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If you want to solve one of the central mysteries of today's auto business, consider this tale of two cars: the Ford Taurus, built at plants in Atlanta and Chicago, and the Nissan Altima, made in Smyrna, Tenn. Neither vehicle is fancy; they're mainstream sedans for buyers on a budget. Both sell well. But when you talk about profit, the Taurus wobbles off the road. Ford must entice Taurus buyers with rebate offers and financing deals that slice 13%, or roughly $3,000, off the sticker price. After allowing for dealer profits, that leaves a negative return for Ford. The Altima, meanwhile, earns Nissan an estimated $1,500 (beyond the dealer's profit), contributing to the company's fat overall operating margin of 10.8%. You know the joke about the merchant who loses a little money on each sale but says, "I'll make it up on volume"? Don't tell that joke in Detroit.

So here's the mystery: if foreign-based companies like Nissan — along with BMW, Honda and Toyota — are building more vehicles in American factories, using American workers and American suppliers, and selling the vehicles to Americans for a good profit, why aren't DaimlerChrysler, Ford and General Motors doing the same? Last year the Big Three collectively lost money on car sales in North America (and earned a mere 1.8% profit on overall sales). Honda and Nissan earned higher margins and record profits, and Toyota is expected to post similar results.

The stock explanation for this situation is that the foreign makers pay their U.S. workers less in wages and benefits than do the Big Three. But that answer is wrong; the compensation is roughly equivalent. The real reasons for the transplants' success are much more interesting and instructive: more efficient manufacturing systems, better labor relations, more collaborative relationships with suppliers, lower "legacy" costs for retirees' pensions and health benefits, and hard-earned reputations for quality.

These advantages have been accruing since 1983, when the first transplant factories, built by Honda and Nissan, began producing sedans in Marysville, Ohio, and Smyrna, Tenn., respectively. But if the stakes were high then, they're even higher now. The Big Three's overall North American market share slipped to 61.7% last year, an all-time low, and it has declined an additional 1.6 points in the first quarter of 2003. Toyota is just a couple of market-share points from passing Chrysler, the smallest of the Big Three. Though it is narrowing the quality gap, Detroit today squeezes almost all its earnings out of "light trucks," an industry category that includes SUVs and pickups. But the transplants are attacking that bastion. Toyota is adding capacity for its full-size pickup, the Tundra, with a new plant set to open in 2006 in San Antonio, Texas. And later this month, Nissan will inaugurate a new plant (now in test mode) in Canton, Miss., where it will build the Armada full-size SUV and the Titan full-size pickup.

Nissan's strategy, championed by turnaround CEO Carlos Ghosn, exemplifies the latest transplant wave: a direct assault on Detroit's most profitable models. The Titan was designed by a California-based team of mostly Americans, who Nissan thought could best understand the U.S. truck crowd's preferences. About 85% of the Titan's components come from U.S. suppliers. And it will be built in the pickup-loving South, which Nissan hopes will add credibility. Says Ghosn (pronounced Goan): "The market is sensitive to the fact that this product is assembled in the U.S."

The rewards could be as king-size as the vehicles' cabs. Ford earns an estimated $2,000 profit on each of its F-Series pickups, providing one of its fattest margins for a high-volume vehicle. The North American market for pickups is about 3 million a year. And while Ford will launch a redesigned F-150 this summer, Ghosn is confident that Nissan's investment in the Titan (whose platform will be used by other vehicles) will pay off. "Each time competitors enter a segment, profits have a tendency to go down," he acknowledges. "But the truck segment will remain one of the most profitable."

All told, North American vehicle sales are expected to grow to 18.4 million a year by 2008, an increase of 1.6 million vehicles since 2002. The transplants alone are adding enough capacity for an additional 1 million vehicles. Hyundai is building a plant in Montgomery, Ala.--the first Korean auto-assembly factory in the U.S.--to make Sonata sedans and Santa Fe SUVs. Mercedes-Benz (owned by DaimlerChrysler, based in Stuttgart, Germany) is doubling capacity at its SUV facility in Tuscaloosa, Ala. And BMW recently expanded its plant in Spartanburg, S.C., where lines run overtime to produce Z4 roadsters and X5 SUVs. Detroit's automakers are by no means sitting still, as we'll see, but the additional transplant capacity can only make their challenge harder. "The Big Three are less in denial than they used to be, but I can't see anything causing import market-share gains to take a downturn," says Bear Stearns analyst Domenic Martilotti. "A fifty-fifty share split is certainly within reason." Here's what Detroit is up against.

More Productive Factories
Chrysler, Ford and GM take an average of eight more hours to make a vehicle at their North American plants than do Honda, Nissan and Toyota. Nissan is fastest at 18 hours a vehicle, and Chrysler (the U.S.-based unit of DaimlerChrysler) is slowest at 31 hours, according to the Harbour Report, an annual productivity guide. These times translate into an extra expense of $300 to $500 a vehicle for the Big Three as compared with the transplants, which in a tough market can kill already slim profit potential.

The transplants have spent decades refining "flexible assembly," a process that Detroit hasn't practiced as well. Flexibility means being able to make several types of vehicles on one assembly line, which can cut investment 25% for a new model and allow for efficiently altering the model mix based on changes in demand. At Toyota's operation in Princeton, Ind., a single line cranks out the full-size Sequoia SUV and Sienna minivan. What's novel: the Sequoia is built on a frame, while the Sienna, as a "unibody" vehicle, isn't. Toyota's line is the first in North America to assemble such fundamentally different vehicles. By 2005, five of Toyota's nine U.S. lines will produce multiple models, accounting for 71% of the automaker's North American volume, according to analyst Michael Bruynesteyn of Prudential Securities. Only a third of Big Three plants, with 34% of their production volume, will be as flexible by then. Winning the flex race, Bruynesteyn writes, "has been the key catalyst for the dramatic acceleration in market-share transfer from the domestics to the transplants and imports since 1998."

Doing flexible assembly well is a lot tougher and, initially, more expensive than it may sound. Of the $1.5 billion Nissan has invested in its new plant in Canton, Miss., just north of Jackson, about a third went into making the operation as flexible as possible. At full capacity, the Canton plant can produce 400,000 vehicles a year, including sedans, minivans, SUVs and pickups.

With advanced robotics and software, particularly to weld vehicle skeletons, Nissan can switch among models quickly. Major suppliers, some housed on site, receive orders 90 minutes before production time, cutting inventory costs for both parties. Nissan's suppliers also preassemble "modules," say, for a front-end or cockpit, and deliver them in the sequence in which they're needed on the line: a batch of leather-finished cockpits for SUVs, followed by plastic-finished versions and then different cockpits for pickup trucks. Nissan's paint shop was designed for high flexibility too, using robotic painters that are programmed to switch spray patterns based on the model mix.

Some Big Three assembly lines feature similar technologies and practices, and upgrades continue. But execution is key. "It takes tremendous discipline to keep everything organized as you switch between models and to maintain the right quantities of supplies at the line," says Jeff Liker, an engineering professor at the University of Michigan. "In that regard, GM, Ford and Chrysler aren't as advanced."

Warmer Labor Relations
Contrary to popular belief, workers' wages and benefits at the transplant factories — none of which are unionized except for joint ventures with Detroit — are comparable to those at factories organized by the United Auto Workers (UAW). Assembly-line workers, regardless of their location, earn about $45,000 to $100,000 a year (depending on experience and overtime). Bonuses are typically tied to profitability, and health-care and pension benefits vary only slightly.

But job classifications at transplant factories are broader. Line workers are trained in a variety of tasks — say, spot welding as well as interior assembly — and they rotate jobs frequently. They're less susceptible to boredom and repetitive-stress injuries. They're also trained to do preventive maintenance. At Toyota plants, every assembly-line worker has the authority to stop the line if he or she spots, say, a flaw in a windshield. More important, workers are encouraged by management to do so.

The long and often bitter relationship between the Big Three and the UAW means that their work practices are rooted not in mutual trust but in a system of sometimes picky rules. A "skilled tradesman" may be required to change a fuse in an assembly-line machine, a task that an assembly worker could easily be trained to perform. Work rules differ from plant to plant because agreements are negotiated with local union leaders. If a tradesman notices a line worker fiddling with equipment, he may file a grievance, claiming that his job is being undercut by a lower-paid employee.

A flexible work force is especially critical for maintaining line speed if the model mix changes frequently. After a switch, a worker who formerly needed two minutes to help install a wiring harness might need only 90 seconds, meaning he or she could do another job — if allowed. But at some Big Three plants, assigning a new task to a worker requires consulting the local union leader, who might approve the extra job but insist on a quid pro quo — say, extra break time. Such complications can make it more costly to adjust the vehicle mix — leading to unsold vehicles and requiring more profit-eating 0% financing.

Since the early 1980s, the UAW has mounted campaigns to organize the transplants' hourly workers, but they have consistently voted against joining, in part because of strong community support for the manufacturers and a sense of mutual loyalty. "Nissan takes care of its employees, and if the union tries to organize us, I'll probably oppose it," says Murphy Wilson, 27, a newly hired technician in Canton. The UAW has tried four times to win over Nissan's Smyrna work force but was voted down 2 to 1 in its last try in 2001. "We have not given up on the transnationals," says UAW president Ron Gettelfinger, who claims that "fear, intimidation and threats hold workers back" from inviting unions into transplant factories. In 2001 some organizers publicly accused Nissan managers of strong-arming employees in Smyrna.

In the next round of national labor negotiations this summer, the Big Three are expected to demand benefit cuts and broader job classifications. Griping has already begun. "They want us to do more and more and offer us less and less," says Bill Parker, president of UAW Local 1700 in Detroit and head of a Chrysler work force. In theory, Detroit could emulate the transplants and set up nonunionized shops in the South, but the UAW would probably bring assembly operations to a halt.

Closer Ties with Suppliers
Japanese carmakers have forged stronger relationships with suppliers than have the Big Three, inspired in part by Japan's keiretsu system, in which suppliers bond with manufacturers for the long haul. By no means is the system perfect; Nissan nearly went bankrupt in the late 1990s because of cronyism and other inefficiencies in its keiretsu. But suppliers, in both the U.S. and Japan, have been more willing to invest in equipment to manufacture new technologies — such as hybrid electric-gasoline engines — out of confidence that Japanese automakers won't abandon them, or the technology, before they can recoup costs. The Big Three now want to outsource more R. and D. to suppliers, but Detroit has made low cost a priority, tending to negotiate short-term deals and drop contracts with partsmakers if a better offer emerges — resulting, sometimes, in mutual acrimony.

Lower Legacy Costs
At GM, 2.5 workers help support each retiree. Worldwide, GM's underfunded pension and health-care obligations stand at around $77 billion, which shaves an estimated $1,700 in potential profit off every sale (Ford's and Chrysler's liabilities are less severe). GM says the problem is manageable — assuming the stock market rallies and GM hits its cost-savings and revenue targets. Transplants' legacy costs aren't as high, in part because they haven't had to downsize in North America and because their governments pick up more of the costs of health care and pensions at home.

Detroit is progressing in its competition with the transplants. In terms of initial quality, its vehicles now match those produced by European transplants. GM scores close to the industry average, and Chrysler's new models show improvement over the vehicles they replaced, according to the latest survey by J.D. Power and Associates. GM, the Big Three's lowest-cost producer in terms of materials, is ahead of Chrysler and Ford in standardizing platforms across models, which reduces development costs. The influence of its North American chairman and product guru, former Chrysler and Ford executive Robert Lutz, 71, is emerging: Cadillacs are rolling out with bold designs and high performance, Chevy is launching the SSR pickup convertible, and Pontiac is reviving its 1960s muscle car, the GTO. In areas of engineering weakness, GM is swallowing its pride and outsourcing: Saturn's 2004 VUE SUV will use Honda engines.

Ford, which marks its centennial in June, is in deeper trouble. It lost nearly $6 billion in the past two years, and since 2000 its North American market share has fallen 2.8 percentage points (GM's is down 1.5 points). CEO William Clay Ford Jr., the founder's great-grandson, is focused on cutting new-vehicle development time from the current three years (a full year longer than industry leader Toyota) and increasing parts-and-platform sharing. Ford's new Futura sedan, due in 2005 to replace the outgoing Taurus, will use a Mazda platform that Ford plans to leverage across 10 cars and crossover vehicles in its global lineup, including its Ford, Lincoln and Mercury brands. (Ford owns a controlling stake in Mazda.) But the core of Ford's global "product-led revival"--65 new models in the next five years — doesn't kick in until mid-decade.

As for Chrysler, some analysts say it has little chance of becoming a low-cost producer any time soon. A handful of its new vehicles — the Pacifica wagon and Crossfire sports car — incorporate the prized engineering of its corporate sibling, Mercedes-Benz. By 2005, Chrysler will start using a Mitsubishi small-car platform. (DaimlerChrysler owns a controlling stake in Mitsubishi.) But Chrysler's annual run of 2.5 million vehicles comes from 15 plants and incorporates 11 platforms — an inefficient scheme.

Though the UAW has resisted manufacturers' attempts to outsource much production to lower-paying suppliers, GM may have set a precedent with its new Cadillac plant in Lansing, Mich., which opened last year. Be more flexible about work rules, and let us outsource more, GM said, or we'll set up shop in Mexico or Canada (where the Canadian Auto Workers split from its American parent in 1985). The plant is now a model of Detroit lean and mean. Its vehicles rate second, to Lexus, in initial quality. Suppliers deliver components every four hours (vs. every two weeks at some GM plants), and management lets workers freeze the lines if they notice a component or assembly flaw.

One of Detroit's toughest problems is that as its vehicles and plants improve, so do those of its foreign-based competitors. Today's global auto industry is a race in which it's difficult not only to win but also to survive — a contest that Chrysler, in a sense, lost when it gave up its independence. That prospect stalks other U.S. automakers — and keeps them running hard.

• Daren Fonda