Last Laugh

How Hyundai's carmaking prowess went from punchline to powerhouse--and is shaking up the world's auto industry.

The 2006 Hyundai Sonata made a startling entrance at the Detroit auto show in January: It descended from the ceiling. Competitors who stepped onstage for a closer look were even more stunned by what Hyundai's sleekly redesigned flagship had to offer: six airbags, electronic stability control and a long list of standard equipment, all for less than $20,000.

Hyundai has been crashing a lot of parties lately. The Korean automaker, whose shabby cars made it a laughingstock just a few years ago, wants to move into the front ranks of carmakers--which would give Detroit even more headaches. In 1998 Hyundai ranked number 12 among global manufacturers, selling 1.3 million vehicles (including those of its sister company, Kia Motors). Last year it was number 7, jumping over such makers as Renault and PSA Peugeot Citroën, with sales of just over 3.1 million vehicles.

Now it has set a grander goal: By 2010 it wants to sell 5 million vehicles globally, which would likely push it into the number five spot, now held by Volkswagen. For the moment General Motors is in first place with 9 million cars and light trucks in 2004.

Hyundai's rapid growth has been fueled by an extraordinary improvement in vehicle quality--and by targeting the once-ignored entry-level market. Last year Hyundai's cars sprang to a virtual dead heat with quality leaders Toyota and Honda in J.D. Power and Associates' annual study of initial vehicle quality. And the April Consumer Reports found the 2004 Sonata the most reliable car on the road, with just two problems per 100 vehicles.

Rivals aren't laughing anymore. In fact, Hyundai is now dictating trends that others must follow. Its success with cheap cars inspired General Motors to buy its own Korean company, Daewoo, to try to match Hyundai's offerings. Hyundai's breakthrough ten-year, 100,000-mile warranty spawned extended warranty offers by Chrysler and Mitsubishi. And the new Sonata, which goes on sale in May, raised the safety bar for midsize sedans by including stability control, a feature it will make standard on all its vehicles. A month after the Sonata's debut in Detroit GM announced it, too, would make stability control standard on all cars and trucks by 2010.

The U.S. market--largest in the world--is Hyundai's biggest target, but it's also betting heavily on Europe and on fast-growing China and India, with new plants in each region. With militant labor unions in Korea, Hyundai also plans to use India as an export base for small cars.

"It's a company we must watch out for," says Honda Chief Executive Takeo Fukui. Even Toyota, widely considered the world's best automaker, is looking over its shoulder at the Koreans. Says Toyota President Fujio Cho: "We will watch them more carefully than in the past and try not to be overwhelmed by them."

For U.S. automakers Hyundai's rise is like a rerun of a bad movie. "To some extent they are doing what the Japanese did before them, but on a faster track," says Dieter Zetsche, chief of Chrysler.

Now Hyundai is taking another page from the Japanese handbook: It's building a 168,000-square-foot design and engineering center near Detroit and a $1 billion, 2-million-square-foot factory outside Montgomery, Ala. It plans to build 300,000 Sonata sedans and Santa Fe SUVs annually in Montgomery. That production would put Hyundai closer to its goal of doubling U.S. sales to one million units by 2010. (GM's U.S. sales totalled 4.7 million vehicles in 2004.) The nonunion wage rate in Alabama is $14 per hour to start, rising to $21 in two years, versus $7 in Korea. But Hyundai says manufacturing in Alabama makes sense because of currency considerations and proximity to the U.S. market.

Can Hyundai hit its ambitious goals? For all the progress the company has made, the long-term durability of its vehicles remains suspect. In the past three years its ranking has improved steadily in J.D. Power's initial-quality study (which tracks problems in the first 90 days of ownership), but it ranks near the bottom in another J.D. Power study, which measures vehicle dependability in three-year-old cars. "This year will be a good litmus test to see if their short-term quality gains will translate into long-term durability," says Chance Parker, J.D. Power's executive director of product research and analysis.

Hyundai's turnaround began under its workaholic Chairman Mong-Koo Chung, 67, whose father founded the company in 1967. Long the heir apparent and aching to run the prominent auto unit controlled by his uncle, Chung was instead stuck during the 1980s with responsibility for Hyundai's aftersale service and dealerships. Back then Hyundai Motors' sole purpose was to churn cars out of factories. It showed that volume took precedence over quality in the 1980s and 1990s.

But it was Mong-Koo Chung who had to clean up the mess. Irate customers complained to dealers, and costly repairs were made on Hyundai's shoddy cars, all by his unit. Finally in 1999, after the Asian financial crisis and a breakup of the company, his father handed Mong-Koo the reins to Hyundai-Kia Automotive Group, moving the uncle aside.

Chung's first step: Replace the bean counters in top management with engineers. Then he began working methodically on a strategy to challenge Toyota for leadership in J.D. Power's quality rankings. He hired a raft of consultants and worked closely with J.D. Power experts to benchmark the world's best auto companies. He sent Korean quality task forces to the U.S. to study weather and road conditions, as well as driver habits.

Chung expanded the quality department tenfold, to 1,000 people, and made it report directly to him. He also encouraged employees to share their ideas for improvement, promising bonuses that averaged $150. At Hyundai's Asan factory, outside Seoul, workers have dropped 25,000 ideas into the suggestion box, of which 30% have been adopted. One worker won $500 after noticing that the Sonata and the XG 350 sedans had differently shaped covers over their spare tires. Sharing the cover saves the company $100,000 a year.

Chung, a freckled, round-faced golf lover, starts each week with a demanding quality meeting at 9 o'clock Monday morning. As many as 50 engineers, designers, suppliers and factory managers are summoned to a large conference room for three hours. Cars are displayed on turntables, or even on hydraulic lifts, so that Chung and his quality experts can see the problems firsthand. "He's not looking at it on paper; he's very hands-on," says Robert Cosmai, chief executive of Hyundai Motor America.

Chung is so obsessed with quality that he's been known to take the unusual--and expensive--step of modifying a car's design midway through its life cycle, or even delaying a car's launch to resolve niggling issues.

The new Sonata's launch in Korea was held up for two months after the newly empowered quality department identified nearly 50 problems it wanted fixed. Employees at the Asan factory, where the Sonata is built, worked feverishly to fix such things as a tiny error in the size of the gap between two pieces of sheet metal near the headlight, even though it wasn't obvious to the naked eye and didn't affect the car's operation. "It was narrower than 0.1 millimeter," says Sang Kil Han, the quality manager who noticed the gap and then worked every weekend and until 10 p.m. nightly to identify its cause. Sixty factory managers, assembly-line workers, supplier experts and engineers from Hyundai's nearby research and development center pored over the problem for 25 days before it was solved with special training for those assembling that part.

Drive tests revealed a rattle coming from the Sonata's front doors. It took two months to fix: Engineers replaced the plastic strip at the bottom of the door with a more rubbery polymer at a cost of 40 cents more per car. Had the same problem occurred five years ago, "we'd probably leave it," says Don Hyung Jo, manager of the Asan factory quality control department.

Most automakers keep tabs on customer complaints and deal with them all at once, when a car is due to be redesigned. But Hyundai scrambled to respond in 2003 after Santa Fe buyers complained of wind noise. Engineers redesigned the side-view mirrors to reduce friction and relocated a crossbar on the vehicle's luggage rack. The result was impressive: Santa Fe's initial quality score improved from 149 problems per 100 vehicles on J.D. Power's 2003 study to 93 the following year.

The better quality has helped build brand loyalty among Hyundai owners. Four of the top five cars traded in to Hyundai dealers are Hyundais, according to auto research site Edmunds.com. "Before, Hyundai was a springboard to other makes," says Michael Chung, analyst at Edmunds.

Kia's quality has improved dramatically, too, but it started much lower. Since buying a controlling interest in Kia in 1998, Hyundai has moved to consolidate much of the product development efforts. The first vehicles to use a common chassis--the Hyundai Tucson and Kia Sportage compact SUVs--recently went on sale. "A year and a half from now, we'll be at Toyota-quality levels, too," vows Kia's U.S. president, Peter Butterfield.

Both companies have a pipeline full of new products on the way. After the Tucson and Sonata, Hyundai will replace its Accent, Elantra and XG 350 sedans, and add a larger Santa Fe, with three rows of seats, and a new minivan. Kia will introduce redesigned versions of its Sedona minivan, as well as its Rio and Optima sedans. One challenge is keeping Hyundai and Kia distinct. Company officials define Hyundai vehicles as "refined and confident." Kias are "exciting and enabling."

For recent models the two have been able to charge higher prices--and hence enjoy better margins. But Hyundai must be careful not to let prices creep up too much, says its former U.S. chief, Finbarr O'Neill. "The biggest challenge for Hyundai is always hubris," says O'Neill, now chief executive of Reynolds & Reynolds, an automotive software and services company in Dayton, Ohio. Emerging Chinese automakers are eager to move into the entry-level market Hyundai and Kia have come to dominate.

The goodwill that Hyundai has built up could also be jeopardized if it stumbles with the factory launch in Alabama. Poor quality at a now-defunct Canadian factory killed Hyundai's sales momentum in North America in the early 1990s. Built on what was once a rolling cow pasture, Hyundai's new factory is highly automated, with 250 robots converting stamped steel into welded vehicle bodies. In the paint shop vehicles do ten somersaults through dip tanks to ensure each coat is applied without trapping air that can cause imperfections. All that automation helps keep down labor costs and ensure quality. But "once something goes wrong, the whole operation shuts down," says Hyundai Chief Executive Dong-Jin Kim, 55. To guard against that, Hyundai brought 400 American workers to visit the Asan factory in Korea and sent 60 Koreans to the Alabama plant so that they could learn from each other.

Hyundai officials are wrestling with expanding their line into luxury cars and pickup trucks. A decision on a luxury brand won't be made until at least 2007. Pickups would probably require construction of another U.S. plant, says Butterfield.

No one should be surprised if it happens. To other automakers, Hyundai is looking like the party guest who won't go home.