Daimler (DAI:GR) Chief Executive Officer Dieter Zetsche was leaning back in the rear seat of a prototype Mercedes-Benz S-Class sedan in 2010 when he realized it didn’t recline far enough. With wealthy consumers accustomed to sumptuous airline seats, he figured Mercedes needed to approach that level of comfort in its flagship model. “Engineers traditionally focus on the driver seat position,” Zetsche says. But “S-Class owners often experience their car from ‘the second row,’ especially in China,” where luxury cars are frequently driven by chauffeurs.
So Zetsche had his designers create a back seat that reclines to a 43.5-degree angle, available as an option on extended-wheelbase versions of the revamped S-Class unveiled on May 15. For back-seat sleeping, the front passenger seat slides forward to add legroom and the backrest recedes into a recess illuminated by ambient lighting. A calf support swivels forward and a heel rest pulls out of the front seat. A hot-stone-massage function in the back part of the rear seat aids relaxation on long drives. There’s even a special air bag to prevent slumbering passengers from sliding under the seat belt during an accident.
Back-seat amenities are critical to reviving the Mercedes brand among well-heeled Chinese buyers, who account for more than half of all S-Class sales worldwide, and those sales are key for Daimler’s bottom line. In the first quarter, Mercedes’s operating profit margin was 3.3 percent vs. 11.1 percent at Audi (VOW:GR) and 9.9 percent at BMW (BMW:GR). Commerzbank estimates the profit margin on the S-Class at 25 percent (vs. 1 percent for the A-Class hatchback), so boosting its sales would have an outsize impact on Mercedes’s earnings.
McKinsey forecasts sales growth of upscale vehicles in China will average 12 percent a year through 2020, outpacing the 8 percent rate for the country’s overall car market. That increase would put sales of high-end autos there ahead of those in the U.S. by 2016 and on par with demand for all of Western Europe by the end of the decade, the consultant said in a March report. Mercedes lost its long-held rank as the No. 1 global luxury brand in 2005. “Mercedes can only become No. 1 [again] if they improve in the biggest market—China,” says Thomas Schiller, an automotive partner at consulting firm Deloitte in Munich. “The S-Class serves as a brand ambassador.”
Zetsche in 2011 announced a goal of overtaking BMW and Volkswagen’s Audi luxury brand in global sales and profit by the end of the decade. But 2013 Mercedes deliveries—441,500 vehicles through April—trail Audi by 61,500 and No. 1 BMW by 70,500.
The S-Class has been the clear leader in luxury sedans since it first hit the market in 1972. The halo effect from the car—which can cost as much as $486,000 in China, due to heavy import levies—also allows Mercedes to generally charge more than rivals for its other cars. “The S-Class stands for luxury, prestige, comfort, and safety,” says August Joas, head of the global automotive practice at consultant Oliver Wyman in Munich. “It’s the absolute flagship model, and a thorn in the flesh of the competition in terms of volume, pricing, and margin.”
That leadership position isn’t unassailable. Last year, Mercedes sold 80,300 S-Class vehicles globally vs. 59,200 for the BMW 7 Series and 38,600 for Audi’s A8. In 2008, S-Class sales were more than double those of the 7 Series and more than four times those of the A8.
One reason for the falloff was Mercedes’s decision in 2006 to maintain separate China sales organizations for locally made vehicles, such as the smaller C-Class sedan, and imported cars like the S-Class. That pitted Mercedes models against one another and led to price-cutting: S-Class discounts shot up to an unprecedented 25 percent in 2012. Daimler finished recombining its sales operations this year; in February, Nicholas Speeks, CEO of Mercedes-Benz China, lashed out at the brand’s Chinese dealers for missing already-lowered sales targets. “These sales figures can be reached by call-center employees,” Speeks wrote in a February letter to dealers that was obtained by Bloomberg. He accused the brand’s sales partners in China of “slack work and a neglect in the ambition to develop the Mercedes-Benz brand.”
That tough talk drew a chilly reception from Chinese dealers. “Automakers can’t act like they have all the power,” says Shen Rong, deputy secretary general of the China Auto Dealers Association. With all brands looking to expand, “it’s now a buyer’s market in China, so to succeed it’s crucial to handle dealer relationships well.”
Mercedes’s bigger focus is wooing more well-heeled mainland customers. The brand’s dealer in Shanghai offers perks like a 13-seat movie theater, a cigar room, and an in-house tea artist. Mercedes also offers some features that are extra-cost options elsewhere in the world as standard equipment on S-Class cars sold in China. These include active parking assist technology, a night-vision package, and—surprise—a rear-seat entertainment system.