The alleged assailant, identified as 35-year-old married father-of-three Yassin Salhi, also smashed his vehicle into the Air Products factory, causing an explosion.
The grisly attack near France’s second city of Lyon came on an especially bloody day worldwide, with at least 37 gunned down at a beach resort in Tunisia and 25 killed in a suicide bombing in Kuwait claimed by Islamic State extremists.
“The intent was without doubt to cause an explosion. It was a terrorist attack,” said Hollande in Brussels, cutting short an EU summit to chair emergency meetings in Paris.
The victim was found with Arabic inscriptions scrawled on him and Islamic flags were also found on the site at the small town of Saint-Quentin-Fallavier, some 40 kilometres (25 miles) from Lyon.
The head of the victim, a 54-year-old local businessman, was “hung onto the fence surrounded by two Islamic flags bearing the Shahada, the profession of (Muslim) faith,” said French prosecutor Francois Molins.
The attack was the first instance in France of a beheading during an attack — which has become a trademark of the Islamic State group in Iraq and Syria.
The gruesome killing came nearly six months after the Islamist attacks in and around Paris that left 17 people dead, starting with a shooting at satirical magazine Charlie Hebdo.
– ‘Normal family life’ –
Salhi had been known to security services for a number of years but did not have a criminal record, Interior Minister Bernard Cazeneuve said.
He had been investigated for links to radical Salafists but had never been identified as planning an attack.
One co-worker said he was mysterious and deceptively calm. “He was a wolf in sheep’s clothing,” Abdel Karim told RTL radio.
Karim said Salhi had spoken to him in the past about Islamic State, “not to try recruit me for anything but simply to ask my opinion”.
Molins said Salhi, his wife, his sister and one other man had been taken into custody.
The other man is being investigated on terrorism-related charges but his link to the attack is not clear. Molins said there was no indication that Salhi had an accomplice with him during the assault.
A woman identified as Salhi’s wife told French radio: “On the news they are saying that it’s a terrorist attack, but that’s impossible. I know him, he’s my husband. We have a normal family life.”
Molins said the victim was 54 and sources close to the investigation said he ran the delivery company that employed Salhi.
“Islamist terrorism has hit France again,” Prime Minister Manuel Valls told reporters in Bogota, where he was on an official visit.
The attack shocked residents of Saint-Quentin-Fallavier.
“This is a small town and a large industrial zone. There’s never been any concern in the region. We’re all surprised,” an employee at a nearby business told rolling news channel BMFTV.
Hollande ordered security tightened to the highest possible level in the region as a consequence of the attack.
The president was due to hold a second emergency meeting of key ministers at 0900 GMT on Saturday.
– ‘Terror’s blind hate’ –
Salhi drove into the factory at 9:28am (0728 GMT) local time, and disappeared from the view of security cameras until 9:35am when they picked up the van accelerating towards one of two hangars, Molins explained.
A minute later a massive blast was heard.
Firefighters were called and arrived at the site at 9:41am. At 10:00am they found the suspect inside one of the hangars, which contained bottles of gas, liquid oxygen and highly explosive acetone.
“Firefighters surprised the suspect while he was busy opening bottles of acetone,” said Molins.
The blast destroyed part of the hangar and severely damaged the delivery van, which Molins said was sign of “a significant explosion”.
For months, Europe has been on high alert for so-called “lone wolf” attacks by supporters of Islamic State, which has urged its followers to strike wherever they can.
France has been on edge since January 7 when two Islamist brothers attacked Charlie Hebdo, killing 12 people.
A policewoman and four hostages in a Jewish supermarket were also killed during three days of attacks, which brought nearly four million people, including dozens of world leaders, onto the streets of France in a historic “march against terrorism”.
World leaders reacted swiftly to the news of the latest attack, with Spanish Prime Minister Mariano Rajoy saying that “barbarism will always be confronted by unity among democrats.”
German Foreign Minister Frank-Walter Steinmeier said his country stood united with France against “terror’s blind hate” and in defence of “free society”.
France, home to western Europe’s biggest Muslim population, has seen hundreds of citizens travel to Iraq and Syria to fight alongside jihadist groups.
Earlier this week, the country passed a controversial new spying law granting sweeping powers to snoop on citizens