Porsche's record sales could endanger exclusivity, tech leadership

Whether you're talking vehicle sales, revenue or profits, Porsche is booming.

Strong global demand has Volkswagen Group's sports car brand on course to top its goal of 200,000 annual vehicle sales this year or next -- well ahead of its 2018 deadline.

But the sales surge has some industry watchers worried that Porsche's parent is placing too much emphasis on volume. That could rob the brand of its exclusivity and increase the danger of quality problems.

So far these aren't pressing issues at Porsche, which has been an absolute steal for VW Group since VW paid 8.4 billion euros ($11.2 billion) for the equity while shouldering another $3.3 billion in debt. Porsche made $935 million in operating profit in the first quarter alone.

Even if the VW brand were to have boosted its first-quarter earnings by another half, it still wouldn't have matched Porsche despite selling 26 times as many cars. In the future, Porsche likely will contribute even more than the $3.5 billion it provided to VW last year now that VW executives estimate cost savings from the acquisition will total more than $1.3 billion a year vs. the previous estimate of more than $935 million.

Margins continue to hum along at double-digit rates, and perceived workmanship is among the industry's highest.

Porsche came in first for the second straight year in J.D. Power's U.S. Initial Quality Study, which examines problems experienced by vehicle owners during the first 90 days of ownership. The Boxster, 911 and Panamera ranked at the top of their segments, while the Cayenne finished second only to the Lincoln MKX. Porsche's Leipzig, Germany, plant also took home J.D. Power's award for the best European plant in terms of build quality. A separate J.D. Power annual survey for Germany also placed Porsche at the top.

"The acid test is customer satisfaction," Porsche CEO Matthias Mueller said in June after the results were published. "For us, the ratings are both a confirmation as well as an incentive to continue along our path to quality growth."

Porsche expects another sales and profit boost as it benefits from the global rollout of its new Macan, a mid-sized crossover derived from sibling brand Audi's Q5. Starting in 2015, the company plans to build 50,000 Macans a year, but that total could rise as the waiting time to get the crossover is already six months.

When Mueller became Porsche's CEO in 2010, he concluded that doubling sales volumes to more than 200,000 cars by 2018 was achievable without having to sacrifice its operating margin target of at least 15 percent.

"Taking our exclusivity and our premium standards as a given, this development will be driven by expanding our product portfolio and our worldwide market presence," he said at the time.

Mueller says that out of every 1,000 cars sold around the world only two or three are Porsches, the implication being it will stay that way. Now he's set to meet his 2018 volume goal three years early, and operating margins, which have ranged between 17 and 19 percent since 2010, remain strong.

Managing such an expansion can prove problematic, especially for a brand that thrives on exclusivity. Porsche this year had to recall the 911 GT3 to replace engines because of problems with the connecting rods that could lead to a fire. Also this year, brake boosters on the Macan needed to be checked for faults.

Arndt Ellinghorst, head of automotive research at ISI in London, fears VW Group is killing the golden goose and argues that Porsche needs to make headlines with trailblazing technology rather than churning out more model lines to fill vacant market segments.

"Volkswagen's financials pretty much rest on the earnings performance of their premium business, so it's very important [to VW] that these brands achieve the returns that they are generating," he said. "Just like with other parts within the Volkswagen Group, it's a sales-driven business and Porsche is going for volume. The question then becomes at what point do you lose your premium image? Porsche is already becoming a pretty mainstream product in some markets such as London."

Ellinghorst cited the price of the Macan as a prime example. In Germany, the 3.0-liter six-cylinder Macan S with 340 hp has the same $77,500 price tag as the equivalent BMW X4 xDrive35i, which offers only 300 hp. In the United States, the Macan's base price is just 4 percent higher.

Porsche's expansion differs from the more conservative approach taken by its Italian rivals Ferrari and Maserati. Ferrari boss Luca Cordero di Montezemolo said the race car manufacturer could easily sell a lot more cars in markets such as China or the oil-rich Persian Gulf, but it doesn't want to.

"Exclusivity plays a big role. That's why we are the only car company to decide to build and sell fewer cars in the future. ... It's enough for the moment," Montezemolo told German weekly news magazine Focus. Sibling brand Maserati plans to cap its sales once it reaches its target of 75,000 cars in 2018.

Brand experts argue that customers' perceptions of luxury brands have evolved over time. That means the benchmark no longer can be described simply as selling one fewer Porsche car or Hermes handbag than the market demands.

Star fashion designers Stella McCartney and Jimmy Choo went downmarket with clothes and shoe collections they sold through Swedish fashion chain H&M, yet the excitement generated crowds that went around the block.

"Twenty years ago a luxury brand would never have collaborated with a High Street retailer," said Manfred Abraham, managing partner at BrandCap consultancy. "Maintaining the perception of luxury by artificially restricting the number of sales is a very old-fashioned view. Offering a personalized experience for the customer can achieve the same effect."

For example, the Porsche Travel Club offered customers the chance to drive the Macan before its market launch, taking the crossover on a two-day road trip through the Pyrenees mountains before ending up in Barcelona, Spain. The company also runs driving schools in 13 of its biggest markets. Customers who bought the Porsche 911 Club Coupe had their names engraved by laser on the exterior trim of the car's body panel.

Clients also receive a personalized photo album documenting the vehicle's manufacturing process.

"It is our intention to offer our customers a unique purchasing and ownership experience," Kjell Gruner, Porsche's vice president of marketing, said in a release.

Much of Porsche's success can be attributed to its former CEO, Wendelin Wiedeking, who rebuilt the company almost from scratch after inheriting a once proud carmaker on the brink of failure in the early 1990s.

He was the architect behind stretching the Porsche brand to incorporate models beyond the traditional rear-engine 911 Carrera, starting with the Boxster and following up with the Cayenne SUV. The Cayenne is now the brand's top-seller, accounting for more than 40 percent of sales in the first half of the year.

Unlike fellow Stuttgart premium carmaker Mercedes-Benz, Wiede-king lacked the advantage of scale, and needed to maintain extreme vigilance when it came to Porsche's fixed-cost base. While Mercedes could afford a Formula One team to boost its reputation, Porsche eschewed the circuit to preserve profits.

Wiedeking introduced a lean production system in which all lower-margin operations that were not a core competence were outsourced to third parties.

If Porsche wanted to expand output to meet demand, it couldn't simply adopt the usual cost-effective solution and add a production hall to its traditional factory in northern Stuttgart. Its plant, in the relatively densely populated district of Zuffenhausen, Germany, was limited by zoning considerations and other municipal hurdles.

To avoid building a new plant and adding to its fixed costs, Porsche contracted Finnish coachbuilder Valmet to assemble the Boxster. Despite slowly expanding its Zuffenhausen factory through the purchase of adjacent land, Wiedeking maintained his flexible production approach when it came time to begin manufacturing the Cayenne and the Panamera.

While both models roll off the line in Leipzig, the plant in the former East Germany initially only served as a destination for final assembly as most work was carried out in VW factories.

This ceased with last year's production start of the Macan, when Leipzig finally had a dedicated paint and body shop at the cost of a half a billion euros.

Ferdinand Dudenhoeffer, head of the Center for Automotive Research at the University of Duisburg-Essen, argues that this kind of flexible production system in which capacity of Porsche's plants runs flat out is more important than creating economies of scale through ever-rising volumes.

"The secret to Wiedeking's success was keeping the manufacturing capacity at all times fully utilized," he said. "Porsche's decision to invest heavily in insourcing its production endangers that since its fixed costs increase in step with capacity."

Ironically, it was Wiedeking's plan to acquire the much-larger VW Group that gave VW the opportunity to buy the sports car maker in the first place. The Porsche and Piech families wanted to keep the carmaker independent, but Wiedeking's risky maneuver almost bankrupted the company and the clans had to sell their coveted sports car maker to VW to repay banks billions of euros in borrowed money.

Indeed the price agreed was so cheap that the call options used by VW Group to guarantee the purchase became more valuable than anyone could have possibly predicted. Altogether VW was able to book nearly $25.4 billion in additional noncash profits in 2011 and 2012, thanks to the deal.

Mueller and his boss, VW Group CEO Martin Winterkorn, are looking for ways to keep Porsche's sales on the rise. First they lifted the ban on diesel-powered Porsches, adding an Audi 3.0-liter TDI engine to the Cayenne, something Wiede-king had refused to do. News that Porsche wants to add two model lines on top of the Macan also raised eyebrows.

Mueller is considering shrinking the Panamera four-door large sedan to offer a smaller four-door model and is eyeing a sports car that fits between the 911 Turbo and Porsche's highest priced model, the $845,000 918 Spyder. This would allow the brand to launch a redesigned next generation each year.

ISI's Ellinghorst said Porsche's sales-driven approach is a problem over the longer term.

"They are now going to squeeze the brand by using the VW toolbox, re-engineering a few bits here and there, rebadging it as a Porsche and then selling 50,000 to 100,000 units, since they know the Chinese will buy them," he said.

"Being an innovation leader is a different story, and that's where I haven't seen a lot coming from Porsche in the last decade. What BMW is doing with the i3, what Tesla is doing with the Model S, that is innovation-leading. [Porsche] risks losing their exclusivity -- not in the next five years certainly, but over the longer term if they continue like this."