Quotes of the Day

Chung Mong Koo, chairman of south Korea's Hyundai Motor, carefully scrutinizes a newly designed gearshift lever for the automaker's Sonata sedan while his entire senior management team hovers around, anxiously awaiting his approval. The execs are justifiably edgy. Engineers added a plastic plate beneath the shifter to prevent spilled coffee and other flotsam from falling into the mechanism and gumming it up.

It's a minor change, but no one is treating it that way, least of all Chung, a hard-nosed, detail-oriented boss with a penchant for micromanagement. ("He still makes the decision on how big a Christmas tree to put in the lobby," quips one former Hyundai executive.) After eyeballing the plastic plate from several angles, Chung demands, "Is this enough?" He's worried that the gizmo won't do its job. Finally, he nods his O.K., but reminds his executives: "We can't allow any defects to damage our cars."

Chung, 67, has spent six years hammering this zero-defects message into the heads of Hyundai's employees — and the result has been one of the most surprising turnabouts in automotive history. A few years ago, Hyundai, South Korea's largest car manufacturer, was a synonym for "shoddy." Seoul was the only place in the world where you were likely to see large numbers of its cars on the street. Today, the company's line of pleasantly stylish, relatively inexpensive and certifiably reliable sedans and sport-utility vehicles is tailgating the industry's best-known brands in several prime markets. In the U.S., where the Sonata offers a lower-priced alternative to Toyota's Camry and Honda's Accord, Hyundai's sales reached 419,000 cars last year — up 360% since 1998. In Europe, sales spurted 21% in 2004. In India, Hyundai's 17% share of the passenger-car market made it the largest foreign automaker in 2004 and the second biggest car company overall behind Maruti, a Suzuki subsidiary. Hyundai is beating competitors by modifying its small cars with features designed for Indian customers, like elevated rooflines to provide more headroom for turban-wearing motorists.

Perhaps most surprising: in China's hotly contested emerging car market, Hyundai's operation sold more cars than any other foreign joint venture in the first quarter, according to Singapore's AutoAsia, an automotive data company. In fact, with a compounded annual revenue growth of 20% over the past five years, Hyundai has been the world's fastest-growing major automaker since 1999, according to Lehman Bros. Hyundai is "putting pressure on everybody," says Rob Hinchliffe, an auto analyst at UBS. Indeed, even Toyota vice chairman Fujio Cho last year acknowledged the blur that is getting bigger in his rearview mirror. "Hyundai has quality and prices that have caught customers' attention, not to mention ours."

It should be easy enough for Cho to recognize the secret of Hyundai's success. The South Korean company is following much the same formula that Toyota used decades ago to overcome its "cheap Asian import" stigma and become one of the world's most respected brands. When Hyundai first entered the U.S. market in 1986, its Excel sedan — an econobox with a $4,995 price tag — was an instant hit with frugal buyers. But customers soon discovered they were getting what they paid for: Excels were prone to quality-control problems and frequently needed parts replaced. Sales tanked, and Hyundai became a laughingstock. In 1998, Late Show TV host David Letterman listed his "Top 10 Hilarious Mischief Night Pranks to Play in Space"; No. 8 read: "Paste a 'Hyundai' logo on the main control panel." Says Brandon Yea, director of Hyundai's marketing-strategy team: "The Hyundai brand was worse than nothing."

But like Toyota, which overcame consumer prejudice in part by inventing kaizen, a manufacturing process and corporate mantra translated as "continuous improvement," Hyundai has rapidly built up regard for its products through an almost fanatical attention to Getting It Right. Consumer Reports magazine recently named the Sonata the most reliable car in the U.S. And Hyundai placed a solid third among nonluxury brands in J.D. Power and Associates' 2005 survey of initial-car quality, beating out Honda. Six years ago, Hyundai ranked among the worst in terms of initial defects. The comeback "is astounding," says Chance Parker, executive director at J.D. Power in Westlake Village, California. "We really haven't documented that level of turnaround in that period of time."

The architect of Hyundai's rise is Chung, who was named chairman in 1998. Although his father, Chung Ju Yung, founded Hyundai Motor in 1967, it was clear the son would not get a free ride. Shortly before his appointment, the Korean economy had been slammed by the 1997 Asian financial crisis and Hyundai was forced to lay off 25% of its staff. Complicating matters, Hyundai agreed in 1998 to acquire South Korean rival Kia Motors, which had to be assimilated. Chung had little experience with the automotive industry — he had spent most of his career managing a smorgasbord of affiliates in the Hyundai conglomerate, including a steel company, a pipemaker, a shipping-container manufacturer, and Hyundai Motor's service business. When Chung began broadcasting his intention to turn Hyundai into a top-five automaker, few outside the company took him seriously. Hyundai was ultra-hierarchical and slow to change. Managers rarely cooperated with one another and division chiefs ran their operations as personal fiefdoms. "When a problem occurred, each division would blame other divisions," says Lee Hyun Soon, a senior executive in research and development.

But Chung was quietly engineering a revolution. Revered by the staff as a member of the founding clan, he was able to gather information quickly and impose his will on the organization. After years managing the after-sales service operation, he concluded that quality problems were the crux of the company's ills. Suh Byung Kee, Hyundai's president, recalls Chung bursting into his office five years ago and saying: "Quality is crucial to our survival. We have to get it right no matter what the cost!"

Though Chung's revelation might seem obvious, it wasn't to Hyundai's staff. A premium had always been placed on making cars quickly and cheaply. Even Suh, who is in charge of Hyundai's quality-improvement efforts, admits, "When I first came to Hyundai, I too didn't think quality cars were important." But the new chairman made blemish-free manufacturing the top priority. To break down interdivisional barriers, Chung forced designers, engineers and factory managers to work as a team by creating joint committees to examine blueprints of new models. Twice a month, Chung summons senior managers into a conference room at his Seoul headquarters to analyze reliability issues, sometimes bringing in a whole car and lifting it up on a hydraulic platform to get a firsthand look. Likewise, the company's 68,000 workers are encouraged to make suggestions for improving quality. Late last year, Yu Seung Byul, a quality inspector on the assembly line in Hyundai's Asan factory in Korea, invented an improved method for detecting missing bolts and brackets in hard-to-see nooks inside the car frame. He and his managers spent weeks debating how to solve the problem, with no results. Then, says Yu, "I woke up one morning, looked in the bathroom mirror, and realized 'That's it!'" He simply installed a row of mirrors above part of the assembly line to gain a better view of the car's innards.

In the short run, Chung's obsession with quality can be costly. Last year, he delayed the launch of a new Sonata in Korea for two months while engineers cleaned up 50 minor defects. In 2003, he asked Lee, the senior R&D executive, to get rid of an annoying noise made by grinding gears in the transmissions of Kia Amanti sedans. Lee worried that he'd have to shut down production entirely to work on the problem. "I told him that we'd lose two months of sales," he recalls. "The chairman said: 'If it's for quality, it's O.K.'"

Of course, quality isn't everything. Chung has also ramped up efforts to ensure Hyundai is competitive in technology and styling. Hyundai's R&D budget has expanded 110% since 1999, to $1.6 billion this year. Hyundai invested $200 million to open or expand research-and-design centers in California, Michigan and near Frankfurt, Germany; a $60 million proving ground in California's Mojave Desert opened in January. In South Korea, Chung expanded his R&D headquarters, adding a new design center last year complete with a 3-D cinema for viewing virtual models of new cars. Lee says Chung visited his office recently and asked: "Do you have enough money?" Lee, with a wry smile, says he told his boss he didn't. Chung immediately offered several hundred million dollars. "I have an unlimited account," Lee says.

Meanwhile, Hyundai has also needed to be innovative to woo reluctant customers back to its dealerships. In 1998, the company began offering a 10-year warranty, at the time the best in the industry, to rebuild confidence in its cars. And to compete with bigger brands, Hyundai loaded up its models with special features that many of its rivals sell only as expensive extras. A 2006 Sonata for the U.S. market comes with six air bags (most competitors offer only four as the standard), a six-speaker CD and MP3 player, and an advanced antilock-braking system — all for less than $20,000.

With some of its biggest rivals in disarray, Hyundai sees an enticing opportunity to build on its progress overseas. Chung is moving Hyundai's product line away from its traditional small cars into larger, higher-profit vehicles. In October, Hyundai unveiled a small sport-utility vehicle, the Tucson, and later this year, the company will launch a new high-end sedan for the U.S. market, the Azera. In addition, the company is opening manufacturing plants around the world that should help it penetrate key markets. Hyundai is investing $600 million in a factory in the southern Indian city of Madras; due to open in 2007, the plant will be Hyundai's second in the country. And in May, Hyundai opened its first U.S. factory. The $1.2 billion plant in Montgomery, Alabama, will produce 150,000 Sonatas this year, and next year will start making the Santa Fe, Hyundai's popular suv.

Even with its recent success, Hyundai's market position remains insecure. "They're not out of the woods yet," says J.D. Power's Parker. Dwindling profit margins are another problem. The average Hyundai car retails for 10-15% less than a comparable Toyota or Honda in the U.S., but with rising labor costs and a weaker dollar, Hyundai must persuade customers to pay more so that profits keep growing. Last year, Hyundai's earnings edged up a mere 2%, while sales grew 10%. Zayong Koo, an auto analyst at Lehman Bros. in Seoul, says it could take several years before Hyundai achieves this crucial pricing power: "They need to show a track record of good-quality cars in order for them to take that next step and raise pricing."

After all, the company is still only the world's seventh largest carmaker, with 3.3 million vehicles sold globally — and that includes sales by its Kia subsidiary. But Chung has grand ambitions. "We will make ourselves an invincible competitor," he says. Hyundai's larger rivals should mark those words whenever they check their rearview mirrors for overtaking traffic.

• MICHAEL SCHUMAN / Seoul
• In a reversal of fortune, low-cost carmaker Hyundai shifts gears, boosting quality and global sales