December 11, 2001

Toyota Prius
Developing the Next-Generation Automobile

In November 1993, Takeshi Uchiyamada was handed the most significant responsibility of his
career. The goal of his project team, which would draw engineers from numerous development
centers throughout Toyota, was to create “the global car for the 21st century,” code named G21.
Toyota’s executives in charge of technical development had recently signed off on the vehicle
concept of “environmentally friendly,” and Uchiyamada’s team was charged with creating its
blueprint for the vehicle.1

As Chief Engineer, Uchiyamada had limited resources and had no idea how long his assignment
would take. G21 was to be a completely new vehicle, which meant there were no previous
development programs from whic h to benchmark. Uchiyamada decided he could not afford to
have his engineers dividing their time between different technologies. He had made up his mind –
there were to be no backup plans. Uchiyamada also reasoned that the existence of backups could
allay any sense of urgency among his team. 2 With his decision, Uchiyamada was crossing the river
and burning the bridge behind him.

History of the Automobile Industry

Although the first patent for a gasoline-fueled automobile was issued to German Karl Benz in
1886, it was not until several decades later that the internal combustion engine became the
dominant power system technology in cars. In 1900, steam, electric and gasoline-powered
engines were each proposed as the best power system of the nascent automobile industry.
However, engineering advancements, infrastructure and cost made gasoline the clear top choice.
First, the development of electric starters made it easy for anyone to start a car. Second, because
kerosene was used throughout the U.S. for heating after the turn of the century, gasoline could be
distributed by leveraging the existing infrastructure. Finally, Henry Ford insured the ascendancy
of the internal combustion engine when he selected it for use in his low cost, mass-produced
Model T. Steam and electric vehicles simply could not compete with the convenience, range and
cost of the gasoline engine in light of these conditions.

Automobiles became a true industry as a result of the Model T. Although Ford’s mass production
system was adopted throughout the industrialized world, the American manufacturers became
global leaders as a result of World War II, which destroyed much of Europe and Japan’s industry.
Wartime production also encouraged the American manufacturers to improve their production
systems and technological innovations.

After World War II, European manufacturers competed to make “the public car” for overcoming
the deep recession. During this period, Dr. Ferdinand Porsche developed the Volkswagen
(German for “people’s car”) Beetle for consumers and the model became the best-selling car in
history, with worldwide sales at 22 million. In the U.S., automakers produced the big and
This case was prepared by Matthias Brachmann, Benjamin Cole, Hongseok Eum, Venkat Gopalakrishnan, Mark Hancock and Anand Narayan
under the guidance of Allan Afuah for the course “Strategy, Technology & Management of Innovation” as a basis for class discussion rather than
to illustrate either effective or ineffective handling of an administrative situation.

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luxurious cars that American consumers preferred, such as the Cadillac and Lincoln. Meanwhile,
the relatively immature Japanese automobile industry took years to recover from the war and did
not have the domestic demand enjoyed by manufacturers in other countries.

The 1970s brought a fundamental shift in the global market for autos, especially in the U.S. The
American automotive industry was severely impacted by the oil shocks of 1973 and 1979, when
oil prices roughly tripled. The change in American consumers’ preference towards energy
efficient vehicles gave a boost to Japanese import sales because American automobiles were too
heavy and inefficient to compete. In addition, Japanese quality had improved drastically since the
1950s and now surpassed that of more expensive American makes. During the 1980s, Japanese
makers established factories in the U.S. and Europe to increase their sales and avoid trade barriers.

During the 1990s, the intense competition among American, European, and Japanese companies
was joined by industry newcomers, such as Korean manufacturers. Japanese makers became the
benchmark for both quality and cost-cutting, introducing the concept of lean production, which
other companies tried to duplicate. Another factor for cost competitiveness was economies of
scale. Every maker increased its production capacity. This trend finally generated the problem of
over-capacity leading to consolidation throughout the industry through mergers, acquisitions, and
shutdowns of weaker players.

Recently, the emphasis of much of the R&D by automobile manufacturers is on reducing

emissions and improving fuel economy in response to increasing governmental regulations and
public concern for the environment. This includes developing alternatives to the gasoline-
powered engine. The increased costs of this research and the need to compete globally mean that
only the few companies that can meet the enormous capital expenditure requirements for
developing the next generation car are expected to survive.3,4

U.S. Regulatory Environment

Through the 1960s, the American public became increasingly concerned with their air and water
quality. High profile incidents, such as the Cuyahoga River fire in Cleveland in 1969 and
increasing smog in Southern California, served as rallying points for the growing environmental
movement. In response, Congress passed the Clean Air Act (1970) and the Clean Water Act
(1973) to establish pollution control standards, and President Richard Nixon established the
Environmental Protection Agency (EPA) (1970) to monitor environmental issues.5

The Clean Air Act (amended in 1977) ma ndated the use of emission control devices in all new
cars to reduce the amount of carbon- monoxide (CO), hydrocarbons (HC), nitrogen oxides (NOx),
volatile organic compounds (VOC), sulfur oxides and lead released. Though these regulations
were effective in reducing some pollutants by as much as 60-80%, motor vehicles still accounted
for a majority of VOC and NOx emissions that are harmful to the ozone, and over 90% of the CO
emissions in urban areas. This prompted a revised Clean Air Act (1990) that established tighter
emission control standards for cars, and to a lesser extent trucks, which became effective in 1994.
The law also increased the required effective life of emission control devices from 50,000 to
100,000 miles versus the 1970 Clean Air Act. Exhibit 2 shows the trends in emissions and
vehicle sales.

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Though CO emissions from motor vehicles dropped 43% and HC emissions dropped 60% from
1970 to 1997, NOx emissions dropped just 5%. 6 These reductions were much smaller than the
90% reductions suggested by the pollution regulations. An increase in passenger miles driven
from 1.1 billion in 1970 to 2.6 billion in 1997 as well as malfunctioning emission control devices
were blamed for the low reductions in vehicle pollution. As a result, twelve Northeastern states
adopted the National Low Emission Vehicle (NLEV) Standard in 1997, requiring reduction of
NOx emission level from 0.4gm/mile mandated by the Clean Air Act to 0.2gm/mile. The NLEV
standard was adopted nationwide in 2001.

A trend that contrasted markedly from the environmental progress made in automobile emissions
was the growing popularity of light trucks, including SUVs and minivans, in the 1990s. Existing
regulations allowed light trucks to emit almost four times as much as passenger cars. The
development of the minivan was due in part to Chrysler’s attempt to circumvent the more
stringent regulations placed on station wagons. The light truck fleet grew from about 19 million
in 1970 (17% of the total fleet) to about 80 million (37%) today. The rise in the popularity of
minivans and SUVs in the U.S. can be directly attributed to the relatively low gasoline prices in
the U.S. Exhibit 3 shows the average price of regular unleaded gasoline from 1970 through 2000.
While the gasoline price has increased approximately 2.5 times in nominal terms from 1970 to
2000, when adjusted for inflation the prices are nearly at the 1970 level and less than half the
prices in Europe and Japan (Exhibit 4).

In 1999, the Clinton administration proposed a tougher “Tier-2” standard for pollution control,
primarily to close the emission requirement gap between cars and light trucks. 7 The Tier-2
standards not only require trucks to meet the same emission standards as cars but also lower NOx
emissions to 0.05 gm/mile, one fourth the NLEV level and 1/100th the level in the 1960s. In
addition, the emission control devices are required to function for 120,000 miles. For cars, these
new rules will be phased in between 2004 and 2007, while trucks will have to meet this standard
by 2009. The rules apply to a manufacturer’s entire fleet, so that a car company can offset a
highly polluting SUV by selling a low emission car to achieve the required fleet average.

Although federal emissions regulations have become increasingly strict in the U.S., California
leads the nation in establishing air quality regulations. California's Legislature established the Air
Resources Board (ARB) three years before the establishment of the EPA to combat some of the
worst air pollution problems in the nation. Gasoline and diesel powered vehicles contribute 60%
of the smog- forming emissions and a majority of toxic air contaminants in California. 8 The U.S.
Clean Air Act of 1990 established a clean fuel car pilot program in California, requiring the
phase- in of tighter emission limits for 150,000 vehicles in model year 1996 and 300,000 by the
model year 1999. Also in 1990, the ARB adopted the Zero Emission Vehicle (ZEV) mandate.
The original mandate required that 2% of all vehicles produc ed for sale in California in 1998
would be ZEVs. 9 Though revised numerous times, the current mandate still requires that
production include 2% ZEVs. Credits towards this goal can be earned by producing “partial”
ZEVs, which include Super ultra low emission vehicles (SULEV), hybrid electric vehicles
(HEVs) and fuel cell vehicles. Exhibit 5 shows pure ZEV requirement for the next several years
under the most recent mandate. Because standards set in California can impact production
requirements for all other states, automakers have lobbied extensively against the ZEV mandate

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citing reasons that are not always credible and causing many to question the true commitment of
automakers to improving the environment.

Despite the skepticism of environmental groups, there are real cost and technology challenges
faced by automakers as they struggle to develop the ZEV that will become increasingly mandated.
Existing combustion engine technology cannot be improved to meet these restrictions, leading
companies to seek alternative power sources for the next generation of automobiles.

Internal Combustion Engines

Today, two major types of combustion engine dominate the market: gasoline and diesel. Though
each has specific benefits and drawbacks, both are inefficient at low speeds and during
acceleration (e.g., city driving), and highly efficient at high revolutions and stable speeds (e.g.,
highway driving).

Gasoline – Gasoline engine technology dominates the world’s roadways. Gasoline engines work
by injecting fuel into combustion chambers, mixing that fuel with air, then exposing those
flammable mixtures to sparks. The resulting explosions drive the engines pistons up and down,
which turns the drive shaft, and therefore the wheels. The combustion also gives off
hydrocarbons (HC), which cause photochemical smog; carbon monoxide (CO), a toxin; nitrogen
oxides (NOx), which can bring on asthma attacks; and carbon dioxide (CO2 ), a greenhouse gas.
Further, less than 20% of gasoline’s calorific value is used in propelling the vehicle; the rest of the
energy is wasted. Remedying this inefficiency has been the driving force in engineering over the
past century. This has brought about technology such as electronic fuel injectors and lean-burn
engines that run on lower fuel-air ratios.

Diesel – Diesel fuel combusts when placed under intense pressure in the combustion chamber,
rather than from exposure to a spark. Because it combusts at a lower fuel-air ratio, diesel burns
more efficiently than gasoline, giving a diesel engine better mileage and thus less CO2 emissions.
Diesel, however, has higher NOx emissions as well as unsightly black smoke. Diesel makes up
nearly 40% of the European market, but has never really taken off in the U.S. due to the public’s
perception that diesels are dirty and noisy. Significant strides in technology, however, have been
able to reduce emissions of black smoke and to boost performance to levels equivalent with
gasoline.

Alternative Power Systems

Concerns about emissions and the depletion of oil reserves has spurred numerous technological
innovations in alternative energy, most of which have seen little commercial success due to poor
performance, limited range and lack of supportive infrastructure (e.g., fuel and charging stations).
Exhibit 6 compares alternate power systems to gasoline engines.

Methanol – Also known as methyl alcohol, methanol can be burned but holds only half the
calorific value of gasoline by weight, limiting range. Methanol may corrode metal auto
components and generates harmful aldehyde when it does not combust completely.

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Natural Gas – The principal component of natural gas is methane, which remains gaseous no
matter how much it is compressed. This means that bulky canisters must be used to store the fuel,
limiting range to one- fourth to one-sixth of gasoline. Related to methane is liquid petroleum gas
(LPG), which can be compressed and liquefied. Both Methane and LPG emit little CO2 , little
NOx and no black soot.

Hydrogen Combustion – Hydrogen can also be used in internal combustion engines. Hydrogen
and oxygen are injected into the combustion chamber and, as in the case of gasoline, the resulting
explosions drive the pistons that turn the drive shaft, and therefore the wheels. During combustion,
however, there is always a surplus of oxygen. This oxygen absorbs part of the heat, and thereby
hinders the development of NOx. Harmful emissions are virtually eliminated and the outcome of
the combustion is water. The hurdles for this technology are the availability of hydrogen and its
storage onboard the vehicle. By cooling hydrogen to –424° F, it can be stored as a liquid in a tank,
which takes up 1/1000th of its gaseous volume.10,11

Electric – Electric vehicles run on electricity stored in onboard batteries, which are charged after
use. As such, pollution is not generated in the electric vehicles themselves, but rather when the
electricity is generated at large centralized power plants. Altogether, the use of electric vehicles
could reduce CO2 emissions between 10% and 40% compared to gasoline vehicles. Electric
vehicles are hampered by charging requirements, which can take up to 10 hours, and by limited
range (less than 200 miles) between charges. Electric vehicle advances tend to focus on
improving battery life, efficiency, and weight.

Hybrid – Hybrids get their name from their use of multiple fuel or propulsion sources. Public
transportation buses that switch between internal combustion engines on the freeways and trolley-
like electricity feeds in the city are one example of hybrids. For automobiles, there are essentially
two major system types: parallel and series. In Parallel systems, the engine supplies the main
power while the electric motor assists. In Series systems, the electric motor supplies the main
power and engine acts as a generator for the battery. The Toyota Hybrid System combines the
two systems into a Parallel-Series system so that the engine is only used at its most efficient range
(Exhibit 7). The system shuts off the engine when the vehicle stops, engages the electric motor at
low speeds and supplements the engine during acceleration. The engine also keeps the battery
charged so it never needs outside charging. 12

Fuel Cell – Originally developed for the U.S. space program in the 1960s, fuel cells work on the
chemical principle of reverse hydrolysis. By exposing hydrogen to a catalyst and ambient air, a
fuel cell system creates electricity and water. The electricity can drive an electric motor the same
as a battery does on an electric or hybrid vehicle. Environmentalists have hailed the fuel cell
vehicle as the ultimate eco-car because it is completely emissions free when fueled by pure
hydrogen, which can be generated from sources ranging from natural gas to biomass. The lack of
a hydroge n fuel infrastructure, however, means that automakers are investigating the reformation
of gasoline and methanol to provide hydrogen.13

Comprehensive adoption of new power system technologies depends on more than just providing
the cost of development and surpassing technological challenges. It also depends on the
commitment of manufacturers to reduce negative environmental impacts, the willingness of

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consumers to trade vehicle performance and convenience for fuel efficiency (at least in the short
run), and the insistence of regulatory bodies in setting and enforcing environmental laws. One
company that has taken the initiative in developing the next generation automobile is the Toyota
Motor Corporation.

Toyota – A History

Japan’s leading manufacturer of automobiles was founded as Toyoda Spinning & Weaving Co.
Ltd. by Sakichi Toyoda in 1918. Sakichi’s company was centered on his 1902 invention of a
weaving loom that stopped automatically when a thread broke. Sakichi was motivated to end the
waste he observed in existing looms, which continued weaving even after a thread broke to
produce defective fabrics. The desire to eliminate waste and improve efficiency became a driving
force in the company that has continued to this day.14

The transition to automobile manufacturing began in 1929 when Kiichiro Toyoda, Sakichi’s son,
persuaded his father to fund research on automobile production. In 1934, Kiichiro completed the
first Toyoda prototype engine, followed by its first automobile in 1935, and its first production
passenger car in 1936. In 1937, Toyoda Motor Co., Ltd. was established as an independent
company. Kiichiro spent a year in the U.S. studying Henry Ford’s mass production system and
sought ways to adapt it to the much smaller production volumes and limited resources
characteristic of Japan. Kiichiro soon refined what he termed “just in time” production, which
reduced inventories and increased manufacturing flexibility relative to conventional mass-
production. 15 Toyota continued to develop its production system under Kiichiro’s successor, Eiji
Toyoda, and with the work of Taiichi Ohno. The culmination of this development was the Toyota
Production System. 16

Toyota launched its first full- scale production model, the Crown, to the Japanese market in 1955.
In 1957, Eichi renamed the company The Toyota Company (“Toyota” has an auspicious meaning
in Japanese numerology) and introduced the Crown to the U.S. The car was a total failure
because of its unreliability. Toyota made its next entry into the American market in the 1960s
with the compact Corona, followed in 1966 by the extremely successful Corolla. In 1977,
Toyota’s cumulative production reached 10 million. 17 In 1983, Eichi again changed the
company’s name to the Toyota Motor Corporation. Eichi visited the U.S. to study automotive
production in 1986 and returned to Japan determined to not just copy the American automotive
industry, but to take initiative in developing and producing superior products. This led to the
1989 launch of the Lexus luxury car line in the U.S., which became the leading luxury name in
2001.18

By 2001, Toyota’s cumulative domestic production had surpassed 100 million cars. It was the
third largest automobile manufacturer in the world (9.9% market share)19 , fourth in the U.S. (9.0%
market share)20 and the largest in Japan (40.8% market share). 21 Toyota’s fiscal year 2001 sales
were 17,010 billion yen (approximately US$140 billion in March 2001), allocated among Japan
(59%), North America (29%), Europe (6%), and Other (6%) ma rkets. 22 Though nearly 78% of
Toyota vehicles were made in Japan, 23 the company operated a total of 41 overseas manufacturing
organizations in 24 countries.24

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The Toyota Production System has become an industry model for both quality and efficiency.
Though Toyota has never stopped improving its production system, most development has been
characterized by incremental improvements and adaptations of existing technology. Toyota
attributed much of its product development success to its integrated and consensus-based
approach to research. A core group of development managers was nurtured, who then taught “the
Toyota Way” to proceeding generations of engineers. Due to the firm’s lifetime employment
policy, Toyota did not fear losing engineers to competitors, and thus was able to bring up
generations of risk averse, quality-oriented engineers. Toyota’s biggest challenge as it enters the
21st century may be to drive the disruptive changes impacting the automotive industry.

Prius Development

The choice of someone like Uchiyamada as Chief Engineer was unprecedented for Toyota.
Rather than choosing any number of experienced engineers, Toyota management chose someone
with absolutely no product planning experience. However, Uchiyamada had recently helped
coordinate the largest reorganization of Toyota’s technical divisions in history. As a result, he
knew the location, specialization and processes of every engineering division within the company.

Soon after his appointment, Uchiyamada had the chance to voice his concerns to Shinichi Kato,
board member in charge of technical management. Kato’s response: “As you know, the mission
of the G21 project is to build a car for the 21st century. However, that is not the only intention.
We would like you to establish a new method of developing a car through this project.” Since
there was no existing car to reference in the making of G21, the project team was free to develop
the car however it wished. Management further agreed to allow the team to develop any size
model it wanted, even at the risk of cannibalizing current sales. The G21 team was also allowed
to develop any new parts needed.25

Uchiyamada began his task by encouraging his team members to absorb new ideas by traveling,
meeting new people and reading different books. The engineers kept close contact even on days
when there were no meetings – coming and going from each other’s divisions and sharing
information, rather than staying chained to their technology. The team met in secret in an old
conference room known as the “red carpet room” – far away from other engineers. Knowledge of
the G21 project was to remain strictly need-to-know.

Three members of Uchiyamada’s team were given the task of developing the concept car for
display at the Tokyo Motor Show in October 1995. The concept for this car was the same as the
concept for G21: a compact passenger-car that sets the standard for the 21st century. The concept
car was to be named “Prius,” which means “prior” in Latin, demarking the launch of the vehicle
prior to the 21st century.

At the urging of Executive Vice President Akihiro Wada, the team decided to position the concept
car as a hybrid vehicle in order to explain its fuel economy. After researching various systems,
the team decided to link a 1,500cc direct- injection gasoline engine with a continuously variable
transmission (CVT), a motor, and a capacitor for charging the batteries. Recognizing the potential
for fuel savings with such a system, the team recommended a similar system for G21 to the

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management. Uchiyamada’s team was thrilled to discover they could achieve 50% better fuel
economy than conventional cars by pursuing this technology.

The management was unimpressed. “A 50% improvement is not good enough. You understand
that we are talking about a car for the 21st century, right? The fuel economy shouldn’t be just
50% better. You must double it!”26 The team was at a loss for words.

Uchiyamada resisted but Wada put his foot down, threatening to pull the plug on the entire G21
project if the team did not pursue a hybrid system capable of achieving twice the fuel efficiency of
a conventional car. Uchiyamada gave in, but not without getting Wada to agree to assemble the
finest engineers at Toyota to discuss which system to develop. The advanced hybrid it was.

The Heart of the Vehicle

As automobiles grew more complex electronically, Toyota management began to believe that the
competitive differentiation of automakers would eventually be determined by their electronic parts.
The executives feared that without the ability to produce electronics internally, Toyota would be
doomed to become me rely an assembly manufacturer. Finally, without knowledge of the
technology, Toyota believed there was room for opportunistic pricing by makers of this vital
component. These concerns brought about the construction in 1990 of the ¥15 billion ($120
million) Hirose Plant – the first plant dedicated exclusively to the production of electronics parts
by an automaker in Japan.

Hybrid systems require the complex balancing of engines and motors to produce propulsion.
They also require the ability to safely and efficiently control high voltage electricity from the
battery pack. At the time of the G21 development, Hirose already produced integrated circuits,
but the hybrid system would require a much more robust semiconductor – the insulated gate
bipolar transistor, or IGBT – that could handle up to fifty times the power surge of Hirose’s other
products. The vehicle could not be completed without the IGBT but Toyota management still
faced a make-or-buy decision.

Those in favor of developing the IGBT internally believed that the component would eventually
become the heart of the car, as important as the engine or transmission. They feared that without
the knowledge, Toyota would not be able to follow G21 with other hybrid variants. Those
opposed to internal development understandably questioned the ability of Toyota’s ten- year-old
semiconductor division to compete with state-of-the-art electronics companies. They reasoned
that, as an automaker, Toyota’s primary competency was in making cars, not in component
manufacturing.

In the end, management decided to challenge the Hirose plant with the development. Toyota
Managing Director Masanao Shiomi believed that even if Toyota commissioned the development
to outside manufacturers, there would be no incentive for those firms to cut costs. He also
believed that Toyota should inject its resources into developing parts that have great future
potential, rather than developing parts that are already mass-produced. Because the market for
high-capacity IGBT was less than 50,000 units a month at the time, Shiomi reasoned that if
Toyota could produce its own IGBT, the company could set the standards for the market and thus

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control it. Shiomi also believed that future automobiles would be powered by electricity and
eventually fuel cells. Shiomi strongly endorsed Toyota’s development of next-generation power
sources so that the development of IGBT was just a milestone on a long road of research and
development.27

Hiroyuki Watanabe, head of Toyota’s EV, Hybrid and Fuel Cell Vehicle development, addressed
this issue of hybrids as transition technology. “Hybrid technology actually expands the potential
of the internal combustion engine. Any type of engine could potentially be coupled with a battery
and electric motor for significant fuel efficiency gains – gasoline, diesel, compressed natural gas,
fuel cells...anything!”28

“The really exciting part of our power train research is that the advances we have made in
building the Prius will aid our efforts in developing fuel cell-powered vehicles,” explained
Watanabe, who has followed Toyota’s fuel cell research since it began in earnest in 1992.
“Currently, an internal combustion engine provides motive power in the Prius. But what if we
replaced that engine with a fuel cell? The same efficiencies that we have realized here can be –
and will be – applied in Toyota’s Fuel Cell Hybrid Vehicle.”29

The promise of fuel cell vehicles drove Toyota to produce a prototype in 1996. That vehicle
became the first fuel cell vehicle to store pure hydrogen on-board the vehicle in a hydrogen-
absorbing alloy. The following year, Toyota made history again by unveiling the world’s first
methanol-powered fuel cell vehicle at the Frankfurt Motor Show. Toyota has since moved into
product development for its fuel cell vehicle, and expects to launch one by 2004.

Prius Debuts
Hiroshi Okuda was known for his aggressive and self-confident management style. Within
months of becoming Toyota’s new president in 1995, he swiftly moved to establish new
production facilities in the U.S., India and France. With the Motor Show nearing, Okuda
questioned Wada about the December 1998 launch schedule. “There will be great significance in
launching the car early. This car may change the course of Toyota’s future and even that of the
auto industry. If we delay things by being overly cautious, we will never finish it. Tell them to
get it done earlier.” 30 The launch was moved to late 1997, leaving less than two years to
commercialization.

Toyota unveiled the world’s first mass-produced hybrid-electric vehicle – the Prius – at the 1997
Tokyo Motor Show. The Big3 were caught completely off- guard, rushing to slap together
prototypes for the January 1998 Detroit Motor Show just months after decrying the Kyoto
Protocol on Global Warming. Toyota had shaken the world’s automakers out of their slumber.

The Prius became the first car in history to claim both “Japan Car of the Year” and “RJC New Car
of the Year” awards. It also claimed the “Global Climate Protection Awar
Environmental Protection Agency, among dozens of other accolades.

Sales for the revolutionary vehicle in Japan were brisk. Production figures were doubled to 2,000
units per month in order to meet strong demand. Within months of the launch, Toyota announced

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plans to sell the vehicle in both the U.S. and Europe. Within 22 months, the Prius sold over
30,000 units – more than the combined total of all electric vehicles sold worldwide since 1960
(Exhibit 7). Toyota launched the Prius in the U.S. in July 1999.

Sales for the Prius have hobbled along at an uninspiring 1,500 units or fewer per month. With
gasoline prices at their lowest in decades, U.S. consumers are not looking for high fuel efficiency
vehicles. Dealers are equally lukewarm – pricier vehicles can bring them juicier margins. Some
analysts estimate that Toyota is losing thousands of dollars on every car sold.

Toyota’s Challenge
Though clearly the most successful alternative power vehicle in history, the Prius could not be
considered a success by conventional volume and profitability measures. Toyota faces difficult
decisions as it continues its pursuit of the next generation vehicle. Should it continue selling the
Prius in the U.S.? Should it introduce additional hybrid models as it has done with considerable
success in Japan? How can the company convince American dealers to carry the vehicle when
there is currently little consumer demand? Should Toyota discontinue with the development of
hybrids and direct all its resources to develop a viable fuel cell technology – the technology that
pundits say will define automotive transport in the next century? Or, does the continued hybrid
development experience and scale up of prototypes to mass production translate to a competitive
advantage in getting a fuel cell model to market?

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Exhibit 1: Technology Development by Competitors

Electric vehicles based on current technology have inherent limitations as is evident from the EV1
vehicle from General Motors (GM). Toyota’s major competitors are betting on hybrid cars in the
short run and fuel cell cars in the long run. Automakers also see a wider energy source market
outside automobiles for fuel cells. Hybrid cars are functionally very viable but fall short of long-
term air quality goals. Challenges for fuel cells include their large size, lack of a hydrogen supply
infrastructure, difficulty storing hydrogen, and high cost. An overview of the efforts by Toyota’s
competitors to develop cleaner, more fuel-efficient vehicles is presented below.

Honda –Honda beat Toyota to the U.S. market with its Insight hybrid vehicle launch in 1999.
Honda saw little success with the tiny two-door in its first two years. Honda has plans to roll out a
hybrid version of its wide-selling Civic in Japan in December 2001, and in the U.S. in spring 2002.
The vehicle is expected to have 30% more power than the Insight, higher fuel efficiency than the
Prius, and a lower price tag. Honda hopes to sell 25,000 to 30,000 a year in the U.S. and is
directly trying to displace Prius in the market. In October 2001, Honda announced its “FCX-V4
concept car,” featuring a fuel stack developed by Ballard Power Systems. Honda plans to bring a
fuel cell vehicle to market in 2003.31,32,33,34,35

General Motors Corporation – General Motors launched its first generation electric vehicle
(EV1) in 1997 after more than 10 years of research and development. The EV1 is propelled by a
137 hp motor, is powered by batteries and has a range of 55 to 95 miles. After making 950
vehicles, GM declared the car a failure because of limited range, heavy batteries and high cost.36
Limited availability in Arizona and California, low gasoline prices, the lack of a battery charging
infrastructure and poor marketing efforts by GM are also blamed for the EV1 failure. GM signed
an agreement with Toyota in 1999 to develop advanced environmental technology, including
electric, hybrid, and fuel cell vehicles, as well as technological standards.

In January 2001, GM introduced a hybrid power train called ParadiGM. ParadiGM is designed
for a global mid-size vehicle platform called Epsilon and will allow GM to use the hybrid power
train on a number of vehicles starting in 2004. GMs’ first running fuel cell vehicle is the
HydroGen1, an Opel Zafira minivan made in Europe. GMs’ first gasoline-based fuel cell vehicle
prototype is a Chevrolet S-10 pickup – a modification of its electric version of the S-10 pickup.
GM is concentrating its efforts on developing a technology to convert gasoline to hydrogen. In
October 2001, GM and Suzuki Motors Corporation announced an agreement to collaborate on
fuel cell vehicle development. In early 2001, GM also invested in strategic alliances with General
Hydrogen and Quantum Technologies to accelerate the spread of a hydrogen infrastructure and
develop a hydrogen storage device for future vehicles.

Ford Motor Company – Ford’s electric vehicle, the Ranger EV, has been available since 1998.
Th!nk technologies, a division of Ford, will launch its golf cart sized Th!nk city neighborhood
electric vehicle (NEV) in the U.S. in 2002. Ford is currently working on a hybrid vehicle, the
Ford Escape HEV, which will be ava ilable for sale in 2003. Ford predicts that production fuel cell
cars are at least 15 years away. 37 By 2004, Ford plans to begin low volume commercial
production of fuel cell electric vehicles.

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DaimlerChrysler – DaimlerChrysler has an electric version of its Dodge Caravan minivan in use
in California. Christened the EPIC (electric powered interurban commuter), these electric
vehicles are present in limited numbers with the fleet of Xpress Shuttle and the postal service. In
October 2000, DaimlerChrysler purchased Global Electric Motor Cars LLC, a maker of NEVs.
The Dodge Durango will be offered with a hybrid power train in 2003. DaimlerChrysler will
invest $1.4 billion in fuel cell research by 2003 and has two demonstration vehicles – the NECAR
4 and 4A. Both run on hydrogen – the former uses liquid and the latter compressed gas and have
a range of 280 miles. The company’s latest prototype, NECAR 5, runs on methanol reformed into
hydrogen.

Ballard Power Systems – Ballard Power Systems, based in Burnaby, British Columbia, is the
world leader in the development of Proton Exchange Membrane (PEM) fuel cell power systems
for automobiles, power plants and portable applications for recreational and emergency use. 38 In
October 2001, DaimlerChrysler and Ford increased their ownership of Ballard to 23.6% and
19.5% respectively, and sold XCELLIS (the fuel cell engine subsidiary of DaimlerChrysler) and
Ecostar (the electric drive train and power conversion subsidiary of Ford) to Ballard. 39 The
acquisition enables Ballard to expand beyond PEM fuel cells to include complete fuel cell systems
and fuel system drives, and become a dominant player in the market. Both Ford and
DaimlerChrysler have plans to leverage Ballard’s expertise to develop their fuel cell vehicles.
Ford has a deal with Ballard to provide it with Mark 900 series fuel cells that will enable Ford to
launch its first commercial fuel cell vehicle in 2004. 40 DaimlerChrysler plans to use Ballard fuel
cells to launch 30 fuel cell buses in 10 European cities by early 2003 and test drive 75 buses and
cars in California by 2003. Even though DaimlerChrysler and Ford own large stakes in the
company, Ballard works with other auto- makers, such as GM, Honda, Nissan and Volkswagen, in
their fuel cell vehicle development. In October 2001, Honda Motor introduced its FCX-V4
concept hydrogen fuel-powered electric vehicle powered by a 78kW fuel cell stack designed by
Ballard 41 and GM plans to test drive a fuel cell version of its S-10 pickup truck in late 2001
powered by Ballard fuel cells.

GM, Ford and DaimlerChrysler are clearly behind Toyota and Honda in developing a marketable
hybrid car. While the “Big3” promises to make significant investments in fuel cell technology, it
remains to be seen if they will continue to lag Toyota in delivering a functional fuel cell vehicle
for consumer use. Ballard Power Systems, in which both Ford and DaimlerChrysler have a
significant stake, is emerging as a dominant force in the next generation of automobile power
technology.

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 Toyota Prius

Exhibit 2: Trends in Emissions and Vehicle Sales

Source: Association of the German Petroleum Industry

Exhibit 3: U.S. gasoline prices Exhibit 4: World Gasoline Prices

US Gasoline Prices

2.5

Nominal
2 Real (1996 base)
$ per Gallon

1.5

0.5

0
1975 1980 1985 1990 1995 2000

Year

Source: U.S. Department of Energy Source: International Energy Agency

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 Toyota Prius

Exhibit 5: Pure ZEV requirement

60000
51000
50000
Vehicle volume
41000
40000
30000
30000
23000
21000
20000
14000
10000
10000 8000 8000

0 0
2002 2004 2008 2012 2016
Year

Source: California Air Resource Board

Exhibit 6: Power System Comparison to Gasoline Engines

Energy
Performance Emissions Range Efficiency Infrastructure Cost

Diesel = = + + = =

Methanol = + = + - =

Natural Gas = + - + - =

Electric -- ++ -- + - -

Hybrid - + + + = -

Fuel cell - ++ -- + -- -

Hydrogen
combustion = ++ - + -- -
Legend: = comparable; + better; ++ far better; - worse; -- far worse

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 Toyota Prius

Exhibit 7 – Hybrid System Comparison

Hybrid System Comparison

Parallel Hybrid Series Hybrid Toyota Hybrid
System System System
Motor/
Battery
Battery Battery Generator
Inverter Inverter
Inverter Inverter
System Engine Engine Engine

Power Split Motor/

Motor/ Generator
Device
Transmission Generator Generator Motor/
Generator
B

B M/G B G M
Energy Flow Wheels Wheels E Wheels
E T E G M/G

Main Power: Engine Main Power: Motor Two Power Paths

Main (Controller Selects
Characteristics Power Assist: Motor Engine Generator Engine or Motor)

Source: Toyota Motor Corporation

Exhibit 8: Comparison of Toyota Prius and Honda Insight

Maker Toyota Honda Toyota Toyota
Prius 4DR Insight 2DR Camry 4DR Corolla 4DR
Model
CVT CVT AT AT
Price (MSRP) $19,995 $21,280 $20,285 ~ $13,468 ~

Warranty (Basic) 3yr/36,000m 3yr/36,000m 3yr/36,000m 3yr/36,000m

2.4L/157hp I4
Engine 1.5L/70hp I4 1.0L/65hp I3 1.8L/125hp I4
3.0L/192hp V6
Fuel Economy 23/32 (I4) 29/33 (3AT)
52/45 57/56
(city/hwy) 20/28 (V6) 30/39 (4AT)
Sales in US Total 7,406 2,973 198,522 123,548
(First six Avg. per
1,234 496 33,087 20,591
months, 2001) month
Source : MSN Carpoint, www.carpoint.msn.com and official web sites of Toyota and Honda

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 Toyota Prius

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32
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33
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34
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35
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16