Ford: Luxury Is Job One

The profits aren't there. Will expanding volume help?

Mike Price is thrilled with the silver 2003 Jaguar S-Type sedan he bought in September, calling it "smooth as silk." The retired New Orleans oil-company manager has long admired the elite British sports-car maker, now owned by Ford Motor Co. (F ) Yet he ended up trading in his last Jag, the new small X-Type, because of glitches, and upgraded to the larger $50,000 model he now owns. He frets that production flaws in the first year's X-Type, and selling the cars with discounts risks cheapening the Jaguar brand. As happy as he is with his new car, all that has made him anxious about its resale value. Laments Price: "I only hope that in Ford's desire to increase profits that it doesn't compromise those qualities that have set Jaguar apart from its rivals."

Price isn't alone. Lately, investors, Wall Street analysts, and Ford executives themselves have voiced similar concerns. Ford is taking Jaguar to the masses, and the Dearborn (Mich.) company is betting that the profits from the sale of more high-priced cars will fatten up Ford's anemic bottom line. So far, however, the heavy reliance on luxury is proving to be a bust--mostly because of problems at Jaguar Cars Ltd.

Back in January, when Chief Executive William C. Ford Jr. unveiled his turnaround plan for Ford, he singled out Ford's collection of luxury cars, the Premier Auto Group (PAG), as a prime force in Ford's recovery. He promised investors that the luxury brands--Jaguar, Volvo, Land Rover, Aston Martin, and Lincoln (since moved out of PAG)--would deliver fully one-third of corporate profits by mid-decade. Now, though, it looks as if Ford tried to ramp up production too quickly. Jaguar sold 101,000 cars last year, and sales have risen 49% so far in 2002--but at a cost of numerous quality snafus. Meanwhile, amid brutal competition in the luxury segment, Ford resorted to overly aggressive financing and still faces high development costs for future models. The result: Jaguar will post an estimated $500 million loss this year, say Ford officials. That will likely throw the whole luxury group into the red.

While most of the problems are at Jaguar, the rest of PAG has not distinguished itself, either. Volvo sold 412,000 cars last year, but sales are off 2% so far this year. Ford has changed Volvo's leadership in the U.S. and is working to improve its marketing. And Land Rover, with sales of 164,000 vehicles in 2001, has been an automotive money pit. In 2001 alone, it lost an estimated $236 million, says Morgan Stanley analyst Stephen Girsky. It probably won't do much better this year.

The stumble in luxury cars was one of the major reasons that Standard & Poor's on Oct. 25 downgraded Ford's credit rating to BBB, two levels above junk status. Ford shares have lost nearly 50% of their value since January, and trade around $8. "We need to see some tangible evidence of progress toward improved profitability," says Scott Sprinzen, a Standard & Poor's managing director. "They have a long way to go." Until PAG--run since April by former Mazda Div. chief Mark Fields--recovers, Ford will have a tough time making the money it needs to invest in new cars and trucks.

The original architects of the PAG expansion were former Ford CEO Jacques A. Nasser and his luxury chief, Wolfgang Reitzle. Reitzle left last spring after it became clear he didn't have a shot at replacing Bill Ford as CEO. But Ford did adopt the ambitious goals for luxury growth. He wanted to more than double PAG's share of Ford profits from 2000 to 2005. That meant ramping up output of the four European brands to more than 1 million vehicles from 673,000.

Many of the new cars would be more-affordable models intended to lock in the brand loyalty of younger buyers. True, Volvo is aiming to increase its sales of upscale family vehicles by almost 50% and Land Rover hopes to expand its luxury SUV niche by roughly 40%. Aston Martin (which sells 1,500 cars a year) is too tiny to make much difference. But it is blueblood Jaguar, with plans to double sales within a few years, and a flurry of new model debuts from the X-Type to the updated S-Type and next year's upscale new XJ, that is now bearing the brunt of rapid expansion. The thinking in Dearborn was that if Mercedes-Benz could successfully expand into entry-level luxury with its C-Class cars and BMW with its 3-series, why couldn't Ford do the same with Jaguar?

Where Ford seems to have gone wrong is in how fast that should happen. Sure, BMW now sells 906,000 cars a year. But it took them more than 20 years to nearly triple worldwide sales. "Jaguar expected too much volume too quickly," says Susan Jacobs, an analyst at Jacobs & Associates in Rutherford, N.J. Even Bill Ford now agrees: "We stumbled this year at Jaguar. We were too ambitious with our growth expectations, and we stretched Jaguar to the limit."

The latest Jaguar, the $30,000 X-Type--the "baby Jag"--began rolling off Ford's Halewood (England) production lines last fall and hit the U.S. in September. It extended a line that tops out at $95,000 for a fully loaded XKR convertible. Although the X-Type wowed new buyers, it soon annoyed them with a series of production faux pas, such as hesitating engines and faulty trunk latches. That pushed up warranty costs and dragged Jaguar down 17 notches in the latest J.D. Power & Associates Inc. initial quality survey, to 19th place. Worse, it marked a major reversal for Jaguar's image. Since buying the company, Ford had spent hundreds of millions of dollars to improve Jag's once notoriously poor quality, which at one point rivaled that of the Yugo. The X-Type just revived those memories.

The fact that the X-Type was built on the chassis of the cheaper Ford Mondeo compact also cheapened Jaguar in the minds of some buyers. "Component-sharing is fine, but it can be trouble if it gets to the point that people start thinking, `Gee, this is just a gussied-up Ford,"' says Christopher W. Cedergren, managing director of Nextrend Inc. auto consultants in Thousand Oaks, Calif.

As the bottom of the luxury car market got increasingly crowded, BMW and other luxury auto makers offered cheaper lease deals--but did it discreetly. Jaguar, on the other hand, trumpeted a $369-a-month lease on its new car. In auto parlance, it was blatantly "selling the deal" rather than the car--a major gaffe for a marque known for exclusivity and taste. Ford admits the cheap leases cost it money.

In fact, the sales outlook became so bleak that in September Ford cut production of the X-Type to 75,000 cars annually from 90,000. The rest of Ford's luxury offerings suffered, too. With high manufacturing costs at its Solihull (England) facilities, Land Rover may still be in the red, despite rising sales--up 6% this year.

Volvo, meanwhile, is just starting to perk up, thanks to the arrival of a highly regarded new SUV, the XC90. Ford feels that Volvo, while moving away from its boxy look in the mid-1990s, never really lived up to its potential in the U.S. Now it has a new marketing chief and a plan to get back to its long-standing message of safety with performance.

CEO Ford has tried to reassure skittish investors by reconfirming the importance of the luxury group. Ford says the group is rebounding, and he still expects it to kick in what amounts to $2.3 billion of a total $7 billion pretax operating profit in 2005. "Overall, the PAG strategy is still sound," Ford insists.

Luxury group chief Fields says the group needs "a period of consolidation," but he doesn't plan to delay or cancel future vehicles. He'll cut costs by slashing overhead and reducing incentives. "Our target is profitability," Fields says, "not just blindly pursuing volume." He also thinks it will help when the number of Jaguar and Land Rover dealers in the U.S. increases, and as more of them sell both brands--a transition that is under way. Buyers of those lines are similar demographically, and Ford believes the vehicle lineups are complementary.

Ford's supporters say recovery will be painful, but they expect the luxury strategy to eventually pay off. Expanding a niche brand is a slow process, says Wilmington (Del.) dealer Frank Ursomarso, who owns Jaguar, Volvo, and BMW franchises. He adds: "I believe they're going to need a little more time than the bozos on Wall Street are giving them." Ford has to hope that its luxury bet pays off, and it winds up having the last laugh.

By Kathleen Kerwin in Dearborn, Mich.

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