cars sold in the U.S. have no common heritage and seem to have been randomly selected from Toyota's model lineup. Simon Humphries, the British-born designer leading the Lexus effort, wants to develop a more consistent look for the brand. He intends to lower the front grille to differentiate Lexus from Mercedes and BMW. He also plans to lengthen the passenger compartment and stretch the window areas--moves that would further separate Lexus from the German competition. But he doesn't want the design to be so consistent that Lexus cars all look as if they came from the same sausage factory, only in different lengths.

Humphries describes his design theme as "seamless anticipation, incisive simplicity, intriguing elegance." Translation: He wants to make Lexus sexier. "Lexus isn't bold enough for the Japanese market," says Humphries. "The cars are too understated. They are in danger of being boring." Demanding Japanese buyers want more glitter than Americans, so the LF-S concept car, shown at the Tokyo Motor Show, combines long expanses of elegantly surfaced sheet metal accented by bits of bright metal, jewel-like headlamps and taillights, and oversized spoked wheels. The car's rakish design and long, sweeping lines could signal the look of the upcoming GS series sport sedans.

The Lexus makeover is part of a global reorganization of Toyota's design process. Studios in Japan, France, and Southern California that formerly specialized in show cars now compete against each other to develop new looks for production models. Separate design divisions work more closely with engineering to prepare new models for manufacture. This structure should loosen the grip of the engineers and make Toyota more accessible to fresh ideas.

Better-looking cars can only accelerate the company's rise in the U.S., where Toyota-brand cars began outselling Fords and Chevys this year. After surveying U.S. car dealers, Saul Rubin of UBS Securities observed: "The Toyota brands finished at the top of the pack in almost every measure--desirability, market-share prospects, relationships with manufacturers and customers. Toyota is truly in a class of its own."

For all its newly learned American ways, Toyota remains at heart a conservative and deliberative company. Although it is gradually pushing responsibility down to regional operations, it still controls major functions--engineering, design, manufacturing, purchasing, and sales and market-ing--from Japan. The com-pany's American executives make numerous trips to Japan, sometimes traveling there for a single meeting. That's not likely to change. Inaba has little use for the matrix organizations or cross-functional teams so prevalent at other automakers. He sees no value in coordinating disparate operations at a local headquarters in, say, Los Angeles or New York. "Toyota's strength is very much with each function or silo working hard and not worrying so much about coordination," Inaba says. "Ninety-five percent of a job can be done in a silo."

Toyota isn't strong everywhere. It has spent years finding the right products to sell in Europe, though it is now gaining momentum. And it is playing catch-up in China. It recently got government approval to produce the popular Camry in Guangdong province and announced plans to increase its current 2% market share to 10% by 2010.

After the company reached its Global Ten objective a couple of years ago by capturing 10% of the world's auto sales, Cho challenged his executives to push Toyota to a 15% market share by the end of the decade. He complains halfheartedly that the goal was leaked to the press, but he doesn't regret having set it. "When you achieve one objective, you strive to reach the next objective," he says. Cho professes not to care whether Toyota will be larger than GM at that point. But it doesn't take much effort to visualize a more Americanized Toyota achieving its target and passing its Detroit rival to become the world's largest auto company. Many people would say it is already the world's best.

FEEDBACK ataylor@fortunemail.com