Hyundai Grows Up

By Michael Schuman/Seoul

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 treats 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 a former Hyundai executive.) After eyeballing the gizmo from several angles, Chung demands, "Is this enough?" Finally, he nods his O.K. but reminds his execs, "We can't allow any defects to damage our cars."

Chung, 67, has spent six years hammering that 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 or 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 ingenious 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. 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 to have 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."

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 & 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, Calif.

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 that the son would not get a free ride. Shortly before his appointment, the Korean economy was 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, including a steel company, a pipemaker, a shipping-container manufacturer and Hyundai Motor's service business. When Chung broadcast his intention to turn Hyundai into a Top 5 automaker, few took him seriously. Hyundai, like many family-controlled Korean companies, was ultra-hierarchical and slow to change. 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. 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!"

Although 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 to weed out potential defects. 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 in regular factory-floor meetings. Late last year, Yu Seung Byul, a quality inspector 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 had spent weeks debating how to solve the problem. Then, says Yu, "I woke up one morning, looked in the bathroom mirror and realized, 'That's it!'" He simply installed mirrors above the assembly line for 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 senior R&D executive Lee to get rid of an annoying noise that grinding gears were making in the transmissions of Kia Amanti sedans. "I told him that we'd lose two months of sales," Lee 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 that 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 R&D centers in California, Michigan and Germany; a $60 million proving ground in California's Mojave Desert opened in January. And in South Korea, he expanded R&D headquarters, adding a new design center complete with a 3-D cinema for viewing virtual models. Lee says Chung visited his office recently and asked, "Do you have enough money?" With a wry smile, Lee says he told his boss he didn't. Chung immediately offered several hundred million dollars.

Meanwhile, Hyundai has also needed to be innovative to woo back reluctant customers. In 1998 the company began offering a 10-year warranty, the best in the industry at the time. And to compete with bigger brands, Hyundai loaded up its models with 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 opportunity to build on its progress overseas. Slammed by rising costs and slumping U.S. sales, General Motors recently shocked investors by reporting a $1.1 billion first-quarter loss, and Ford has downgraded its 2005 profit forecast. Chung is determined to keep the pressure on. He's moving Hyundai's product line into larger, higher-profit vehicles. In October, Hyundai unveiled a small sport-utility vehicle, the Tucson. Later this year the company will launch a new high-end sedan for the U.S. market, the Azera, and early in 2006 it will introduce a minivan, the Entourage. Down the road Hyundai plans to roll out a larger SUV and its first hybrid vehicle. The company is also 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 India. And in May, Hyundai opened its first U.S. factory. The $1.2 billion plant in Montgomery, Ala., will produce 150,000 Sonatas this year and next year will start making the Santa Fe, Hyundai's popular SUV. The highly automated factory, Hyundai's most modern, is a sea of frenetic welding and painting robots. Components are shuttled about by electronic sensors in the floor. Chung says the factory gives Hyundai "firm ground as a global leader in the auto industry."

But even with its recent success, Hyundai's market position remains insecure, and the next few months will be challenging. With a host of new models coming out and its U.S. plant just revving up, Hyundai may have a harder time maintaining quality. "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% to 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%. Lehman Bros. auto analyst Zayong Koo says, "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, Hyundai's road trip is really just beginning. Despite its impressive winning streak, 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 mirror for overtaking traffic. --With reporting by Daren Fonda/New York and Frank Sikora/Montgomery

With reporting by Daren Fonda/New York, Frank Sikora/Montgomery