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Inside Honda's brain
The automaker's habit of poking into odd technical corners sets it apart - and gives it a big edge on the competition.
By Alex Taylor III, senior editor

(Fortune Magazine) -- As the lighting dims in the auditorium of California's Computer History Museum, a four-foot-tall robot, Asimo, strolls onto the stage. "Hello, Tiffany," Asimo greets its human assistant, in a voice slightly too flat to be human. "It's nice to see you." After a little more chitchat - Asimo, a polite sort, is thrilled to be in San Jose - the robot shows off some tricks. It balances on one foot, kicks a soccer ball, sidesteps in two directions, and climbs up and down stairs. For its final stunt, Asimo jogs around the stage, legs churning and arms pumping, leaving the ground between each stride - just the way a human would.

Asimo (derived from "advanced step in innovative mobility") is a remarkable technical achievement. Just balancing on one foot requires the constant adjustment of 34 small electric motors. Asimo can also move to a pointed direction, recognize faces, and distinguish sounds. The product of two decades of work by Honda engineers, Asimo is, in its unassuming way, very cool.

Yet with the auto industry in turmoil brought on by global warming and $100-a-barrel oil, why is Honda playing with robots? Or, for that matter, airplanes? Honda is building a factory in North Carolina to manufacture the Hondajet, a sporty twin-engine runabout that carries six passengers. Or solar energy? Honda has established a subsidiary to make and market thin-film solar-power cells. Or soybeans? Honda grows soybeans in Ohio so that it can fill up cargo containers being shipped back to Japan. The list goes on. All this sounds irrelevant to a company that built some 24 million engines last year and stuffed them into everything from cars to weed whackers.

But Honda makes it work; in fact, its research operations are one of the secrets to its success. For example, Honda researchers were curious about how the human brain reacts to images. They found that people recognize faces, especially angry faces, more quickly than other images. Honda has incorporated this research into its motorcycle designs (like that of the DN-01). By designing the front of the bike to evoke the features of the human face, Honda believes that other drivers will recognize the presence of a motorcycle more quickly and therefore lead to greater traffic safety.

Along with Toyota and BMW - the only other car companies to crack the top 20 among the World's Most Admired Companies (see chart) - Honda Motor (HMC) has a record of excellence. Since 2002 its revenues have grown nearly 40%, to $94.8 billion. Its operating profits, with margins ranging from 7.3% to 9.1%, are among the best in the industry. Propelled by such perennial bestsellers as the Accord, the Civic, and the CR-V crossover, and spiced with new models like the fuel-sipping Fit, Honda's U.S. market share has risen from 6.7% in 2000 to 9.6% in 2007.

The numbers speak for themselves. What they cannot express is the extent to which Honda's success is due to its willingness to let its engineers, well, dabble. Unlike Toyota ™, which is stodgy and bureaucratic, Honda's culture is more entrepreneurial, even quirky. Employees are paid less than at the competition, and advancement is limited, given Honda's flat organization. Their satisfaction and fierce loyalty to the company come from being around people like themselves - tinkerers who are obsessed with making things work.

The irony is that Honda's habit of looking into odd corners has given it a significant advantage in the industry's biggest challenge: finding a replacement for the gasoline-powered internal-combustion engine. Honda has expertise in half-a-dozen technologies, ranging from batteries to biofuels, giving the company a good chance of finding the right solution. "I would rank them at or near the top in gasoline engines, at or near the top in fuel cells, at the top in compressed natural gas, and No. 2 in hybrids, behind Toyota," says Mike Omotoso, senior manager of global powertrain forecasting at J.D. Power & Associates in Detroit. "Honda is trying to cover all the bases."

On fuel cells, Honda is literally years ahead of the competition. The FCX Clarity will go on sale in California this summer. It is powered by a fuel cell that uses no gasoline and emits only water vapor. Though mass production is at least a decade away, the Clarity is no mere test mule. Elegant and efficient, its hydrogen-powered fuel-cell stack is small enough to fit in the center tunnel - a significant improvement over other, bulkier power packs - and robust enough for a range of 270 miles.

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The wellspring of Honda's creative juices is Honda R&D, a wholly owned subsidiary of Honda Motor. Based in Saitama, west of Tokyo, R&D engineers create every product that Honda makes - from lawn mowers to motorcycles and automobiles - and pursue projects like Asimo and Hondajet on the side. Defiantly individualistic, R&D insists on devising its own solutions and shuns outside alliances. On paper it reports to Honda Motor, but it is powerful enough to have produced every CEO since the company was founded in 1948.

Honda's current president and CEO, Takeo Fukui, 63, spent some two decades at R&D working on motorcycles - Honda's original product. An engaging, slightly built man with a warm smile, Fukui meets R&D's management only once or twice a year. "I'm not in a position to give direct orders to the engineers in R&D," he said during an interview in Tokyo conducted through an interpreter. "This is a positive. On their own, they can carry out their work with a different set of values." That said, hardly a day goes by that Fukui does not talk to Masaaki Kato, president and CEO of Honda R&D. The engineer in Fukui cannot help but be intrigued by what his former colleagues are up to, and his office is only a few steps away from Kato's. But even with the CEO just down the hall, says Kato, "We want to look down the road. We do not want to be influenced by the business."

Right now, for example, scientists at the Honda Research Institute, established in 2003 as part of R&D, are conducting experiments in material and computer science that may never pay off. One recent project financed the development of nanocars the width of a single strand of DNA. The nanocar features a chassis, a pivoting suspension, and rotating axles, and yes, it can move. The market for cars too small to see is not a large one, but the point is that such efforts get Honda's car-obsessed researchers thinking. Now HRI is looking into the use of high-strength nanotubes made from carbon to use in automobile bodies.

As an engine company that specializes in transportation - it is still the world's largest manufacturer of motorcycles - Honda allows its engineers wide latitude in interpreting its corporate mission. "We've been known to study the movement of cockroaches and bumblebees to better understand mobility," says Frank Paluch, a vice president of automotive design. Honda R&D gets about 5% of Honda's annual revenues. Most of the money goes to vehicle development, not cockroach studies, but there is plenty left over for special projects, in part because Honda limits the number of models it makes: There are 15 for sale in the U.S., compared with 28 for Toyota.

Honda R&D has a distinct identity within Honda - a cult within a cult. All employees at research centers (there are 13 in North America) wear white uniform pants and jackets with a red Honda logo embroidered over the pocket. In the U.S. there are more than 2,000 R&D engineers; they have a reputation within the company for a kind of edgy attitude. At the offices in Dublin, Ohio, a stone's throw from Honda's Marysville factory, engineers often roar to work on motorcycles. "We have a lot of boy racers," says Paluch, vice president of automotive design at Dublin. "Not a heck of a lot of bean counters drive in here."

The birth of the Hondajet captures R&D's spirit. In 1986 a young engineer named Michimasa Fujino was plucked from his work on the NSX sports car to join a team beginning research into aviation. Honda later put the project on the back burner, but the group persisted, toiling away discreetly in a corner of the research center outside Tokyo. In 1997, Fujino proposed a new design for the plane with the engines mounted above the wings; this made for a roomier cabin and greater fuel economy. The unconventional design won over management, and the project moved from the corner to the heart of things.

The Hondajet made its first flight in 2003, and the company began accepting orders for it in 2006. One of the first of a new class of very light passenger jets, it is due to go on sale in 2010 for $3.9 million - or about 125 times more than the most expensive Accord. Honda has already booked more than 100 orders and thinks it can sell 70 planes a year, mostly to corporate fleets and the nascent air-taxi industry. Kato anticipates a "ten- to 20-year payout."

To channel its freewheeling ways, R&D managers meet annually to review the most promising projects. Each gets specific timelines that are closely watched. Within this disciplined framework, though, R&D's expansive charter leads it in directions no other car company would attempt. For instance, Honda isn't just developing exotic engines but the infrastructure to service them as well, such as a hydrogen home-refueling station that takes up the space of a refrigerator.

For the more conventional work of developing new models, R&D is reined in to a degree, working with the parent company's sales and manufacturing divisions. When R&D wanted to introduce a new body structure to protect pedestrians as well as occupants in a frontal crash, it meant redesigning components like the bumpers and windshield wipers and raising the profile of the hood. That changed the way the cars looked and introduced some wrinkles into the manufacturing process. Those kinds of competing priorities can make cooperation stressful.

CEO Fukui likes to say that Toyota "spends a lot of money on advertising but not so much on R&D." At times, however, Honda R&D's lack of consumer orientation has led it astray in a way that would be almost unthinkable at Toyota. When Honda launched the hybrid Insight in 1999, for example, it beat all manufacturers to the U.S. market (the Toyota Prius came six months later). But while the Prius looked like a conventional small car, the Insight resembled a science project; it didn't even have a back seat. Honda halted production in September 2006 after sales dropped to embarrassing levels. Toyota sold more than 180,000 Priuses last year.

Such miscues can happen when scientists are behind the wheel. Recognizing that, Honda reorganized R&D two years ago to tie it more closely to specific business functions. The intent is not to clip R&D's wings; Honda scientists are still encouraged to think expansively. But as a project approaches the market, the company is asserting more supervision. Besides, mistakes like the Insight are also the exception. R&D has provided Honda with a long list of engineering firsts that consumers liked, including the motorcycle airbag, the low-polluting four-stroke marine engine, and ultralow-emission cars. Honda thinks it has another winner next year - a small hybrid (still unnamed), that will sell for less than $20,000. Details are still secret, but this one is likely to have a back seat. Asimo is quiet about it; the robot is not programmed to have an opinion just yet. Paluch, though, has a vision: "Asimo, jet planes, automobiles - they are all going to converge at some point," he predicts. No, he doesn't know how or when. Neither does Kato. But then, they don't need to. Honda is willing to let them dream.

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