SPECIAL REPORT-Inside Toyota's epic breakdown

Tue Feb 9, 2010 4:24pm EST

PAYING FOR A SCREW-UP

Toyota knew how to run a textbook recall. When Toyota launched its Lexus brand in 1989, the long-awaited LS400 was hit by a series of glitches, including a tail lamp prone to overheating. The recall threatened to kill the luxury brand in its cradle.

Toyota suspended production and ramped up output of replacement parts. Its California-based sales arm sent representatives out to pick up every one of the 8,000 LS400s that had been sold and provide owners with a free loaner while repairs were under way. The cars were returned washed and with a full tank of gas.

Lexus dealers and customers were impressed by the attention and the brand went on to outsell BMW and Daimler AG in the U.S. market over the next two decades.

That record of success made Toyota dealers deeply loyal -- and rich. It also drew investment from listed dealership groups that bet Toyota franchises would continue to outsell and out-service the rest of a wildly cyclical industry.

As of end September, 2009, Houston-based Group 1 Automotive drew 39 percent of its new-car sales revenue from its Toyota stores. At Fort Lauderdale-based AutoNation it was 21 percent. For Bloomfield Hills, Michigan-based Penske it was 20 percent.

"Toyota is struggling with being the largest automaker in the world. It certainly has issues, but you have to give them credit. They face reality. They deal with it," AutoNation CEO Mike Jackson said in September, before the first of two massive recalls.

In part because Toyota had kept a tight lid on the number of its dealerships, the franchises remained far more profitable than U.S. car dealerships. In 2008, during a recession, the average Toyota dealership sold four cars a day. The average Ford dealer sold one.

In a pep talk last month partly aimed at its dealers, Toyota pledged to contain the damage to its brand from the recall announced in September for the risk that floor mats could trap accelerator pedals.

"A product recall is an opportunity to reconnect with customers in ways we haven't before and to re-prove ourselves in their eyes," Inaba said on Jan. 12 in a speech in Detroit.

But four days later -- a Saturday -- Toyota's safety staff in Washington called NHTSA to let the agency know it had discovered a flaw with an accelerator manufactured by CTS Corp (CTS.N), an Indiana supplier that the automaker had begun to use in 2005 during its fast-growth phase.

The problem: the CTS-built accelerator -- a $15 part -- could become stuck in some cases due to wear and moisture, Toyota had found. The bigger problem: the flaw affected over 2 million vehicles and the automaker had not yet fully figured out a way to fix it quickly.

On Tuesday, Jan. 19 Inaba, Toyota U.S. sales chief Jim Lentz and others were summoned to Washington. NHTSA officials say they said they wanted prompt action. Toyota's executives called back several hours later to say that they were launching a recall.

The announcement on Thursday, Jan. 21 looked bad for Toyota. But the situation turned dire the next Monday. U.S. safety regulators told Toyota it would have to take the unprecedented step of suspending sales of eight models while it rushed to find a fix.

In one stroke, Washington stranded $2.5 billion in unsold inventories of cars and trucks at the automaker's dealerships. Worse, the negative publicity was driving away shoppers in the last week of the month, typically the peak for showroom traffic.

Toyota rushed to keep dealers informed with daily updates and conference calls. But frustrations were starting to boil over.

The lines of communications also got tangled. Sometimes Toyota's California-based sales arm seemed not to know what its Kentucky-based manufacturing arm was doing or what its Washington regulatory team had heard in the fast-evolving talks with NHTSA. Sometimes it spun the other way.

In one example, Toyota representatives told dealers on the morning of Wednesday Jan. 27 that the company would be expanding its floormat recall by 1.1 million vehicles. Toyota had determined that five additional models including the 2010 model-year Corolla, Venza and Matrix were at risk of having their accelerators held open by floormats stuck underneath them.

But the move had not been announced to an increasingly jittery public and would not be for hours, a gap that made some dealers immediately uneasy. "Our jaws dropped when we heard that," said one, who said he thought the episode showed how the company was slow to come to terms with the stakes of the safety crisis.

When asked to comment that afternoon, Toyota spokesman Brian Lyons said talk of the recall was "an unsubstantiated rumor." Just before 8 o'clock that night on the East Coast, Toyota's Washington office filed the paperwork making the expanded recall for floormat risk official.

In a similar move that has prompted criticism and drawn at least one lawsuit in California, Toyota quietly fixed a problem with the brakes on the Prius for vehicles still on its Japanese assembly line in January.

But consumers were not informed that Toyota had found the flaw or developed a fix for the software controlling the Prius brakes until safety engineer Yokoyama told reporters in Tokyo on Feb. 4.

Analysts say Toyota's wild ride has brought it back to a crossroads. It has a chance to start to win back trust the old-school way but it also faces the risk that the congressional inquiry will open a second act of the crisis.

"The damage to the reputation has been done," said Jeff Hess, a professor of marketing at California Polytechnic State University and former auto industry analyst with J.D. Power. "It's not about the message now. It's about hundreds of dealers and millions of customers."

Sean Kane, founder of Safety Research & Strategies and an expert witness who has been called to testify in the upcoming congressional hearing, said Toyota has to confront the possibility that it has problems with unintended acceleration in its vehicles that go beyond models that have been recalled and beyond the fixes it has described.

Back in Toyota City, there was evidence of the quiet resolve the automaker will need a lot more of in the weeks ahead.

"The difficulty when a company -- any company -- becomes big is that employees become detached from the problems," said one Toyota manager, who like most others asked not to be named. "When you can't do anything about this, that's how companies fail. But our job is to drill this sense of crisis into as many employees as possible."

(Additional reporting by John Crawley in Washington, Soyoung Kim, David Bailey, Bernie Woodall and Nick Carey in Detroit, Chang-ran Kim, Chikafumi Hodo, Nobuhiro Kubo in Tokyo, Yuriko Nakao in Toyota City, Japan, Tim Gaynor in Georgetown, Kentucky, Steve Gorman and Sue Zeidler in Los Angeles, editing by Jim Impoco and Claudia Parsons)

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