Why Is BMW Driving Itself Crazy? The Rover deal was a dog, but it didn't cure BMW's desire to be a big-league carmaker--even if that means more risky tactics.
By Sue Zesiger

(FORTUNE Magazine) – For the millions of Americans contentedly motoring around each day in their slick, well-engineered BMWs, it may come as a surprise that the proud Bavarian carmaker's latest attempt to conquer the world ended this spring with both a bang and a whimper. Once the company had admitted defeat, in March, on its disastrous acquisition of the Rover Group, 80,000 British workers rioted in the streets, beating a 3-Series with sledgehammers and staging a demolition derby with old BMW sedans (local police handled the crowd on foot, fearing that their BMW motorcycles would also get clobbered). Then last month, BMW finally unloaded Rover to the hastily assembled Phoenix Consortium, for the pathetic sum of ten pounds sterling. How could an acquisition that had been BMW's hope for the future become, in six short years, literally worthless?

On the face of it, BMW occupies a position in the automotive world that any carmaker should envy. Sales of its cars last year rose 8% worldwide and 18% in the U.S., where BMW outsold both Mercedes and Lexus. And although the GMs and Fords of the world sell exponentially more vehicles, BMW makes more than twice as much money on each car it sells: Its margins are the second highest in the world (only tiny Porsche's are higher). Until the Rover mess, BMW hadn't had an unprofitable year for 40 years--almost unheard-of in the cyclical car industry (only Toyota can claim the same). Its stock, which is traded in Germany, has climbed steadily from the equivalent of $8.80 a share in '91 to nearly $30 last month. BMW buyers are primarily wealthy baby-boomers and up-and-coming Gen Xers--two huge demographic gold mines. And the brand's popularity is only rising: In several U.S. markets right now, there's up to a year's waiting list on some models. "BMW is the most strongly positioned luxury marque out there," says Susan Jacobs, president of Jacobs & Associates, a New Jersey-based automotive consulting firm. Over the decades, with fanatical devotion to manufacturing quality, a single-minded focus on sporty luxury, and careful, conservative nurturing of its brand, BMW has established a franchise second to none.

With so many charms, BMW makes a tempting takeover target. In fact, it's considered to be the last great catch in the automotive industry. There isn't a major car company that hasn't tried to strike a deal with BMW in the past few years. "If BMW was put on the block tomorrow," says Merrill Lynch analyst Stephen Reitman, "you'd need Mace to separate the warring factions." Ford has been cozying up for a while and scooped up product czar and former No. 2 exec Wolfgang Reitzle after he left BMW early last year. VW CEO Ferdinand Piech sparked rumors last year by letting it slip that Volkswagen was in talks with BMW--which BMW firmly denied--and then this year, Piech hired ousted BMW CEO Berndt Pischetsrieder. And General Motors, according to several industry observers, has a standing offer to buy any piece of BMW it can. (GM officially says it doesn't, but insiders confirm the No. 1 carmaker's long-standing desire for the luxury brand.) "GM needs BMW," says AutoPacific analyst Jim Hall. "Caddy could be a premium brand in 20 years, but not in three."

But BMW has no intention of being taken over by anybody. Quite the contrary: It wants to grow big enough to join the ranks of the auto industry's superpowers. The fiercely proud company is horrified that the troubles at Rover (which included the Rover, Land Rover, MG, and Mini brands) have put a spotlight on management weaknesses. And it is quick to point out that the ever-appreciating British pound was a huge factor in Rover's demise (by last fall BMW was losing about $3 million a day at Rover).

After such painful lessons, the company is even more determined to prove it can go it alone. "The BMW Group will continue to grow under its own power, without requiring any mergers or diversification," CEO Joachim Milberg told shareholders at the annual meeting in May. "And from now on we will pursue a strategy based on the BMW brand extending from the lower midrange segment all the way to the luxury-performance segment." Whoa: That sounds exactly like the range-stretching plan that got BMW mixed up with Rover in the first place. As that failure has shown, whether BMW likes it or not, it can't be king of every hill--multiple brand management isn't its strong suit, and neither is building anything other than performance cars.

And yet, in a consolidating global industry, BMW can't seem to stand the thought of playing in the minors. So it is embarking once again on a campaign to be many things to many drivers. It has announced a plan to build an entry-level compact under the BMW marque--the very step it was trying to avoid by acquiring Rover (the idea was to protect the prestige of BMW by selling higher-volume, cheaper cars under the Rover brand). It is expanding its line of four-wheel-drive SUVs. If that weren't brand-stretching enough, the other prongs of BMW's strategy may raise the reader's eyebrows all the way to his receding hairline: a German Rolls-Royce and a tiny, front-wheel-drive, two-seat Mini that drives like a go-kart. Is this really the way for BMW to grow enough to outpace its sizable competition?

It's not hard to see where the urge to expand is coming from. Other small to midsized manufacturers--Saab, Volvo, Jaguar, Subaru, Mazda, Nissan--have been swallowed by the big carmakers. Closer to home, Daimler merged with Chrysler, and Volkswagen has been scooping up luxury brands like Lamborghini, Bugatti, and Bentley. Between record sales and the cost efficiencies the behemoths can effect, the shape of the business has changed. Conventional wisdom now states that to survive long-term, a manufacturer must build two million vehicles a year. Not counting Rover, BMW made fewer than 800,000 in 1999. And although BMW's margins offset those volume numbers somewhat, the product magic behind those supremely capable vehicles is expensive, time-consuming, and archaic. No acquirer in its right mind would spend the extra cash to test each new model at venues like Germany's famed Nurburgring racetrack as BMW now does.

BMW's determination to march ahead without the deep-pocketed help of a major automotive manufacturer is no whim: It comes directly from its largest shareholders, the Quandt family. The enormously rich, powerful, and secretive clan has controlled the company since 1960. In that year Herbert Quandt bought up stock, gathered shareholders together, and saved BMW from the clutches of Daimler-Benz, which wanted to buy out the then-struggling carmaker. The family, which owns 47% of BMW, has guarded the company's independence stubbornly ever since. Through their spokesman, Thomas Gauly, the Quandts maintain they're in it for the long haul. "Of course the family is not happy about the money they spent at Rover, but they have an emotional commitment to BMW," Gauly told FORTUNE. "And that commitment remains unbroken, so there's no reason to sell shares." And they have plenty to say about every strategic decision at BMW--Herbert's son Stefan, 33, and daughter Susanne Klatten, 37, both joined the supervisory board in May '97, when their mother, Johanna, stepped down.

Some industry observers are skeptical that the Quandts will stick it out long term. First of all, BMW has lost five top executives since Stefan and Susanne joined the board. Tired of Rover's travails, BMW's board fired Pischetsrieder last February--a first. Along with him went No. 2 Reitzle when he failed to win the top job. This year, three more key automotive talents were ousted. It appears that the next generation is more prepared to shake up the conservative company--perhaps because it is growing impatient with management decisions. "It's clear that all actions taken by BMW since February 1999 point to a much greater concentration on the bottom line," says Merrill Lynch's Reitman. Some have speculated that a coming change in Germany's capital gains taxes in 2002, which will reduce the tax threshold substantially, could provide the financial incentive for the family to sell its holdings. Others argue that the incentive wouldn't be sufficient to trigger the sale of such a well-defended stake. A source close to the family has another theory: "The Quandts want to get the company back in shape first after Rover, since they'll get an even better price for it if they do." For their part, the ultraprivate Quandts refuse to speak to the press. No one even knows what they look like, because, believe it or not, no public photos of any of them exist.

For the past 60 years, ground zero of haute car-building has been the pastoral town of Crewe, England. It is where generation after generation of veneer specialists, wood carvers, leather stitchers, and engine builders have hand-assembled Rolls-Royce and Bentley motorcars. A mini-museum in the headquarters highlights the brands' benchmarks, from Bentley's wins at Le Mans in the '20s to Rolls-Royce's work for Britain's royals. (Even some less glorious work has been preserved, such as a kneeling version of Rolls' triumphant Spirit of Ecstasy hood ornament--commissioned by a Middle Eastern customer who preferred his women to assume a humbler position.)

It is this heritage-drenched world that BMW is trying to replicate with its reach for the stratosphere of the luxury-car market. BMW is building an all-new, from-scratch Rolls-Royce that will be launched in January 2003. And if you think this brand-extension approach sounds odd, the way it came about is even odder. Back in 1998, then-CEO Pischetsrieder wanted to own both Bentley and Rolls. BMW was already supplying engines and some technical support to Crewe for its latest models, the Rolls Silver Seraph and the Bentley Arnage. So when BMW offered Vickers $560 million for the whole package, it seemed like a done deal--until VW CEO Piech threw a bid for $790 million on the table, which BMW didn't match. But in a freakish twist, Rolls-Royce PLC, which held the rights to the Rolls name, awarded them for a mere $66 million to BMW, with whom the company had been building jet engines for years.

And so it seemed that BMW got a good deal on one of the world's most recognizable brand names. But here's the surprise: Today Bentley sells three cars to Rolls' one. While the Rolls-Royce name conjures images of stately coachwork and mile-high grilles, the Bentley brand is sportier--and therefore has the potential to attract the new economy's younger wealth--and less well known, meaning there's room to stretch the brand's image. VW plans to introduce a mid-sized Bentley in 2003, which will compete with the Mercedes S-Class and top-of-the-line Jaguars; VW hopes to sell as many as 9,000 a year. BMW acknowledges that the smartest thing to do with Rolls is just the opposite: keep it as close to its rarefied roots as possible, which means that selling its stated minimum goal of 800 cars a year would constitute a big success.

Ever proud, BMW insists that it's all for the best, even though it will have to build a $100 million new factory and raid Crewe for some key interior artists. (It's a good guess that veneer specialists in northern England are about to enjoy enormous salary hikes.) While Bentley is more performance oriented and therefore closer philosophically to BMW's current products, Rolls presents a whole new challenge--how to build a car that cushions the driver from the road. "I never had any doubt that Rolls-Royce is the right addition to the BMW portfolio--Bentley would have been a continuation of what BMW already stands for," says CFO Helmut Panke.

BMW firmly believes it can decode Rolls' genetics, without the assistance of any engineers or designers from Crewe. "Saturday afternoons, we take one or two Rolls-Royces out [in Munich] for testing and listening," explains Karl-Heinz Kalbfell, the BMW board member in charge of the Rolls-Royce project, in a thick German accent. "I've ordered my crew to think about door handles, and should there be a rev counter, and how many electronics can you see in a Rolls?"

Knowing that lineage and authenticity would be uppermost in collectors' minds, Kalbfell had his team of mostly German and American designers spend six months last year in London's Hyde Park neighborhood, where Rollses are as common as house cats. "The experience turned them into Englishmen," says Kalbfell without a trace of irony. "Nowhere else can you smell Rolls-Royce so intensively." (Does John Cleese know about this?)

However good a Rolls by BMW might be, it is hard to see the business logic in revamping a brand that sold only 429 cars last year. In fact, many analysts worry that Rolls will only distract BMW from developing the new, higher-volume models it needs to thrive. "I'm not sure they wouldn't be better off without Rolls," says Susan Jacobs. "Just as Mercedes is doing the Maybach [luxury limousine] under the Mercedes brand name, BMW could move into that high-end market on its own, without having to own Rolls."

If only Rolls were the sole offbeat Anglophilic scheme in BMW's bag of tricks. But, no, there's the new Mini, which is the one brand BMW retained from the Rover sale. Not unlike $210,000 Rollses, the Mini seems to be exactly what buyers--in the U.S., at least--aren't clamoring for: a retro remake of a two-seat, front-wheel-drive, subcompact performance car that has sold wildly well in Europe and Asia for decades--but only briefly in the U.S. during the '60s. BMW has spent several years developing the new version. (The old Mini is still sold, but its fate will be determined by Rover's new owners.) "The new Mini takes bends and curves like no other car," insists Panke. "So the Mini is in sync with BMW's philosophy of driver orientation--but it's a small car." That means the new Mini will be sporty and well built, but it isn't likely to bring the company the kind of high-volume, mass-market sales it needs to grow. BMW believes it can sell 80,000 to 100,000 of them a year, and although the company hasn't announced prices, it maintains the Mini will be classified as a luxury car. Says AutoPacific's Hall, "The Mini's a brilliant idea, but the number of vehicles they want to sell is unrealistic, its following outside the U.S. will be much stronger, and the price will be too high."

When BMW jettisoned Rover, along with it went the one piece of the beleaguered group that might have had market potential for BMW--the Land Rover division. Why did BMW get rid of the upscale SUV manufacturer (its models include the Range Rover, Discovery, Defender, and new entry-level Freelander), whose demographics are very similar to BMW's own? Because, despite the unbelievably strong sport-utility boom in the U.S. and the rise in Land Rover sales a record 37% here last year and 16% worldwide, BMW wasn't able to make the division profitable. Rather than look for cost efficiencies such as shared parts, BMW chose to highlight the brand's exclusivity by building each of the four Land Rover models on entirely separate platforms--and priced itself right out of the business. "The investment costs for a new platform would have been double for BMW what it will be for Ford, because BMW's competitive advantage and expertise is not in doing big four-wheel-drive trucks," says Morgan Stanley Dean Witter analyst Gregory Melich. Worse, the sale went through before BMW ever benefited from the introduction of the Freelander to the U.S. Brought to European showrooms in late '97, the $20,000 four-wheeler now accounts for 39% of Land Rover's sales worldwide. What happened? "With the Rover problems, BMW just wasn't keeping its eye on Land Rover," says a source at the company. It isn't hard to imagine how well such a vehicle will do in the SUV-happy U.S., but BMW didn't move fast enough to get it there in time. Once again, BMW lost when it tried to act like the big boys.

Platform inefficiencies weren't the only problems at Rover. BMW's management style after the acquisition was another. The executives from Munich tiptoed in, led the Rover managers to believe it was all really just a merger of equals, not an acquisition, and left the folks in Birmingham to their own devices. "We were afraid of being too German," admits Panke. And so troubles that should have been spotted early on slid by unnoticed for months--or years. By the time BMW shifted its approach, it was too late. Even simple-to-combine systems such as parts, purchasing, and distribution were left independent for years--too late, say insiders, to offer BMW any financial benefits. (After six years, the U.S. headquarters of Land Rover hadn't yet moved into BMW's headquarters.)

On a deeper level, a key factor in Rover's demise was that BMW believed--either through arrogance or naivete--that it could turn Rover into a British version of itself. What the executives in Munich didn't realize was that the Rover brand had suffered too many quality problems over time, and consumers weren't going to come back--not even for a BMW-vetted product. "Yes, we should have been more hesitant and looked at other alternatives instead of just taking the strategic approach of 'Let's do it,' " says Panke, sighing. "Then we could have reached the conclusion that Rover was not strong enough."

CEO Milberg, who declined to be interviewed for this article, dished out some good news with the bad at the press conference in March to announce the sale of Rover. First, he revealed that BMW would build a whole family of "sport activity vehicles" (as BMW calls its carlike SUV) to capitalize on the success of its new X5. It's easy to imagine that an X3--priced well below the V-8-engined $50,000 X5--could be a big hit, and perhaps one day a Range Rover-fighting X7. And so what the company wasn't able to do with Land Rover it now hopes to do under the BMW banner--drawing from shared engineering with Land Rover.

But the really big news was that BMW will build an as-yet-unnamed entry-level model line (the 1-Series?). The compact BMW will be cheaper and smaller than the 3-Series but larger than the Mini, and will have rear-wheel drive. In other words, a BMW that would attract the many buyers who don't want to spend $28,000 for a base 3-Series--but who want performance and luxury beyond a VW Golf's or a Honda Civic's. So, after six years and $6 billion- plus wasted on the English Patient (that's what the German press nicknamed Rover), BMW is finally going to do what it went all the way to Great Britain to achieve in the first place: build a high-volume, lower-priced car.

It's impossible to resist the question: Why didn't the company just build a starter BMW from the beginning? Back in the early '90s, its management was worried that a low-end car would cheapen the BMW brand. Panke tries to explain it by saying, "The markets have changed in the development of the different segments, which makes it really attractive to go with the BMW-branded concept now." He pauses, then adds, "And we believed in the strength of Rover, and it didn't work."

In the meantime, BMW wasted years. "The lost money from Rover is one thing," says a source close to the situation. "But the lost development time--BMW may find that it's harder to make that up in the long term than they think."

Because the U.S. is BMW's second-strongest market, after Germany, BMW will have to bring the new "1-Series" stateside--the U.S. offers enticing numbers of potential buyers. But there are risks: After all, in America small cars don't sell well, and buyers think of BMW in high-end luxury terms. "With fuel prices and the nature of the domestic car market, we'd want to make sure this new line can be sold in the U.S.," says Tom Purves, head of BMW North America. BMW is counting on small-car-hungry Europe and Asia to be more natural markets.

From a balance-sheet perspective, BMW's got the goods to weather the uncertain short term in strong shape--sub-3-Series or not. BMW can use its considerable cash hoard--$3 billion as of March--to pursue its expertise in class-leading technologies and engine design. "Those advantages allow BMW to charge a premium price," says Melich. "And there's plenty of cash flow to continue to invest in them in the foreseeable future."

One of the key innovations that BMW is investing heavily in at the moment is hydrogen fuel technology. Most experts agree that within the next handful of years, consumers will see fuel-cell vehicles--100% clean engines that run on hydrogen and produce only water as a byproduct--hit the roads. To speed up progress and share some R&D costs, BMW has formed an alliance with Delphi and Renault to pursue fuel-cell designs. (DaimlerChrysler and Ford have also teamed up on similar work.) BMW showed a 7-Series sedan last fall with a climate-control system powered by a brick-sized fuel cell in the trunk. Technicians proudly served the water produced to thirsty passersby at the Frankfurt auto show.

Beyond passenger cars, BMW's other divisions are also solid. Sales on certified pre-owned BMWs in the U.S. were up 116% through May. And the motorcycle division--which BMW has had since 1923--continues its ascent; sales jumped 30% in the U.S. last year.

On the downside, in addition to the $3.1 billion hit BMW took in '99 for extraordinary Rover-related expenses, according to analysts it looks as if it will have to swallow another $320 million or so on this year's books. But, says Merrill Lynch's Reitman, "Even though BMW has more Rover losses to eat in 2000, the core brand is so strong there'll be substantial earnings-per-share growth." BMW's other chief drain has been its joint Aero engine business with Rolls-Royce PLC (in fact, BMW first started in 1916 by building aero engines; that history is the inspiration for BMW's blue-and-white propeller logo). Last year BMW lost $136 million on it, and subsequently sold its 50% stake of the joint venture in exchange for a 10% slice of the parent company, Rolls-Royce PLC. "It means a transition from a position as a supplier to a position as a strategic partner of the most important full-line supplier of aero engines in Europe," says Milberg.

After decades of conservative business policies, evolutionary (not revolutionary) designs, and an unflinching focus on engineering excellence, Bimmers (yes, it's "Bimmer" for cars--the often misused "Beemer" refers only to the motorcycles) have evolved into the automotive equivalent of Hermes: They are classics.

Most experts agree that the best scenario for BMW would be to remain independent. "The things that give BMW its value would dissipate under different ownership," says AutoPacific's Hall. "And once that dilution started, it would happen at a progressive rate." Charlie Hughes, a former president of Land Rover, puts it slightly differently: "When it comes to building great product, I'd put my money on BMW rather than the group that wrings the last penny out of a vehicle." (Well, by the way, there are a lot of impeccable new Rover 75 sedans at fire-sale prices these days in Britain, if anyone's interested.)

By keeping the focus on product excellence, BMW can spend its available funds on its class-leading R&D (rather than Rover-like cleanups), which will lure buyers and assure continued high profits. That success will in turn keep the company a prime takeover target--but who cares? The attention is flattering, good for brand image, and, most important, a sign of prosperity.

But if BMW tries to stretch too far afield--as it did with Rover and as it may be doing with Rolls or Mini--that is when Munich may find itself in trouble. Other specialty-car manufacturers have hurt themselves doing the same thing. Take Porsche, which nearly self-destructed when it strayed from its core 911 franchise with experiments like the VW-powered 914, the Audi-powered 924, and the underpowered 968. It returned to health by focusing on the 911 and now on its younger sibling, the Boxster--although the company's current plans to build a sport-utility vehicle by 2002 may demonstrate that it hasn't learned its lesson. Jaguar's plans to introduce an entry-level sedan next year are questionable (how do you do a sopping-with-luxury compact?), and Mercedes' A-Class has been accused of tarnishing the three-pointed-star's image with that of a low-end van. A happier role model for BMW is Honda, another great automotive company, which has managed to remain independent by staying--you guessed it--focused on strong quality and highly innovative vehicles. No mergers, no acquisitions--and no identity crises.

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