Why is General Motors (NYSE:GM) putting so much effort into Cadillac? At first glance, it seems like something of a mystery. Post-bankruptcy GM is facing a lot of long-term challenges. Many aspects of its business still need serious attention.
While GM is solidly profitable, it's still losing money in Europe, it has fallen behind a bit in China, and it has lost considerable ground in the United States, which is still GM's most important market.
Even back in GM's heyday, Cadillac's sales were only ever a small fraction of GM's global sales. So why have GM's post-bankruptcy leader made Cadillac one of GM's highest priorities?
To understand that, let's take a look at one of GM's fiercest global rivals.
Luxury vehicles can generate remarkable profits
German auto giant Volkswagen Group (NASDAQOTH:VLKAY) reported its full-year 2013 earnings last week, and those earnings statements contain a big lesson for anyone looking at profitability in the global auto business.
Globally, VW sells about as many vehicles as GM. (It sold slightly more than GM in 2013, slightly less the year before.) But its lead in profits is far from slight: On a pre-tax "operating" basis, VW made $16.26 billion in 2013 -- versus GM's $8 billion.
What accounts for that huge difference? Some of it is global efficiencies that have given VW a cost advantage. But that advantage is already shrinking: GM is working to streamline its global product portfolio around a smaller number of platforms. It has already made good progress, and should largely close the gap by 2018 or so.
Here's the big difference: VW makes a lot of money from luxury vehicles. And I do mean a lot: The Audi and Porsche brands accounted for 17.85% of VW Group's global vehicle sales last year, but 65.1% of its total operating profits.
In terms of profit margins, GM's global business looks a lot more like the VW brand -- which was nearly out-earned just by tiny Porsche alone, despite selling more than 36 times as many vehicles -- than it does Audi or Porsche. Clearly, there's an opportunity there. And it's an opportunity that GM needs to take.
GM needs more than pickups driving its earnings
GM has huge operations all over the world, but like its crosstown rival Ford (NYSE:F), its profits are disproportionally driven by U.S. auto sales -- specifically, U.S. sales of full-sized pickups. Some analysts have estimated that pickups have accounted for as much as 90% of Ford's profits in recent quarters. The actual percentage is probably not quite that high, and it's probably less at GM than at Ford, but it's still huge.
For a management team determined to realize GM's potential as a global giant, that dependence on one product in one market has to be hugely troubling.
How can GM diversify that risk? At minimum, it needs more big contributors to its profits. Building out Cadillac into a global luxury brand that has Audi-like profit margins and a significant share of the U.S. and Chinese luxury-vehicle markets would be a big help, both to GM's profitability and to its overall risk profile.
Cadillac is disproportionally important to the ongoing GM overhaul
That's why GM is making such big investments in Cadillac. That's why it put so much effort behind products like the CTS and ATS sedans, and the all-new Escalade. That's why it's starting to lay the groundwork for a revamp of Cadillac's brand image with attention-getting new ads.
It'll take several more years to bear fruit -- and Cadillac may never make the contribution to GM's profits that Audi makes to VW. But if it works, it'll be a big change for GM -- and a big boost for its stock.
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John Rosevear owns shares of Ford and General Motors. The Motley Fool recommends General Motors. It recommends and owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.