A $50,000 Volkswagen?

The Phaeton may have trouble cracking the luxury market

When German Chancellor Gerhard Schröder arrived in New York in January to attend the World Economic Forum, he chose, of course, to be chauffeured in a German limousine. Not a BMW or a Mercedes-Benz or even an Audi, the car the Chancellor normally uses for official business. Instead, Schröder cruised the Big Apple in a sleek black Volkswagen Phaeton--the first luxury car to bear the VW badge.

With a starting price of $49,000 in Germany, the Phaeton is no humble "People's Car." A pet project of retiring VW Chief Executive Ferdinand Piech, who has been pushing the VW brand upmarket where profit margins and prestige are greater, the Phaeton will roll out in Europe in June and in the U.S. next year. The luxury sedan will go bumper-to-bumper against the Mercedes S-Class and BMW's new 7 Series.

The car is equipped with all-wheel drive and eight airbags, and offers five engine choices, including a 12-cylinder monster with a top speed of more than 200 mph. Tucked discreetly into the walnut-paneled interior are a phone and computer. Plush leather seats are outfitted with individual temperature controls--and an optional massage function. Eyeing the Phaeton at the Geneva car show, a rival auto executive admired even the trunk's hinges, which are crafted in Italy. "You could probably build a Smart minicar for what these cost," he says.

But the competition doesn't seem rattled--at least not yet. Perhaps they take comfort from the old Greek myth: Phaeton, the son of Apollo, set the world ablaze when he took his dad's chariot of fire for a spin. But Zeus cut down the uppity youth with a thunderbolt. Auto analysts and rivals predict VW will have a tough time marketing a luxury sedan sporting the same badge as the humble $10,600 Lupo compact.

Then there's the risk that the Phaeton could cannibalize VW's premium Audi marque. Although it boasts a history of technological prowess, Audi trails BMW and Mercedes in global sales. "That shows you the difficulty of getting accepted into the [luxury] club," says Merrill Lynch & Co. analyst Stephen Reitman. VW board member Martin Winterkorn disagrees. The company estimates 40,000 VW owners trade up to premium marques each year, but fewer than a fourth go for top-end Audis. With the Phaeton, "we're going after the others," Winterkorn says.

Former BMW CEO Bernd Pischetsrieder, who steps into the driver's seat on Apr. 16, hopes to sell 20,000 Phaetons by 2004, when all the engine versions will be available. It's hard to see how such sales will generate an adequate return on VW's $900 million investment, which included construction of a state-of-the-art factory in Dresden. Some analysts believe management should instead concentrate on filling gaps in VW's mass-market lineup: It has been slow to roll out a sport-utility vehicle for the U.S. and a compact minivan in Europe. VW reported a 12% earnings increase for 2001, to $2.6 billion, on revenues of $78 billion. But the company is off to a poor start this year: Its sales in Europe fell 7% in February, compared with a 1.4% decline industrywide. Pischetsrieder defends the Phaeton: "All VW customers will benefit from the know-how we gain from producing a luxury vehicle." One day, perhaps. But probably only VIPs will ride this chariot.

By Christine Tierney in Geneva

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