Audi's U.S. Growing Pains

Sales are up 11% for Audi of America, but its growth targets remain buffeted by a weak dollar, tired showrooms, and tough competition

To hear Audi of America Chief Johan De Nysschen talk about how his sumptuous new $110,000 race car, the R8 (BusinessWeek, 9/29/06), is sold out for this year and next, you would think he is riding high. Overall sales for Audi, too, are up 11%. Not bad in a topsy-turvy year for the stock market, a burst housing bubble, and a U.S. dollar that is so weak against the euro that George Washington may as well be pictured on his knees.

But don't mistake De Nysschen's easy smile and manner for comfort. Despite the wave of positive press Audi has received over the last two years for its new generation of vehicle designs, the South African-born executive has plenty to worry about as the Audi brand tries to hold its place in the same league in the U.S. with BMW (BMWG) and Mercedes-Benz (DAI), not to mention Toyota Motor's (TM) Lexus Div. and Nissan's (NSANY) surging Infiniti.

Hefty sales target

A model-by-model look at Audi's sales reveals a picture that isn't all sausages and beer for the German brand. Yes, the Q7 SUV (BusinessWeek, 12/8/06), a tank-like luxury ride Audi introduced last year, has sold exceptionally well—14,500 in the first eight months of this year. The Q7 is Audi's second-best-selling model, after the A4 (BusinessWeek, 11/14/06).

But sales of the A6 sedan (BusinessWeek, 2/1/06) are down 38%, and the A8 flagship (BusinessWeek, 8/7/07) is down 27%. The A3 (BusinessWeek, 7/13/06), introduced in 2005, is down 27%.

Audi is on track to sell about 90,000 vehicles this year. "But that's not enough to be a real player," says De Nysschen, who turned around Audi's Japanese unit before arriving in the U.S. a few years ago. Indeed, Dr. Martin Winterkorn, chairman of Volkswagen (VOWG), which owns Audi, has a sales target in mind for Audi of America that appears to be the source of De Nysschen's worry lines: 200,000 sales per year by 2015.

Room for Improvement

The luxury car business today demands that kind of sales volume to stay competitive, as Lexus, BMW, and Mercedes-Benz are all on their way to 300,000 per year in the U.S. Though De Nysschen doesn't confirm this, Audi is unprofitable in the U.S. and has been for the last 20 years. Two decades ago, rumors—later proved false—that Audi cars were prone to sudden acceleration, brought the company—and its reputation—to its knees.

Since that debacle, dealers have been reluctant to invest in new facilities, which are crucially important to luxury car buyers. "People spending in excess of $40,000 for a car expect to see an exclusive, new, brilliant showroom," says De Nysschen. Of Audi's 270 dealers, just 90 have up-to-date exclusive sales floors and repair bays. About 93 have multiple brands on the selling floor. And another 90 or so still carry Volkswagen and Porsche models on the same floor, a legacy of the 1960s when all three German brands were imported by the same distributor. Indeed, in those days, Volkswagen dealers who paid for the franchise were given the Audi franchise for nothing.

Quality of customer handling and the products themselves go hand-in-hand with updated showrooms, and Audi has been in investing in making the brand competitive with the luxury leaders after several years of underperforming and backsliding. In this year's J.D. Power & Associates Initial Quality Study, Audi ranked below average, with 136 problems per 100 cars. The brand had scored 130 problems per 100 cars in 2005 and 106 in 2004. In J.D. Power's Sales Satisfaction Study, which tracks how well dealers treat customers, Audi has only been able to hold ground at slightly above the industry average. (Like BusinessWeek, J.D. Power is a division of The McGraw-Hill Companies (MHP).)

Without improvement, Audi risks falling below average in service, as well as product quality. To push dealers, Audi has tied 3.5 percentage points of their profit margin on new car sales to the dealers' customer service performance. Moreover, he has laid down the law with dealers who refuse to invest in new showrooms—either invest now or Audi will buy you out.

Cool cachet

De Nysschen is only being practical as he drives toward the loftier sales targets foisted on him by his German parent. He points to markets like Miami, which has a big new facility and sales that are up 25% this year. In New York, home to another new operation, sales are up 14%. In Phoenix, sales are up 19%.

Better retail distribution is only part of the recipe for challenging Audi's rivals. De Nysschen needs more product, as well. The new Q5 SUV (BusinessWeek, 4/25/07), which is said to be midway in size between BMW's X3 (BusinessWeek, 5/22/07) and Lexus' RX350, is due to arrive in U.S. showrooms in early 2009, along with a diesel version of the Q7. A third crossover SUV is also expected. With industrywide sales of luxury crossover SUVs expected to climb from 200,000 this year to 400,000 by 2012, it is the fastest-growing luxury segment.

Audi is already well underway in attaining the "cool" factor required in the luxury segment. Jim Hall of AutoPacific, an auto industry consultancy, says that among luxury car buyers, Audi "is well on the way to being seen as a legitimate alternative choice from a technology and performance standpoint to Mercedes and BMW."

Audi buyers have long been attracted to the brand's all-wheel-drive Quattro system, and increasingly they have been drawn to Audi's performance bona fides, which come in "S" performance versions of its cars that are meant to compete against Mercedes-Benz's AMG special models, and somewhat against BMW's M-Series cars. De Nysschen says he aims for Audi to be an "exclusive brand among exclusive brands." That's a backhanded way of saying that Mercedes and BMW have become too ubiquitous in recent years and have stretched their brand portfolios so much that they are losing some of their premium and exclusive cachet.

Quite the Halo

Audi's biggest headache nowadays is the weak dollar. The company has no U.S. manufacturing as a hedge, compared with BMW, which manufactures two models in South Carolina, and Mercedes, which builds two vehicles in Alabama. And it's not likely that Audi will build in the U.S. any time soon. Its sister company, Volkswagen, is looking to establish a plant in the U.S. But as Audi has stepped away from sharing engineering platforms with VW, it isn't likely Audi would share in VW's U.S. manufacturing.

Audi took a gamble this year by bringing out the R8 mid-engine sports car as a halo car for the brand. De Nysschen fought his masters in Ingolstadt, Germany, to keep the base price down at $110,000. He will have but 250 or so to deliver this year when he could, in fact, sell more like 1,000 if he had them. The car has been so well reviewed in the auto press—USA Today dubbed it the "best sports car. Period."—that one of the first buyers to take delivery resold the car on for $244,000.

Of that sale, a dejected but good-humored De Nysschen says: "It doesn't make all my work to keep the price down look very smart back in Ingolstadt, does it?" Sales and image are on the upswing at Audi, but that doesn't mean De Nysschen has much opportunity to enjoy it.

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