A Japanese luxury brand? Doubters scoffed -- but not for long

Lexus was high-stakes gamble that paid off

It seems like a quaint notion today, but when Toyota launched the Lexus brand in 1989, one of the central issues it faced was whether Americans would even consider a Japanese luxury brand.

The answer was an emphatic yes.

-In fact, the original price target for the LS 400 was even less — around $25,000 — but the yen-dollar exchange rate forced the higher price.

"Most of the luxury market was between $25,000 and $30,000, and half of that was Cadillac and Lincoln. So we felt we had to come in at $25,000," says Dave Illingworth, the first Lexus Division general manager after the brand was launched.

"But the yen appreciated (against the dollar) from 150 to 115, and suddenly we're riding above $30,000. I was wondering how we were going to sell 40,000 of them for the dealers to make money. When it finally came in at $35,000, everyone was screaming bloody murder. But there was no looking back," says Illingworth, now senior vice president, chief planning and administrative officer for Toyota Motor Sales U.S.A.

THE CHAIRMAN'S NEW BENCHMARK

It all started in 1983, when Toyota Motor Corp. Chairman Eiji Toyoda proposed a luxury vehicle line, later code-named "Circle F," for "flagship," to compete with Mercedes-Benz, BMW, Jaguar, Cadillac and Lincoln.

"The vision from Dr. Toyoda was: We're going to build the finest car we know how, and build a new benchmark. Lexus started as a flagship for Toyota," says Bob Carter, general manager of Toyota Division and a former Lexus general manager.

Then came another key decision: In 1987, Toyota decided to create Lexus Division rather than sell the new premium vehicles under the Toyota brand.

"We knew early on this had to be a completely separate customer experience," says Brian Smith, who worked on setting up the original dealer network for Lexus. He is now corporate manager of truck operations for Toyota Motor Sales.

These decisions seem obvious in hindsight. And the starting point for them was the sobering realization in the early 1980s that Toyota was about to lose many of its best customers.

Before the birth of Lexus, the U.S. market clearly demanded bigger and more prestigious products than anything Toyota offered in Japan, said Jim Press, another former Lexus general manager. Until his recent departure for Chrysler, Press was president of Toyota Motor North America Inc.

The postwar population explosion carried Toyota to success in the United States. Baby boomers on both coasts grew up associating Toyota with good quality for the money. But in the early 1980s, as they hit their peak earning years, the oldest baby boomers were defecting to European luxury brands.

Bryan Bergsteinsson, who was in charge of Lexus in the late 1990s, says baby boomers were "aging out" of their Camrys and Cressidas. Creating Lexus "was a defensive move, as in 'What are we going to give our owners?' And it had to be a new channel." He believes a flagship with Toyota badging would have sold a few thousand units but ultimately would have languished.

By the late 1980s, Toyota engineers had buried the image that "made in Japan" meant poor quality. "The demographics of baby boomers became an opportunity," Press said. "And the engineers wanted to prove to the world that they could do it."

But there were serious questions:

* Would wealthy consumers accept luxury products from a brand that lacked 50 or 100 years of snob appeal?

* Would customers balk at luxury vehicles that shared content under the skin with mass-market vehicles such as the Camry?

* Would customers patronize Toyota-brand dealers to buy the expensive products that the "Circle F" project would produce? Or should the U.S. company establish a new brand, with separate dealers?

WHEN AND HOW?

Press said there was no disagreement that Toyota Motor Sales U.S.A. needed bigger, more upscale products. But the question of a separate brand was hotly debated within Toyota, both within the U.S. organization and between the U.S. organization and the Japanese parent.

"Lexus was driven by the product. But first, there was a great deal of debate — active, acerbic debate — about when is the right time and how to do it," Press said.

Toyota's top U.S. executives and some allies in Japan favored a separate brand for the luxury division. But the idea that the Toyota brand wasn't prestigious enough in the United States to pull off a luxury car was a difficult issue to raise with the Japanese hierarchy.

"It was a very emotional and difficult decision," Illingworth says.

He says Yukiyasu Togo, president of the U.S. subsidiary; Bob McCurry, the executive vice president; and Jim Perkins, the pre-launch Lexus general manager, "carried the ball and fought very hard" with the parent company for a separate Lexus franchise.

"There was a lot of resistance. Their insistence and pushing made it happen," Illingworth says. He says Togo offered to resign if the separate franchise was not a success.

Even after the decision to create a separate brand was announced, Illingworth says he continued to get calls from Toyota insiders who worried that funneling Toyota assets to Lexus would create two weak brands.

"At times it was not really friendly. I never felt backstabbing, but you could feel the tension. And there's always the competition for budget dollars. We needed advertising dollars to launch the division," Illingworth says.

Then there was the question of staffing. Illingworth says: "We were not allowed to take more than 50 percent of our people from Toyota, so we had our work cut out for us."

The naysayers were a particularly vociferous group, often using the acronym "NFL." The "N" stood for "no." The "L" stood for "Lexus." And the "F" certainly did not stand for "flagship."

DEALER ISSUES, TOO

Another delicate issue: Many U.S. Toyota dealerships did not give customers the kind of kid-glove treatment future Lexus customers would demand.

"Having the best customer service was paramount to us," Bergsteinsson says.

He says that about 40 percent of the first Lexus dealers were not Toyota dealers because the Toyota dealer in a given market often did not have the best customer satisfaction survey scores in the area.

The situation also put Steve Haag and others in charge of dealer development in the awkward position of demanding high dealer standards and big investments for an unproven brand.

"I think there were a lot of dealers who were anxious — were they doing the right thing? The investment we were asking for from them for a facility was substantial, and there was nothing we could do to prove the (projected sales) volumes," he says.

Haag joined Toyota in 1982. He also helped set up the initial dealer network. Today he is corporate manager of private distributors.

According to The Lexus Story, a book the company published in 2003, the dealer commitment for a startup Lexus dealership was $3.5 million to $5 million, not counting operating capital.

And parts and service, a major source of dealership profits, would be small for the first few years.

Brian Smith, who was involved in the dealer development process, said original projections were that it would take three to five years for a store to become profitable. But some dealers made their investment back the first year.

In retrospect, sales projections were extremely conservative. Haag says: "The plan was never beyond 125,000 to maybe 150,000 in a year. Of course, Lexus sells more than double that now. But it wasn't a given that Lexus was going to be successful.

"Fortunately, the dealers had enough confidence in Lexus."

For shoppers, the new Lexus brand could lean on the Toyota brand's quality reputation, Haag says. "The first buyers in the first six months, they were buying because they had confidence in Toyota," he says.

Illingworth said that setting up the franchise to satisfy demanding customers and to make money at the same time was one of the biggest challenges. One of the keys was that the company kept the number of Lexus dealers low so they could have high per-store sales and not compete against one another.

HOW HIGH IS UP?

Today Lexus is so successful that one of the central issues it faces is how big can a luxury brand get and still provide good service and the required air of exclusivity. So far, 300,000 units a year doesn't seem to be a problem.

From its start in 1989, it took Lexus a little over a decade to break 200,000 annual U.S. sales, which it did in 2000. It broke 300,000 in 2005. That was the first time a luxury brand topped 300,000 U.S. sales since Cadillac did it back in 1986.

In contrast, Mercedes-Benz was roughly a century old when it broke 100,000 U.S. sales for the first time in 1997.

You can reach Jim Henry at autonews@crain.com.