How quickly the mighty can fall, remarked the UK's most widely distributed consumer magazine, Which?, in its car reliability review in August 2005. Having had an excellent rating three years ago, the luxury brand, Mercedes-Benz 'now languishes in the 'poor' category, with its newest cars faring particularly badly'.
The Which? survey covered its readers' experience of nearly 34,000 cars over the previous 12 months and grouped them into excellent, good, average and poor for reliability. It was, however, no secret that Mercedes had been suffering quality problems for some time. There had been plenty of anecdotal evidence for anyone, including the management of parent company DaimlerChrysler, to see on web logs such as www.consumeraffairs.com , www.mercedes-benz-usa.com or www.mercedesproblems.com . Unhappy owners from a number of countries had taken to the internet to air their complaints.In 2004, DaimlerChrysler reported a profit of EUR5.754bn, of which EUR1.7bn came from the Mercedes car group. This was only just over half the 2003 level. The reasons given for the slippage at Mercedes were a 2% fall in unit sales, amplified by a change in the model mix, appreciation of the euro against the dollar and 'expenses for the ongoing quality offensive'.
The annual report says, 'The vehicles currently rolling off our assembly lines reveal the highest level of quality ever achieved by Mercedes-Benz.
We have worked hard over the past few years to ensure that this would happen. With regard to vehicles in the market that do not meet our quality standards, we have implemented measures with a clear target: everything must be done at benchmark levels. The ultimate goal is clear: to consolidate Mercedes-Benz's number one position, and also achieve this in terms of quality. This will cost money in the short-term, but the investment will be worthwhile.'
In March 2005, DaimlerChrysler recalled 1.3 million Mercedes, built variously between June 2001 and March 2005, depending on the model, for such changes as updating the braking systems. At the time the company said very little and no costs have so far been disclosed.
In its report and accounts, DaimlerChrysler publishes an extensive risk review, which in 2004 acknowledges, 'In view of increasing price pressure, the fulfilment of DaimlerChrysler's own high quality standards is extremely important for the group's future profitability. Product quality has a key impact on a customer's decision to buy a particular brand of passenger car or commercial vehicle.
'Technical problems could lead to further recall and repair campaigns, or can even necessitate new developments. Furthermore, deteriorating product quality can create higher warranty and goodwill costs.'
Yet, a key question remains unanswered - what caused the quality control problems at Mercedes in the first place? The company sets out sophisticated, enterprise-based risk management processes and procedures in some detail in its annual risk report - so what went wrong?
Certainly, the group has been going through a long period of upheaval, which seems not to be over yet. DaimlerChrysler released its interim results for 2005 on 28 July. The operating profit of EUR1.7bn in the second quarter, although said to be 'significantly above analysts' estimates' and much better than EUR628m for the first quarter, was still down from EUR2.1bn for the same period of 2004. Board changes were announced the same day, including the departure at the end of 2005 of Jurgen Schrempp, chairman of the board of management, two years ahead of schedule.
The size of the rise in the company's share price following the announcement quickly prompted Germany's financial market regulator, BaFin, to launch an investigation into possible insider trading.
Dieter Zetsche, head of the Chrysler Group, was announced as Schrempp's replacement from 1 January 2006. The market liked that appointment, but apparently the head of the Mercedes car group, Eckhard Cordes, did not.
He left at the end of August 2005 at his own request after 29 years with the company, and Zetsche immediately succeeded him as head of Mercedes, again a generally popular development.
Schrempp is the architect of DaimlerChrysler. His intention was simple: to create the world's leading motor manufacturer. By adding North American and Asian operations to Daimler-Benz's established European car, commercial vehicles and financial services, he believed the Stuttgart-based group could motor past its rivals, General Motors, Toyota and Ford.
He has been with the company for 44 years. Having led major group interests in South Africa, the US and Germany, he became chairman of the board of management in 1995. In 1997, the group was reorganised, fusing Mercedes-Benz with Daimler-Benz. Four divisions were created in the restructuring: passenger cars, commercial vehicles, aerospace (Daimler-Benz Aerospace) and services (debis).
On 12 January 1998, while in the US for the North American International Auto Show in Detroit, Schrempp visited Robert Eaton, chairman and CEO of Chrysler Corporation, to discuss a possible merger. In May, the merger agreement was announced; in November, it was completed. Daimler-Benz and Chrysler were to combine to form the world's leading automotive, transportation and services company. By 2000, 37.3% of Japan's Mitsubishi Motors and 10.5% of Korea's Hyundai Motor had been added. Schrempp became chairman of the combined board of management.
At first, shares in the combined group performed well. From immediate post-deal completion in November 1998, the price climbed from around $80 to over $100 in early 1999, but it became clear that the performance that produced an operating profit of EUR11.012bn in 1999 would not continue, as a slumping US economy hit the big car makers.
Schrempp launched a cost-cutting three year recovery plan in February 2001, aimed at turning the company around, particularly in the US where the Chrysler unit was already showing a loss. In 2001, DaimlerChrysler recorded an operating profit. In 2003, however, the operating profit slipped to EUR5.686bn. This remained almost unchanged in 2004 at EUR5.754bn.
From the spring of 1999, the share price had taken a steady downward route, reaching around $40 just before September 11, 2001. A reasonable recovery then saw the price regain $50 in the spring of 2002, but it turned again, crashing through the $30 barrier in December of that year. Since then, the shares have generally traded in the $30-$40 range with an improvement in the summer of 2005 finally taking the price back over $50, regaining the level they had reached three years previously.
Rivals General Motors and Ford have certainly not outperformed DaimlerChrysler over the last five years, however. More recently, both have definitely under-performed and produced a bouncy ride for investors.
In addition to their company-specific problems, all these car giants have to manage macro economic and industry-wide risk factors: weak economic developments, particularly as a result of a sustained high oil price, over-capacity and competition, and financial risks: foreign exchange rates, interest rates and commodity prices. DaimlerChrysler sets out these risks and its approach to them in its risk report.
Signs of recovery
There are now signs that the measures effected by Schrempp and his board are starting to affect results. After an operating loss in the first quarter of 2005, the Mercedes car group recorded an operating profit of EUR12m, modest but enough for the company to say it had reached a turning point.
The group continues to expect that 2005 revenues will be higher than in 2004 and expects a slight increase in operating profit.
In the Which? reliability report, Ford joined the ultra-reliable Japanese brands such as Honda, Mazda and Toyota, among those related excellent.
'Ford's excellent showing this year proves that it is possible for a manufacturer to turn its reliability around in a relatively short time. This result is the latest in a series of steady improvements since 2000, when Ford languished in the poor category.'
Clearly, too, there is some time lag while quality control measures work their way into test results. The important US research report, the J.D. Power and Associates Initial Quality Study, reported that during 2004, Mercedes-Benz had made a 20% improvement in the quality of its new vehicles.
Sales of Mercedes and Smart brand cars were picking up mid-year after a sluggish start. At Mercedes, for instance, worldwide deliveries rose 4.4% in July 2005 compared to 2004. The first new S-class Mercedes were to be delivered to customers in September, and autumn would also see the launch of the new R-Class in the US.
At the same time, Mercedes still lags significantly behind one of its competitors, the Toyota Lexus. J.D. Power's first Initial Quality Study for 2005, published in May, gave its top ranking to the Lexus SC 430, for the second year in a row. Toyota's Lexus plant at Tahara, Japan, received Power's platinum quality award for worldwide plant quality for the fourth consecutive year. Toyota vehicles received more than half of the top model segment awards.
Thus, a question for shareholders emerges from the Mercedes story. How does management create risk to shareholder value that it is unable to identify in advance, and is subsequently reluctant to recognise, thus delaying remedial action?
Lee Coppack is a risk management writer. She is also editor of Strategic Risks' sister publication, Catastrophe Risk Management, E-mail: email@example.com
- Pictured above: Micro Compact Car France S.A.S (MCC), an enterprise of Daimler Chrysler AG, is producing the Smart in Smartville, the production facility in Sarreguemines Hambach.
DAIMLERCHRYSLER RESPONDS TO STRATEGIC RISK'S QUESTIONS
- To what do you attribute the quality control problems which resulted in the recall?
No complex, mechanical or electronic piece of equipment is ever free of faults, however minor. The most expensive computer systems in the world are occasionally prone to minor errors. Cars, computers, airplanes - even the multi-billion dollar space shuttles - are occasionally affected by technical hitches. Recognising such potential faults in advance and learning from them is vital for the continued success of the equipment in question.
As more and more technology is introduced into a vehicle, the potential for errors is increased. This increase in technology is unavoidable if we wish to fulfil the needs and wishes of our customers. Technological advancements play an immense role in increasing the safety of vehicles and reducing the burden on the environment.
As Mercedes-Benz has grown dramatically over the last decade, the number of cars produced has risen significantly. For this reason, a single fault in a particular model range will now result in a greater number of cars being checked at the workshop than was previously the case.
- What have you done to rectify the situation?
We have introduced further stringent quality processes in all areas of development, testing, sales and service. These measures also involve our suppliers and their suppliers. A prerequisite for the effective safeguarding of our quality standards and the production processes in the Mercedes Car Group is the Mercedes-Benz Production System (MPS). The control of all points during the manufacture and the continual observation of the product in the marketplace are also extremely important, as is the early integration of system partners in the digital phase of product development.
The process safeguarding with simulations and the alignment of the development processes with our suppliers are integral parts of our quality system.
- How many of the recalled cars have been received and how many repaired and returned to their owners?
Not all the vehicles affected by this recall are brought into the workshop immediately, for reasons of capacity. The fulfilment of these checks is a continual process - owners of the cars in question will receive written notification of when their car is to be checked by the service organisation.
The checks and remedial work (if required) are then carried out - this process should only last a few hours at most.
- How are you working to improve the relationships with owners whose cars were recalled?
By carrying out a voluntary recall, we are showing our customers that we care. Although the recall was not safety-related, and despite the fact that only a minimal number of faults were reported worldwide, our customers accept that this brief precautionary measure is necessary.
- What is the likely impact on your 2005 results?
Following the recent quality issues, Mercedes-Benz has undertaken significant efforts to fulfil the high expectations of its customers and again stand for superior quality. After significant expenses in 2004, the 2005 financial year is also expected to be significantly impacted by the quality offensive.
Warranty costs are, however, expected to decline in future periods.