European car manufacturers have frittered away more than €4 billion on futile and egocentric luxury car products, while ignoring mundane but crucial projects which could have buttressed profits for their bread-and-butter businesses and fought off competition from the Japanese and Koreans. Even if sales targets are met, returns are seen as too small and some analysts say the money would have been better spent on improving basic business, writes Neil Winton.

Investment banker Goldman Sachs said in a report that it calculates that over €4 billion has been invested in so-called high-end projects in the past six years, but the projects are unlikely ever to provide a positive return.

Automotive industry expert Karel Williams, Professor of Accounting and Political Economy at The University of Manchester, agrees that this spending on luxury car capacity will not meet sales targets and will be a hostage to fortune when an economic downturn comes. Industry leaders have been swayed by emotion, and fear of the consequences of tackling head-on basic problems which need to be solved.

Better to dream
“Petrol head engineers at DaimlerChrysler, BMW and Volkswagen have read too many enthusiast magazines and this got the better of them. Why sort out boring things that are really difficult like high wage costs and labour unions which stop the reorganisation of the production process, when dreaming of super sports cars costing £125,000 (€190,000) is much better,” Williams told just-auto.

“There is gross excess capacity, and when European and north American economies turn down, this will be really painful. They’ve got away with it so far because there’s been no sharp downturn since 1989,” Williams said.

Consultant Global Insight disagrees, saying sales projections are likely to be met, with one notable exception, VW‘s Bugatti project.

According to Goldman Sachs, new capacity to make high-end luxury cars like VW’s Bentley, Lamborghini and Bugatti, BMW’s Rolls Royce, Mercedes’ McLaren and Maybach, Ford’s Aston Martin, Fiat‘s Maserati and Ferrari, and the Porsche Carrera GT is likely to reach about 25,000 a year.

No halo
Not only will this not generate anything like enough return on capital, there is no real so-called “halo” effect. “Owning Bentley does not raise the brand value of a Golf. Aston Martin does not help sell Mondeos. McLaren-Mercedes may be an exception, offering some brand benefits,” Goldman Sachs concedes.

Goldman reckons this is has squandered money and management time; the Europeans could have built new capacity in the U.S, like the Japanese, to avoid foreign exchange risk.

The €4 billion represents Peugeot‘s R&D for two years, a new range of volume cars, or 4 plants the size of Nissan’s Canton facility, Goldman estimates. Not all experts think that this is a futile adventure.

Philipp Rosengarten, Senior Market Analyst with Global Insight Automotive in Frankfurt, Germany, reckons that Goldman Sachs’ projections are wrong, although not everybody will make money.

“It’s a bit more complex than suggested by Goldman. You can make a lot or lose a lot in this segment, just like smaller cars, it depends on getting the formula right, and execution,” he said in an interview.

More and more wealthy
Rosengarten points to a huge growth in the number of wealthy people in the last 10 years. Global Insight divides the super luxury sector into two – cars costing between €100,000 and €200,000, like the Bentley Continental GT and Aston Martin (F1), and those costing more than €200,000 like the Mercedes Maybach, Rolls Royce Phantom and Ferrari Enzo (F2).

“The F1 Segment will show tremendous growth over the next couple of years. F2 will see growth but not that strong like the F1 segment, also staying below past records,” Global Insight said.

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Rosengarten concedes that there some turkeys amongst the luxury projects, with the Bugatti Veyron high on the list. Most other projects will see varying degrees of success.

“All the other vehicles are making sense despite the weak dollar. Aston Martin has said it will be profitable this year, that’s a first for them,” Rosengarten said.

First profit in 90 years
Early in June, Aston Martin said it expected to make an operating profit in 2004, for the first time in its 90-year history, although it didn’t say how much. John Walton, vice-president and general manager of Aston Martin North America, said this was possible, despite the steep decline in the value of the dollar.

Ford subsidiary Aston Martin produces its cars in Britain and sells most of them in America. Walton also had some chilling thoughts for his fellow luxury car manufacturers.

Who gets the shortfall?
“If you add up what everybody’s planning to do, divided by the amount of people who buy at that level, somebody’s going to have a shortfall,” Walton said.

Global Insight’s Rosengarten is unfazed. He believes Bentley will make a profit for VW in 2005. Mercedes McLaren, after initial teething problems with the SLR, is on course to meet sales targets. A smaller SLX in a couple of years might start to make money.

Rosengarten points out that some of the more expensive “F2” cars will actually make money for their owners, like works of art, citing the Ferrari Enzo and Porsche Carrera GT. But the new Rolls Royce Phantom is giving owner BMW some aggravation.

“It’s (the Rolls Royce) too slow; it only does 240 km/h. The other German competition regulates its cars to a maximum 250 km/h, so that means someone in a Phantom will be pushed aside by a little BMW 3 series. The speed should have been 250 km/h. But Rolls Royce does have a big customer base and brand recognition.”


Amazing Maybach
“The (Mercedes) Maybach – it’s an amazing car – could do much better if the marketing was improved. They should offer every S class owner a test drive, then they wouldn’t have any problems selling 1,000 units a year,” Rosengarten said.

Goldman Sachs will have none of this, expressing astonishment at the confidence from the manufacturers that their sales forecasts would be reached. It also notes that most of these expensive cars were conceived five years ago or more, when the world economy was booming.

Now they are being launched into a less favourable environment. “The timing and extent of this spending looks unjustifiable for a European industry with severe profitability problems and dismal returns on capital. Building exciting high-end sports cars will not do much to ensure the future of Europe’s volume auto industry, in our view. We also remain unconvinced that the high-end brands can offer a cost-effective means of testing new technology that can later be applied to volume models,” Goldman Sachs said.

Investment recovery looks tough
“To recover €4.3 billion of investment with a reasonable 10-year time frame looks tough to us. Even if all the companies met their volume objectives – over 20,000 units a year – it would mean each vehicle produced would need to generate a genuine profit of €15,000 per unit. That seems unlikely to us,” Goldman Sachs said.

Even if the vehicles are as profitable as this, the actual returns will be miniscule in the context of the big manufacturers.

Assuming Bentley and Lamborghini make a 10 per cent margin, this would leave an annual net profit of €60 million and €24 million respectively to VW.

“A €84 million contribution is irrelevant to a group like VW which, in years prior to 2003-2004’s earnings crisis, was earning EBIT (net profit) of up to €4 billion. The numbers for Aston Martin and McLaren look similarly irrelevant. Aston Martin at 10 per cent margin, making 5,000 cars a year, would make perhaps €50 million for Ford. Mercedes-McLaren at a 10 per cent margin would make €18 million for DaimlerChrysler,” Goldman Sachs said.

Trickle-down factor
Krish Bhaskar, president of Nice, France-based automotive consultancy MIRU, doesn’t buy Goldman’s pessimism, seeing big advantages for companies like VW, who can use its involvement with exciting sports cars and upmarket projects to hire the best engineers. Previously, only BMW or Mercedes had enough prestige or excitement to lure the best talent.

Bhaskar believes in the “trickle-down” factor.

“This means a higher set of engineering ideals at VW than they would normally work on with a Passat or Golf, and that will trickle down the product range,” Bhaskar said.

Bhaskar does believe VW has bitten off more than it can chew though, with 3 luxury projects, the Bugatti, Bentley and the Phaeton, the latter an attempt to move the VW brand into luxury territory. “VW could do one Bugatti, or Bentley or Phaeton, but not all three,” he said.

Bhaskar makes the point that a number of wealthy customers is likely to be enhanced by the recent increase in membership of the E.U., and has no doubt that luxury car sales will accelerate.

Goldman quite wrong
“Goldman Sachs is quite wrong. The segment is growing and growing quite fast and could easily be 20,000 by 2005 and nudging 30,000 by 2007. The addition of 10 new countries means probably 2 million multimillionaires will eventually emerge,” says Bhaskar.

Manchester University’s Professor Williams, firmly in the Goldman Sachs camp, believed the automotive business was prone to taking egocentric decisions which owed more to fantasy than the bottom line because of its unique cushioning from shareholders.

“Many of them are insulated from shareholder value issues. Volkswagen (controlled by Lower Saxony) and Renault (15 per cent government stake) have government blockers of change. BMW, Peugeot, Ford and Fiat have dominant family shareholders. All this means they are not under acute pressure,” Williams said.

Mad, senseless
Williams asked himself the question, and came up with an unequivocal answer. “Was there something pointless, stupid and wasteful about volume car manufacturers making cars costing more than £100,000 (€150,000)? Yes of course there is. Everybody but the enthusiasts could see this was mad and made no sense,” he said.