Hybrids Drive European Growth for Lexus

With EU rules pressuring carmakers and buyers, Toyota's luxury marque hopes its green models will allow the company to take on BMW and Mercedes

Karl Schlicht's job is a bit like being a salesman for Japanese beer in Bavaria. Schlicht is the Toyota (TM) vice-president in charge of the company's Lexus brand in Europe, a region that adores its locally made luxury sedans. Drive down any French or German highway and you'll see many more Mercedeses, BMWs, and Audis (VOWG.DE) than Lexuses. For that matter, you'll also likely see more Alfa Romeos (FIA.MI), Citroëns (PEUP.PA), Volvos (F), and Saabs (GM). Lexus sold only about 39,000 cars in Western and Eastern Europe in 2007, compared to 730,000 for the Mercedes (DAI) brand and 700,000 for BMW (BMWG.DE).

Lexus' performance in Europe stands in stark contrast to the U.S., where the brand is No. 1 in the premium segment. Yet Schlicht, a Canadian of German extraction, is surprisingly optimistic. Sales have improved dramatically from a few years ago. In 2006 Lexus' European orders soared 76% as Toyota relaunched the marque with a network of dedicated dealers and improved service. Results were flat in 2007, which Toyota attributes to problems in delivering some Lexus models. But according to Schlicht the Russian market—which is part of his territory—helped compensate: Wealthy Russians bought 13,000 Lexuses last year, a 30% jump from 2006, bringing the brand within striking distance of the Germans in that booming market.

Still, Lexus sells almost as many cars in the U.S. in a month as it does in Europe in a year. (Ironically, the brand also is weak in Japan, where sales are comparable to Europe's (BusinessWeek.com, 3/20/08).) In Germany, the Mercedes-BMW-Audi heartland, Lexus sold a mere 4,500 vehicles in 2007. How will Toyota meet its goal of selling 65,000 Lexuses a year in Europe by 2010? The strategy can be summed up in one word: hybrids. European carmakers have been slow to offer hybrid vehicles, focusing instead on diesel motors as a way to reduce fuel consumption and emissions. In Europe diesel is cheaper than gasoline and available at every filling station, making it a more appealing technology than it is in the U.S.

Won't Copy Mercedes and BMW

Mercedes doesn't plan to offer a hybrid-powered car until 2009, giving Lexus a head start. Already sales of Lexus' three hybrid models—the GS 450h and LS 600h sedans, and the RX 400h sport-utility vehicle—accounted for 31% of total Lexus sales in Europe in 2007, up from 26% in 2006. Among Lexus SUVs it's 85%. "Hybrid has been our breakthrough," says Schlicht.

The gasoline-electric powertrain helps address one of Lexus' main problems in Europe. Because of the brand's focus on the gasoline-oriented U.S. market, it has a much narrower range of diesel-powered models than do BMW and Mercedes. "We don't want to copy the Germans. They're good at what they do," says Schlicht. "We want to find our own way."

The time may be right for hybrids. All European carmakers are under regulatory pressure to lower fuel consumption and emissions. Buyers also are becoming more conscious of environmental concerns. Lexus hybrid models offer them a way to continue to enjoy a luxury ride without feeling so guilty or spending as much on gas. Lexus also could benefit from a trend for cities to follow London in imposing congestion charges on vehicles in the city. Lexus hybrids have been exempt from the London charge, helping make Britain the brand's strongest market.

Opening Separate Showrooms

Some analysts remain skeptical about whether the hybrid pitch will be enough to make Lexus a serious challenger to Mercedes, BMW, and the other high-end European brands. "It gets people's attention," says Christoph Stürmer, Frankfurt analyst for industry watcher Global Insight. But he points out that hybrids are still an exotic niche in Europe. Moreover, he says, Lexus will have trouble overcoming the advantage established brands have with their huge dealer networks. Lexus has about 280 dealers in all of Europe, including Russia—a fraction of that of the German brands. "Buying these cars is all about convenience. Part of convenience is having a dealer around the corner," Stürmer says.

Certainly it's been a long road for Lexus in Europe, even by Toyota standards. The company began selling Lexuses in Europe in 1990, but without the dedicated dealerships, known for attentive service, that made the cars such a hit in the U.S. The idea was, Toyota dealers would sell Lexus cars to customers wanting to trade up. But that market proved limited. "One of the success factors in the U.S. was complete separation from Toyota," says Schlicht. "In Europe the Lexus was in a corner of a showroom next to a Corolla." Despite strong reviews and top rankings in customer satisfaction (BusinessWeek.com, 6/20/07) surveys, Lexus had trouble getting traction.

British dealers began opening separate Lexus showrooms in the late 1990s on their own initiative. The success of the move inspired Toyota to copy the strategy continent-wide. In 2005 Toyota began rolling out a network of 276 dealers, including Russia, either in dedicated facilities or showrooms separated by at least a solid wall from the Toyotas. That same year Lexus began offering hybrids. Though Schlicht won't give exact figures, he says the increased sales have been enough to make Lexus profitable in Europe. "Of course," Schlicht allows, "we'd like to be more profitable."

Before it's here, it's on the Bloomberg Terminal.