(FORTUNE Magazine) – It didn't work for Godzilla, but the No. 1 rule for success in the automotive business for years has been "size does matter." Manufacturers like to spread their fixed costs--for engineering, technology, marketing--over the largest volume of vehicles possible to keep their costs low. Lately this has become the industry's preeminent philosophy. In the past few weeks General Motors has tripled its stake in Japan's Suzuki, Ford has been making overtures to South Korea's Kia, and shareholders have approved the megamerger of Daimler-Benz and Chrysler.

Like a contrarian investor, one auto company has chosen to put its money on an entirely different strategy. Germany's BMW aims to develop highly refined vehicles, market them to an exclusive audience, and sell them for a premium price. It guards its brand with a vengeance. While other automakers create new models through "badge engineering"--putting a new nameplate on an existing product--BMW disdains such tactics, preferring to give up extra sales rather than dilute its image.

BMW's go-it-alone strategy has paid off handsomely. Since 1993, sales of BMW cars have leaped from 534,397 to 675,076, an increase of 26%, and DRI/McGraw Hill forecasts that they will pass 700,000 this year--not too shabby for models that start at around $24,000 in the U.S. and go all the way up to more than $95,000. Margins are lush in this segment; the cars returned operating profits of 9.1% last year, among the best in the world.

Of course, purveying luxury goods during a global financial panic is a prescription for disaster. And with fissures in the world's economic crust widening almost daily, BMW can expect to see its business start to crumble in Asia and South America. But sales in Western Europe and the U.S., which account for more than 80% of BMW's car volume, show few signs of weakening. Says Chairman Bernd Pischetsrieder: "The car market here in Europe is on very solid ground, though the downturn in the U.S. might be a bit steeper after eight years of a boom period."

Whatever its fears about the world economy, BMW has decided to face them alone. It regularly turns down overtures from other automakers. Recently it has been linked in press reports with Ford, Volkswagen, and Fiat. But the automaker is immune to hostile takeover because 48.7% of its shares are held by the Quandt family of Munich, which says it has no intention of selling. Nor would a merger make much business sense. Since BMW already produces a full range of personal-use vehicles that it sells worldwide, it hardly needs to augment its lineup. And because its cars sell for high prices, it doesn't need more volume. London-based analyst Greg Melich of Morgan Stanley Dean Witter estimates that BMW's pretax profits amount to $3,000 per vehicle.

In fact, BMW is continuing to push upmarket. In July it acquired the rights to Rolls-Royce after outmaneuvering Volkswagen, and it will start selling Rollses around the world in 2003. About the same time, BMW expects to introduce a new line of luxury cars in the U.S., becoming the first manufacturer to do so since Toyota and Nissan launched Lexus and Infiniti, respectively, in 1989. The cars will all be front-wheel drive to distinguish them from rear-wheel-drive BMWs and will be sold under the Rover name.

The Rolls coup pushed the calm, bearded Pischetsrieder into the global automotive spotlight. An engineer who worked his way up through the manufacturing ranks, he was the dark horse when he took over the chairmanship in May 1993, and was criticized for not moving the company aggressively enough. Interviewed at BMW's Munich headquarters in September, Pischetsrieder explained that BMW had its own ideas about winning auto strategies. "Sometimes we have been too conservative with what we are doing," he said. "Certainly we have been rather conservative in what we are communicating. I do not support the idea that DaimlerChrysler should be the starting point of a new wave of mergers. Sheer size is not a very sound recipe for success. You can achieve a lot, but you can easily destroy what the customer is expecting from you, whether in terms of price or quality."

By playing to BMW's strengths, Pischetsrieder has shrewdly steered around potholes that have jostled other automakers. Staying in exclusive market segments, he has protected BMW from overcapacity problems that plague companies like General Motors and Nissan. And BMW is shifting into top gear at a time when its competitors are just getting into first. Volkswagen has not yet raised Audi to BMW's level outside Europe, and Jaguar is just getting ready to go head-to-head against BMW for the first time. Daimler remains a formidable foe, but it will probably be distracted for the next year or two as it integrates its operations with Chrysler. Writes Morgan Stanley's Melich: "We believe that BMW remains one of the best-positioned global automotive manufacturers."

That could remain so even if BMW gets squeezed by the global financial crisis. True, few people have trouble deferring the purchase of an expensive car--even when they can still afford it--if a crumbling stock market makes them feel poorer. But BMW has a solid financial foundation and is exceptionally well positioned to ride out almost anything except a full-fledged depression. It understates its earnings because of its conservative depreciation, and analysts figure its stock sells at a 20% discount to its asset value.

At most points in the economic cycle, selling luxury cars is a highly profitable business, which is why BMW has high hopes for Rover Group, the struggling British maker of cars and off-road vehicles that BMW acquired in 1994 for $1 billion. The last volume manufacturer of cars left in Britain, Rover had been starved of investment for two decades under several owners, including the British government, and was running on empty when BMW stepped in. Since the late 1970s, Rover had been building mostly cars that were designed and engineered in cooperation with Honda and were little more than Japanese clones.

Pischetsrieder envisioned Rover as a second line of upscale cars, which would complement BMW's high-tech Teutonic feel with British flair--grace, comfort, and traditional styling. But he worried about moving too quickly because he wanted to preserve its individual character and not turn it into Munich West. Bringing out the best in Rover has been a painstaking process. As Rover design director Geoff Upex says, "We worked with Honda for so long that we had to design the Britishness back into our cars." Rover is still running in the red, though its losses are narrowing and it expects to turn a profit in 2000.

The first Rover developed under BMW ownership makes its debut this fall. A mid-sized sedan named the 75, it combines the graceful body proportions of a Jaguar with styling touches reminiscent of Rolls-Royce, in addition to a voluptuous interior with enough wood veneer to panel a media room. Says Upex: "This is heritage vs. modernity. We want the car to refer back to an era of more-crafted products."

Under BMW, Rover has expanded into 30 new foreign markets, and Pischetsrieder intends to bring the brand back to the U.S. by 2003. The 75 is one car that will be sold here; another is a new version of the classic Mini. Introduced back in 1959 as the first front-wheel-drive car with a transverse engine--now a standard small-car layout--the Mini has remained in production ever since and has attained cult status in Britain and Japan. BMW's version retains the familiar shoebox shape but is bigger in every dimension. Pischetsrieder thinks the Mini's small size and sharp handling make it a natural for cities like Boston and New York, and believes it could spawn a whole line of cars itself.

Getting Rover reestablished in the U.S. could be dicey. There is no shortage of luxury cars for sale, and Rover has a checkered history. It sold cars in the U.S. in the 1960s and 1970s, and then reintroduced them in the late 1980s under the Sterling brand, but failed both times because of poor quality and customer apathy. Exactly how the cars will be distributed hasn't been worked out, but BMW is unlikely to duplicate Toyota's expensive network of exclusive Lexus dealers. More likely, it will piggyback Rover showrooms on existing BMW and Land Rover outlets and develop shared-service facilities that support all the lines.

If Rover cars can duplicate the success in the U.S. of Land Rover sport utilities, they will be counted a huge success. Sales of the luxury vehicles, mainly the $38,000 Discovery and the $60,000 Range Rover, have nearly quintupled, from 4,906 in 1993 to 23,926 last year. Land Rover paved the way for the Lincoln Navigator and Lexus LX470 with a model lineup that seems to value eccentricity--what the British call "character"--over everything else. There is plenty to spare. Land Rovers are built at a manufacturing complex in Britain's Midlands that could qualify as a museum exhibit from the Industrial Revolution. Some 18 different factories are crammed onto a single site, where some of the buildings bear the remains of camouflage paint used to hide them from German aircraft in World War II.

The complex was expanded and modernized in the early 1990s, but planners wildly underestimated the growing popularity of their products and, short of funds, skimped on automation. As Land Rover's worldwide sales leaped from 56,450 in 1992 to 127,420 in 1997, it has had to boost capacity on the fly. Says managing director Ian Stephenson: "In the cold light of day, we probably shouldn't have done it that way." These days even giant manufacturers outsource as many parts as possible, but tiny Land Rover operates like a craft shop, making its own axles and differential gears and some of its seats. The improvisations haven't helped Land Rover quality, which once ranked as the worst of any vehicle sold in the U.S.

Under BMW, Land Rover has improved its quality and modernized its products. Its latest model, introduced last spring, is a compact SUV called Freelander. The first Land Rover to be built with an integrated body and frame, it benefited from BMW's engineering and its parts catalog (the door latches are shared with the 3 Series). Because of fears that the Freelander was too underpowered for the U.S market, it wasn't initially designed to meet federal regulations and it won't go on sale here until 2001. Estimated price: $27,500. Worldwide, Land Rover expects to sell 60,000 Freelanders annually.

With its acquisition of Rover and Land Rover, and now Rolls-Royce, BMW might be accused of rampant Anglophilia. To Pischetsrieder, though, it is all about brands, and getting Rolls in July for the bargain price of $66 million was unquestionably his finest hour. Rolls needed rescuing. Despite its impeccable lineage and stately history, it had been a marginal player on the automotive scene for years. It hasn't sold more than 2,000 cars annually in the past five years, and its models are little more than drawing rooms on wheels--replete with wood, leather, and fine wool but not very sophisticated or reliable.

The image-conscious Pischetsrieder had long sought to boost BMW into the ultra-luxury segment but felt he couldn't do so under the BMW brand. So when Rolls and its stablemate, Bentley, were put up for sale last spring by their owner, Vickers, BMW made an offer of $560 million that was quickly accepted. Then, to BMW's surprise, Volkswagen lobbed in a bid of $790 million, prompting Vickers to turn around and declare VW the winner.

But Pischetsrieder knew something that nobody else did: While Vickers owned the Rolls factory and the Bentley brand, the right to the Rolls-Royce name was held by Rolls-Royce PLC, the aircraft engine manufacturer. By coincidence, BMW had enjoyed a long business relationship with the engine company. A backroom bargaining session ensued, and when the dust settled, BMW got Rolls, and VW got what was left over: the sportier but less prestigious Bentley brand, the obsolete factory in which both cars are made, and the right to sell Rolls cars for another three years. After that the Rolls name reverts to BMW, which plans to start building Rolls-Royces somewhere in England beginning in 2003.

Another manufacturer might immediately start planning for a Rolls roadster or a Rolls sport utility. Not Pischetsrieder. Says he: "You can either use this brand as an icon, sticking to a very high price and a very limited volume, or you can exploit it, with the risk that in 20 years it won't be worth any more than it is today. That is what VW is going to do. They will go for 10,000-unit volume. Our strategy is to keep Rolls as an icon and limit sales to 1,000 units a year. What we can do is to exploit the identity of Rolls for the sake of the BMW brand so it can build cars that might compete in a higher price segment with Bentley."

Rolls will at least look right at home next to BMW's cars: Neither undergoes a design change very often. New BMWs seem to be all about evoking the look and feel of old ones. Says California-based product analyst Christopher Cedergren: "BMW has been in an evolutionary styling mode for quite some time." Even dedicated BMW enthusiasts will have difficulty distinguishing the 1999 3 Series from the model that was launched in 1991. The most visible difference is that the trademark dual-kidney grille is integrated into the hood of the car rather than incorporated into the headlamp and front fascia assembly.

Design is treated like a religion at BMW, and its cathedral is the gleaming white design center in Munich. Outside the locked doors of the "Penthouse," where executives view new models, hang the appropriate relics: some 30 different versions of the kidney grille as they have been used on BMWs through the years. BMW's design chief, a 40-year-old American named Chris Bangle, is a determined acolyte. Says he: "At this level, car design is all about refining, refining, refining."

But change is in the wind. Cedergren believes that Bangle is working on a whole new styling theme for BMW that will be unveiled in a couple of years. Certainly there are hints of fresh ideas. In Bangle's studio is a voluptuous, new two-seat convertible sports car, dubbed the Z07. Although it was created as an homage to a legendary BMW roadster of 30 years ago, it looks entirely new. Sitting in the art deco-inspired interior of the car makes you feel as if you are having dinner in Rockefeller Center's Rainbow Room. As it should: The car may cost about $120,000 when it reaches the market.

Another design of Bangle's, due to be unveiled at the Detroit auto show in January, has been the subject of intense industry speculation: It is BMW's first sport-utility vehicle. BMW executives dithered for years over whether they should tap into the growing American preference for off-road vehicles. Management board member Helmut Panke recalls seeing a drivable BMW four-wheel-drive concept back in the early 1990s. But Panke and others worried that nobody would buy the kind of SUV that BMW wanted to build: one that wouldn't so much churn through the mud as zing along the highways like a proper BMW passenger car.

After such luxury makers as Lincoln, Lexus, and Mercedes introduced SUVs, it looked as if BMW had missed the market. Once again, appearances are misleading. Customer preferences appear to be shifting away from those heavy, trucklike vehicles to ones that behave more like cars. This year's hottest SUV is Lexus' highway-friendly RX 300. BMW's hesitation is looking both lucky and smart.

The new entry, which BMW prefers to refer to as a "sports-activity vehicle" to distinguish it from its bulky brethren, should arrive on the market late next year. It will only accelerate BMW's momentum in the U.S., where sales have more than doubled since 1991, to an anticipated 130,000 this year. The 3 Series cars are the bestsellers, but the entire line has benefited from the surprising sustained success of the Z3 roadster, built in BMW's Spartanburg, S.C., plant. Another atypical BMW design, the Z3 has an extravagantly long hood and prominent, almost cartoonish side vents; it has been a sellout ever since it was launched more than two years ago. An even more outrageous hardtop version, the M coupe, is being introduced now.

Popular models help, but BMW's U.S. management has worked aggressively to keep customers happy, working hard to reduce ownership costs. Since scheduled factory maintenance costs as much as $1,180 during the first three years or 36,000 miles of ownership, BMW simply decided to offer free service on all its cars. To help boost resale value, it encouraged dealers to sell used models right alongside new ones, instead of consigning customers to separate treatment on a separate lot. A 325i now retains 69% of its value after three years of ownership, vs. 37% in 1991. It doesn't hurt that the assembly quality of BMWs has increased dramatically. In the latest J.D. Power survey of European assembly quality, BMW's facilities won the top three places, beating out Mercedes, Volkswagen, Audi, and Jaguar, not to mention Toyota and Honda.

Besides addressing ownership costs, BMW is making its cars more customer-friendly. After owners complained that the 3 Series came up short on interior space, safety, and value, BMW designed the new version to be roomier and installed side- and head-protection airbags. It also kept a lid on prices. The six-cylinder 1999 323i carries a base price of $27,600, only 1.8% more than the four-cylinder model that it replaces. North American President Victor Doolan says BMW expects to sell 40,000 of the new 3 Series sedans annually, compared with 22,000 for the old one.

Despite the economic clouds gathering around the world, Pischetsrieder remains confident about BMW's prospects. "The skill of management," he observes, "is to make sure that when a crisis hits you by surprise, you're prepared." How long the crisis lasts will be the key. Conservative management and family ownership will enable it to ride out a short downturn, but a prolonged slump would make the question of owning a BMW almost irrelevant. When money counts, a Volkswagen provides transportation that is every bit as good. Getting there just wouldn't be as much fun.