Mercedes-Benz is one of the great auto brands of all time. But is it running out of steam?
Mercedes was once the dominant luxury-car brand. But several years ago, it fell behind BMW (NASDAQOTH:BAMXF) -- and then, more recently, behind Volkswagen's (NASDAQOTH:VWAGY) Audi brand, in total worldwide sales.
Despite strong growth rates for luxury-car sales in general around the world, Mercedes' parent company, Daimler (NASDAQOTH:DDAIF), actually lowered its profit expectations last month, after its first-quarter earnings missed Wall Street estimates.
Daimler, which is also the world's biggest big-truck maker, blamed weaker than expected Mercedes sales in China for the miss.
But the problems with the famous brand may be larger than that. Is the shine wearing off of the famous three-pointed star?
An important and fast-growing market
Luxury cars are a small part of the overall auto market, but they're important to investors because they're exceptionally profitable products. To take just one example, Audis represent a small portion of VW's overall worldwide sales, but they account for roughly half of VW's total profits – and VW's profits lead the industry.
VW is using profits from Audi to fund a massive global expansion. That example hasn't been lost on VW's chief rivals. General Motors (NYSE:GM) is in the midst of a massive multi-year overhaul of its Cadillac brand, a key part of its push to close the profit gap between it and VW, which remains significant.
But what of Mercedes-Benz? While BMW and VW have seen their stocks jump in the seven years since Dieter Zetsche took over as Daimler's CEO, Daimler's stock is up just 14% over that same period. That disparity is mostly due to the fact that Mercedes-Benz hasn't performed as well as its rivals in two big areas: China and smaller cars.
Why Mercedes lags in China
So far in 2013, Mercedes is the leading luxury-car brand here in the U.S. It's a different story in China, though. Mercedes is a distant third behind BMW and Audi, China's luxury-car leader. That gap has grown recently: Mercedes' sales in the world's largest auto market fell 11% in the first quarter, while both of its German rivals score gains.
Daimler blames a restructuring effort for the China decline, but the deeper story is that the restructuring was necessary because Mercedes' initial China strategy was a mess. The company had two separate Chinese distributors, who competed aggressively with each other via loud ad campaigns and deep discounts. That did considerable damage to the brand.
The larger challenge facing Mercedes-Benz
Mercedes-Benz has a larger challenge, though, one that has become increasingly apparent as the auto industry has consolidated: Simply put, the company lacks the scale of many of its rivals.
To take the most obvious example, Audi shares engineering resources (and many parts) with other brands in Volkswagen's vast global empire. That gives Audi advantages in both engineering and in costs that Mercedes can't really duplicate. Similar advantages favor GM with Cadillac, which will compete more and more directly with Mercedes over time, and Toyota's (NYSE:TM) Lexus brand.
BMW, like Mercedes, lacks an affiliation with a major global automaker. But it has done better, in part by expanding downmarket with smaller and less-expensive models that depart from old-school notions of "luxury cars". That strategy has increased BMW's volume and scale, and so far BMW has mostly appeared to avoid the dilution in brand cachet that has worried many analysts.
Mercedes has followed in that direction, though its smaller cars haven't had great sales. The company is looking to change that with its new CLA, shown above. The CLA is an "affordable" compact sedan that it hopes will attract younger buyers to the brand (and away from the likes of BMW).
The CLA's starting price is over $5000 less than that of the C-Class, long the cheapest Mercedes sold in the U.S. But that affordability comes with an interesting trade-off: Unlike most other Mercedes cars, and most of the cars from Mercedes' rivals, the CLA is front-wheel-drive – a layout more commonly associated with mass-market cars.
Are more drastic moves in Daimler's future?
So can Daimler turn Mercedes around? It seems strange that such a great luxury-car brand is struggling to find growth at a time when luxury-car sales are booming in many parts of the world. Certainly the brand still has tremendous strength, and many of its products remain very strong.
But competition in this space continues to intensify, and in time Daimler may find itself stretching its resources to keep up. Will that lead the company to try to find a mass-market partner for Mercedes, an approach it tried (and failed at) with Chrysler? Only time will tell.
Motley Fool contributor John Rosevear owns shares of General Motors. Follow him on Twitter at @jrosevear. The Motley Fool recommends BMW and General Motors. 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.