By William Boston 

BERLIN -- After decades of churning out huge profits and setting the standard for premium cars, Germany's top luxury auto makers are on the retreat, hurt by increased competition, allegations of foul play and tech-heavy upstarts.

The combination of forces hitting the German premium brands was on display Wednesday, when Daimler AG -- owner of the Mercedes-Benz brand -- issued its third profit warning in nine months and said profits fell nearly 50% last year. In addition, Tesla Inc. overtook Volkswagen AG as the world's No. 2 most valuable auto maker.

Daimler, Volkswagen and Bayerische Motoren Werke AG continue to rack up record new car sales, but the auto brands are becoming less profitable and losing market share in the U.S. and elsewhere. Germany's premium car makers have been hit by reputational damage from legal scandals; a global slowdown in vehicle sales; and higher expenses caused by the cost of investing in electric vehicles.

The beneficiaries are new rivals such as Tesla and recharged competitors such as Volvo Cars. The German companies are spending tens of billions of dollars to develop electric vehicles, but they are playing catch up with Tesla, which is seen as the trendsetter of the new electric, connected car industry.

"The benchmark today is Tesla," says Ferdinand Dudenhöffer, director of the Center for Automotive Research at Duisburg-Essen University. "Ten years from now, Tesla is going to be as big as BMW."

The separate legal challenges facing Daimler, BMW, Volkswagen and Audi AG aren't just tarnishing the image of the companies that created the premium car brand, but they are also sapping financial resources each of them needs to invest in new technology. Over the past three quarters, Daimler has set aside more than $4 billion in the wake of investigations into allegations that it cheated on diesel emissions.

BMW is fighting a ruling by the European Commission, the European Union's executive arm, that it colluded with other car makers to fix prices of emissions technology. Last year, the company took more than $1 billion in charges against earnings for legal fees in connection with the antitrust action.

In December, BMW said the Securities and Exchange Commission was investigating its business practices on suspicion that the company falsified sales figures to show better performance. BMW said it was cooperating with the SEC but declined to comment on the allegation. The SEC didn't respond to requests for comment.

Having an even deeper impact on profits is the technology shift in the industry. Cars are being designed to run on battery power and to be networked and function more like smartphones on wheels than simple vehicles to get around town.

"We are valued as an automotive company, but Tesla is valued like a tech company," Volkswagen CEO Herbert Diess said this month at a gathering of the company's top executives in Berlin, according to a transcript of his speech.

Tesla sales in the U.S. have grown 10-fold since 2014, while Mercedes and BMW have lost market share. Audi sales did soar over the past five years, but the German brand is in the throes of restructuring and has barely gained any market share because rivals such as Tesla, Infiniti and Volvo Cars racked up bigger gains.

Daimler's profit margin from its automotive businesses has fallen from around 9% in 2013 to an estimated 3% in 2019, lower than the 4.3% margin forecast for Ford Motor Co., according to data provided by Evercore ISI, a London-based brokerage.

After years of double-digit profit margins, BMW's margin may have fallen to as low as 5% in 2019, Evercore said, less than half the 11% margin the company posted in 2012, the last time it generated double-digit returns.

Another reason for this loss of luster is that others have discovered how lucrative a market the German luxury brands' niche was. Rivals developed their own premium brands and took their established models upmarket in search of higher profits.

In 2013, Ford Motor Co. revived the long dormant Vignale subbrand, to compete against Volkswagen. Peugeot breathed new life into its DS brand. They followed Toyota Motor Co., Nissan Motor Co., and Honda Motor Co., which had created their respective Lexus, Infiniti and Acura brands years earlier.

One way midmarket makers have raised the luxury content of their cars has been to pack them with tech. Volvo, nearly extinct until it was revived with Chinese money after a 2010 takeover by Zhejiang Geely Holding Group Co., billionaire Li Shufu's company, has come roaring back with a new fleet of technology-laden premium vehicles. Still just a third of the size of BMW in terms of sales, Volvo has teamed up with Alphabet Inc.'s Google to save development costs on in-car digital technology.

"We now have the products. We are catching up with Audi and BMW. We have to be seen as an alternative to them," Volvo CEO Hakan Samuelsson told The Wall Street Journal. "It's about premiumness; that's how we will grow."

Some threats faced by the German luxury makers aren't limited to the premium segment.

China, the world's biggest auto market by sales and the largest market for VW, BMW, and Daimler, declined for the second year in a row last year. World-wide demand for new cars is softening as the global economy weakens.

In Europe, profits are coming under renewed pressure across the car market as companies spend tens of billions of euros to make electric cars and lower the average carbon-dioxide emissions of their fleets because of new legislation that threatens them with billions in penalties if they miss their targets.

Pushed by regulators to lower emissions and spurred on by the successes of the Tesla generation, the German auto giants have realized that the times are changing.

"The storm is coming now," Mr. Diess told the VW executives. "The year 2020 will show whether we're braced for inclement weather."

Write to William Boston at william.boston@wsj.com

 

(END) Dow Jones Newswires

January 22, 2020 14:56 ET (19:56 GMT)

Copyright (c) 2020 Dow Jones & Company, Inc.
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