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Commentary: Small Cars Mean Small Profits, Mr. Schrempp (Int'l Edition)

International -- European Business

Commentary: Small Cars Mean Small Profits, Mr. Schrempp (int'l edition)

DaimlerChrysler Chief Executive Jurgen E. Schrempp is at it again. The savvy dealmaker who shocked the auto world by bagging Chrysler two years ago is now set to conquer new frontiers in Asia. Schrempp has personally been courting everyone from Mitsubishi Motor to Daewoo Motor Co. in an effort to round out DaimlerChrysler's lineup by adding a specialist in small cars. "I could imagine that there will be a resolution this year," he says. The plan is to come up with a strong compact entry that can be used to exploit the expected explosion in car sales in emerging markets. Sounds great. But it could be a costly mistake.

Schrempp's strategy is based on the conventional wisdom that size is the key to success in the auto world. Proponents argue that a carmaker needs a stable of products ranging from affordable, fuel-efficient compacts to luxury sedans in order to take advantage of national tastes. Only with the high volumes and economies of scale that come with a broad product range can a carmaker secure earnings growth.JEEP THRILLS. The problem with this strategy is that it requires a carmaker to mass-produce in the most competitive and least profitable market segment. The cost advantages that come with making 500,000 small cars a year are considerable. But more often than not, the carmaker loses money anyway. Margins are razor-thin, with makers such as troubled Daewoo slashing the price of its entry level Matiz to just $7,500. Such perils have led even some DaimlerChrysler senior managers to question the wisdom of the small-car strategy. "It spells `ugly,"' says Chrysler President James P. Holden. "We should not jump off a cliff to have a small car just so we can participate in markets where you don't make any money." Chrysler's current small-car entry, the $15,000 Neon, has an aging design, and its sales have failed to dazzle.

Where DaimlerChrysler does make money, lots of it, is with its Mercedes-Benz sedans, Jeeps, and Chrysler pickups, all of which command high margins. Earnings last year rose a healthy 19%, to $5.8 billion. The group's forays into small cars mostly have done more damage than good. Take Mercedes' compact $14,500 A-Class. Before its introduction in 1997, the car was billed as a "Golf killer"--a reference to Volkswagen's popular compact. But then the A-Class betrayed a tendency to tip over. A costly retrofit followed, but the real damage was to what had previously been Mercedes' flawless reputation for quality. Similarly, the two-seat Smart Car has been plagued by safety concerns. While sales of the $8,750 runabout have picked up recently, it has run up losses of $2.7 billion.

A misstep in Asia could make those losses seem like peanuts. Even if Schrempp finds a bargain, the market is already crowded. Toyota and Honda are there big-time. Ford owns Mazda and is vying for Daewoo as well. GM has alliances with Isuzu Motors, Suzuki Motor, and Fuji Heavy Industries, and is also bidding for Daewoo. Then there's Renault, which bought control of Nissan last year after Schrempp wisely balked at a deal that would have included the company's massive debt.

So why does Schrempp persist? One of his arguments is that DaimlerChrysler, like other producers, will have to adhere to stringent fleet emission standards in Europe starting in 2008. One way to compensate for gas guzzlers like the $100,000 S-Class would be to build or import more smaller cars. But rather than investing billions in a small carmaker, Schrempp might be advised to develop more efficient engines for his luxury cars and trucks.

Schrempp's real reason for a major push in small-car production might have more to do with his thirst for another big deal. The afterglow of masterminding the Daimler Benz-Chrysler merger faded long ago. For Schrempp, running the world's fifth-largest carmaker might not be enough. But an ego-driven strategy could backfire. For his shareholders' sakes, he should remember that bigger isn't always better. The proof is in his backyard in Stuttgart. The carmaker with the fattest profit margins in the world is one of the smallest: Porsche.By Matthew Karnitschnig; Karnitschnig Covers the Auto Industry from Frankfurt.

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