The Luxury Trap: Mercedes, BMW Struggle as Car-Buyers Downsize

By Dietmar Hawranek

German luxury carmakers Mercedes-Benz and BMW have been particularly slammed by the economic downturn as cash-strapped consumers go for cheaper models. A cooperation between the two companies would make a lot of sense, but the rivals are wary of each other. Meanwhile upstart Audi is eating into their markets.

Daimler's executive board has moved offices within the southwestern German city of Stuttgart a number of times over the years. They first relocated across town from the district of Untertürkheim to the higher-lying district of Möhringen. A few years later, they returned to the valley. Then recently the top executives had to transfer from their high-rise office building there to the former company museum.

But wherever the company's senior management goes, a fog of rumors always follows them. And at the moment it is billowing thicker than ever.

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Dieter Zetsche, the company's mustachioed CEO, is even allegedly due to be replaced soon -- apparently by the current chairman of the supervisory board, Manfred Bischoff. And the more the managers whisper in backrooms, the more often they meet other colleagues who have already heard the rumor. For some people that even counts as a confirmation that the gossip is true.

Rumors are spreading faster than ever in Stuttgart these days. The giant carmaker Daimler is not doing well. Car sales have declined by almost 18 percent, while truck sales have plummeted by around a half. The company reported losses of €2.4 billion ($ 3.5 billion) for the first six months of this year.

Zetsche has introduced a savings plan aimed at reducing costs by €4 billion a year. But he still hasn't been able to come up with conclusive answers to key questions. Can the premium carmaker Mercedes-Benz survive alone, or does it need a partner? And how long can Daimler continue to compensate for the drop in sales by relying on government-sponsored "short time" programs which support workers on reduced hours? If sales don't pick up soon, the company will have a surplus of 25,000 employees on the payroll, according to internal calculations. Will the carmaker have to close plants and lay off thousands of workers?

Hard Hit

The global economic crisis has unnerved Daimler, a carmaker which had grown accustomed to success. It is difficult to compare the current downturn with previous sales slumps. One difference is the introduction of a government "cash for clunkers" scheme designed to support the auto industry -- but which almost exclusively benefited high-volume carmakers. But that's only part of the story.

Up until now, premium producers like Mercedes-Benz have had an easier time weathering economic storms. This time around, the luxury class is the hardest hit. Sales are also collapsing at brands like Bentley, where sales are down by 50 percent, Rolls-Royce (minus 41 percent), Porsche (minus 25 percent) and BMW (minus 18 percent).

There are multiple reasons why the luxury segment is suffering so badly. Many customers can no longer afford a luxury model, partly because companies have reduced bonus payments for executives, partly because fewer models are being ordered as company cars and also because many managers have lost their jobs.

And there are other consumers who are simply no longer willing to spend so much money on a car. Times are changing and drivers' relationships with their cars are evolving, according to a study conducted by the PricewaterhouseCoopers consulting firm. The automobile is increasingly being seen as a means of transportation -- and less as a status symbol.

Downsizing Trend

Until recently, customers always wanted to move up to a larger class when purchasing a new car, but now the opposite is true. Mercedes-Benz purchasers are ordering an E-Class instead of an S-Class luxury sedan, or a compact executive C-Class instead of a larger E-class. A similar development can be observed at BMW, with serious consequences for the carmaker.

Small cars generate only small profits -- if that. Consequently, today's downsizing trend has taken a big bite out of manufacturers' earnings.

With a decline of just over 7 percent, Audi is the German upmarket car brand least affected by the current drop in sales. The Volkswagen subsidiary sells a higher proportion of its cars in the compact and lower midsize range. In addition, Audi is profiting from the other two German luxury carmakers' failures by offering what many consumers are looking for during the crisis: premium with a touch of understatement. By contrast, Mercedes-Benz and BMW have been caught unprepared by the new trend in consumer behavior.

Many customers define luxury differently than they did only a short while ago. Cars are still expected to be fast, sexy and safe. But for many people today, prestige now also means that their luxury sedans run in a more environmentally friendly manner or, better yet, act as a trendsetter for green technology. As a result, Daimler and its competitors need to invest billions in electric, hybrid and hydrogen technology.

But it will take some time before they can earn money on these models. In the meantime, their core business has crumbled, leaving them with insufficient profits to finance the necessary investments. Daimler and BMW have fallen into the luxury trap, and they will have a hard time getting out.

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