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Hot Audi


Chef Sache. That's German for "the boss's business." And when it's the boss's business at Audi, watch out. Each month, Audi's compulsive chief executive, Martin Winterkorn, rolls up his sleeves and leads a trouble-shooting session with managers and engineers at the company's electronics center, zeroing in on faulty systems and problem parts. Winterkorn's rules: no shifting the blame to anyone else, such as suppliers. No phone calls to subordinates -- the brains to remedy the defects better be in the room. And no one leaves until a fix is found.

The boss's business extends way beyond that monthly session. Not even the smallest buttons on the dashboard escape Winterkorn's attention. At the first auto show under his watch, he summarily ordered a gorgeous Audi sedan removed just hours before the opening: The stitching on the upholstery wasn't right. (Audi staffers now bring two of each model to every show.) The 57-year-old PhD in metal physics is obsessed with creating perfect cars. "We want to be the No. 1 premium brand," says Winterkorn.

There's a lot riding on Winterkorn's precision mania. Audi, the $32 billion high-end car unit of Volkswagen, has been striving for two decades to move its cars upmarket. The effort has cost billions in investments in technology, design, and performance. The goal: to match the exclusive image of mighty Mercedes-Benz and BMW. Individual Audi models have been making a splash for years. The 1994 aluminum frame A8 Sedan was an industry first. The iconic Audi TT sports roadster and coupe, introduced in 1998, polished Audi's image as a design leader. The A4's cool, minimalist styling and powerful four-cylinder motor created a new generation of popular Audis, including the sizzling Cabriolet. The A4 line accounts for nearly half of all Audi sales.

Now, Winterkorn is presiding over the arrival of Audi into the front ranks. On Feb. 16, Detroit-based AutoWeek voted the $41,000 A6 sedan its Car of the Year. Late last year the magazine heralded Audi's flagship luxury model, the A8, as America's best luxury car. In car-crazed Germany, Auto Motor & Sport on Feb. 15 elevated Audi to No. 1 in its four key model segments, from the A3 hatchback to its flagship A8 sedan. "Audi is on the cusp of its full first turn as an international luxury brand," says James N. Hall, vice-president for industry analysis at researcher AutoPacific Inc. in Southfield, Mich.

WINNING CONVERTS

Audi is building up a roster of famous customers, from Spain's King Juan Carlos to musician k.d. lang. It's also luring buyers from rival German auto makers. Bernd Pooch, chief executive of a Berlin machine tool maker, was a diehard BMW fan. But last November, turned off by the avant-garde styling of the latest 7 Series, the 64-year-old test-drove a $100,000, 275-horsepower Audi Quattro A8. Smitten by the smooth handling and finely crafted interior, he quickly signed a lease. "It's a dream of a car," he says. "People just don't know how good Audi really is."

The numbers track Audi's upward march. Revenue per vehicle is $41,389, up from $25,125 in 1994. Sales have nearly tripled, to more than $32 billion in the same period. Profits in 2004 rose 7.4%, to hit a record $1.15 billion. The share price (a small tranche of Audi shares still trade, despite VW's ownership) has soared to $347 from $79 in 2000. In Europe, Audi nearly matched BMW's sales last year with 559,428 vehicles to BMW's 579,632. Its most powerful versions of the A8, with 8- and 12-cylinder engines, outsell Mercedes and BMW models with comparable engines. "In the last 15 years, Audi has made an incredible advance. They did a super job," says BMW Chief Executive Helmut Panke. "They wanted to be fully accepted as a premium brand, and they made it."

Winning a spot in the club, though, is just the first lap of a long race. Audi now must strengthen global sales outside Europe, upgrade the struggling U.S. operations, and add new models to match the depth of BMW and Mercedes offerings. Winterkorn also must make sure that the models coming off the production line make a quantum leap in long-term reliability. Like its German rivals, Audi's cars have been plagued since the late 1990s with electronic glitches as auto makers stuffed more and more microchips into their vehicles. Now, Audi and its rivals are staffing up with electronics experts and redoubling efforts to eradicate software snafus before cars arrive in showrooms. Reliability "has been our Achilles' heel," says Marc Trahan, Audi of America's quality director.

Audi also has a long way to go to match the revenue and profit horsepower of Mercedes and BMW. Last year, Audi clocked sales of 779,000 cars, but Mercedes and BMW sold more than 1.2 million each. By revenues, Audi is still only 55% the size of BMW and 48% that of Mercedes-Benz. Audi's profits are a fraction of its rivals' income, too, since it has fewer expensive models on the market.

Winterkorn's challenge is to pump Audi's profits into a steady pipeline of new hits, just as BMW did over the past six years. After adding two sport-utility vehicles, the 6 Series coupe, the inimitable Mini, and the 1 Series compact, BMW took off. To replicate his competitor's success, Winterkorn aims to spend some $15 billion over the next four years, 80% of it on new products.

The son of Hungarian emigrants who moved to Germany in 1945, Winterkorn admits his weakness is impatience. To get workers charged up, he exhorts his troops to act like entrepreneurs, take risks, and own up to failure quickly. "What he hates is when people cover up mistakes or problems, or shift the blame to someone else," says one manager. The trim and demanding "big boss," as Audi workers refer to Winterkorn, prowls the production line and software labs and pokes into every corner of the business, seeking intelligence from line workers and technicians. A favorite Winterkorn saying: "Don't bore me with the good news. Give me the worst."

MUSCLE CAR

In Winterkorn's race to bulk up Audi's size, 2005 is a crucial year. The new models launched in 2004 in Europe have already given Audi momentum with one of the newest fleets on the market, including the elegant new A6 sedan, the redesigned A4 sedan, and the A3 hatchback. One of the most keenly awaited products is the Q7 SUV, costing roughly $40,000 and competing with Mercedes' M Class and BMW's X5. The Q7 will be unveiled in September and hit European showrooms in early 2006, followed by a baby SUV, the Q5, one year later. Under wraps is a high-performance sports car in the $100,000 to $200,000 range, dubbed the Le Mans, which is expected to upstage BMW and Mercedes with a 610 horsepower engine that can accelerate from 0 to 100 kph in just 3.7 seconds. Based on Audi's R8 racing car, a three-time winner of the Le Mans 24-hour race, it is expected to hit the market after 2007. "It would show that anything BMW and Mercedes can do, Audi can do better," says Garel Rhys, professor of automotive economics at Cardiff Business School in Wales.

But the Audi chief's biggest priority for 2005 is clinching quality gains. Winterkorn is betting his three-year crusade to stamp out glitches, especially in electronics, will boost Audi's rankings above its German rivals in J.D. Power & Associates Inc.'s 2005 quality and reliability rankings, due out in June. "If they make sure they get quality right, they could pick up a lot of dropped straws," says AutoPacific's Hall.

Audi's other tough goal will be boosting visibility in the U.S., where it sells less than half the volume of BMW, Mercedes, or Toyota Motor Corp.'s (TM) luxury brand Lexus. Audi still suffers in the U.S. from an outdated sales and marketing network, which harkens back to Audi's former days as a mass-market sister brand of Volkswagen. VW's hammerlock on Audi's worldwide marketing and distribution impeded Audi's move upmarket, creating a frustrating disconnect between Audi's customers and headquarters.

When former Audi chief Ferdinand Piëch took over as CEO at VW in 1993, he cut Audi free, giving it responsibility for its own marketing and distribution. A decade later, Winterkorn faces a huge task upgrading Audi's dealer network, especially in the U.S. Of Audi's 263 dealerships, 127 share floor space with other brands, and 115 also sell Volkswagen. Johan de Nysschen, Audi of America's boss, is in the middle of a major push to upgrade dealerships and introduce more exclusive showrooms. "The cornerstone for brand building is making Audi more successful in the U.S.," says Albrecht Denninghof, senior auto analyst at Hypo-und Vereinsbank in Munich.

Improving quality is harder than building a global distribution network. But years of hard work are starting to pay off. In J.D. Power's 2004 ranking of initial quality, Audi moved up three places to rank 11th out of 37 auto brands, one place above BMW and one notch below Mercedes. Chance Parker, Power's quality guru, says Audi still needs to improve its reliability over the long haul -- an area where Winterkorn hopes Audi will excel this year. "Some of Audi's [last-generation] launches have been very buggy," Parker says. That's why Audi is 22nd in Power's 2004 ranking of long-term dependability. The good news for Audi is that Mercedes sank to 28th in the same year. Audi's dependability ratings should trend upward thanks to the quality of the new models hitting the market.

Winterkorn, who took control in March, 2002, is just beginning to put his stamp on the company. He started his career at Audi in 1981, moved in 1993 to VW as chief of quality, and then became head of product development. He is close to VW Chairman and former Audi boss Piëch, the architect of Audi's upmarket strategy. Ironically, it was Winterkorn, at Piëch's bidding, who developed VW's ill-fated luxury sedan, the Phaeton. A rival to Audi's A8, it flopped in the market despite strong praise for its engineering.

Now, Audi's growth and profits are increasingly vital to Volkswagen, where high costs and missteps with key models like the Golf and Phaeton have clouded prospects. Although internal tussles with VW over shared platforms and competing model launches have cost Audi precious time in getting new products to market, the division accounted for nearly 100% of the VW group's net earnings last year. In 2004 the average operating profit per car at Audi was $1,374, while Volkswagen brand cars, suffering from high costs, model mistakes, and an aging fleet, lost an average $13 per vehicle, according to estimates by Paris-based brokerage Exane.

The wholesale parts-sharing of the early 1990s between Audi and VW has given way to a more sophisticated sharing of modules that still saves money but allows Audi cars to look and behave differently. And VW's plummeting profits have dashed Piëch's ill-fated drive to push Volkswagen upmarket. VW Chief Executive Bernd Pischetsrieder is scrambling to refocus the company's efforts on affordable small cars like the soon-to-launch subcompact Fox. A recent report by Morgan Stanley (MWD) puts Audi's value at $14 billion -- 80% of VW Group.

Winterkorn is reaping the payoff of billions of dollars in investments since 1980, when Audi introduced the four-wheel-drive system Quattro. To earn its stripes, Audi had to out-engineer its rivals, setting industry benchmarks in everything from lightweight aluminum frames, drive systems, and engine performance to the "soft skin" materials covering plastic parts that give Audi's interiors a richer feel. The auto maker's navigation and information system wins high marks as user-friendly and intuitive. "Audi is like the iPod of cars. It's more intelligently designed," says Bill Joy, partner at venture-capital firm Kleiner Perkins Caufield & Byers in Menlo Park, Calif., and former chief scientist at Sun Microsystems Inc. (SUNW)"Other cars can drive you nuts just trying to turn on the defrost among 12 buttons. Audi's system is ergonomic. There's one round knob, and you don't have to take your eyes off the road."

INVISIBLE SEAMS

Audi's 53,000 workers -- fiercely proud of the company's engineering heritage, which goes back to founder August Horch -- are as obsessed as Winterkorn with building cars that outshine BMW and Mercedes. Production Chief Frank Dreves pauses in the lobby of headquarters to make a point about the latest A3 Sportback. "Feel this," says Dreves, running his fingers over a nearly invisible laser-welded seam between the roof of the tomato red car and the side panel. "This is normally a gutter in every car. We invented a new laser welding process to eliminate the gutter to reduce interior noise. None of our competitors bothers to do this."

Forging a luxury brand has also required stand-out design. In 2002, Piëch lured Italian designer Walter Maria de Silva to Audi from Alfa Romeo. A year later, De Silva unveiled a bold, more sculptured look for the A6 and A8 sedans that started hitting the market last year. The deep front grille, now being extended through most of the model line, gives Audi an edgier look.

But closing the revenue gap with BMW and Mercedes will take another generation of cars at least. Audi has six basic models, compared with 10 at BMW -- soon to be 12 -- and 13 at Mercedes. By selling more top-end cars, BMW and Mercedes generate much greater revenues and higher margins. In 2004, Audi earned an operating margin of 5.5%. "Our goal is to achieve an operating profit margin of 8% within this decade," says Audi Chief Financial Officer Rupert Stadler.

One risk along the way is that a struggling VW shaves capital expenditure, crimping Audi's investments. Winterkorn insists his $15 billion investment plan is secure, but CEO Pischetsrieder has announced he aims to cut spending 6%, or nearly $1 billion, over the next two years.

Audi also needs to invest heavily in marketing and distribution outside Europe to match BMW's and Mercedes' global reach. Although Audi is already a premium-car market leader in China, with a 65% share, rivals are coming on strong, and the market for luxury vehicles has slowed. In Japan, where Audi trails BMW and Mercedes, Winterkorn has canceled a dealership-sharing agreement with Toyota and set up a network of 100 exclusive dealerships. He's also planning to spend $130 million on building a dealer network in Russia over the next five years.

For Winterkorn, the final heat to catch BMW and Mercedes is the challenge of a lifetime. For Piëch, likewise, a victory would crown his life's work as engineer and manager. But getting there will require perfect execution -- and a steady hand on the wheel.

By Gail Edmondson

With Kathleen Kerwin in Detroit and Karen Nickel Anhalt in Berlin


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