(FORTUNE Magazine) – Helmut Panke, chairman of BMW, hates to say the word. He's in his stark, white office at the company's headquarters near Munich, describing a future vehicle his team is developing. A precise man who has a doctorate in nuclear science as well as a deep appreciation for exquisite engineering, Panke is fond of talking about the "DNA" of BMW. When he talks about the company's tradition and values, his entire body contorts with emotion. "A BMW will always be true BMW," he says. "We will never build a boring BMW." And yet the more he describes his new dream machine, the more the word he's avoiding hangs in the air. This means of conveyance will be large and roomy. (Min ...) It will have the utility of an SUV yet the handling of a BMW. (Miniv ...) As Panke talks, it's hard not to think "juice boxes" and "soccer practice." It can't be. A minivan?

Actually, Panke would prefer you use the term "space-functional concept." But in essence, yes, BMW is planning a minivan. It won't be out until the end of the decade, which will come as some relief to Beemer purists, but still. A BMW minivan?

Panke's loathing of the m-word has less to do with snobbery than with the fact that he's forcing the company through a major change. The minivan is just one part of a strategy to transform BMW from a specialized producer of sporty rides for high-income aesthetes into a full-line automaker, with a complete range of sedans, wagons, SUVs, roadsters, all of it. (Except pickup trucks. There's no danger that there will ever be a BMW pickup truck.) He has pledged to boost sales of the BMW group, which includes MINI and Rolls-Royce, from 1.1 million cars last year to 1.4 million by 2008. And his latest step in that direction is to head into unfamiliar territory: downmarket. In mid-September, BMW added a new, entry-level model called the 1 Series. The 1 Series won't be a small-volume promotional leader either--BMW expects to sell some 120,000 next year. After that will come the space-functional concept.

Panke is walking a dangerous line. On the one hand, he knows growth means expanding into new markets with new kinds of products. BMW ranks only 14th among the world's automakers, ahead of Mazda and behind Mitsubishi in global unit sales, which severely limits its economies of scale. Worse, all of its luxury competitors are divisions of larger, deep-pocketed corporations. Mercedes can tap the resources of DaimlerChrysler, and Lexus has a direct line into the cash vaults of Toyota. Enmeshed in a brutal competitive struggle, BMW needs all the resources it can muster. Because it is an independent company, it could plausibly become a takeover target at the first sign of weakness. (There is no hint that its controlling shareholders, Munich's very private Quandt family, who own 46.6% of the voting stock, have any intention of selling. But that could change if BMW's leadership position starts to slip. There's no reason for the family to own the stock if the company stops growing and paying dividends.)

On the other hand, there's the high-end BMW cachet to protect. The company is revered by millions of owners and fans for engineering cars that put the driver first. For many customers, buying a BMW is like joining a semi-exclusive club. "BMW is the most charismatic brand, and charisma is something you can't buy or manufacture," says analyst Rebecca Lindland of Global Insight in Boston. "People would rather have a used BMW than a new anything else. And once they are in it, people don't leave." High prestige, of course, is highly valuable: BMW's profit margins are among the richest in the industry.

Panke's mass-with-class strategy puts that cachet in peril. BMWs command premium prices partly because of their scarcity. Once BMWs turn up at every mall and hockey rink, the snob appeal will disappear. Panke and his team are painfully aware of the case of Cadillac, whose long decline accelerated in 1982 after it bolted its wreath-and-crest to the hood of a humble Chevrolet Cavalier and renamed it the Cimarron. Buyers were not amused.

Even in times of stability, BMW executives tend to be anxious. Acutely conscious of the value of the brand, they fret endlessly about what BMWs look like and how they perform. The slightest model changes cause endless handwringing by the company--and relentless backseat driving by financial analysts, the automotive press, and all those Beemer fanatics the world over. Typical is chief designer Chris Bangle, who worried that buyers might confuse the new entry-level car with the 3 Series, the next most expensive model in the BMW lineup, and then declared, "The 1 from every angle is not a 3."

That obsessiveness should give you some idea of the intensity with which Panke and his engineers are gauging reactions to the 1 Series. It's still too early to say for sure whether BMW has avoided a Cadillac-like detour. The response at the Paris Auto Show, where the car was introduced, was tepid. The sweltering crowd of journalists in the humid exhibition hall was far more interested in the unveiling of the M5, BMW's superfast, limited-production sedan. And BMW itself made a much bigger deal out of its new, hydrogen-powered racecar (see box). But early reviews have been positive, and customers in Europe and Asia have been enthusiastic. They bought more than 5,600 of the 1 Series cars in a little under two weeks.

Clearly BMW is embarking on its expansion from a position of strength. Unit sales are up 8.8% so far this year, and it sold more cars in September than in any other month in its history. In the U.S. it sold 240,859 BMW-branded cars in 2003, beating Mercedes for the third year in a row and making America its largest single market. Although BMW's revenues are a fourth of GM's, its market cap is $27.2 billion to GM's $23.6 billion.

With a base price of about $25,300, the 1 Series costs about $5,000 less than BMW's current lowest-priced sedan and makes club membership available to a whole new kind of customer. Moreover, the 1 enters BMW into the burgeoning global market for compact cars, a segment populated by such stalwarts as the Volkswagen Golf and Toyota Corolla. About 12.6 million such cars were sold last year. Panke figures that demand will increase 20% by 2010, while the market for more expensive models in that class--the Mercedes A Class, Audi A3, and BMW 1 Series--will grow 50%. So far the idea of a small luxury car is a European phenomenon. The Mercedes A Class won't arrive in the U.S. for several years, and the Audi A3 isn't expected here at all.

BMW is proceeding gingerly with the 1 in the U.S. because it was burned by the reception given an earlier entry-level car. It sold the two-door hatchback 318ti in the U.S. from 1995 to 1999 before withdrawing it from the market. The 318ti bore a strong family resemblance to the full-size 3 Series and competed with it for customers, rather than attracting the younger buyers BMW had hoped for. The other problem: Americans don't believe in hatchbacks on fancy cars. While hatches are becoming accepted by upscale customers in Europe and Asia, Panke has decreed that the hatch does not fit BMW's American image. The U.S. won't get a 1 Series car until 2007, when BMW will export one with a proper trunk and a six-cylinder engine.

Panke and design chief Bangle have made sure that the 1 Series looks and feels every bit the BMW. While every other car in the segment is driven through its front wheels, the 1 Series has rear-wheel drive, as does the rest of the BMW line. That layout extends the engine bay back toward the passenger compartment, cramping rear seat room, but it provides the kind of dynamic handling that BMW is convinced separates its cars from the competition's. Everything from the steering wheel and the gearshift lever to the dials on the instrument panel looks and feels comfortably Beemerian. (About 60% of the 1 Series' parts as measured by value come from the 3.)

A brief test drive into the countryside south of Munich confirms the value of the rear-drive/rear-legroom tradeoff. Acceleration is brisk (0 to 62 mph in 8.7 seconds), and the 1 Series carves a tight line through turns while tracking solidly at speeds over 100 miles per hour. Analysts at Bernstein Research expect sales to reach 300,000 annually once all the body styles are on the market. That would make the 1 the second most popular BMW after the 3 Series.

Convincing buyers that the 1 Series is echt BMW will be easy compared with winning them over on minivans. Panke sees two potential models. The first is supposed to be a roomy sports tourer similar to the Chrysler Pacifica, only with lots more amenities. The second would be a nimbler half-SUV/half-car crossover vehicle that sounds a bit like an Infiniti FX45. But, without getting into the details, Panke says he's going for something different. Whatever he has in mind, he'll have to make a decision soon if he wants to have his space-functional concept on the market by 2007 or 2008 as planned.

Panke's decision to grow BMW organically is a 180-turn from a strategy that blew up in the company's face a decade ago. In 1994, Panke's predecessor Bernd Pischetsrieder bought Rover Cars in the belief that BMW could convert the failing British brand into a second line of cars. Rover continued to decline under BMW ownership. By the time the company woke up to that fact and tried to fix it by airlifting in German engineers and investing millions of deutsche marks, it was too late. Rover's collapse forced Pischetsrieder's resignation in 1999, and in 2000 the company paid a British private-equity group $755 million to take Rover off its hands. The misadventure cost the company more than $4 billion. The sole reward has been Rover's MINI, which has developed into a robust business since its relaunch in 2002.

After the Rover catastrophe, BMW flirted with artistic disaster in its design department. Traditionally, BMWs have borne a distinct family resemblance, with the small 3 Series sharing the same proportions and design cues as the mid-sized 5 and top-of-the-line 7. That was reassuring to longtime customers, but in the late 1990s, executives decided that the similarity was dampening sales. "BMW was criticized, clobbered, and basically nailed to the wall for having identical designs for the 3, the 5, and the 7," says Panke.

BMW's American-born designer Bangle took on the task of stretching the company's design envelope. Bangle performed his first makeover on the 2002 model 7, restyling the front end, stretching the passenger compartment, and creating a high-deck, short-lid trunk that was quickly dubbed the "Bangle butt." Customers and critics who were put off by the shock of the new also hated the decision of BMW engineers to try something different inside the car. They installed a tilting, plunging, rotating knob on the console to control hundreds of electronic features--and managed to complicate life for drivers rather than simplify it.

Traditionalists were outraged by both changes, and Bangle was subject to virulent personal attacks on the Internet, including a "Stop Chris Bangle" website that collected more than 10,000 signatures. (Sample: "Bangle is the worst that's ever happened in BMW's history of making the finest cars in the world!") Another wave of criticism broke when Bangle's new 5 Series, in some ways even more radically reshaped, appeared in 2003. Yet for all the brouhaha, BMW sales haven't noticeably suffered, and the cars retain more of their value than almost any other make. Automotive Lease Guide projects that 7 Series cars will be worth 54% of their new-car price after three years of ownership, vs. 52% for the Mercedes S Class and 50% for the Audi A8.

Panke defends the decision to inaugurate the new styling direction with the 7 Series because that was the first model due for an overhaul, but concedes that his call "can be challenged." He is beginning to feel vindicated, though. With the styling of the 1 Series creating only a quiet murmur, he says, "I would say the controversy over the design is basically not there anymore, at least in Europe." Many analysts agree. "I think Bangle has been proved mostly right," says Graeme Maxton of Britain's Autopolis consultants. "His designs are not to everyone's taste, but they are also distinctive and bold in an industry that often fears any radical change."

The controversy may have died down, but life won't be getting any easier. Mercedes is expanding its range of models; Lexus continues to add style to its already superbly built cars, and Cadillac is in the midst of a $4 billion makeover. BMW has to continue to move faster than everyone else in order to stay on top.

And even if the 1 Series does become a hit, there's still that cachet problem. Imagine the dealerships: Big shots shopping for $76,000 6 Series convertibles while sneering at entry-level couples asking about cupholders. It is not a recipe for retail harmoniousness. "I think the plans are risky," says Maxton. "Taking a brand like this into the middle market is a mistake to me, and one that could be hard to reverse. It carries the risk of brand degradation." There's a potential financial impact too: More small cars will dilute the fat margins BMW enjoys on large cars. And the 1 Series could cannibalize sales of the more expensive 3 Series, just as the 318ti did.

But this is a road that BMW must travel. The risks of not growing are too high. The 1 Series, the minivans, and whatever other downmarket line extensions BMW dreams up give it an opportunity to attract younger buyers. It wants to lure budding careerists even if they never make their first million.

Panke likes to say BMW shares a philosophy with another purveyor of premium products: Starbucks. When customers go to a Starbucks, they know they are getting Starbucks coffee, whether they order espresso or a Frappuccino. "You would not go to Starbucks to look for some freshly made carrot soup." It's the DNA thing again. When you buy a BMW, you don't want a cheap imitation. The hardest part of his job now is making sure that never happens.

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