The grandson of the founder has the carmaker back on track after a spell of bad luck and breakdowns.

By Alex Taylor III, February 9, 2012

FORTUNE — When the final tally was made for 2011, Toyota Motor (TM), formerly the world’s largest automaker, slipped to third place in production behind General Motors (GM) and Volkswagen. It’s not surprising: Toyota has endured a string of calamities over the past three years — natural and man-made — that would make even the company’s famous paranoia seem like sunny optimism. The latest is endaka, the strong yen that causes everything that Toyota manufactures in Japan to be more expensive and undermines its profitability. A November issue of Automotive News predicted “more misery” for Toyota as “sales slip, floods delay, shoppers stray.”

At the head of the company all this time has been a young president who was effectively born into the job and has little experience in crisis management: Akio Toyoda, the grandson of the company’s founder. For a decade, while the automaker was being run by professional managers, Akio rose up the corporate ladder without making much of a mark. (For the sake of clarity, we’ll use his first name, pronounced a-KEY-o, in this story.) Thrust into the presidency in 2009, he immediately had to cope with a global recession, massive recalls, and a deadly tsunami. Auto production plummeted, and at the same time Toyota lost its most important competitive advantage: its reputation for exceptional quality. Americans saw Akio apologizing before Congress and later tearing up in a YouTube video. U.S. market share tumbled. After reaching 18.3% at the end in 2009, it fell all the way to 12.9% for 2011. Emboldened by the recall crisis, competitors spread word that Toyota, once considered the unstoppable force of the automotive world, had been reduced to the status of also-ran.

But I had been hearing different things — that Toyota had coped remarkably well with the tsunami, and that the recall crisis had served as a wake-up call for a company grown complacent. With a big boost from its new president, who took an intensely personal interest in its products, it was connecting with customers again.

The University of Michigan’s Jeffrey Liker, a leading Toyota scholar, told me, “Akio has reenergized the company. He’s promised to be the closest president ever to the gemba [where the real work is happening].”

Toyota’s big product offensive

The Toyoda scion was traveling to the U.S. more frequently to fire up dealers and had taken charge personally of the sagging Lexus brand. Independent studies were beginning to show that Toyota cars were regaining their reputation for quality and value. With 19 new or redesigned models coming in calendar 2012 — an exceptionally large number — including a big expansion of the Prius hybrid line, the Toyota steamroller seemed ready to regain its old momentum.

One of Toyota’s guiding principles in times of crisis is genchi genbutsu, or “go and see.” So to find out for myself what the changes meant for a company I had been covering for more than 20 years, I interviewed Toyota executives in California and New York, and then flew to Japan.

Of all the woes Toyota has suffered, none has stung like the recall crisis of 2009-10. Ignited by reports of horrific accidents, some fatal, caused by cars that ran out of control and couldn’t be braked to a stop, it eventually involved the recall more than 8 million Toyotas and Lexuses — equivalent to a year’s production. Independent investigations turned up no mechanical or electronic defects — only some misplaced floor mats and sticky accelerator pedals to go along with driver error — but exposed major flaws in the corporate culture. Toyota, it turned out, was still being managed the way it had been in the 1950s: Every decision was tightly controlled in Japan; the U.S. was treated like a vassal state. When American managers found defects in vehicles, they had to follow a tortuous bureaucratic process to register their complaints in Japan, where they were often met with skepticism and defensiveness. As it had long feared, Toyota had succumbed to “big-company disease.”

Consumer confidence in its cars plummeted, and Toyota’s higher-ups were shaken. “We learned we are not so ahead of competitors as we might have thought,” Yoshimi Inaba, who heads sales and administration in the U.S., told me. “We were a little complacent.” Toyota began to develop quicker reflexes. When a defect was identified in a Lexus SUV, Toyota organized a recall in just eight days. But it balked at delegating more executive authority to America. Rather than designate one person to head all of its North American operations, it maintained its traditional silo structure. Its giant sales operation in Southern California, and its equally large manufacturing complex headquartered in Kentucky, continued reporting to different executives in Japan.

Just as it was trying to put the recall crisis behind it, the new management was tested again in March, when an earthquake and massive tidal wave disrupted production. The tsunami damaged plants in the north of Japan, disrupting the supply of over 500 parts, and Toyota couldn’t find replacements. Its first-tier, just-in-time suppliers near Toyota City were not directly affected, but up north were second- and third-tier suppliers that Toyota did not know much about.

Akio assembled general managers of departments such as body engineering and powertrain in Japan, and took the unusual step of instructing them to restore production and not waste time reporting upward. They sent two-man teams of engineers to visit each supplier plant and to identify and locate backup parts until the suppliers were running again. By April, unavailable parts were down to 150, and by May, according to Liker’s count, all but 30 of the 500 parts were available. Toyota solved the problems in half the time expected, but Liker figures the company still lost 800,000 production units — 10% of its annual output. Plans to make up most of the shortfall through overtime work were pushed back by October floods in Thailand that affected about 100 suppliers. As a result, inventories in North America won’t be completely replenished until March.

As I fidgeted through a 14-hour flight to Japan in a well-worn Boeing 777, I wondered what I would find. I figured Toyota had gotten some bad breaks, but I wondered about how committed this ponderous and bureaucratic company was to change.

After overnighting in Tokyo, I moved on to Nagoya, Japan’s third-largest city — one hour and 40 minutes away by Shinkansen bullet train — where Toyota occupies several office buildings. I met with executive vice president Yukitoshi Funo, one of Akio’s key advisers. Funo, who holds an MBA from Columbia and formerly oversaw U.S. sales, told me there had been an upheaval at Toyota. “[Akio] has dramatically changed the way the company is managed,” he said through an interpreter. “There are two major pillars to how he manages: First, be fast; and second, be flexible. Usually Japanese companies are based on a ‘bottom up’ management style, which slows down the pace of decision-making. In looking at other companies, we realized the need for a certain level of ‘top down’ to move quickly.”

Akio shrank the board of directors by half and took out layers of management. Funo revealed a more significant development: Akio has begun meeting informally with his five top advisers every Tuesday morning to review the company’s operations. They work so closely together that Funo called it “pit work” management. No agendas or written reports are allowed, and decisions are made on the spot. “Basically, the six people have a very strong personal bond. So it’s not a very emotional or heated debate as we have a very good understanding among each other.” They can move quickly. After Akio visited Tesla Motors (TSLA) in California in 2010, the Tuesday morning meeting signed off on a $50 million investment in the electric-car maker. Subsequently Toyota agreed to buy $60 million worth of Tesla batteries to power its all-electric RAV 4 crossover.

Funo said Akio has made another fundamental change in the way Toyota is managed. Traditionally, Toyota has rotated its top executives, so a sales specialist could be assigned to purchasing, or a product engineer to manufacturing. Now they stay within their specialties so that they can leverage their experience. “It’s very American,” said Funo. “I’m not really sure how what he learned at Babson [the Boston college where Akio studied business] has affected how he is running the company. But he is not typical Japanese management.” That turned out to be an understatement.

The next day I made the 40-minute car ride to Toyota City to meet with Takeshi Uchiyamada, Toyota’s top engineer and another participant in the Tuesday morning meetings. In 1993, Uchiyamada accepted the challenge of Toyota’s elders to develop a car with 50%-better fuel economy; today he’s known as the father of the Prius. More than 3 million of the hybrids have been sold since 1997, and it has been expanded into a sub-brand with additional models.

Akio is pushing Toyota to make “always better cars,” and Uchiyamada is the point man. For years enthusiasts have complained that Toyota treats cars like transportation appliances and allows companies such as Hyundai to seize design leadership. Uchiyamada says the critics were right. He told me: “Basically, Toyota’s growth had been underpinned by QDR [quality, dependability, reliability] that was very high compared with competitors’. However, since the Lehman shock [in 2008], large-scale sales of Toyota vehicles have decelerated. Compared with past practices, we need to make products that are even more attractive. We have stepped up our efforts emphasizing design, high quality of the interiors.”

Appearances count, but Uchiyamada has no intention of allowing Toyota to lose its green credentials either. This spring Toyota will launch the plug-in Prius, a $32,000 car that he believes is the best short-term solution to freeing the automobile from gasoline. Unlike conventional hybrids, the plug-in has a large battery that can power the car for up to 15 miles on electricity alone and be recharged at home. “I think the plug-in is the most practical technology of the future that will see great potential for mass dissemination. It can be recognized as an electric vehicle without having to worry about running out of battery. If the battery runs out, the car can be driven as a normal hybrid, so the amount of battery mounted in the vehicle can be minimized.” I asked him how he compared the Prius to the much-publicized Chevrolet Volt, and he gave me a surprisingly candid answer. “The Volt has a longer driving range in EV mode, but for that they have greater battery volume. After the battery runs out, the Volt’s power performance deteriorates when driven by a gasoline engine. So I believe the cost of the Volt will be higher than the Prius plug-in.”

Akio Toyoda’s Toyota timeline

When my interview with Uchimayada concluded, it was time for the meeting with Akio. It was to be held in a characteristically Japanese setting: a meeting hall in a private park near Toyota headquarters, where the company had reassembled the former residence of Kiichiro Toyoda, Akio’s grandfather. Akio bounded into the interview room with the energy of a TV game show host, clearly more confident and relaxed than the man I had met 2½ years earlier, just after he had become president. Seated at a table across from me, he took questions in English and watched me intently while the interpreter translated his answers from Japanese.

Unlike his gray-suited, office-bound predecessors, Akio, 55, is more comfortable in a fire-resistant Nomex suit and crash helmet than he is in a coat and tie. A certified test driver, he evaluates as many as 200 Toyotas and competitive vehicles annually, and appears happiest when he’s behind the wheel. After speaking at a U.S. dealer meeting in Las Vegas last April, Akio unwound by driving an 850-horsepower NASCAR stock car at a nearby speedway. His passion, he says, has made it easy for him to settle into his job as president. He explained, “I was very glad to hear from my father [honorary chairman Soichiro Toyoda], ‘I leave everything in your hands.’ Of course, over the past two years the environment has seen dramatic change, but one thing I maintained, which I think protected me from these hardships, is that I love cars, and I kept saying to people constantly that we need to come up with always better cars. Whenever a new car is launched I have to drive it myself. So by trying out as many vehicles as possible, I think I can compare Toyota cars with comparable vehicles, and by driving directly I can understand the strategic direction of the company.”

Much of his wheel time recently has been in a Lexus. Although it is intended to be a global brand, the Lexus has never caught on in Europe, and its aging designs were turning off U.S. buyers. Akio bypassed several layers of management to take direct responsibility for the brand and invested hours fine-tuning the ride and handling of the latest model, the 2013 GS. To give Lexus a sportier image, he also championed the development of the $375,000 LFA, a carbon fiber supercar, and personally tested the car on Germany’s famed Nürburgring, where speeds top 180 mph.

“It has a limited production run of 500 units,” he said of the LFA. “It seems to be a very secret sauce.”

Does it make sense for the head of a company as large as Toyota to spend so much time evaluating its products and micromanaging small details? Well, it worked for Steve Jobs, and Akio believes it is an essential component of his leadership. “As you know, our cars are evaluated as good, not emotional,” he said. “I think it’s possible for Toyota to improve upon the emotion of cars. There are capable engineers who are about to do that. So what I think is needed is to really have a champion to encourage people to take action on that, to serve as a leader to address any problems after a challenge.”

The smooth functioning of his Tuesday morning group makes it possible for Akio to spend more time with product development. “Actually I was very uncomfortable since I was a little boy with so-called yes-men who were just obedient to what I said. These five executive vice presidents who support me are experts in their respective areas, with experience of more than 40 years. I am the ultimate person in charge of this company, [but] I found it is very important to ask them for their views.”

One topic on which advice is plentiful is how to deal with the strong yen, which has appreciated 35% since 2007 and is at a 65-year high. At 77 to the dollar, the currency cost Toyota $1 billion in profit during the quarter ended Sept. 30; Toyota needs an exchange rate of 80 yen to the dollar to remain profitable. It is working with its suppliers to reduce costs, but the currency imbalance threatens the future shape of the company. Already two-thirds of Toyota production comes from overseas, compared with half as recently as 2006. Akio has pledged to maintain a manufacturing base in Japan with a capacity of 3 million cars to protect parts makers and its skilled-labor supply, but Funo said that number “is not carved in stone” and that Toyota may shift more production to the U.S.

I had more questions to ask Akio, but my hourlong time slot had expired. He stayed around to shake hands and pose for pictures. Then he ducked into a black LFA and drove off, the sound of the exhaust growling in his wake.

Most of my concerns about Toyota had been addressed. No company is better at the nuts and bolts of the car business, but years of success had hardened some ill-advised practices that are now being discarded. Akio had personally taken on its most persistent shortcoming — an inability to connect emotionally with customers through its products — and he was making progress. Toyota does not make a practice of showing future models to outsiders, but I learned from dealers that the 2013 Avalon sedan, due next spring, will be something special in style and appeal. If subsequent models achieve a similar high standard, then Akio’s mantra of “always better cars” may join the Toyota lexicon alongside genchi genbutsu.

This article is from the February 27, 2012 issue of Fortune.