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What is a Two-Mode Hybrid?
From Christine & Scott Gable,

How do Two-Mode Hybrids Work?
In short, a two-mode is a hybrid vehicle that can operate in two distinct ways (modes). The first
mode works much like a regular full hybrid. It is the second mode that makes the
difference--where the hybrid system can adjust varying amounts of engine and motor function
to meet very specific vehicle/task/traffic requirements.

The Partnership Makes it Possible
A joint engineering and development effort among General Motors, Chrysler Corporation,
BMW and to some extent, Mercedes-Benz, has birthed the system known as the Two-mode
Hybrid. Distilled down to its most basic components and elements, it is a system in which a
conventional automatic transmission with gears and bands and clutches has been replaced with
an externally similar shell that houses a pair of electric motors and several sets of planet gears.

The two modes of operation can be described as a low speed, low load mode, and a higher speed,
heavier load mode that work as such:

First mode--at low speed and light load, the vehicle can move with either the electric motors
alone, the internal combustion engine (ICE) alone, or a combination of the two.

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In this mode, the engine (if running) can be shut down under appropriate conditions and all
accessories as well as vehicle locomotion continue to operate exclusively on electric power. The
hybrid system will restart the ICE at any time it is deemed necessary. One of the motors,
actually better described as motors/generators (M/Gs) acts as a generator to keep the battery
charged, and the other works as a motor to propel, or assist in propelling the vehicle.

Second Mode--at higher loads and speeds, the ICE always runs, and the hybrid system uses
technologies such as cylinder deactivation (GM calls it Active Fuel Management; Chrysler calls
it Multi-Displacement System) and variable valve timing to increase its engine's efficiency. In
the second mode, things get a little tricky as the M/Gs and planet gear sets phase in and out of
operation to keep torque and horsepower at a maximum. Basically, it works like this: At the
threshold of second mode, both M/Gs act as motors to give full boost to the engine. As the
vehicle's speed increases, certain combinations of the four fixed ratio planet gears engage
and/or disengage to continue multiplying engine torque, while allowing one or the other of the
M/Gs to switch back to generator mode. This dance among the two M/Gs and four planet gears
continues as vehicle speed and/or load fluctuates across road and traffic conditions.

The Best of Both Worlds: Efficient and Powerful
It is this unique combination of M/Gs and fixed ratio gears that allows the two-mode system to
function like an extremely efficient electronic constant velocity transmission (eCVT) while still
providing solid, heavy-duty mechanical torque multiplication via the planet gear sets. At the
same time, efficient and functional packaging of this system within a conventional automatic
transmission body reduces crowding in the engine bay that would otherwise occur with large
externally mounted M/Gs. It all translates into a vehicle that is a very fuel efficient cruiser
under light loads, while at a moment's notice, can apply the full grunt of a big engine for
maximum towing and hauling power.

Ref:
http://alternativefuels.about.com/od/hybridvehicles/a/howtwomodeswork.htm