Analysts had predicted that Toyota would eventually overtake General Motors as the No.1 selling car manufacturer in the world--but few knew it would happen so soon. In April 2007, Japan's irrepressible auto giant reported sales of 2,348,000 units, compared with GM's global sales of about 2,260,000 units. The numbers marked the first time Toyota beat GM in global sales. The successful quarter was driven by strong demand for fuel-efficient vehicles, such as the Corolla and Prius.

Detroit's Big Three automakers have been in sharp decline for decades, as concessions to the United Auto Workers (UAW) have hobbled GM, Ford, and Chrysler with burdensome pension and health care expenses--almost to the point of bankruptcy. Continued failure to bring labor costs under control could keep Toyota on top for the foreseeable future.

Caving to UAW demands isn't the only reason for the Big Three's big slide--government fuel economy regulations also have a stranglehold on U.S. manufacturers. Corporate Average Fuel Economy (CAFE) standards--which require car and truck fleets to average 27.5 mpg and 20.7 mpg respectively--force U.S. automakers to produce vast numbers of compacts that aren't in high demand. But since U.S. companies must produce these cars in order to comply with CAFE standards, they end up slashing prices and selling the compacts at huge losses. GM Vice Chairman Bob Lutz once blogged that the CAFE regulation is analogous to "trying to address the obesity problem in this country by forcing clothing manufacturers to sell smaller, tighter sizes."

Detroit's troubles are only partly responsible for Toyota's ascendancy. Toyota's rise from a World War II truck maker for the Imperial Japanese Army to the planet's top selling car manufacturer is owed to an innovative production philosophy known as "The Toyota Way." According to Yuki Funo, chairman and CEO of Toyota Motor Sales USA, The Toyota Way includes the Japanese ideal of continuous improvement, or kaizen, a commitment to constantly seeking better ways of doing things in order to achieve greater efficiency and quality. Though kaizen is a never-ending pursuit, Toyota's ultimate aim is to build cars with no defects.

If the idea of flawless production is impressive, outselling U.S. automakers on their home turf is perhaps even more so. Mr. Funo sees Toyota's victories through the lens of the economic and language barriers his company has overcome to make and sell cars in America: "The biggest economy in the world is the U.S.—bigger than Japan. It's the Big Three who have an advantage in operating in the biggest economy in the world. For myself, I invested in my English education. If you're born here, there's no need to invest in that."

When confronted with claims that Toyota isn't competing on a level playing field, Mr. Funo insists that the hurdles are stacked against Toyota, not the other way around. "The Camry chief engineer is a Japanese man; why the heck does he develop the most favorite car in the U.S.?" Funo asks. "That Camry car doesn't sell in Japan—it's a failure….If we talk about the level playing field, what is it? [Camry's engineer] had to overcome such a big handicap being Japanese to create a car that's the top seller in America."