Honda Goes Whole Hog for Hybrids

TOKYO - With a solid lineup of small cars and superflexible factories that can quickly shift from SUVs to subcompacts, Honda Motor (HMC) has prospered lately. In June the Japanese automaker saw its sales jump by 14% even as its biggest rivals slumped.

But Honda's satisfaction with its results is tempered by the knowledge that they might have been far better if the carmaker had gotten its hybrid strategy right. While the company was the first major automaker to offer a hybrid in the U.S.—the Insight, introduced in 1999—Honda's efforts have long been overshadowed by Toyota Motor's (TM) success with the Prius. Honda misread what customers wanted, acknowledges research and development chief Masaaki Kato. As a result, the company has sold just 277,000 hybrids to date, compared with Toyota's 1.5 million. Honda stopped making the two-seat Insight in 2006 and last year ditched an unpopular Accord hybrid. Today, the company sells only one hybrid model: a version of the Civic compact. "I must admit that Toyota was better with its strategy of focusing on the Prius and trying to build an environment-friendly image," he says.

Now, Honda is fighting back. By early next decade, it aims to sell 500,000 hybrids annually, up from just 55,000 in 2007. Next year it expects to offer a new compact in the U.S., Japan, and Europe that, like the Prius, will be sold only as a hybrid. Honda has high hopes for the car, and wants to sell 200,000 units a year eventually. In 2010, Honda will launch a hybrid sportster based on a sleek concept car called the CR-Z that it unveiled at the Tokyo Motor Show in October. That same year, Honda will likely release a new hybrid Civic, and it's planning to market a hybrid version of the Fit subcompact soon thereafter.

As sales pick up and Honda gets better at making hybrids, the company expects to reduce costs sharply. R&D boss Kato says he can bring the price differential between a hybrid and an equivalent gasoline-only car below $2,000. While not as powerful as Toyota's hybrid technology, the Honda system is lighter and less complex, so its new models may offer better gas mileage. Honda hasn't disclosed pricing, but the compact hybrid due next year could retail for around $18,000-$3,000 less than a Prius, reckons Tatsuo Yoshida, an analyst at UBS (UBS) in Tokyo. He adds that while selling 500,000 hybrids a year will be a challenge, the new cars could also help Honda steal some of the green limelight back from Toyota. "Publicity-wise, the new hybrids are very good news for Honda," he says.

RISKS OF THE ROAD

Honda is less interested in hybrid technology for heftier vehicles. Unlike Toyota, which makes hybrid versions of the Highlander SUV and some large Lexus models, Honda believes cleaner diesel is more appropriate for bigger cars. Next year, it's planning to add diesels to its Acura luxury line. Kato says Honda could introduce larger hybrids in the future, but its lighter hybrid system is less suited to big vehicles than Toyota's technology is. And he says he's skeptical of plug-in hybrids, which can be recharged using home electricity. Battery technology, Kato says, simply isn't ready.

Honda's rapid hybrid expansion has its risks. First, there's no shortage of potential competition in greener cars. By late 2010, Toyota plans to introduce five new hybrid-only models in the U.S., including a revamped Prius, a minivan, and a new Lexus-some of them plug-ins. "Without focusing on measures to address global warming and energy issues, there can be no future for our auto business," Katsuaki Watanabe, Toyota's president, said at an environmental forum in Tokyo on June 11. European automakers have a slew of new, cleaner diesels in the works, and GM is developing the electric-powered Chevrolet Volt. Even Nissan Motor (NSANY) chief Carlos Ghosn, once skeptical about hybrids, is promising electric vehicles for the U.S. and Japan for 2010.

LOWER MARGINS

Selling more hybrids could also eat into Honda's profits. Small cars typically offer lower margins than bigger vehicles, and adding hybrid technology is expensive. That means Honda will earn less on its new hybrids than it does on most of its current range of models, at least until it can pass on the full cost of the technology to customers. "They're finally getting the strategy right in terms of how they're going to position their hybrids in the market, but do the numbers add up?" asks Andrew Phillips, an analyst at KBC Securities in Tokyo. "They're going to have to be really careful on the cost and achieve their volume targets."

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