Saturday, December 27, 2014

Marico: Back to basics

One would usually associate data mining and loyalty programmes with consumer marketing, with the benefits accruing to the end customer. Home-grown fast moving consumer goods maker has turned the model inside out to make its back-end operations more cost effective.

At Marico India, life begins with - the biggest and the most important commodity purchased by the company. With coconut-based products like Parachute,Advansed, Nihar, and Body Lotion in its portfolio, its production capacity can be optimally utilised only on the back of a steady supply of copra.

Around 10 years ago, Marico was faced with an acute shortage of copra, which led to its capacity lying fallow. In the words of Jitendra Mahajan, chief officer, Marico India, "There is no bigger crime an FMCG company can commit than to have a demand and being unable to supply." Traditionally, Marico bought its much needed raw material from the markets of Kochi, Kozhikode (Kerala) and Kangayam (Tamil Nadu). But consistency in supply was a problem, along with a long chain of middlemen, which kept Marico away from direct access to farmers. Thanks to market inefficiencies, arbitrage was the order of the day.

The only way to source copra under both bullish and bearish cycles sustainably was to reach out to the lowest end of the supply chain - the farmer. Further, Marico wanted to widen its sourcing base beyond terminal markets to break the cycle of ad hoc pricing. But that was not easy: Farmers were situated at diverse locations and had strong ties with local middlemen and local distributors. The attendant costs would have been difficult for Marico to absorb.

The solution to these challenges appeared moving its buying centres closer to the farmer. Thus, emerged the idea of setting up copra collection centres. That was back in 2006 and today, Marico has 25 copra collection centres in Kerala and Tamil Nadu. Two years ago, Marico sourced 25 per cent of its copra requirement from these centres; today, that figure stands at 50 per cent.

Marico launched these centres with the prime objective to source raw material as and when required, and to pass some benefits on to the farmer (save his freight cost of shifting goods to the terminal market as opposed to Marico's buying centres located closer). Marico still gave the farmer terminal market rates, which improved his remuneration. Another issue the centres addressed was transparency. A typical problem the farmer faces in the open/terminal market is unstable price realisation (realisation was lower if the moisture content in the copra was higher as that yields less oil). Marico started incentivising the farmer - paid better, provided him with a weighing scale with calibrated weights to ensure he is satisfied that he is paid for the right quantity and offered an open inspection process. Furthermore, Marico loosened its criteria for a minimum supply quantity - Marico centres would buy quantities as small as 50 kg. Above all, the farmer received his payment on the spot as opposed to credit systems prevalent at the terminal markets, helping him manage his cash flow better.

What started years ago as an experiment has led to a movement of sorts at Marico India, helping it make its supply chain more efficient.

Loyalty marketing for farmers
Till date, the concept of a loyalty programme has been consumer-driven at large or trader-driven at best. Marico has taken it one notch higher with a loyalty programme for its farmer community. Marico has formed a network of 25 service providers or entrepreneurs to manage its collection centres. The chosen ones had to be individuals who were respected by the local community, and had knowledge of the processes. These entrepreneurs have several mandates: to transfer the know-how and best practices for farm management to farmers, work with engineering firms to create mechanised conversion (of nut to copra) models and transmit that knowledge to farmers, conduct training to enhance the conversion process, and so on. These entrepreneurs are also managers of the loyalty programme (which was first tested in 2011) to reward farmers for their loyalty to Marico's copra collection centres.

The transactions at the centres are incidentally connected to SAP systems, so data is entered on the system real-time. Christened Kera Ratna (kera means coconut in Malayalam), the loyalty programme uses data to assess every farmer on three parameters: the quantity he supplies during every transaction, the frequency of supplies in a month, and the achievement of monthly targets given to him on the basis of historical records in order to qualify for loyalty points.

Once a farmer is registered after document verification, he gets a vendor code, and his points are added to that code. These points can be redeemed at the end of the financial year. There were years when Marico redeemed the points through a gift catalogue. Depending on the points, a farmer would be given gifts like a television set, a refrigerator etc. Marico also works closely with the Coconut Development Board to propagate government schemes to farmers. As part of Kera Ratna, it facilitates interactions between farmers and experts for knowledge sharing. Currently, Marico has 4,700 farmers connected to Kera Ratna. What began as an initiative to streamline sourcing has now become a full-fledged farmer outreach programme.

Improving production and sales
Sometime back, Marico upgraded its IT backbone to remove the possibility of time overruns. Now, the company gets real-time data and is better able to analyse collection centre-wise quality variations, farmer-wise performance over the years etc. "Through data analytics, we can actually identify which farmers need to improve to meet our quality requirements," says Mahajan. Data also ensures credibility as the farmer, at the time of transaction, gets a payment voucher as well as a quality voucher - thereby ensuring he is always in the loop.

IT has also ironed out the pricing and transparency issues for Marico's farmer community. Marico defines the rate for copra every morning (depending on demand and supply position, terminal market prices) and communicates it to the collection centres. The entrepreneurs who are not Marico employees are expected to convey the same to farmers at the centres. "But how do we determine they are doing so honestly?" Mahajan muses. The solution was discovered as recently as last year, when the company provided electronic panels at all the centres, so that the farmer could read what that day's price was. The panel is akin to a moving ticker/indicator that you find on a railway platform.

Then, how does Marico ensure that even a remote farmer gets the right price? Farmers register their mobile numbers with Marico and the moment the payment voucher is generated, they get a text message about the transaction. This creates transparency. is also being used for research to improve yield. Says Mahajan, "We are working with private research institutes to develop hybrids and test them for yield deliverability."

That apart, Marico has adopted the use of handheld devices to shorten the stock replenishment cycles. It has equipped its on-field sales teams with smartphones and tablets for faster relaying of sales data and information from the field to the distribution centres. The upgraded process now takes only two days as opposed to a week under the erstwhile manual system. "So, rather than have 8-10 days' worth of stock lying with the distributor and then wait for the stock to drop down to a certain level before replenishment, Marico has a proactive stock replenishment cycle based on market orders," says Samardeep Subandh, chief sales officer, Marico India.

Over the last few years, Marico's portfolio has expanded - in the metros, Marico salesmen sell more than 150-200 active SKUs per market. With the use of handhelds, the fill rate has gone up to 90 per cent, and the closing stock at the distributor level goes down.

The benefit at the front-end is bigger. Once a salesman starts handling 150-180 SKUs, there are different promotions every month where the price varies, and doing things manually is complicated. The teams there find it easier to work with an IT-enabled system. Second, it enables faster billing at the distributor level, faster loading and unloading of stocks, planning of the routes etc, as it all gets automated. Marico is making use of Google Maps and geo-tagging for distribution. On obtaining an accurate location of stores, one can do route optimisation, increase market reach etc. This year, an important project for the sales function, named Project One, was rolled out in association with Nielsen. It involved increasing Marico's direct coverage significantly. As a result of the project, Marico added 60 per cent new stores in the top six metros.

Mahajan says unavailability of skilled labour - conversion of coconut to copra is a fully manual process - has been a nagging issue. Over time, Marico has developed a prototype of a production line, which cuts down manpower requirement by 80 per cent, while the time taken shrinks from five to two days. Started last year in one collection centre, this production line is also eco-friendly. In the traditional way, when you break the nut, the water unfortunately is drained on to the ground. Under a mechanised process, the water is used for creating biogas, and the workers based in the centres can use it for cooking. "We are working on optimising the cost of operations and reaching the benchmark level in a year's time," says Mahajan, "post which we will take this prototype to all centres. This can revolutionise the whole process."

Parachute is among the leading brands in the branded coconut oil segment in Bangladesh. Traditionally, the copra needed for manufacturing oil in that market was exported from India. But with demand in India growing, Marico couldn't meet its export demand. It identified an alternative supply source in Indonesia. But the country doesn't use copra the way Indians do (for chutneys, flavouring etc). So, it is not a priority to harvest/pluck the nut at the right time. The challenge, therefore, was to train people there to produce the quality of copra that Marico does in its home country.

Another area of concern was that Indonesia gets more rainfall than Tamil Nadu. Uninterrupted sunshine, needed to dry copra, was a problem. Marico developed microwave ovens in coordination with an engineering firm to convert the nut into copra. Today, Marico buys 70 per cent of its copra requirement in Bangladesh from Indonesia. This reduces Marico's need to export copra from India, thus freeing up a vital raw material for domestic use.

Friday, December 26, 2014

Investment: Loser’s game

The debate over how our savings should be managed has raged for years. Should our retirement funds be placed, as they have typically been for many decades, with “active” managers, who go out and choose the stocks or bonds that they think have the best chance of beating the market? Or should they be entrusted to “passive” managers who merely try to match a market index — and can therefore charge a much lower fee for their services?
For active managers, 2014 looks uncomfortably as though it marked a tipping point in the debate. They have failed to match their market benchmarks on a scale not seen in decades. Some estimates suggest that as few as 10 per cent of active managers in the US managed to beat their benchmark.
Meanwhile, sales of actively managed funds have collapsed, particularly in the huge market for US funds investing in equities. Over the past 12 months, such funds saw redemptions exceed new sales by $92bn, even as rival passive funds took in a net $156bn.
The money from institutions and retail investors that was already flowing instead to rival passive funds has turned into a flood. Fidelity Investments, once the world’s largest fund manager, saw $24.7bn flow out of its active funds this year; Vanguard, its successor as the largest US mutual fund group, took $188.8bn into its passive funds.
Fund groups traded on the success of their fund managers. The Fidelity Magellan fund grew to be the largest in the world, its assets briefly exceeding $100bn in 1999, thanks to the fame of Peter Lynch, its long-time manager, who achieved success investing in smaller stocks throughout the 1980s. Its performance for much of the past two decades has been mediocre, and it now has only $17bn of assets under management.
“These trends are remorseless,” says Amin Rajan, head of Create, a UK consultancy that tracks the fund management industry. “Something like 20 per cent of European pension funds’ money is tied up in passive funds, and we believe that figure is likely to double by the end of this decade.”
Faith in active management may have been lost. When State Street conducted a survey of investors in 19 countries this year, they found that only 53 per cent of individual investors believed that outperformance was based on skill rather than luck. As for investment professionals themselves, the number was even lower, with only 42 per cent attributing outperformance to superior skill.
The evidence is on their side. A study by S&P Indices last month demonstrated that outperformance almost never persists. As Craig Lazzara of S&P puts it: “Your chances of finding a fund manager who can stay ahead of the index five years in a row are about the same as tossing a coin and calling it correctly five times in a row.”
The stakes are high because the sums involved are vast. Strategic Insight, a New York-based consultancy, estimates that the mutual fund industry manages $37tn globally, and brings in an extra $1tn in fresh money from investors each year. Active investing still accounts for more than two-thirds of assets under management in the US, and rather more than that in the rest of the world, so far more money could still be moved — with harsh implications for the many people employed to beat the market.

ETF boom
The flow out of active funds is driven in particular by the phenomenon of exchange traded funds, passive vehicles that can trade directly on a stock exchange. ETFs now have $2.76tn in assets globally. So far this year, about $275bn in new money has flowed into ETFs — a figure almost equivalent to the entire assets that were held by ETFs 10 years ago.
This added to the weight of academic theory, which suggests that active management is a “losers’ game”. In aggregate, all funds will match the market. Between them, they are the market. But they have to charge fees, which are almost always deducted as a percentage of total assets under management — a percentage that is fixed, regardless of whether the fund has beaten its benchmark. This guarantees that, in aggregate, they will fail to beat the index.
However, the problems of active managers create dangers. Somebody has to do the job of “price discovery”, or setting a sensible price for shares, so that capital will be efficiently allocated to where it can be of most use. Index funds, which merely accept whatever prices are on offer, do not do this.
Mr Rajan predicts that the trend towards passive will eventually reverse. “The more money that goes into passives, the more they will become dumb,” he says, and prone to massive overshoots. He adds that active managers’ problems have been in large part caused by central banks, which have intervened to stop share prices correcting on several occasions. Indexing, he says, has also helped fuel investment bubbles; new money coming into tracker funds is automatically allocated to the companies with the highest market value.
“I can’t believe that this amount of money going into passives isn’t going to have an impact,” he says.

Changing the game
There are signs of a counter-reformation. Now that the failure of the current model for active management seems clear, academics and fund managers are looking for new models. They are finding them in the field of behavioural finance, which applies the lessons of psychology to economics. Understanding how human psychology leads to bad investment decisions opens the chance to correct those decisions.
Annualised returns for active funds 1990-2003
According to Chuck Widger of investment management firm Brinker Capital, behavioural psychology has revealed some 117 psychological biases that are pervasive in investors. For example, people tend to be over­confident, they will go to greater lengths to avoid losses than to make profits, they tend to extrapolate any current trend far into the future and latch on to the most recent information about a company, even if it is irrelevant in the longer term. All these biases are good ways to lose money.
That has led to an attempt to improve active managers, and to identify genuine investing skill, using techniques borrowed from psychologists and sports coaches. Investment coaching firms will break down each investment into separate decisions — when to buy, how much to buy, and when to sell — and create prompts to stop managers from making the mistakes to which they are most prone. Rather than analyse price/earnings ratios or market trends, it simply tries to prompt managers out of bad behavioural habits.
Michael Ervolini of Cabot Research in Boston, one of the leaders in the field, provides minute feedback to portfolio managers. For example, some have a tendency to hold on to their “winning” stocks too long — the most pervasive flaw he has found, suffered by one in four managers, and rooted in the tendency to overvalue things that we own ourselves. Cabot will arrange for cues to appear on their screens, prompting them to consider whether they should sell their best performing stocks.
Applied to 100 fund managers around the world, Mr Ervolini claims this approach has turned an average under-performance of one percentage point into an outperformance of 1.5 percentage points over the course of five years. If applied to the $37tn managed by regulated funds, this could make quite a difference.

‘Closet indexing’
Efforts to remodel active funds have also been driven by research first published in 2006 by Martijn Cremers and Antti Petajisto, when they were at Yale University’s School of Management. They showed that many “active” funds were in fact “closet indexing” — holding a big portfolio of stocks that was only slightly different from the index. In effect, they were charging active management fees for a passive product, while contributing to asset bubbles.
When they divided funds according to their “active share” — the proportion by which their portfolio differed from the benchmark — they found that the most active funds did reliably beat the index.
That suggests that active managers have a future, but only if they are prepared to make bold and active bets. Thomas Murray of AthenaInvest, a fund group, is a former academic who has applied these ideas radically, and states that it is easy to beat the index — provided managers have a concentrated portfolio pursued systematically with conviction. This is very different from the current model.
He has taken this approach to extremes. His portfolio only holds 10 stocks — Fidelity Magellan currently holds more than 170. And he causes gasps at investment conferences when he claims not to remember either the names of his stocks or how much he paid for them — a discipline that makes it far easier to avoid behavioural biases. As his annualised return over the past 10 years is 16.2 per cent, against 8.5 per cent for his benchmark index, it looks as though he is doing something right.
The other way to close the gap with passive managers is by reducing fees. Some fund groups are tentatively introducing new fee structures, forgoing some fees if they fail to outperform.
This could help because in most years the “average” active manager does beat the benchmark before fees. The business of fund management is not a perfect “zero-sum” game because substantial holdings belong to actors who are not making any attempt to beat the market. Stocks belonging to founding families, or allocated to employees as incentive pay, are not being deployed in an attempt to beat the market.
It means there is evidence that in most years, if not 2014, most active managers can beat their index before fees.
So if only active managers would pay themselves less, they might have a far more valid proposition to offer to their clients. That has led to a flurry of attempts to reduce running costs by changing the way funds are structured. Last month, Boston-based Navigate Fund Solutions proposed a new class of “exchange traded managed funds”, which could avoid a raft of fees incurred by mutual funds, such as embedded fund distribution and service fees, the trading costs incurred when shareholders buy or redeem units from the fund.
It claims that this would have reduced the average US mutual fund’s costs by 0.65 percentage points per year from 2007 to 2013, enough on its own to ensure that 55 per cent of actively managed funds could have beaten counterpart passive funds over that period.
These ideas are yet to be tested in the marketplace. After the travails of 2014 it is highly likely that they will be.
So the chances for an active renaissance at some point look healthy. But the traditional model of active management is doomed. In future, active managers will find it hard to attract investors’ money, unless they can show that their investing is truly “active”, and their fees are as low as they can be.

M & A: Takeover volumes move to highest post-crisis levels

Corporate takeover deals surged to their highest levels since the financial crisis this year, with merger and acquisition volumes rising 47 per cent to $3.34tn globally.
In the busiest period since 2007, megadeals returned with a vengeance, as historically low borrowing rates, buoyant capital markets and inflated share prices prompted big transactions with the potential to remake industries — particularly in pharmaceuticals, technology and media.
The thirst for deals is expected to pour into the new year, led by the US and UK, where growth prospects are rosier than in other developed economies.
Wilhelm Schulz, head of M&A at Citigroup for Europe, Middle East and Africa, said: “A clear theme of this year has been the need for large European companies to make acquisitions outside their main markets. That outbound M&A is likely to persist in 2015.”
But by number of deals, Thomson Reuters data show that M&A activity climbed just 5 per cent from a year ago, meaning that midsized and small companies have yet to join in.
Henrik Aslaksen, global head of M&A at Deutsche Bank, said: “The large deals are masking subdued growth in M&A activity. The rate of growth of deal activity in the US is likely to normalise next year following a very strong 2014. However, we could see Emea activity pick-up from a comparatively low base.”
Three deals this year, including Comcast’s $71bn acquisition of Time Warner Cable and AT&T’s $67.2bn takeover of DirecTV, ranked among the 10 largest of the past decade if debt on the target company’s balance sheet is added.

The moves — which are reminiscent of the earlier dotcom days when AOL offered a stunning $164bn in stock for Time Warner — give the acquiring internet and media distributors greater purchasing power and scale.
Content makers responded, punctuated by 21st Century Fox’s unsolicited and later abandoned $80bn approach for Time Warner, the parent company of HBO and Warner Brothers film studio.
“What we’ve seen this year is not just large strategic deals that changed industry structures, but the speed with which consolidation happened,” said Michael Carr, head of Americas M&A at Goldman Sachs.
That differentiates from the pre-crisis period, which was dominated by large buyouts. Advising on nearly $1tn worth of deals, Goldman Sachs ranked first among advisory banks.
Energy was the busiest sector in the year to December 17, with oil services company Halliburton pouncing on smaller rival Baker Hughes last month in a $38.5bn deal that is seen as a prelude to further consolidation given the dramatic fall in oil prices. That trend continued last week with Spain’s Repsol acquiring Canada’s Talisman for $8.3bn. On Monday, UK-listed Afren said it had received an approach from Nigerian oil group Seplat.
Dealmaking helped the pharmaceuticals industry tackle the boom in biotechnology and the rise of challengers with tax-friendly corporate domiciles — the latter pressuring the US’s Pfizer and AbbVie to unsuccessfully pursue European rivals AstraZeneca and Shire in failed efforts to lowertheir tax profile.
Using its tax-efficient structure, Valeant became a household name with its dogged chase of Botox-maker Allergan, but it could not best a $66bn bid by rival deal-machine Actavis.
In many instances, investors blessed these aggressive actions, sending up stocks of acquirers and emboldening boardrooms.

Food the new frontier for Italian luxury

Christmas panettone crowd the copper counters of Pasticceria Marchesi, the 200-year-old Milanese coffee and cake house bought this year by Italian luxury goods group Prada.
Cakes and fashion may seem an odd coupling, but despite appearances food is emerging as a new frontier for luxury goods.
Sales of “Made in Italy” €1,000 handbags and €700 shoes may be slowing amid falling demand from Chinese buyers and austerity-minded US and European consumers. But premium Italian foods — from raisin-filled Christmas sponge cakes to Parmesan cheese and gianduja hazelnut chocolate — have become a feeding ground for investors looking to jump into the global trend for eating well.
“I’m convinced of an enlarged view of luxury and wellness,” says Patrizio Bertelli, chief executive and co-founder of Prada along with his wife, the designer Miuccia Prada. He plans to roll out a chain of Marchesi coffee and cake stores in Dubai, Hong Kong and Tokyo for starters.
Mr Bertelli is not alone in the fashion business in getting a taste for food. Bernard Arnault, chairman of LVMH, bought Cova, another Milanese pasticceria, last year and insiders say that, like Mr Bertelli, he has plans to expand.
Chart: Worldwide luxury market
Renzo Rosso, the entrepreneur behind Diesel and Marni, has bought BioNatura, an Italian organic food chain. Fashion designer Brunello Cucinelli is reclaiming industrial land flanking his hilltop village Solomeo where he intends to produce olive oil.
Meanwhile, in Italy’s wine industry a new generation of luxury entrepreneurs is seeking to put the stamp of their experience with branded high-end goods on a sector that has lagged behind better-marketed rivals in France and California.
Gaetano Marzotto, head of the Italian clan that developed Valentino and Hugo Boss, is behind Ca’ del Bosco, a high-end wine brand. Members of the Ferragamo shoe dynasty have developed wine labels Il Borro and Castiglion del Bosco, while the founder of Italian underwear chain Calzedonia is opening a chain of wine stores called Signorvino.
Chart: Italy wine exports
Luigi Consiglio, who has advised many of Italy’s food groups, says there are parallels between Italy’s nascent fashion industry in the 1980s and its food industry today — both feature small family-owned groups with great products that are able to command a premium overseas.
“It is not about just selling food, it is about selling dreams,” says Mr Consiglio.
Diego Selva, head of investment banking for Bank of America Merrill Lynch in Milan, says Italy’s premium food industry shares similarities with the luxury goods industry, such as “allure and exclusivity,” while facing the same obstacles, such as the need for “proper distribution and international presence”. “It is all to build,” he says.
Italy’s food exports totalled €27.4bn in 2013, up 27 per cent on 2007, its previous peak, according to Italian think-tank Censis in a report published this month.
Italy has several large established industrial food groups — Ferrero, maker of Nutella; pasta and dry goods group Barilla; and The Bolton Group, the world’s second-largest producer of canned tuna. 
But the new wave of investors in Italian food entrepreneurs is focusing on Italy’s biodiversity, its artisanal qualities and the great variety of its cuisine. Italy has 266 products which have an indication of origin — the DOC or DOCG marque — such as pesto from Liguria. This is higher than France, its closest foodie competitor, with 216.
Chart: Italy food exports
Companies including Giovanni Rana, which controls 40 per cent of the global market for fresh pasta, or the Italian food chain Eataly, are commanding multiples equal to those in the luxury goods industry.
Sales of Giovanni Rana pasta are up 20 per cent year on year. Eataly’s New York flagship is making €70m in revenues this year, having opened only in 2010.
Oscar Farinetti, the entrepreneur behind Eataly, which has more than 20 stores worldwide, plans to list the chain on the Milan stock exchange as early as next year to help fund expansion.
There is more growth potential than in personal luxury goods because healthy is a global trend
- Francesco Moccagatta, managing director, N+1 SYZ
The biggest private equity deal in Italy this year was Charterhouse Capital Partners’ €300m purchase of 80 per cent of Nuova Castelli, the largest Italian exporter of Parmesan cheese. Dante Bigi, the founder who still owns 20 per cent, said the aim is to increase production of its Parmesan cheese truckles to 400,000 a year from 120,000.
FSI, the Italian state private equity fund last month bought a stake in Cremonini, one of the big meat producers in order to fund its international expansion.
Francesco Moccagatta, managing director of N+1 SYZ, a mergers and acquisitions boutique, last year advised two Turkish businessmen on the takeover of Pernigotti, the Italian chocolate and ice cream company, which has €450m in revenues.
Chart: World wine exports
The attraction of Italy’s small food companies, he says, is that they are positioned to tap into projected changes in Chinese food consumption habits and to appeal to US and European demands for premium foods and general attention to wellness and eating well.
“There is more growth potential than in personal luxury goods because healthy is a global trend — it also costs €600 for a Louis Vuitton bag but €30 for a great piece of prosciutto,” Mr Moccagatta argues.
“Today you can also have it shipped anywhere in the world and the internet gives you a shopping window for the world,” he says.

Toyota: The World's Biggest Car Company Wants to Get Rid of Gasoline

The first thing you notice about the Mirai, Toyota’s new $62,000, four-door family sedan, is that it’s no Camry, an international symbol of bland conformity. First there are the in-your-face, angular grilles on the car’s front end. These deliver air to (and cool) a polymer fuel-cell stack under the hood. Then there’s the wavy, layered sides, meant to evoke a droplet of water. It looks like it was driven off the set of the Blade Runner sequel.
Just as the Prius has established itself as the first true mass-market hybrid, Toyota hopes the Mirai will one day become the first mass-market hydrogen car. On sale in Japan on Dec. 15, it will be available in the U.S. and Europe in late 2015 and has a driving range of 300 miles, much farther than most plug-in electrics can go. It also runs on the most abundant element in the universe and emits only heat and water—and none of the gases that lead to smog or contribute to global warming. “This is not an alternative to a gasoline vehicle,” says Scott Samuelsen, an engineer and director of the National Fuel Cell Research Center at the University of California at Irvine. “This is a quantum step up.”
The Mirai is hardly a speedster, though it’s quicker than a Prius. It can reach 100 kilometers (62 miles) per hour in 9.6 seconds. When you punch it, the car feels like an electric—there’s none of the vibration of a combustion engine. Driving the Mirai around a large, man-made island in Tokyo Bay called Odaiba is a little surreal. The interior is a Zen sanctuary of silence, save for the rush of wind passing around the vehicle and the occasional muffled sound of the suspension doing its work. The car can double as a mobile power station: A socket in the trunk can electrify the typical Japanese home for about a week in the event of an earthquake or other emergency.  
As cool as the Mirai is, selling it is a hugely risky move. While fuel cells are a proven technology, used by NASA during Apollo missions in the 1960s to generate electricity and produce drinking water, a mass market for fuel-cell cars will require big investments in hydrogen fueling stations that may not be forthcoming. And, thanks in large part to Toyota itself, the auto industry has sunk serious money into hybrids, plug-in electrics, and advanced batteries in the expectation that these technologies will dominate the post-gasoline era, whenever that may be. “Every manufacturer has multiple hybrids and electrics coming,” says Mike Jackson, chief executive officer of AutoNation(AN), the largest U.S. retailer of new cars, trucks, and SUVs. “And here you have Toyota saying, ‘We’re not going to go full electric. The ultimate answer is fuel cells.’ ”
Volkswagen (VOW:GR) CEO Martin Winterkorn, Nissan Motor boss Carlos Ghosn, and Tesla Motors (TSLA) founder Elon Musk all question the economic viability, environmental credentials, and safety of Toyota’s fuel cells. One could also ask why Toyota, which does well with its hybrids and plug-in electrics, is bothering with a commercially unproven technology that may undermine a core franchise. Akio Toyoda, Toyota Motor’s (TM) president and the scion of the automaker’s founding family, says there’s room for both plug-in electrics and hydrogen cars; he dismisses doubters. “Fifteen years ago they said the same thing about the Prius,” he says. “Since then, if you consider all [our] hybrid brands, we have sold 7 million of them.”
As the grandson of founder Kiichiro Toyoda, Akio’s elevation to the top job in 2009 was nothing short of the restoration of the Toyoda clan. The last family member to run the company, Tatsuro Toyoda, gave up control in 1995 after being waylaid by a stroke.Toyoda leads one of the most finely tuned capitalist enterprises in history. The company is on course to earn a record $18.2 billion this year—more than the combined projected profits of Ford Motor (F),General Motors (GM), and Honda Motor (HMC). But Toyoda doesn’t just want to sell cars. He wants to save the planet. “The automobile industry can contribute to the sustainable growth of earth itself,” he says, without a trace of irony. “At Toyota, we are looking out 50 years and even more decades into the future. I do believe that [the] fuel-cell vehicle is the ultimate environmentally friendly car. But the point is not just to introduce it as an eco-friendly car with good mileage. I wanted it to be fun to drive and interesting as a car.”
t 58, Toyoda is owlish, wears stylish, rectangular eyewear, and is fond of such concepts as smart mobility and sustainable growth. He speaks English pretty well and has a deep, raspy, and ready laugh. He almost always carries stickers in his suit pockets of Morizo, his cartoon alter ego, which he eagerly hands out. And he regularly suits up in tailor-made Nomex fireproof, red-and-white racing gear to drive souped-up Toyota rally cars at speedways around the world. Judging by his YouTube videos, he’s on a quest to achieve the perfect “Tokyo drift.” That’s a racing maneuver pioneered in Japan involving an interplay of gear shifts, braking, and oversteering to intentionally cause a car’s rear wheels to lose traction with a track’s surface in high-speed turns.

The burden of the Toyoda family’s legacy in a recession-prone Japan can be a heavy one. Despite record profits the last two years, Toyota faces challenges. China may be the fastest-growing car market in the world, but it’s a tough market for Japanese automakers given the toxic political climate between the two countries. Toyota and other automakers have recalled millions of vehicles this year to address air bag problems at Japanese supplier Takata.
Nor has Toyoda had an easy time establishing his credibility in a hierarchical and consensus-driven culture in which corporate elders, not young mavericks, are prized. “There was a civil war internally,” says John Casesa, senior managing director of investment banking at Guggenheim Partners and a former auto analyst. “Akio was not only not part of the professional management team, but he was a member of the family that’s a whole generation younger. He had a lot of the top of the institution stacked against him.”
Toyoda says he often channels inspiration from Kiichiro in quiet moments before the family butsudan, or Buddhist altar, at his home outside Nagoya. “My grandfather was 57 when he passed away, and I’m 58 right now,” he says. “I haven’t found the answer of what my role should be, so I ask him to please use my body to create the company that he wanted.”
Just outside Nagoya, in Toyota City, where company headquarters are based, the automaker has created a community of smart homes equipped with solar cells and energy storage devices that can allow plug-in vehicles to power the dwellings in emergencies. Residents can monitor their energy usage on tablet PCs and pay lower rates as a reward for conservation and off-peak usage.
Two other demonstration projects, one also in Toyota City and the other in Grenoble, France, suggest what the clean city of tomorrow might look like: ultracompact, electric vehicles for inner-city commutes that are networked to an intelligent traffic system. The more wirelessly connected trucks, cars, and buses there are, the greater the ability of software algorithms to reroute traffic, easing congestion and improving safety.
However gauzy and utopian these ideas might seem, there’s a business rationale behind them. The auto industry’s fast and furious expansion in recent decades may be, in many parts of the world, a spent force. Personal mobility is a wonderful thing, even crucial. Yet if you’re a commuter in Mumbai, where 12.5 million people are packed into about 230 square miles and six-hour traffic jams aren’t unheard of, driving to work is nuts. Only 14 percent of commutes there are by personal car, and more than half of all workers take the train, according to a report by Mumbai Railway Vikas. China, one of the last fast-growing frontiers of auto industry expansion, is an ecological wasteland. In the vehicle-saturated, rich countries, Uber’s ride-booking service and car-sharing companies such as Zipcar (CAR) offer alternatives to car ownership for a generation of younger urban commuters turned off by the expense of owning a car or concerned about the environment.
Toyoda sees the evolution of the car as nowhere near finished. By the time hydrogen rivals fossil fuels, he envisions even more dynamic radar systems, high-resolution lasers, and predictive data systems reducing traffic fatalities. Above all, he sees the fuel-cell car as the catalyst, as he puts it, in the “creation of a hydrogen society.”Cars, trucks, and other forms of transportation generate about 22 percent of the world’s greenhouse gas emissions, the International Energy Agency estimates. Auto accidents each year take a huge number of lives—some 1.2 million in 2013, according to the World Health Organization. So what happens when the number of cars and vehicles on the world’s roads more than doubles, from 900 million now (excluding two- and three-wheelers) to 2 billion by 2050, as the IEA forecasts?
 Toyota started its fuel-cell development in 1992, roughly the same time it began its work on the Prius gas-electric hybrid engine. By 2008, executives were keenly aware that Daimler (DAI:GR), Honda, and Hyundai Motor were also quickly moving forward with hydrogen car projects. Toyota Chairman Takeshi Uchiyamada, the driving force behind the Prius, decided to move the car out of development and into mass production that year. At the time, however, the cost of manufacturing a fuel-cell car was “close to $1 million per vehicle,” says Satoshi Ogiso, Toyota’s managing officer in charge of product development and chassis engineering.
The inability of fuel-cell developers to reduce costs was a big reason why the technology never took off in the 1990s and early 2000s, despite best-selling books such as The Hydrogen Economy by futurist Jeremy Rifkin. A number of car companies began developing fuel-cell vehicles, from Honda’s FCX to GM’s Sequel, but high production costs, plus battery technology advancements, swayed momentum to electric vehicles. Toyota says it made the Mirai economically viable by reengineering the fuel-cell stack with less expensive materials, reducing the amount of platinum in the catalyst that separates hydrogen protons from electrons (electricity), and standardizing the production equipment to make the car. Toyota’s earlier work with the Prius’s power electronics and batteries also gave it an edge, says Ogiso: “We had a kind of feeling that ‘We could do it with the hybrid, why not the fuel-cell vehicle?’ ”
Toyota’s fuel-cell launch is getting plenty of government help in Japan, where some early adopters will be eligible for a 2.75 million yen ($23,754) subsidy. In the U.S., Toyota will charge $57,500 for the Mirai. Federal and state incentives could reduce the price as much as $13,000, and Toyota plans to provide free fuel to early buyers. Customers can also lease the car for three years, at $499 a month.
The Mirai’s hydrogen tank can be refilled in less than five minutes via a large hose that pumps supercooled hydrogen into the car’s pressurized tanks. In California there are 13 research hydrogen-fueling stations, 9 public stations, and an additional 18 that have been funded and are expected to be operational in the next few years. Yet it will take a far bigger build-out to give the market for hydrogen cars a chance to develop. “Its infrastructure is constrained much more than electric vehicles, where you can charge them at home,” says Dan Sperling, director of the Institute of Transportation Studies at the University of California at Davis.
One of the Mirai’s most acerbic critics is Tesla founder Musk, who sees the post-gasoline world dominated by pure electric vehicles—preferably Tesla models powered by lithium-ion battery packs. More than four years ago, Musk invited Toyoda to his California home and let him take the company’s Roadster sports car out for a spin. It was quite a bromance. Within weeks, Toyota agreed to buy a $50 million stake in Tesla and sold a shuttered California factory to its new partner for a mere $42 million.
The two agreed to make an electric Toyota RAV4 and considered extending the collaboration to retrofit the Lexus RX SUV. The RAV4 EV flopped after Toyota slapped it with a sticker price of almost $50,000—almost double the gasoline version—and limited its availability to residents of California. The bigger issue was that Toyota embraced “fool cells,” as Musk dismissively calls them.
During a news conference in Tokyo following a Tesla event in September, Musk delivered an unforgiving takedown of hydrogen cars. Currently, 95 percent of U.S. hydrogen production is made from heating up natural gas, a process that produces greenhouse emissions. Fuel-cell vehicles such as the Mirai, Musk said, are “hydrocarbon-burning cars in disguise.” While EVs take hours to recharge, the fueling cost is a fraction of the roughly $45 a hydrogen fill-up will cost. Musk also noted that hydrogen, while well-suited to the rocket business, is “highly volatile and can have explosive consequences.”
Easing the minds of consumers familiar with the 1937 Hindenburg disaster will take some effort. Toyota engineered its hydrogen tanks with a three-layer structure of carbon-fiber-reinforced plastic and other materials that can withstand not only the usual crash dummy collision tests but also a bullet fired at close range. In the event of a leak, special sensors can shut off the hydrogen flow.
Musk’s comments have drawn return fire from Toyota North America CEO James Lentz. “If I put myself in Elon’s shoes, I’d be doing the same thing. He’s got his eggs in the electric vehicle basket,” he says. “There are drawbacks to EVs in the marketplace. Customers have range anxiety. There’s the length of time it takes to recharge.”
Musk and others have a point about one thing: The environmental benefit of fuel-cell cars won’t be fully realized if hydrogen isn’t eventually produced from renewable sources. Splitting water into hydrogen and oxygen using electricity, a process called electrolysis, from a renewable source such as solar is one option. Another is biomass conversion, the biochemical conversion of methane gas, say, from landfills into hydrogen. “There’s a high possibility that there will be many sources of hydrogen in the future, such as solar energy and even waste,” says Toyoda. Yet whether these methods will ever be cost-competitive with gasoline and diesel is unclear.
Every fall, Toyota’s top executives retreat to the towering pines and white stone courtyards of the Ise Grand Shrine on the Pacific Coast, about a four-hour train ride south of Tokyo. There, the company shows off its newest domestic models, and everyone pays homage to the Shinto sun goddess Amaterasu. This company loves its traditions, one of which is never to publicly criticize corporate elders.

Such restraint wasn’t shown in one of his first media appearances as president, where Toyoda sounded a little like a Greenpeace activist when he said that his company had fallen prey to “the hubris of success” and the “undisciplined pursuit of more.” That didn’t reflect well on his three nonfamily immediate predecessors—Hiroshi Okuda, Fujio Cho, and Katsuaki Watanabe.
That was in October 2009, when the industry was reeling from the financial crisis and five months after Toyota had reported a 5.5 billion yen loss. The company also became the target of U.S. regulatory scrutiny after multiple deaths were attributed to accidents involving unintended acceleration of its cars, leading to the eventual recall of 10 million vehicles over two years.
When Toyoda made an emotional apology before Congress in February 2010, he placed partial blame for the recall crisis on Toyota’s aggressive growth during the previous decade. Yet a quality review, ordered up by Toyota and led by American safety experts, concluded the problems ran deeper. The company’s slow response to acceleration problems dating back to 2002 owed much to its insularity, even arrogance. The internal review noted that Toyota was slow to respond to feedback from outside, including customers. In March, Toyota paid a $1.2 billion penalty to settle a U.S. government criminal probe into safety issues at the company. 

Toyoda struggled in the early stages of the crisis. “I have never seen Akio so sick; his face was white, and he was getting fat,” recalls Javier Quirós, Toyoda’s roommate at Babson College during the 1980s and president of Purdy Motor, a Toyota distributor in Costa Rica. “His grandfather and his father’s work was falling into a cascade, and he didn’t know what to do.” Auto industry consultant and author Maryann Keller believes the recall crisis was transformative for Toyoda. “Those are humbling experiences for somebody who wasn’t previously humbled,” she says. “That was a pivotal time that did change him.”
After years of emphasizing faster development cycles to revamp its lineup with freshly redesigned models, Toyoda tacked on four weeks of work to shore up the reliability and safety of each new car. The company named chief quality officers for North America and other regions, all of whom have direct lines to Toyoda. It also became one of the first full-line vehicle makers to make an advanced brake override system standard on new models. Toyoda has a moratorium on new assembly plants until 2016.
He took some criticism internally when he urged executives to return to basics and pull back from the breakneck plant and product expansions of the previous decade, according to Shigeki Tomoyama, a managing officer in charge of business development and IT. Given the company’s sales-driven culture, that was kind of like placing Godzilla on a vegan diet. “Only Toyoda could say that,” says Tomoyama. “He is from the family, so he’s allowed to talk about the longer term.” Toyoda is open about the second-guessing he sometimes gets from the company’s old guard. “The past presidents that I have spoken with say that I don’t understand my responsibility,” he says with a smile. “I believe that I’m aware and that I understand.”
Toyoda’s most immediate adversary may be prosperity. The automaker’s $210 billion market value is greater than that of Ford, GM, Honda, and Nissan combined—and eight times that of Tesla. The Toyota Camry is the best-selling car in America, and the revived Lexus brand and Toyota lineup finished No. 1 and No. 2 for the second straight year in the annual Consumer Reports quality survey of the U.S. new-vehicle market.
Toyoda could well run the company for roughly another decade. By then the world will get a better sense of whether his legacy play of fuel-cell vehicles and new forms of mobility has a realistic shot. It’s a world that his grandfather, Kiichiro, could scarcely have imagined. Yet one way or another, Toyota’s hydrogen car embrace will probably inform how Akio is remembered 30 years from now.