Mercedes vs. BMW

By FRANK GIBNEY JR.

When Daimler-Benz, the maker of Mercedes, took over Chrysler three years ago, it argued that globalization demanded not just speed but also size. Selling dozens of models in every price range, the reasoning went, was the only way a car company could afford the huge investments necessary to incorporate the latest technologies. That meant that if you were a small independent, you would have to merge--or face the Darwinian consequences. So Daimler coupled with Chrysler, Renault bought Nissan, Ford scooped up Volvo, and everybody mused that it was just a matter of time before the biggies gobbled up BMW and Honda, and maybe even Porsche. Yet here we are in 2001, and among the most successful players in the auto industry are...BMW, Honda and Porsche.

Jurgen Schrempp, the once swaggering chairman of DaimlerChrysler, is praying that the billions of dollars in losses at Chrysler and Mitsubishi (in which he bought a ruling share last year) don't sink the entire company. Ford CEO Jacques Nasser has a collection of premium brands in his stable: Aston Martin, Jaguar, Land Rover and Volvo. But amid a weak economy, sales at Ford and GM are down some 15% this year, and even the luxury brands are under new pressure from smaller Japanese and German automakers.

At BMW headquarters in Munich, you would never know there was a downturn. First-quarter sales set records, and April sales soared 30% over last year's numbers. In North America, BMW overtook Mercedes for the first time. BMW executives have announced a plan to expand their selection to 76 models from 70. They expect to sell 200,000 units, up from 189,423, and increase their share of the luxury-car market. "I cannot recall ever having seen such a clear correlation between size and success," BMW chairman Joachim Milberg wryly told a Detroit audience. "At the moment, it seems the greater the size, the more the problems."

Yet it seems that only hours ago, most auto execs and industry analysts agreed that global reach was essential to provide protection against foreign-exchange swings and local labor crises. They also agreed that a company had to produce about 2 million vehicles a year to achieve necessary economies of scale. Schrempp still insists that buying Chrysler gives Daimler the mass-market heft--and the profits--necessary to keep developing the cool features that make Mercedes buyers drool.

Schrempp may be proved right over the next decade. But what's decisive now is not so much size as (surprise!) sound management. Which car company is nimble enough to hop in and out of new market niches and still provide high-quality, sexy cars that people aspire to own? Mike Flynn, an auto expert at the University of Michigan, observes that new technology is only one of the elements--including styling and reliability--that make a car attractive. "Companies like BMW and Honda," he says, "offer products that keep them successful." So does Porsche, where sales are soaring 16% so far this year. It produces a mere 48,815 cars a year--but at an enviable 11.9% profit margin.

What's special about BMW is its management depth and persistence. Two years ago, the company floundered when its attempt to get big--the 1994 takeover of Britain's Rover--went awry. That cost the company $3.9 billion and prompted a flurry of talk that BMW would be bought by Ford or GM or Toyota. But since Milberg emerged as chairman in 1999, the company has stayed ahead of the luxury pack. Although most of its 21 factories are in Europe, BMW built a new plant in Spartanburg, S.C., which now exports the company's popular X5 SUV to 100 countries. Aiming to develop technologies such as alternative-fuel engines and drive-by-wire (an electronic, joystick-controlled steering system), Milberg forged partnerships with Robert Bosch and Delphi Automotive. Karl Ludwigsen, an auto analyst in London, contends that a carmaker need not be huge to survive. Rather, he says, "you've got to be big in the segments in which you compete, and you've got to be competitive in those segments globally."

BMW and Porsche have defied the notion that keeping pace with tech advances will break an indie carmaker's bank. One reason: parts suppliers have become powerful arbiters of success, as more auto companies outsource R. and D. of their components. Traditionally, Mercedes would develop a new antiskid technology in conjunction with a high-end component maker like Germany's Robert Bosch. Then, after Mercedes had made a splash by being the first to sell cars with the new technology, it would allow Bosch to sell the technology elsewhere. Now the suppliers are driving the process. Says Flynn: "BMW is going to get a shot at the suppliers' best technology because suppliers want to be associated with them." And Porsche has an engineering-services division that supplies other automakers with high-end equipment.

Paradoxically, Daimler and Chrysler began their union with long lists of rules that prevented that kind of synergy. Chrysler parts were not allowed in Mercedes cars, for instance--out of fear that the luxury brand might somehow be cheapened. That stance has since been relaxed. Schrempp still insists, however, that "Mercedes will never do a platform exchange with Chrysler."

BMW's Milberg, like top executives at Honda and Fiat, contends that the best way to stay ahead is to rely on partnerships rather than mergers. Schrempp disagrees, telling TIME editors that "consolidation in the industry is far from over." He may be right. But investors around the world are placing wagers on these two visions. And right now, most of the betting is on BMW.

--With reporting by Joseph R. Szczesny/Detroit and Charles P. Wallace/Berlin

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With reporting by Joseph R. Szczesny/Detroit and Charles P. Wallace/Berlin