NAGOYA, JAPAN – Despite critics’ claims of missed targets and mistaken business priorities, post mortems on Toyota Motor Corp.’s launch of its Lexus brand into the Japanese market are premature.

As the luxury brand approaches the halfway point of its second year, opinions are divided about the past, present and future of its performance.

Sales during the first 12 months, factoring for a staggered launch of three models in August and September 2005, totaled nearly 27,000 units – 25% below target. Meanwhile, plans to boost sales to 60,000 in 2008 and 100,000 after 2010 have been put on hold.

Yasuhiko Yokoi, managing officer in charge of Toyota’s Lexus marketing division, admits initial sales targets were too ambitious.

“We were too aggressive,” he tells Ward’s at Lexus sales headquarters here. “But keep in mind that our primary objective was building the brand.”

The current annual sales goal, based on targets for four models now in dealer showrooms, is 51,000 units. While reaching that level is unlikely until the brand expands its model lineup, approximately 40,000 units is within reach next year if current monthly sales trends continue. This is due, in part, to the popularity of the all-new LS 460, the brand’s flagship model, which went on sale in September.

If internal customer satisfaction audits are accurate, the auto maker has made substantial progress, with nearly 70% of new Lexus owners giving the brand high marks, Yokoi says.

“High scores correlate with second-time purchases,” he explains. “Because the Japanese market is so mature and growth prospects are limited, our focus must be on lifetime customers.”

In particular, Yokoi sees opportunity among well-to-do seniors and retirees, reflecting Japan’s aging population, 20% of which are now 65 and older.

“These are people who want to buy something with ‘emotional value’ – and will pay for it,” he says.

Yokoi admits to problems in launching Lexus’s Japanese dealer network, some 160 franchises comprised almost exclusively of Toyota sales companies. But he believes most issues have been resolved.

Ironically, Lexus has gone back to the future to cultivate its new sales culture. In a throwback to the practices of the 1950s and 1960s, Lexus is attempting to personalize its services, doing everything for customers, including filling out registration and insurance forms, visiting homes to answer questions and picking up cars for inspection and repair, Yokoi says.

It is not clear whether Lexus will invigorate Japan’s static luxury car market, which, depending on how the segment is defined, has peaked at about 200,000 units annually. Yokoi believes the brand will stimulate growth by fostering competition. However, views from analysts range from pessimistic to guardedly optimistic.

“First-year sales were disappointing,” says Kunhiko Shiohara, managing director at Goldman Sachs Japan Ltd. “The lineup is too small, and Japanese consumer interest in cars, in general, is diminishing.”

Seiji Sugiura, senior analyst with HSBC Securities (Japan) Ltd., adds introducing Lexus in Japan “was a mistake, as (most) models are carryovers from Toyota models with an expensive price that is hard to justify.”

The IS 250, Lexus’ entry model, is priced from ¥3.9 million ($33,900), ¥1.7 million ($14,800) more than the previous generation of the car, known as the Altezza in Japan. Meanwhile, the LS 460, starting from ¥7.7 million ($67,000), carries a ¥2 million ($17,400) premium over the Celsior, the domestic version of the LS 430, which was phased out in June.

Others are less pessimistic and feel that first-year sales were disappointing, in part, because Toyota set its own bar too high, particularly for the entry-level IS, which came in 40% below target.

“The targets were extremely aggressive,” says Ashvin Chotai, director of Asian automotive research for the London office of Global Insight Inc. “The next few years will be key, although I expect Toyota to eventually succeed because they’ve made a strategic commitment to Lexus.”

Adds Lance Ealey, head of automotive consulting for Freedonia Group: “Setting aggressive sales targets, then not meeting them, is a self-inflected wound. Toyota must now be careful not to do something to devalue the brand.”

“Without question,” he says, “they (Toyota) should focus on the flagship (the LS 460), while further promoting exclusivity.”

So far, the LS 460 is off to a fast start with some 12,000 orders placed through its first month on sale.

This pace puts the LS 460 on a course to blow past primary competitors BMW 7-Series and Mercedes-Benz S-Class. However, those cars, priced at ¥17.5 million ($151,000) and ¥19 million ($165,000), respectively, could be considered in a class by themselves.

Not included in Lexus’ sales tallies in Japan are its cross/utility vehicles (RX, GX and LX), which in North America compete directly against BMW’s X3 and X5 and Mercedes’ G-, GL- and M-Class models, all of which are sold in Japan.

Combined, the three Lexus models account for nearly half of the brand’s global sales, while the RX, sold in Japan as the Toyota Harrier, is on track to post record deliveries this year of 170,000 units.

Yokoi has not ruled out introducing a Lexus CUV in the future, but not in the near-term. “For the time being we will concentrate on sedans,” he says. “Remember, it took nearly a decade before we expanded our North American lineup beyond sedans (introducing the LX 450 SUV in 1996).”

Some analysts speculate that if Lexus were to add the RX, GX and LX to its Japanese lineup, or perhaps a new RAV4-based compact SUV believed to be in the works for North America, the brand’s sales total would come close to the auto maker’s long-term target of 100,000 units.

In addition, if the LS 460 achieves its monthly target of 1,300 units, it will pass all but one Mercedes and BMW model, the BMW 3-Series. However, all models sold by the three luxury brands still trail models of Toyota’s Crown priced above ¥4 million ($35,000), the traditional cutoff point for the luxury segment in Japan.

Still, some analysts are skeptical. Chief among their concerns is image – or lack thereof – for a brand that has become so much a part of the popular culture in the U.S.

“The U.S. and Japanese markets are inherently different,” says Koji Endo, Tokyo-based research chief at Credit Suisse Securities (Japan) Ltd. “Image, for instance, is clearly more important in Japan, where Mercedes-Benz and BMW are nothing if not status symbols. It will be difficult for Lexus to woo away their customers.”

Yokoi is aware of this problem and doubts whether even the LS 460, despite its many high-tech features, will take away business from BMW and Mercedes. Yokoi is bullish, however, about the LS 600h, due out next spring, and insists the gasoline-electric hybrid vehicle has great potential to cut into the traditional customer base of the brand’s German rivals.

“We feel our hybrid technology will give BMW and Mercedes owners an excuse to switch,” he says.

So confident is Yokoi about the LS 600h that he predicts monthly sales of 200 units, which would put the model in the same volume range as BMW’s 7-Series. And while not confirming the car’s price, the executive says the base model will list for more than ¥10 million ($87,000).

Whether other technologies in Toyota’s arsenal will succeed in giving Lexus the same sort of luxury cache its European rivals have is unclear. But engineers at the auto maker’s 3-year-old Lexus Development Center are focused on accentuating differences between Toyota and Lexus brands while adding value in areas visible to the human eye, such as trim, seats, dashboard displays and other advanced technologies.

Lexus models get more vibration damping material than Toyotas, for example, allowing for a smoother and quieter ride. Lexus models also feature the auto maker’s most advanced safety and telematic systems, such as the latest Vehicle Dynamics Integrated Management (VDIM) system, which combines active steering, vehicle stability and brake controls.

Insiders, while noting that the Lexus Development Center still is only in its fourth year of operation, expect to see sharper differentiations when the next generation of models comes out in 2010 and 2011.

Meanwhile, much of the disagreement over Lexus’s performance is the direct result of confusion over what constitutes a luxury car in Japan.

For instance, some analysts count virtually all Mercedes and BMW models as luxury vehicles, regardless of price. Conversely, others exclude Toyota’s ¥11.1 million ($97,000) Century and Nissan Motor Co. Ltd.’s ¥8.4 million ($73,000) President and ¥5.3 million ($46,000) Cima, domestic versions of the Q45, Nissan’s top-of-the-line Infiniti model in North America.

In fact, based on a minimum sticker price of ¥4 million ($35,000), Toyota – not Lexus, Mercedes or BMW – is the leading luxury brand in Japan when sales of the Century and Crown, along with certain Land Cruiser and Harrier models, are included.

Largely forgotten in the discussion about Lexus’ performance is the reason why Toyota introduced the brand into Japan in the first place: There is virtually no money to be made in Japan from selling standard cars given the market more or less peaked in the mid-1990s. Competition in small-car segments, which now account for more than half of demand, has intensified, as well.

Credit Suisse Japan’s Endo estimates that Toyota makes less than ¥100,000 ($900) for each Corolla it sells. Margins on 0.66L minicars and 1.0L-1.5L B-segment cars, such as the Toyota Vitz, are even less.

Particularly problematic for the auto maker were the small profit margins (generally less than 10%) for premium and upscale cars such as the Crown, Altezza and Aristo. Even the Celsior, which by all accounts was exceedingly profitable, made less money than the LS 430, its Lexus counterpart in North America.

It still is too soon to grade Toyota on its strategy, but early signs are not discouraging. Of 161 Lexus franchises, most would appear to be in the black after just one year of business.

Meanwhile, the Japan operation is expected to play a key part in Lexus achieving its 2008 global sales target of 520,000-530,000 units, up from an estimated 470,000 in 2006.

Looking ahead, Yokoi expects North America to remain the biggest market for the brand, with Japan, at least for the midterm, coming in second.

“Although the market trend is down in Japan, the Lexus introduction was a strategic gamble, not a mistake,” says Kurt Sanger, senior analyst at Macquarie Securities (Japan) Ltd.

Adds Chris Richter, a Tokyo-based analyst with CLSA Asia-Pacific Markets Ltd.: “Japan is a tough market to crack. It’s going to be slow going, but Toyota will succeed here, eventually.”