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BMW


The lofty new modern art museum in Munich boasts a world-class collection of art, design, and architecture. But on May 19, the specially invited guests weren't there to gawk at the Picassos and Mir?s. They were assembled to appraise the art Bavarians love best: The latest model from Bayerische Motoren Werke. More than 100 German car dealers crowded around the revamped 5 Series sedan, the heart of the BMW franchise. They gazed approvingly at the sleek surfaces and listened as engineers described the tight handling of the new steering and stability systems. Looming over the proceedings was a 10-meter high sculpture celebrating the beauty of auto design, created by none other than Christopher Bangle, the controversial American designer of BMW's new look, and godfather of the latest 5.

Super-theatrical? Well, sure. But to the auto world, the latest Bimmer to hit the road is always a subject worthy of high drama. The Internet chat rooms of the global car-buff community have been buzzing about the fifth-generation 5 Series for months now. And they have a lot more to talk about than the latest rendition of BMW's biggest money-maker. The Munich company is rolling out a new or updated model nearly every three months through 2005 in a ramp-up more ambitious than anything the company has attempted before. "The [new] product initiative is critical to our future success," says BMW Chief Executive Helmut Panke. His goal: expand annual sales by 40% over the next five years, to 1.4 million cars, and beat out Mercedes-Benz (DCX) as the No. 1 maker of premium cars in the world. "We won't give up, and we don't rest on our laurels," says the 56-year-old Panke. "We won't accept the position of No. 2."

Panke, a nuclear physicist by training who is passionate about cars, is pushing BMW into high gear. If the accelerated rollout works, BMW's new raft of models will power the carmaker to a new level of prominence and profitability in the global industry. But as factories ramp up production levels and juggle an increasingly complex variety of models, BMW will have to fight harder than ever to keep its margins and maintain the quality that underlies its success.

It all depends on how BMW's vaunted engineers and workers respond to the challenge. The expansion is well under way. In January, the company unveiled the new $377,760 Rolls-Royce Phantom, for which BMW is still building an exclusive dealer network. The $37,760 Z4 roadster, which arrived in the U.S. at the end of 2002, hits European showrooms this spring, together with a diesel version of the Mini, the old British subcompact that under BMW's ownership is fast becoming a cult car. Next comes the 5 Series sedan, which goes to market in July. In the fall, the X3, a downsized sport-utility vehicle, makes its debut. At yearend, a revival of the high-performance 6 Series coupe hits the road, featuring some of BMW's most powerful engines. "The year 2003 is very, very critical for BMW," says Christoph St?rmer, senior analyst at Global Insight Automotive in Frankfurt.

So is 2004. In the fall of that year, dealers will get their first deliveries of the new 1 Series subcompact that will go head-to-head with the Audi 3, the Mercedes A-Class, and the high-end versions of Volkswagen's Golf. Next year, BMW will introduce a 6 Series convertible and a station wagon version of the new 5 Series.

It's a high-speed shift from a carmaker that 10 years ago churned out just a handful of models -- essentially the 3, 5, and 7 series. But remaking BMW became an imperative in the 1990s as the global auto market fragmented into hot new niches, and demand for luxury sedans -- the company's core business -- started to shrink as a percentage of total auto sales. "We can't make cars anymore that are three differently sized slices of the same sausage," says Panke.

What's more, Panke and his top officers are betting BMW's new-model momentum will propel it past rivals. The Bavarian giant has already overtaken Mercedes-Benz in the all-important U.S. market, with models appealing to a wide swath of X- and Y-generation managers, entrepreneurs, and professionals. "BMW is the brand people aspire to own. When people get to the point they can afford a luxury car, they buy a (BMW) 3 Series," says George Peterson, president of AutoPacific Inc. in Tustin, Calif. "Mercedes is much further down the list and slipping." BMW is also overtaking Toyota Motor Corp.'s luxury brand Lexus as the premium-car leader in the U.S. While the two rivals ended 2002 neck and neck, BMW has outsold Lexus for the first four months of 2003 (table) -- a quantum leap compared with the early 1990s, when the Japanese took the U.S. market by storm.

So far, BMW has steered its own redesign deftly. Despite a 53% increase in research and development and a 75% increase in capital expenditures over the past two years, BMW's net profit last year still rose 8.3%, to $2.36 billion, while revenues climbed 9.9%, to $49.5 billion. Operating margins, at 8% in 2002 and 8.7% in 2001 -- the heaviest years for investing -- were again among the highest in the industry. Lehman Brothers Inc. auto analyst Christopher Will expects the new-model push will generate a 20% rise in revenues next year.

But can Panke keep his highly tuned company on track as it accelerates? "The core strength of BMW will be challenged," says Peter Soliman, vice-president at Booz Allen Hamilton Inc. in D?sseldorf. Management is being stretched to the limit, as BMW builds a new, $1.5 billion factory in Leipzig at breakneck pace. The Leipzig plant, slated for inauguration at the end of 2004, will employ 5,500 workers: the first 400 are already being trained in BMW's complex production methods.

Few expect a major product blunder from the company's highly esteemed Bavarian engineers. Even the top-of-the-line 7 Series sedan, which at first raised howls of criticism for a provocatively imposing trunk design and for its complicated electronic information system, has outsold its predecessor during its first full year on the market.

However, many are betting that BMW's vaunted profit margins will take a hit, at least in the short run. Although Panke vows earnings will be flat in 2003, analysts warn that they could slip by as much as 10%, as marketing costs peak this year on top of higher R&D spending. Panke's bet assumes turbocharged growth in the second half, prompted in part by the new 5 Series. The growing strength of the euro also poses a risk to BMW's dollar-denominated earnings. The company is hedged nearly 100% against its dollar risk this year and 60% for 2004 -- but only 30% for 2005.

The more pressing question: Can an ever-bigger BMW maintain the consistently high returns it once achieved with its exclusive portfolio? For starters, small cars such as the Mini, launched in 2001, and the 1 Series subcompact typically earn lower margins than do midsize sedans and luxury limousines. "Compared with volume producers, BMW's manufacturing costs are much higher, its product development process more costly, and its purchasing costs higher," warns Goldman, Sachs & Co. analyst Keith Hayes in a recent report. Reflecting these risks, BMW shares have slid 41% from a year ago, to $32. Chief Financial Officer Stefan Krause insists BMW will wring cost savings on the 1 Series to maintain its high margins. As for the Mini, he says profits are "way beyond our forecast," thanks to unexpectedly strong sales of loaded models. Buyers are snapping up options from navigation systems to sunroofs, ponying up as much as $35,000 for the cheeky little car.

But rivals are eager to point out other pitfalls. Robert A. Lutz, General Motors Corp. vice-chairman for product development, says Cadillac will not follow the path of German luxury brands in the march to obtain higher sales volumes: "After a couple of 1 Series, they'll have to bring in another brand on top to add prestige," he says. "The 1 Series will diminish the brand in the eyes of 7 Series buyers." Panke is adamant that future growth won't tarnish the BMW badge. "We are not competing with the mass market," he says.

BMW already may be showing some early signs of margin stress. Analysts warn the company has resorted to an aggressive leasing strategy to bolster sales in a weakening market in the U.S. and Europe, and to shore up aging models. That's standard industry practice, to be sure. But up to 75% of its luxury 7 Series sedans and 50% of the 5 Series are leased in the U.S. The company makes its profit by selling the car at the end of the lease to the leaseholder, a BMW dealer, or others.

But there's a risk. If the sale price of the leased cars doesn't match BMW's high residual value estimate, then the company could suffer a lower return on those cars than it has traditionally achieved. And while BMW enjoys some of the highest residual values in the industry, often running over 60% for a three-year-old car, it's unclear what will happen to values if an increasing number of leased cars hit the market down the road. Deutsche Bank (DB) recently calculated an implied incentive of around $4,300 in the 7 Series lease rates. "The bottom line from our analysis shows clearly that in the U.S., BMW is currently offering the most aggressive leasing terms," says Deutsche analyst Christian Breitsprecher in a recent report. Not so, says BMW's Krause -- the leasing business is not being used to ratchet up subsidies on sales. For starters, he says, analysts' calculations use the original price for older models -- models that don't apply to BMW's revamped lineup.

BMW is also redoubling efforts to keep costs down by sharing components across similar-sized cars, such as the 5 Series, the X5 and the 6 Series, as well as the 3 Series, the X3, and the 1 Series. The upcoming 1 Series will share about 60% of its components with the 3 Series. That will save costs, analysts agree, but if the cars are too similar, it could lead to a cannibalization of the sales of the higher-priced 3 Series. That's already happened at Volkswagen, which shares parts across a variety of brands.

As costs come under pressure, preserving quality will be critical. In the first quarter of 2003, BMW's Munich plant won the J.D. Power & Associates Inc. Gold Plant Quality Award. But in the premium car segment, blunders infuriate drivers more and get big headlines. BMW found out the hard way in 2001 when it introduced an innovative knob called the iDrive to control a slew of functions on the dashboard. Software problems with the iDrive left many owners fuming as their new, $69,000 sedans sat in the shop for weeks for software upgrades. First-time customers have had their frustrations, too. Peter Walker, a 33-year-old Woodland Hills (Calif.) information-technology consultant, plunked down $62,500 for a sporty BMW M3 last year. But an engine defect put the car out of commission at 14,500 kilometers. The repair, together with minor problems with the clutch and pedals, plagued Walker for most of a year. A BMW-certified tow truck even broke the rear suspension control arms. "It was just one nightmare to the next," Walker says, requiring endless phone calls and e-mail with the company. "Even then they gave me a rebuilt engine," fumes Walker, who thinks BMW's model push may well have overextended the auto maker he grew up admiring.

The real risk lies in the new models soon to hit streets around the globe. To speed the upcoming X3 to market, BMW outsourced development and production to Austria's Magna Steyr, a unit of Canadian-based supplier and engineering services giant Magna International Inc. Magna Steyr is dedicating an entire factory in Graz to making up to 150,000 X3s a year. Auto experts say the move could be an innovative alternative to building new plants, but warn that the strategy leaves BMW with only limited control over the final product.

Despite the risks, many are betting the Bavarian champion can deliver. BMW's factories are considered the most flexible and most productive in Germany; its suppliers are the industry's best; and the workforce among the industry's most talented. BMW received more than 160,000 job applications last year for 3,500 openings. "Being able to attract and develop the best talent is BMW's hidden success factor," says Bernd Kreutzer, vice-president at consultants A.T. Kearney in Frankfurt. "It's hard to copy BMW because you can't copy culture."

Step inside BMW's factories and research centers, and the high-energy buzz is hard to miss. Everyone knows the story of the engineer who in the 1970s cut a hole in the roof of a 3 Series car in his garage and cobbled together BMW's first convertible to wow reluctant board members. Production engineers in the paint shop recently racked up an impressive first with a new powder-based technology to apply the final clear coat on a car, providing a more perfect finish and better scratch resistance, and completely eliminating toxic waste. "All the Japanese and American auto makers have come to view it," says Walter Wimmer, head of the paint shop at the Dingolfing plant.

BMW's obsession with performance and brand image helped the German auto maker close the yawning gap with Lexus in the U.S. in the 1990s. Munich headquarters read the message to improve quality and customer care loud and clear. BMW now offers a four-year warranty, including maintenance and service, in the price of the car, cutting out complaints that occasional technological glitches made the brand extremely expensive to maintain. "We took the pain out of owning a car," says Tom Purves, CEO of BMW North America.

Now BMW speeds customer feedback to headquarters faster than before. "[Quality] problems have to be solved in a matter of days, not months," says Norbert Reithofer, board member in charge of production. When the new 7 Series drew complaints for its befuddling iDrive, engineers went to work immediately on modifications now appearing in the new 5 Series, including a reduction in the number of control positions from eight to four and a handy reset button to return to the main menu. BMW also outfitted its dealers with kiosks and trained them to help customers master iDrive on dry ground. "We learned a lot from the 7 Series launch," says Purves.

Development teams that pore over everything from such market feedback to new innovations are encouraged to engage in "friendly fighting" to decide the vital characteristics of a new BMW. The development of the new 5 Series shows the concept in action. As the team convened in 1998, marketers demanded more leg room in the back seat and more trunk space: Buyers of the old model had complained it was too small to hold several golf bags. The members of the engineering staff protested. Their goal was a car that accelerated faster and handled even more smoothly. Added weight and length were taboo for the gearheads.

In the end, both sides won. The muscular-looking 5 Series is not only taller, longer, and lighter than its predecessor, it's packed with new technologies that boost engine power, torque, handling, safety, and fuel efficiency. Drive the 231-horsepower 530i 5 Series around a set of sharp curves and it grips the road more like a sports car than a sedan, with its smooth engine effortlessly delivering top acceleration and tight control. One technological coup: a system called "active front steering," which reduces the effort needed to turn at slow speeds and makes the steering more sensitive and agile at high speeds. The powerful front end was designed to appear deep and short to give it a "low, hunkered look," that matches the increased performance, says designer Bangle. A smoother integration of the trunk and angular rear lights gives the rear a racy attitude.

BMW's brand image is tied tightly to such innovation. "BMW really captured the performance space in the market for themselves. They own it," says AutoPacific's Peterson. Sportiness and style made a convert of Debra J. Rosman, senior director of marketing for the NBA's Miami Heat. Rosman traded in her Lexus RX300 SUV for a BMW X5 with leather seats, wood trim, and an on-board computer. "BMW is hipper and cooler," says Rosman, whose monthly lease payments are well above the $450 she paid for the Lexus. Even rivals get the point. "I have to give BMW credit for consistency in their message," says Mike Wells, vice-president for marketing at Toyota's Lexus Div. The engine and styling variations offered by BMW are "clearly an advantage," he adds.

Of course, Lexus is not about to concede. Neither is Mercedes, whose elegant E-Class still outsells BMW's 5 Series worldwide. Mercedes' Stuttgart designers gave the 2002 remake of the E-Class a sportier line, shooting for the more dynamic brand image that BMW has played to advantage. Then there's Audi, which aims to make its cars even more fun than Bimmers, and a whole new generation of models at Cadillac. It's going to be a helluva race. By Gail Edmondson in Munich, with Chris Palmeri in Los Angeles, Brian Grow in Atlanta, and Christine Tierney in Detroit


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