Mercedes, BMW and Audi extend reach at the expense of mass-market brands

As German luxury brands broad-en their reach with new products, they are gaining volume without tarnishing their upscale images, executives say.

In the U.S., for instance, Audi, BMW and Mercedes-Benz sales have climbed this year through August. Audi leads the pack in percentage increase at 12 percent, followed by Mercedes (excluding Sprinter) at 7.3 percent and BMW at 5.9 percent, according to the Automotive News Data Center.

And in Europe, an Audi, BMW or Mercedes is more likely to be bought each month than a Citroen, Fiat or Toyota. The three German luxury brands have increased their combined share of the European market to 17 percent through 2014 from 10 percent two decades ago, according to an Automotive News Europe analysis of sales data from ACEA, the European automakers association.

Audi, BMW and Mercedes have succeeded in "democratizing" luxury and have boosted volume without sacrificing profit margins. They have done so by launching smaller models targeted at customers who typically had driven mass-market brands, as well as creating new segments with vehicles such as the BMW X6 coupe-styled cross-over and the Mercedes CLS coupelike sedan.

"People's aspirations are much higher these days which, combined with the recent recovery in economic performance, means the premium car segment is much more resilient," Ian Robertson, BMW AG board member for sales and marketing, told Automotive News Europe.

But does increasing ubiquity mean that a luxury brand risks damaging its image? No, says Ola Kaellenius, Daimler board member in charge of Mercedes sales and marketing.

"If you deliver a very authentic Mercedes experience in every segment then we are absolutely fine in terms of fulfilling our brand promise," Kaellenius said. "We have just a little over 2 percent of the global car market, so we're not worried about exclusiveness of the brand."

Market watchers say the definition of luxury is becoming increasingly blurred. Exclusivity may have been a key luxury brand attribute, but it was largely the result of an expensive price tag. What is critical, they say, is protecting a brand's equity, which remains one of the most important assets of German luxury carmakers. Mercedes and BMW are estimated to be the second and third most valuable car brands in the world after Toyota.

Millward Brown, a market research firm that publishes annual rankings, estimates that BMW is worth $26.35 billion and Mercedes is worth $21.79 billion.

If either of these figures appeared in the brands' balance sheet, it would dwarf any other individual asset. (According to International Financial Reporting Standards, brands are only recognized on the balance sheet in the event of a disposal, since the value can be easily determined via the goodwill embedded in an acquisition price.)

For the moment, there appears to be no evidence that customer demand is waning. Moreover, all three German luxury carmakers continue to have operating profit margins around 10 percent.

Several factors are driving the German trio's expansion, including carbon dioxide emissions targets, new products and a shrinking middle class. Nowadays managers often talk about how many customers traded in their midsize car built by a volume brand in favor of a smaller compact vehicle that has a luxury badge on the hood.

Luca de Meo, Audi AG's board member for sales and marketing, remembers reading about Harvard economist Michael Porter's "stuck in the middle" phenomenon 30 years ago during his time in college. Porter said businesses that fail to set themselves apart by pursuing one of three strategies -- low cost, product differentiation or a niche market focus -- risk performing poorly by getting "stuck in the middle" chasing all of the strategies. Now, de Meo sees it happening.

"Premium brands are benefiting globally as demand polarizes between the top and bottom categories," de Meo said, adding that it's part of a broader cultural trend. "We see the same happening in the fashion industry, consumer goods, even in food."

The trend is reinforced by the shrinking middle class in many parts of the developed world. Stagnant median disposable incomes combined with a rising share of wealth generated by more affluent segments of the population force many households that might have been midrange vehicle buyers to switch to economy makes.

Additionally, the German brands have been able to boost sales with segment-busting models such the X6 and the Audi A7 Sportback, which have encountered little to no competition from volume brands.

"We created products that generated demand," de Meo said. These products attract "a completely different customer base, people ready to pay for something unique," he said.

Another factor behind the growth of the German luxury brands is Europe's increasingly strict carbon emission goals. The first reduction target was set for this year, with more stringent limits to take effect in 2020. To reduce the carbon dioxide of their fleets, the German companies had to expand their small-vehicle portfolios, which put additional pressure on volume automakers.

Mercedes forecasts that its compact family, which has grown from two to five models in the last five years, will account for 42 percent of its global sales in 2025, up from 33 percent last year. BMW's Robertson said that, including Mini, small cars account for about 40 percent of the automaker's global volume.

BMW Group's Peter Schwarzenbauer has studied volume vs. exclusivity. The former Porsche U.S. sales chief and Audi board member for sales is now in charge of Mini and Rolls-Royce. He said that with the right strategy, the rewards outweigh the risks.

"I often get the question whether the German manufacturers risk diluting their premium image," Schwarzenbauer said.

"If you set a goal to sell so many thousands of Rolls-Royce cars over the next five years, for example, then you would be making a mistake because the direction of the entire company will then be focused solely on simply achieving that volume in the time allotted," he said.

"That doesn't mean you cannot grow -- the natural result of offering a desirable product in an expanding market should indeed be higher sales, but that difference is the key. Were a luxury brand to target volume only, then yes, I do believe this would be a dangerous strategy to pursue." c