HIROSHIMA, Japan (Reuters) - Japan's Mazda Motor Corp (7261.T) has only a tenth of Toyota Motor Corp's (7203.T) research and development budget, but is betting it can make the century-old internal combustion engine as fuel efficient as hybrids like its rival's pioneering Prius.
The gamble on developing gasoline engines, while others move increasingly towards electric cars, could also show whether a small automaker can survive independently in a high-stakes market for mass-produced passenger cars dominated by the likes of Toyota, General Motors (GM.N) and Volkswagen AG (VOWG.DE).
"People used to say there's no way a small carmaker could survive unless they find a partner because it wouldn't be possible to independently pursue costly technologies like fuel cells, electric vehicles and hybrids," said Mitsuo Hitomi, Mazda's top powertrain engineer. "But these may not become mainstream."
Mazda, valued at $13.5 billion and with its roots as a 1920's machinery toolmaker, has chosen to focus on reducing the energy loss in combustion engines, with technology that is a side-show for bigger companies focused on headline-grabbing electric and hybrid vehicles. The move has already helped achieve big fuel-efficiency gains in Mazda vehicles.
Gasoline engines now utilize at most around 35 percent of the fuel's energy, with the rest lost mainly to heat and friction. Engines also typically operate well below the peak, at around 20 percent efficiency.
Mazda wants to improve that to 50 percent at peak efficiency and maintain operation closer to peak levels. A first step would be with a breakthrough technology called HCCI, or homogenous charge compression ignition, Hitomi said.
Honda Motor Co (7267.T), GM and others have also been working on the technology for years, but it has yet to be mass-produced.
In an HCCI engine, as in fuel-efficient diesel engines, the mix of air and fuel ignites without a spark plug, but carmakers have struggled to achieve ignition at low and high engine speeds. Mazda has solved that with a higher compression ratio, squeezing the air and fuel mixture further and boosting temperatures in the combustion chamber, Hitomi said.
One remaining problem, however, is a loud noise similar to engine knocking caused by overly intense combustion when the torque, or turning force exerted by the engine, is high.
Hitomi believes Mazda will be able to overcome this and hopes to have the HCCI engine ready to roll out around 2020, when strict fuel economy standards will likely be implemented in Europe.
"This is very hard and we wouldn't think of doing it if we had the number of people that would let us pursue all kinds of different technologies," Hitomi said. "We are here because this is the only option we have."
Hitomi said a car with an HCCI engine could have a fuel economy similar to gas-electric hybrids. That could mean that a Mazda3 kitted out with an HCCI engine could run at about 30 km per liter (71 miles per gallon) under Japanese standards, about a 50 percent increase from its current gasoline engine, and roughly on par with a Toyota Prius.
GRAPHIC: Japan's carmakers r.reuters.com/hak74v
Mazda's annual vehicle sales, at around 1.2 million, are barely more than a single Toyota model, the world's best-selling Corolla, and many of its similarly-sized peers enjoy special advantages - BMW AG (BMWG.DE) is an established luxury brand; Subaru maker Fuji Heavy Industries Ltd (7270.T) is under the wing of Toyota, its biggest shareholder; and Mitsubishi Motors Corp (7211.T) is backed by the deep-pocketed Mitsubishi group.
Mazda, which made its first passenger car in 1960, lost the protection of Ford Motor Co (F.N) five years ago when the U.S. carmaker, struggling to stay afloat, cut its holding to 13 percent from a more than one-third controlling minority stake it had held for nearly three decades. That stake has since dwindled to just 2.1 percent.
At the same time, Mazda was hit by a strong yen that battered the profitability of its exports. In the four years to March 2012, the company chalked up combined net losses of nearly 250 billion yen ($2.5 billion).
The company - which loaned part of its Hiroshima headquarters building to the local prefecture following the city's atomic bombing in 1945 - hunkered down with a strategy to boost fuel efficiency in its internal combustion engines, achieving gains of 15-20 percent since 2011.
Together with a series of other fuel efficient technologies it calls Skyactiv, a revamped manufacturing process and stylish new designs that it was able to roll out quickly in its relatively small product range, Mazda has boosted profit margins. On each CX-5 sport-utility vehicle loaded with Skyactiv technologies, Mazda makes $1,500 more than it made on the CX-7, a sister model without Skyactiv.
But it still needs to work on cutting incentives. In the United States, Mazda's average incentive level to date this year is $1,937 as it tries to sell off older models. That's more than Toyota's $1,681 and Subaru's $908, although it has dropped 6 percent from 2009, according to TrueCar.
Mazda expects sales to rise 8 percent to 1.3 million vehicles in the year to March and is aiming for 1.7 million vehicles in another two years. But even that hefty growth would still leave it at a fraction of the 6 million vehicles that Sergio Marchionne, CEO of Chrysler and Fiat FIA.MI, once said were essential for an automaker to make annually to survive.
For Mazda, the yen's depreciation in the last year has been a big boost. The company, which exports around 80 percent of the cars it makes in Japan, booked a net profit for the first time in five years in the financial year ended in March.
Mazda shares have jumped more than fivefold since hitting a life low of 85 yen in July 2012, and are currently near 5-year highs. It's the best performing Japanese auto stock over the past 12 months, and trades at more than 2.7 times its book value - the stated worth of its assets - well above the sector median of 1.6 times, Thomson Reuters data show.
While Mazda is betting heavily on the internal combustion engine, it's not entirely rejecting hybrid technology. This month, it will start selling hybrids for the first time, combining Toyota's hybrid technology with its Skyactiv gasoline engine in the Mazda3.
Industry experts generally assign high marks to Mazda's engineering, but some insist it will still need a partner.
Takaki Nakanishi, an auto analyst and CEO of Nakanishi Research Institute, said Mazda's limited product portfolio of sedans, small cars and SUVs is risky as it faces tough competition from many big rivals across all market segments.
"That may have been fine while they were selling cars as a part of the Ford group, but it's a reckless portfolio now they are on their own," he said.
For now, recovery seems to have boosted the confidence among executives to stay independent, and CEO Masamichi Kogai said he is not thinking of an equity alliance.
"The entire company is united now and confident in our own technology, our regional production structure and our sales capability. Now is the time for us to show how much we have evolved," he told Reuters in September.
($1 = 100.0350 Japanese yen)
Editing by Edmund Klamann and Ian Geoghegan