Classy Cars

Why everyone wants to make luxury autos

Sunil Bhoolabhai, a cosmetic dentist who perfects smiles for many of India's movie stars and glitterati, says he decided to buy his first luxury car on impulse. Last November, he snapped up a $56,600 silver Mercedes C180 sedan to pamper himself with the legendary ride of a German luxury brand. "It's a great piece of engineering," he says, referring to the soundproofing, snappy design, and powerful motor. "It's a peppy model compared with other Mercedes [cars], like wearing a miniskirt instead of a sari. Sporty over elegance."

Chalk up another conquest for the world's luxury auto makers. If you've spotted a lot more BMWs, Mercedes, Porsches, and so forth on the highway -- any highway in the world -- you're seeing a major trend zoom by at 85 mph. In the U.S., the world's largest car market, unit sales of high-end autos have risen 67% since 1992, pushing luxury's share of the overall U.S. auto market from 9% to 11%, according to Ward's Automotive Reports. In China, sales of premium marques have tripled in the past five years. Worldwide, unit sales of luxury cars jumped by close to 70% in the past decade, estimates market researcher Global Insight Inc. (chart).

Creamy leather upholstery and burled walnut dashboards are enough to set any auto exec's pulse racing. But profit, not glamour, is what drives the rush to luxury. Operating margins for entry-level luxury cars can hit 10%, compared with 5% for mass-market models. Playing to the plebes just doesn't pay. "These days, being in the middle of the market with no clear image is death," says Mark Fields, chairman of Ford Motor Co.'s (F ) premier auto group (PAG), which includes Aston Martin, Jaguar, Land Rover, and Volvo.

Buyers, of course, get bragging rights for having the nicest set of wheels on the block. But they also get a good deal. Three years after purchase, a $30,000 Ford Thunderbird retains just 29%, or $8,700, of its value. Kind of skimpy -- especially when you compare it with a $38,000 BMW 3 Series. The Bimmer holds 60% of its original price, or $22,800, three years in. "The ultimate arbiter of the health of any automotive brand is residual value," says Fields.

The question is whether any brand can feel healthy in this market. The mass-market carmakers already are feeling battered. On Mar. 10, Volkswagen (VLKAY ) warned investors that first-quarter earnings would fall, adding that it expected no growth in overall vehicle markets this year in the U.S. or Europe. So while sales of luxury goods generally hold up well in a recession, some auto execs fret that premium-brand carmakers and aspiring entrants have glutted the market at precisely the wrong time. Consultants still forecast 40%-to-50% growth in the luxury car market during the next decade. That's nearly double the expectations for the overall industry. But it doesn't duplicate the blistering pace of the past decade. And if economic stagnation turns to recession this year, some luxury auto makers could even see sales decline.

In this environment, no one can afford mistakes. Jaguar's X-type model, for example, was launched in 2001 to attract new buyers to the line. But it was plagued with defects at its start, dragging down the J.D. Power & Associates initial quality ratings for the entire Jaguar brand last year -- all the way from second place in 2001 to 19th in 2002. In the first two months of this year, X-type sales are down 42%. On Mar. 4, Porsche announced it would cut production this year of its classic 911 and Boxster models by several thousand units -- after sales of the 911 in North America fell by 39% in February. "There's going to be quite a shoot-out, given all the players seeking to invade the market," says Karl Ludvigsen, president of Euromotor Consultants in Northampton, England.

But carmakers keep pouring it on. Cadillac's efforts to stage a comeback, for example, could swell the surfeit of luxury models in the all-important U.S. market. Since 1999, General Motors Corp. (GM ) has gambled $4.3 billion on a raft of new Caddies. Cadillac finally is taking square aim at European rivals with rear-wheel models such as the CTS sports sedan and, in 2004, the STS flagship. Later this year, the $75,000 XLR roadster and $40,000 SRX crossover sport utility will give Cadillac a pair of vehicles to challenge Lexus, Mercedes, and BMW. "By mid-decade, Cadillac will be in the hunt again," says George Peterson, president of AutoPacific Group Inc. in Tustin, Calif.

It will be hunting with a lot of other predators. A decade ago, each high-end carmaker typically offered only a midsize sedan, a coupe, and a larger, top-of-the line sedan. This typical trio has been replaced by a mind-boggling array. Almost half the models sold by Mercedes-Benz, for example, didn't exist seven years ago. "Everyone almost doubled their product range," says Michael Trautmann, Audi's marketing chief.

Such diversification is still juicing sales at many luxury carmakers, even as overall auto industry sales retract. Despite the 911's woes, Porsche expects to increase sales in fiscal 2003 by 10,766 units, to 65,000 cars -- a record number, thanks to the addition of its new SUV model, Cayenne. "Our [Cayenne] order books are full to the brim," says CEO Wendelin Wiedeking.

The pressure is on, though, to keep inventing. BMW alone wants to sell 1.4 million cars in 2008, up from 1.0 million last year. The latest fillip: luxury crossover SUVs -- a plush SUV cabin plopped on a car chassis -- to power sales. Worldwide, "the crossover vehicles are the fastest-growing segment," says Scott L. Thompson, chief financial officer of Group 1 Automotive Inc., a Houston owner of 73 dealerships across the U.S.

Even exotic and superluxury auto makers of $100,000-plus specimens such as Lamborghini, Maserati, Bentley, and Aston Martin are adding models to spur growth. Maserati, taken over by Ferrari in 1998, will launch its much-awaited quattro porte (four-door) sedan in September. A sporty wagon may follow. Not to be outmaneuvered, Aston Martin will bring out a two-seater in 2005 -- the V8 Vantage, costing $125,000. And BMW is unveiling a new four-door coupe that will relaunch the 6 Series line.

The search for new models is complemented by the quest for virgin territory. Audi, for example, sold almost 37,000 cars in China last year and expects to boost that number by 10,000 this year. "It's a once-in-a-lifetime chance," says Georg Flandorfer, head of sales and marketing at the $25 billion company.

But where Audi and the other German marques absolutely must excel is in the U.S. It's the largest, richest luxury market -- and the most intense, where small errors can trigger a critical loss in customers. "Brand position is not something that lasts forever," says Helmut Panke, CEO of BMW. The Germans should know. The U.S. advent of Lexus and Infiniti a decade ago -- with lower prices and prompt, hassle-free service -- forced European rivals to bring costs down and coddle customers more. The result is a comeback for the Germans. Mercedes-Benz (DCX ) saw U.S. sales rise 8% in February. And BMW's sales surpassed sales of Lexus' in January and February, making it the leader in the U.S. luxury market for the first time. Audi has rebounded in the U.S. since the sudden-acceleration scare of the mid-'80s seriously dented sales. Sleek styling and smooth power have helped, but Audi is taking no chances. Cars being exported to the U.S. get a double round of checks. "The U.S. customer won't permit us another mistake," says Flandorfer.

The battle goes all the way to the top of the segment, where premium auto makers with the deepest pockets are reinventing status limousines. Witness the dazzling new models: BMW's Rolls-Royce Phantom ($360,000-plus), and Mercedes' Maybach 57 ($320,000). Last year, the market for such cars topped off at some 1,400 units, but analysts say it could easily double, to 3,000 units, by 2005. "New models in this class whet people's appetite for luxury," says Philipp Rosengarten, senior analyst in Frankfurt for market researcher Global Insight Inc.

What do clients get in return for shelling out the big bucks? Recline horizontally in the Mercedes-Benz Maybach 62's back seat and gaze out the transparent roof. Or tickle your toes on the thick sheepskin carpet of the new Rolls-Royce Phantom: It nearly begs riders to take off their shoes. "Driving in the new Phantom is like going somewhere very quickly and very quietly on your own very powerful magic carpet," says Howard Mosher, head of sales and marketing for Rolls-Royce. Just to market its first cars, Rolls jetted the chief designer and engineer around the world to explain to potential customers the concept behind the new Rolls. Of course, the concept is simple: supreme indulgence. Buyers understand that in any language.

Corrections and Clarifications In "Classy cars" (Special Report, Mar. 24), BusinessWeek reported that three years after purchase, a $30,000 Ford Thunderbird retains just 29% of its value, while a $38,000 BMW 3 Series holds 60% of its value over the same period. BusinessWeek stands by its calculations of residual value. But it regrets the choice of the Ford Thunderbird as the base of comparison: The T-bird went out of production in the late 1990s, then reappeared in the 2002 model year as a completely different car.

By Gail Edmondson in Geneva, with Christine Tierney in Detroit, Chris Palmeri in Los Angeles, and bureau reports

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