Strategy and Structure Case: Mercedes-Benz Essay
Strategy and Structure Case: Mercedes-Benz
Mercedes-Benz, world-renowned as a manufacturer of luxury automobiles, was the automotive division of Daimler-Benz AG, Germany’s largest industrial group. Daimler-Benz was created in 1926 by two of Germany’s automobile pioneers, Gottlieb Daimler and Karl Benz, each of whom had been active in early designs of motorized vehicles. Following World War I, with Germany’s economy in shambles and with Ford Motor Company establishing itself as a world leader in passenger automobiles, Daimler and Benz agreed to merge their firms. As the German economy revived during the 1930s, Daimler-Benz prospered. Over the next years, Mercedes-Benz established a reputation as an automobile manufacturer of high quality and superior engineering. Although most of Daimler-Benz’ factories were destroyed during World War II, strong demand for automobiles and trucks during Germany’s postwar recovery helped restore Daimler-Benz to health. During the 1960s and 1970s, Mercedes-Benz’s automobiles became synonymous with prestige and excellence.
Even the oil crises of the 1970s could not dent the firm’s success, as its wealthy customer base was relatively insensitive to these downturns. Until the mid-1970s, all of the firm’s plants were located in Germany, from where it pursued an export strategy. In 1973, reacting to the growing strength of the German Mark (or Deutsche Mark, DM), it shifted the sourcing of its diesel trucks destined to the U.S. to Brazil,1 but production of automobiles remained in Germany. Although Mercedes-Benz continued to grow profitably into the 1980s, by 1985 the firm had concluded that superiority in automobiles would increasingly require expertise in electronics. Accordingly, it undertook the acquisition of the German electronics firm, AEG, and subsequently diversified into aerospace, acquiring Deutsche Aerospace.
By 1991, Daimler-Benz was a diversified industrial corporation with revenues of DM 95 billion (roughly $63 billion at an exchange rate of $1 = DM 1.52) in four products groups: Mercedes-Benz, the automobile and commercial vehicles group, contributed 69% of 1991 revenues; AEG, the electronics group, added 14%; Deutsche Aerospace accounted for 13%; and Daimler-Benz InterServices, better known as debis, a service group with activities in software, financial services, and trading, added 4% of revenues. In terms of ownership, Daimler-Benz was owned by Deutsche Bank (28% of shares), Mercedes Holding (25%), and Kuwait
Professor Philip M. Rosenzweig prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. It is written from public sources only. Copyright © 1993 by the President and Fellows of Harvard College. To order copies, call (617) 495-6117 or write the Publishing Division, Harvard Business School, Boston, MA 02163. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.
Investment Office (14%), with many of the remaining shares owned by private investors. In 1991, the firm employed more than 300,000 German workers and more than 70,000 employees in foreign countries, for a total of 379,000. Daimler-Benz’s financial performance from 1982 to 1991 is summarized in Exhibit 1. Its legal structure, consisting of foreign subsidiaries and holding companies, is presented in Exhibit 2. Mercedes-Benz’ many foreign subsidiaries were responsible primarily for sales and service, with the vast majority of other value-added activities, including design and manufacturing, located in Germany.
The Changing Fortunes of a Luxury Automaker
Mercedes-Benz was organized into two divisions: Passenger Cars (with 1991 sales of DM 39 billion) and Commercial Vehicles (1991 sales of DM 27 billion). The Passenger Car Division offered three levels of luxury cars in 1991: S-Class Sedans and Coupés, including the prestigious 500 SEC and 600 SEC S-Class Coupés, Mid-Series cars including T-models, and the Compact Series, which included the popular Mercedes 190. The Commercial Vehicle Division manufactured trucks and buses, and had production broadly distributed around the world, with manufacturing sites in Mexico, Argentina, Turkey, and the United States. The U.S. operation included Freightliner, a leader in U.S. heavy-duty trucks. In 1992, fully 112,800 commercial vehicles were produced outside of Germany. Recent performance figures for Mercedes-Benz are presented in Exhibit 3. Mercedes-Benz’s automobiles competed at the high end of an industry that was increasingly characterized by global competition. The world’s leading automobile companies included U.S., Japanese, and European firms, as shown on Exhibit 4.
Many firms, including General Motors and Ford, had long ago set up manufacturing plants overseas, and tended to build their cars close to the point of sales. Other firms, including the leading Japanese automakers of Toyota and Nissan, had for decades pursued an export strategy, building autos in large Japanese factories and shipping them across the oceans. In the 1980s, many of these firms began to establish manufacturing plants in the United States and Europe. Automobile manufacturing depended on inputs ranging from steel to auto parts, which could be sourced from many suppliers around the world. Labor, too, was an important component of total manufactured cost. A breakdown of the 1993 manufacturing cost of an average passenger car built in the U.S., compared to an equivalent car manufactured in Mexico for sale in the U.S., is provided in Exhibit 5. Other elements of automobile cost included design and marketing. It was estimated that labor utilized in final assembly accounted for roughly 5% of an automobile’s total cost.
Once dominant in luxury automobiles, by the late 1980s Mercedes-Benz found itself under attack by increasingly capable Japanese auto makers, which had steadily upgraded the quality of their vehicles. Several Japanese firms had begun to offer cars that were similar in quality to Mercedes but lower in price. In 1989, Japan’s leading volume producer, Toyota, established a luxury car franchise in the U.S. under the brand name Lexus; by 1992, Lexus sold 92,890 cars in the U.S. compared to 62,832 cars sold by Mercedes-Benz.
Mercedes’ response to the Japanese challenge was a new S-Class series. Introduced in 1992, after five years in development, the new S-Class series turned out to be a two-ton automobile, perceived as bulky and out of step with demands for lean design and efficiency. Joining the chorus of critics was a report by the Massachusetts Institute of Technology, which described Mercedes automobiles as over-engineered and wasteful. Contributing to Mercedes’ problems was the firm’s cost structure. By 1991, German auto workers were among the highest paid in the world, yet worked the shortest work week (See Exhibit 6).
Mercedes-Benz was not the only German automaker to be affected: its chief rival, Bayerische Motoren Werke AG (BMW), manufactured its automobiles at three German assembly plants where it, too, paid high wages and incurred high production costs. BMW found increasingly that given the strength of the DM relative to the U.S. dollar (Exhibit 7), and given that a 10% import tax on cars costing more than $30,000 was levied by the U.S. government, its cars were becoming unaffordable for many Americans. In early 1993, BMW announced its intention to locate a new production plant in the United States, and selected a site in South Carolina.
Beginning in 1992, Mercedes-Benz announced a series of steps that marked a sharp turn in strategy. In November 1992, the firm disclosed that it would abandon plans to build a new truck assembly plant at Ahrensdorf in eastern Germany. The plant had been intended to be Europe’s most modern truck plant, with more than 4,000 employees turning out more than 400,000 vehicles a year beginning in 1994. Mercedes-Benz chairman Werner Niefer stated that the decision not to go ahead was the result of “sharply worsening structural problems in the European truck industry.” In view of overcapacity at existing plants, he explained, construction of a new plant in Germany could not be undertaken.
Other significant announcements followed. In January 1993, Mercedes-Benz’s newlyappointed chairman, Helmut Werner, announced that the firm would transform itself from an automaker known mainly for luxury cars into a “full-line manufacturer offering high-quality vehicles in all segments of the market.”4 Warning that “Mercedes-Benz has to change to stay alive,” Werner acknowledged that current automobiles would be “priced out of the market” if the excessive spending on engineering persisted.
As part of this new direction, Mercedes expressed plans to develop a number of new automobiles. First, it would introduce a line of small cars aimed at mid-market consumers. Second, it would develop and introduce two “lifestyle” vehicles which had become increasingly popular: a minivan and a four-wheel drive sports utility vehicle (SUV). The European market for sports utility vehicles had already reached 242,000 units in 1992, and the American market, dominated by the domestic giants of GM, Ford, and Chrysler, was nearly 1 million units per year. Japanese automakers, with close to 30% of the U.S. market for passenger cars, had managed to garner 13% of the U.S. market for light trucks and SUVs. Apart from the minivan and SUV, Mercedes stated its intention to produce a low-energy, electrically-powered city car.
In addition to these shifts in product strategy, Werner announced that Mercedes would depart from a traditional reliance on German automobile manufacturing and would step up its production overseas. It already had a plant in Mexico, and in November 1992 acquired a 5% stake in a South Korean vehicle producer, but these had been small initiatives. Mercedes’ top management now made plain that automobile production would adopt a more global posture. The minivan, set for a 1995 launch, was to be manufactured in Spain. As for the new line of small cars, Mercedes-Benz was looking for a new site in Europe to produce 200,000 cars per year.
It was actively evaluating sites in several European countries, including France, Britain, the Czech Republic, and Germany. The Czech Republic was very attractive as its average wages were about one-tenth the level of German wages. By contrast, France and Britain offered superior infrastructure and more experienced workers than the Czech Republic. In some ways Britain seemed most attractive: following a thorough examination of many alternate sites, the major Japanese automakers of Nissan, Honda and Toyota had all picked Britain as the site for their new car plants.
Perhaps most dramatic was the announcement, on April 13, 1993, that production of the sports utility vehicle would take place at a new plant in the United States. The plant was expected to come on line by 1997, and would employ 1,500 Americans in the production of 60,000 vehicles annually. Roughly one-half of the output would be designated for export. Although no site was announced, speculation centered on North and South Carolina, where Mercedes already had a Freightliner heavy truck operation, and where BMW was planning to build its new plant. An alternative was not to build a new plant, but to acquire an existing plant from General Motors, which was in the process of closing several facilities.
These announcements signalled a major shift in direction, but could do little to stem Mercedes-Benz’s slide in performance. In May of 1993, the firm reported that output of passenger cars in the first quarter of 1993 was 39% below levels in 1992, from 153,738 units to 94,500. Production of commercial vehicles was almost as dire, with a decline of 27% from the previous year. Even with an expected rebound in sales due to the launch in June of its new C-Class car, Mercedes expected earnings for the year to be no better than 1992’s level, which had represented a decline from the previous year. Analysts attributed much of this decline to the inroads made by Japanese luxury car brands: Toyota’s Lexus, Nissan’s Infiniti, and Honda’s Acura, which had gained a large share of the U.S. luxury car market.
By late 1993, Mercedes-Benz offered in the United States a line-up of luxury cars that included the C, E and S-series. The C-Class represented the “value” end of the product line, with prices ranging from $25,000 to $40,000. The E-Class, including sedans and wagons, was priced between $40,000 and $55,000. At the top of the line was the S-Class, with prices beginning at $55,000 for an automobile of Mercedes’ traditional luxury. Despite enthusiasm about its product line, however, Mercedes’ slide in performance continued: on September 17, 1993, Daimler-Benz disclosed that it had lost DM 949 million in the first half of the year. It blamed the loss on the continuing European recession, a rise in the value of the Deutsche Mark, which reduced the value of foreign earnings by DM 300 million, and provisions to cover the cost of job cuts. The firm noted that it did not expect any improvement until the final quarter of 1993.
Mercedes Comes to Alabama
In October 1993, Mercedes announced that its American plant would be located in the small town of Vance, Alabama (population 250). Speaking at a press conference in Alabama, MercedesBenz chairman Werner received a standing ovation from local dignitaries and business people, as well as a congratulatory telephone call from President Bill Clinton. Also speaking to the press was Alabama governor Jim Folsom, who opened his remarks with the words “Guten Morgen.” In order to attract Mercedes to Alabama, the state had provided subsidies valued at more than $200 million.
Yet the wisdom of locating in Vance, Alabama, was not apparent to all: Alabama consistently ranked at the bottom of the fifty states in terms of education, income, and productivity. Furthermore, rural Tuscaloosa County had little industrial infrastructure and was located far from international air nodes, ports, canals, or even power and water supplies. Despite these drawbacks, Mercedes-Benz affirmed its commitment not only to center the production of its four-wheel drive sports utility vehicle in Alabama, but to steer the global sales of this product line from Alabama.
Mounting Unemployment in Germany
If Alabama reacted with joy at the prospect of a new Mercedes-Benz plant, the mood in Germany was more somber. News of Mercedes-Benz’s shift toward foreign production came just a few months after news that the Ahrensdorf plant would not be built. That announcement was one more in a series of announcements by German firms that they would be cutting back on domestic employment in favor of production overseas. “Competitive production is simply not tenable in Germany,” remarked the CFO of a Munich-based optics company that estimated it would have more than 50% of its production capacity overseas by 1995. “Wage costs in Malta are one-fifth what they are in Germany, and in Thailand one-twentieth.”
With German labor costs significantly higher than those in Eastern Europe, in Asia, or even in the United States, some experts doubted that many of these jobs would soon return to Germany. “Germany is headed for an experience with long-term unemployment,” warned the chief economist of Daimler-Benz. The firm reduced German employment by 35,000 in 1993, and more reductions were expected. Although some firms, including Volkswagen, sought to buffer the effect of unemployment by shifting to a shorter workweek, there was growing concern that chronic unemployment could lead to heightened social tensions in Germany.