The New Mercedes

Can the once stodgy builder of big-ticket luxury cars trans form itself into a full-range auto maker? The risks are huge

As he roars down twisting Italian country roads in a sleek new roadster, Helmut Werner is having the time of his life. "I have the best job in the world," grins the trim and athletic 59-year-old, speeding past Tuscan vineyards in an open-top Mercedes SLK.

As chief executive of Mercedes-Benz, Werner has a lot more fun than desk-bound CEOs. Test-driving, of course, is part of the job description. And he has a lot to be happy about. Three years into his tenure as Mercedes' chief, he has wiped away the huge losses of 1993, restored profit growth to this Daimler Benz unit, and boosted productivity dramatically.

More important for car buffs, he has brought excitement back to Mercedes, which had been sinking--slowly but perceptibly--under the weight of high production costs, out-of-control pricing, overengineering, and just plain stodginess. Consumers are begging for the right to buy the SLK, which sells for around $40,000 fully loaded, a bargain by Mercedes standards. The convertible, with a retracting steel roof that folds into the trunk, debuts this fall, but you'll have to take a number. The production run of 35,000 is already sold out until 1998. "Cars are emotional things," says Werner, "and this is the most emotional product in our current lineup."

YOUNGER BUYERS. But even this natural optimist knows he still has a tough road ahead. The former tire salesman is racing to transform this builder of big-ticket luxury cars into a full-range auto maker with a value product in every segment. So his makeover of Mercedes-Benz has only just begun, and the most ambitious parts of his plan remain to be done.

Werner does not want Mercedes to enter the next century relying too heavily on big, ultraluxury models such as its famous S-Class sedan. That's a very profitable business when done right, but it has its limits. Growth in the overall market for luxury cars is slow, even when you throw in rising sales in emerging markets. And in the developed world, buyers' ages fall too often in the 50-plus category. If it stays exclusively with luxury, Mercedes could risk becoming like General Motors Corp.'s Cadillac Div., stuck with the defeating image of "the car your parents drive." Although Mercedes has recovered from the initial attacks by Toyota's Lexus in the U.S., Werner knows the Japanese are relentlessly pursuing the goal of more luxury in a car at a lower cost. And many baby boomers are now comfortable with the idea of buying a Japanese luxury car.

The SLK, which is aimed at affluent fortysomethings, is one part of Werner's breakout plan to reach the younger buyers who have made cars such as BMW's Z3 hot sellers. But he's envisioning far bolder changes--changes no one would have thought possible at Mercedes just 10 years ago. Werner wants new customers who covet Mercedes quality but need cars that can be versatile leisure vehicles as well as family runabouts, that tackle rough terrain or city streets, and that offer the best in safety. So he's thinking small, as in small cars that will attract a whole new universe of buyers to the Mercedes brand and double car sales, to 1.2 million, within five years. Archrival BMW shot past Mercedes, to 1 million cars a year, by taking over Britain's ailing Rover Group Ltd. in 1994. Werner's Mercedes is doing it the hard way--by internal growth.

At the fall, 1997, Frankfurt Motor Show, Mercedes will unveil its new A-Class, the smallest car it has ever made, just 3.6 meters long and priced at about $20,000 in Germany. In 1998, in a joint venture with Switzerland's SMH Swatch watchmaker, Mercedes will launch the $10,000 Smart microcar--just 2.5 meters long--for city travel, aiming to capture affluent Europeans who want an environmentally correct second car. Swatch CEO Nicholas G. Hayek brags it's designed for "two people and a crate of beer." Werner wanted the car so badly that he fought furiously for the project inside Mercedes even after Volkswagen turned Hayek down.

Mercedes plans to make 200,000 units of each a year in Europe, plus 80,000 A-Class models a year in Brazil for sale in Latin America. Together with the M-Class four-wheel-drive being made in Alabama that will hit the market in 1997 and a new V-Class minivan being made in Spain, the new models will turn Mercedes into a full-range carmaker of 1.2 million passenger vehicles a year. Says Werner: "We have to learn to make money from small runs of exclusive cars." The A-Class, for instance, while being offered as a four-seater sedan, will also have special short production runs of "fun cars" specially adapted for the likes of golfers or skiers and their sports gear.

Over the next three years, Mercedes will splash out $16 billion in capital spending and research and development outlays, a third for new car models alone. Even then, the model avalanche won't be over. According to local reports, Mercedes plans to churn out nearly 30 new models between now and 2008, including a C-Class compact to compete head-on with Audi's A3 and BMW's smallest 3-Series model. Werner refuses to comment on the reports, but says: "We will make many more product lines."

Werner loves playing the game. A sports nut who still swims, skis, cycles, and plays tennis, he nearly ended up as a bean counter. The eldest of five sons of a successful savings bank director, he decided to embark on the arduous seven-year training that German auditors undergo. After the first stage, he recalls: "My professor told me to go get some real-life experience first." The resulting trainee job with tiremaker Uniroyal was a turning point. As soon as he hit the road as a salesman, he was in clover. Even now, he's never happier than when peddling the product. At the last Frankfurt Motor Show, for instance, he put a slew of planned press interviews on hold while he pitched Deutsche Bank director Ulrich Weiss, who had wandered onto the stand, to buy some more Mercedes sedans for the bank's fleet.

Critics fear that the supercompetitive Werner could just end up doubling unit sales and cutting profits in half. They are quick to point out that it wasn't long ago that Mercedes could barely eke out profits on its core luxury franchise. How can it earn a decent margin on small cars when even mass producers such as Fiat and Volkswagen often struggle to make profits? Internal documents suggest that adding Werner's brand extensions, such as the A-Class, will lower overall return on investment. All the same, they lay out ambitious goals: By the end of the century, Mercedes' sales could soar 40%, to $67 billion, and net profits nearly triple, to $3.6 billion, with an unchanged workforce.

OVERREACHING? Werner's huge ambitions don't surprise his friend and business associate Roger S. Penske, chairman of Detroit Diesel Corp., in which Daimler owns a 20% stake: "He is a risk-taker," says Penske, "[but] Helmut can execute a program." Penske recalls how his racing team won the Indianapolis 500 in 1994 with a new Mercedes-built engine backed by Werner. The engine was designed, built, and tested in less than a year--about half the normal time--under hush-hush conditions imposed by Werner. Adds Penske: "Helmut is a very competitive person."

Yet some analysts figure Werner may have overreached himself in projecting demand for his small cars. DRI/McGraw-Hill consultants in London, for instance, forecast that sales of A-Class sales could peak at 125,000 units in 1999, far short of the 200,000 European production capacity, because of competition in the segment. The Smart could have similar problems, say DRI analysts. BMW, for example, won't make a car smaller than the 3 series under its own name and rejected the idea of building a small two-seater sedan because "the possible uses of such a car are very limited," says a BMW source. "Instead of sticking to what they know in luxury markets," complains Thomas R. Holmes, a partner in Frankfurt private bank Schroder Munchmeyer Hengst (SMH), "[Mercedes] will be making something that everyone else makes."

Not so, retorts Werner. Still the dedicated salesman, he'll tell anyone willing to listen that the A-Class constitutes an entirely new market segment of premium or luxury small cars. It certainly looks different. The body is short but high, making it as roomy inside as an E-Class. The engine is placed so that it will dive below the car's floor toward the road in the event of a head-on collision, rather than being projected backward toward passengers as in conventional designs. Some outsiders agree with Werner. "It's not just a new small-car-market entry--it has a distinct character," says former Ford Motor Co. executive Karl E. Ludvigsen, now chairman of London consultancy Ludvigsen Associates. The same is true for the Smart car, a vehicle that can be sold with electric engines to meet strict emission standards.

The job of peddling the A-Class and Smart cars falls to sales and marketing director Dieter Zetsche, one of Werner's handpicked men. For the A-Class, he started an advertising campaign 18 months ahead of the Frankfurt debut. Research showed the average buyer mulls a new car purchase for a year and a half before closing a deal. Besides, adds Zetsche: "The target groups are new to us--we want to get to know them." So far, 100,000 people in Germany alone have signed up for information packs, and 80% of them have never owned a Mercedes before.

For the Smart car, a different approach is needed. The "swatchmobile" doesn't sport the famous Mercedes three-pointed-star trademark. So the Micro Compact Car joint venture is setting up an initial 100 sales centers around Europe uniquely for the Smart. Some will be located in such places as department stores and airports, offering Swatch watches and other nonauto product lines as well as the cars. Mercedes will be on a steep learning curve with a completely new approach to selling cars. The carmaker will also learn a lot making the Smart: It is designed to be assembled in less than five hours, and 11 major suppliers are working, Japanese-style, directly on the plant site.

The key question is whether Mercedes has the cost discipline to make profits on small cars. Five or 10 years ago, they would probably have failed. But now, says Ludvigsen, "they have the tools to bring the program home on budget. That would not have been possible in the pre-Werner era."

Ten years ago, Werner was not even at Mercedes. He had risen through the ranks of German tire company Continental to the chief executive's office. Then, in 1987, he was recruited as deputy CEO of Mercedes at the behest of Alfred Herrhausen, the former CEO of Deutsche Bank assassinated by terrorists in 1989. Deutsche then, as now, owned shares in Continental as well as a big stake in Daimler Benz, and Herrhausen chaired Daimler's board of supervisors. Werner and Herrhausen were close. They had first met at the end of the 1960s, when the banker tried to snatch away one of Werner's managers at Continental. Both men had meteoric careers and shared a love of sports. Each played on one of Germany's national sports teams: Herrhausen in hockey and Werner as a swimmer. Recalls Werner: "We had a relationship of trust. It made sense to follow Herrhausen's recommendation [to move to Mercedes]."

"SCARED STIFF." After Herrhausen's death, Werner forged a solid relationship with Hilmar Kopper, Herrhausen's successor at the bank and on the Daimler board. It was to prove extremely important. In 1992, when the decision came up to appoint then Mercedes CEO Werner Niefer's successor, the IG Metall labor union seriously considered vetoing Werner's nomination. Rank-and-file union members mistrusted Werner's hard-nosed bargaining over wages and conditions. Kopper, however, smoothed over these objections.

Mercedes badly needed a catalyst for change as it left behind the superprofitable years of the 1980s. The strengthening German mark was ruining exports, especially to the critical U.S. market, where reasonably priced Lexus and Infiniti luxury cars were storming the market. "I was scared stiff," says Ronald D. Ertley, a North American Mercedes dealer in Wilkes-Barre, Pa. "Lexus was a real wake-up call."

In 1993, the year Werner took over, Mercedes had slumped into an $800 million loss, the big-selling E-Class and C-Class models were 8 and 10 years old, and production barely topped 500,000 cars. The company was bloated with six layers of managers between the board and the shop floor. Werner slimmed that to four, because hundreds of managers, according to studies by consultant McKinsey & Co., cost more than they contributed in revenues.

Plant managers were made responsible for containing their own expanding capital budgets. Mercedes, says passenger-car division head Jurgen Hubbert, had struggled for years to cut them. Werner's radical shift had an instant payback: In 1993, capital investment in the car operations' fixed assets was more than halved, to $850 million, from $1.8 billion in 1992. Last year, despite big outlays on new products, it was still only $1.2 billion. Once managers had to answer for the returns on their capital allocation, they dropped their bad old macho habits of piling up the biggest budget possible. "As a salesman, I learned about people, I learned about their motivation," says Werner. In one team-building exercise to show how serious he was, Werner had all his managers draft letters of resignation. The message: Your jobs depend on how much you help in Mercedes' transformation.

Of course, this method can be misunderstood. Some insiders charge privately, for instance, that most of what Werner has done was somebody else's idea, decided and under way before he became CEO. "So much the better if they think it is their idea," he chuckles. What he wants to achieve, he adds with a touch of irony, "can't be done with them applying my ideas--it has to be their ideas."

BIG GAINS. The biggest challenge was to reinvent the corporate culture. Long dominated by engineers, the old Mercedes approach was to build the best possible car regardless of expense and then set the price by adding a profit margin to ballooning costs. Just before taking over as CEO, Werner flipped that strategy completely and for good. In the future, he said, Mercedes would fix a target sticker price according to market conditions and then build to that. Explains passenger-car supremo Hubbert: "We had to break the assumption that each new car had to be heavier, have even more technology--and be more expensive."

It had to come. By 1990, Mercedes confronted shocking evidence from Massachusetts Institute of Technology's International Motor Vehicle Program (IMVP) and internal reports by McKinsey that since 1985, a huge 35% productivity gap had opened up between it and Japanese producers such as Toyota Motor Corp. Toyota's 1989 Lexus LS400 launch and the resurgence of BMW suddenly changed the ground rules.

Werner told his engineers to simplify manufacturing fast. As a result, productivity has risen 30% over the past two years, and $2.3 billion has been saved on purchases from suppliers. Werner vows he will repeat the performance this year and next. The big gains come from major model changes that allow extensive redesign and cost purging. The C-Class assembly time, for instance, was slashed by 10 hours, to 35 hours, and costs cut by wider use of subassemblies. Wiring systems come in from suppliers on a just-in-time basis. Parts such as door interiors and the dashboard, once assembled piecemeal, now come to the line as units for one-step installation.

As a result, Mercedes was able to price the C-Class in the U.S. at $29,900, or $700 less than the competing Lexus ES300. Five years earlier, the comparable Baby Benz 190 cost $9,800 more than the entry-level Lexus ES250. When fast-selling E-Class models were introduced into the hypercompetitive U.S. market last fall, for instance, the most expensive E420 model was priced at $49,900, or 9.7% less than the outgoing model after adjusting for better equipment.

Solving the problems in the U.S. was a critical test of the new Mercedes' skills. By 1993, Mercedes-Benz North America marketing chief Michael Jackson was urgently pressing his German bosses for a revamp of the Mercedes image in the U.S. "We needed to connect to the baby-boom generation," says Jackson, a former dealer himself. "We needed to get people to say Mercedes-Benz is the best car for me." That meant lowering the price to attract the 40-plus buyers. But it also meant catering to the quirks of the American market. In one episode, U.S. dealers pressed the puzzled Germans for cup holders. Now the E-Class sedan sports a nifty retractable cup holder.

"MOVING TARGET." Jackson also had Werner's support for a radical change in the advertising, from the formal, reverential ads that stressed engineering to ones that used humor to reach out to boomers. Ad agency Lowe SMS now has spots featuring a Mercedes navigating through a herd of rhinos and another using Janis Joplin's '60s refrain, "Lord won't you buy me a Mercedes-Benz." Mercedes car sales in the U.S. are up 17% for the year.

Werner will have to keep on running hard. Japanese competitors are keeping the pressure on. Nissan Motor Co. and Toyota, makers of the Infiniti and Lexus, aim to make 30% to 50% savings mn each model. Toyota, for instance, cut costs $1.2 billion last year, boosting profits nearly 14% despite a decline in sales. Says UBS Securities Tokyo-based auto analyst Peter Boardman: "The Germans are going after a moving target."

Still, Werner's mix of new models and pricing is proving a winner, resulting in record first-half sales of 315,000 cars, 7.2% up from the same period of 1995, and booking $15 billion in revenues, a 12% rise. The second half will be tough, as demand in Western Europe softens. But Werner is promising profits up to 1995 levels. Truck operations are also a problem, with $70 million in losses in 1995.

Werner's performance is naturally of keen interest to his boss, Daimler Benz chief Jurgen E. Schrempp. Daimler needs big profits from Mercedes as Schrempp expensively unwinds a failed diversification policy. But German business and auto magazines regularly report stories of rows and back-stabbing that read like TV soap operas. Allegedly, Schrempp was leery of the Smart project and objected to building the A-Class in Brazil. Wrong, says Werner: There was lively debate about Smart, but Schrempp is on board. By another account, marketing czar Zetsche is Schrempp's spy to keep tabs on Werner. In reality, Werner got Zetsche his first big career break. Says an exasperated Werner: "Nothing that is written about personal bitterness is true." But he admits: "We have controversial discussions. It is a very constructive conflict."

Like other auto makers, Mercedes is rushing to spread its manufacturing around the world. It urgently needs to tap into new markets for trucks and cars. And it must find both new and cheaper sources of supplies and new manufacturing sites. Werner's ambitious goal is to raise the proportion of cars Mercedes makes outside Germany to 25% over the next 10 years, from just 5% now. In China, for example, Mercedes is the 45% partner in a joint venture to build 60,000 minivans a year based on the new V-Class. With India's Telco, it will assemble the old E-Class model, which was phased out of other markets in 1995.

Small cars. Swatch cars. Roadsters. New sales techniques. Plants in China. The list of new ventures and efforts Mercedes must quickly master is dauntingly long, especially for a company where redesigning a simple headlight once took months. Werner is betting big-time that the cautious old Mercedes culture is gone forever and that he has a new company that can handle big risks successfully.

If he's wrong, the results could be disastrous. Plenty of things could go awry. Any quality problems in the Alabama plant building the M-Class would be widely publicized and could damage Mercedes' reputation. The A-Class and Smart cars also represent two entirely new ventures where both the manufacturing and marketing will be quite new to Mercedes. An Edsel-style flop in these areas would be a tremendous setback to Mercedes' plans to change.

Perhaps, though, there's no other way--not in a world where companies that fail to reinvent themselves are punished so swiftly. Says Susan G. Jacobs, president of consultant Jacobs & Associates in Rutherford, N.J.: "It is a bigger mistake for Mercedes to make one change too little than one change too many." Changing too little--that's one thing Helmut Werner will never be guilty of.

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