Mercedes' New Boss Rolls Up His Sleeves

Layoffs are just the beginning. Can Zetsche fix production and quality woes?

Only four weeks into the job, Mercedes Car Group chief Dieter Zetsche stunned employees on Sept. 28 by ramming through a program to cut 8,500 jobs at the German auto maker -- 9% of its German workforce. Zetsche's move heralds a new era at parent DaimlerChrysler (DCX ), where the affable 52-year-old who turned around Chrysler takes over as CEO on Jan. 1 in addition to his job running Mercedes. "Mercedes has become flabby," says Garel Rhys, director of the Centre for Automotive Industry Research at Cardiff University Business School in Wales. "Management has woken up to the fact that they have to tackle their cost base."

And how. Although the vaunted Mercedes brand still commands a price premium of roughly 5% over luxury rivals, that's far too little to cover the yawning cost spread it has with the likes of BMW, Audi, and Lexus. "A long hard road lies before us. Our costs in every part of the production chain are clearly higher than those of our best competitors," Zetsche said in a Sept. 28 letter to employees. While auto makers don't reveal the actual numbers, industry experts estimate the cost of producing a car at Mercedes now runs $2,400 to $3,000 higher on average than at No. 1 luxury carmaker BMW. Ferdinand Dudenhöfer, director of the Center For Automotive Research in Gelsenkirchen, figures the gap represents 7% to 10% of total production costs on average. mercedes insiders say the difference runs up to 22% on some models, such as the trouble-plagued E-Class. "Mercedes' whole mantra has been: `We build the best luxury cars in the world -- at any cost,"' says Morgan Stanley analyst Adam Jonas in London.

With Zetsche in the driver's seat, those days are over. The job cuts are a key step in bringing Mercedes' costs down and pushing productivity up. Mercedes lost $1.1 billion in the first half of 2005 and is likely to finish the year with a loss. But analysts say savings from the job cuts give momentum to Mercedes' efforts to save $5.6 billion by 2007. That target was set to help restore an operating margin of 7%, up from analysts' forecast of negative 0.8% this year.

DaimlerChrysler Chief Executive Jürgen E. Schrempp, who will resign on Dec. 31, hasn't made Zetsche's job easier. A year ago, Schrempp granted job guarantees until 2012 for Daimler's 185,000 German workers in exchange for gains in flexibility. "The deal [Schrempp signed] was a disastrous mistake," says Michael Raab, vice-president of automotive equity research at Sal. Oppenheim in Frankfurt. He notes that because of the job pledge, Daimler must shell out more to lay off workers than it normally would -- $1.15 billion, or an average $134,000 per worker.

Downsizing the workforce is just the first step. Zetsche's German plants lag a generation behind rivals BMW and Toyota Motor Corp. (TM ) in cutting-edge factory design and processes, say analysts, and its labor and shift agreements are too rigid. Production lines in the Sindelfingen plant, for example, stop during the lunch hour, while BMW uses staggered lunch breaks to keep its line flowing. "From a capacity-utilization point of view, a production-line stop is deadly," says Raab.

A former Daimler executive who spoke to BusinessWeek on background says Mercedes' costs started veering off track in 1999 when problems with Chrysler Corp. blew up and management attention was diverted. "We stopped doing the tiny, constant things to get productivity gains each time a new model is introduced, such as investing in new equipment, adopting new processes, and reducing the number of workers on each new line," he says. "By contrast, those guys [at BMW] worked on [productivity] constantly. Now the gap is huge. At a minimum, Mercedes has 10,000 workers too many."

While BMW's plants run at 95% of capacity, Mercedes' German factories operate at around 80%, say analysts. One reason is declining sales of the E-Class and C-Class models, both of which have suffered quality problems. A face-lift for the E-Class in 2006 and a new C-Class expected in late 2007 should help buoy weak sales. But union contracts that make Mercedes workers' work rules less flexible than rivals' are also to blame for the relatively low output. At BMW, employees work less during periods of slow demand and then bank the unused hours, paying them back during peak periods, thus eliminating a lot of overtime pay. Mercedes recently instituted more flexible schedules and got union agreement to shuttle workers among plants, long a practice at BMW.


Improving quality is also vital. The drive to lead in new technologies has resulted in cars packed with different electronic systems, which all must be integrated into a core system that functions harmoniously, a devilishly hard task. By contrast, BMW has sought to install common electronics backbones across many model lines. It also saves money by sharing more components among models. "Mercedes overinvested in the wrong things," says Stephen B. Cheetham, a London-based analyst at Sanford C. Bernstein & Co. (AC ) "The competition figured out you don't have to design an entirely new car to offer something new." Mercedes insists its cars use the same electronic architecture but admits that many components vary across the wide array of models.

Quality problems have sent warranty costs soaring. Zetsche's predecessor, Eckhard Cordes, slowed production lines to allow for additional testing, but that torpedoed productivity. The real fix lies in designing less complex cars and improving test procedures before a model launches. The $96,000 S-Class, which hit European showrooms in September, will be a vital test of whether Mercedes has its electronics problems under control. Mercedes testers drove 500 new S-Class cars some 8 million kilometers to search for potential failures.

Redesigning and reengineering all Mercedes models for better quality could take two years or so -- assuming Zetsche can push through changes as fast as he would like. "Mercedes needs new products that are engineered with a different philosophy," says James N. Hall, vice-president for industry analysis at AutoPacific Inc. in Southfield, Mich. The hardest job will be changing the Mercedes mindset.

By Gail Edmondson in Frankfurt

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