The Europeans are Cost Competitive; What Happened?

If you haven't been watching the luxury and near-luxury market closely, you might be surprised to find that Toyota Motor Corp.'s mighty Lexus nameplate actually is being undercut by its once pathetically overpriced German adversaries. What happened?

Analysts say that unfavorable exchange rates, inefficient plants and high labor costs battered European automakers in the late 1980s and early 1990s. But the Japanese really shook up European luxury carmakers when they introduced the flagship Lexus and Infiniti models in January 1989: They were $10,000 less than their closest German competitors and - by any measure - far better values.

Shifting currency rates helped level the playing field after that, this time briefly putting the Japanese at a disadvantage, but the stubborn Germans also started ruthlessly cutting costs while developing cars that were easier to build. Donald N. Smith, a manufacturing expert at the University of Michigan's Office for the Study of Automotive Transportation, says Mercedes probably has taken 20% to 25% of labor cost out of its vehicles in recent years.

Jim Mateyka, an analyst at A.T. Kearney, Inc., points out the Germans now are outsourcing more components, stressing modular assembly and are shifting new assembly operations to lower-cost venues such as the U.S. And most experts say implementing Japanese production techniques played a key role in saving Porsche AG from near disaster.

But most analysts say production changes haven't yielded the biggest cost savings. In fact, one manufacturing expert who asks not to be identified, says the U.S. assembly plants of Mercedes and BMW are "horribly inefficient" compared with the U.S. operations of Toyota Motor Corp. Like most German facilities, they use too many people and make too many inspections and repairs at the end of the assembly line, rather than building the vehicles right the first time, he says. Volkswagen AG's plant in Mexico gets low marks for the same reasons.

Instead, analysts speculate the Germans chopped the lion's share of costs by no longer "over-engineering" their cars with needlessly complex features and systems. Mercedes used to offer an ultra-sophisticated all-wheel-drive system that cost $8,000. It now offers a much simpler system for less than $3,000.

However, Mr. Mateyka says the Germans probably are the world's best when it comes to engineering vehicle platforms that can be used as the foundation for a stunning number of competent global products. Volkswagen, for instance, is using only four vehicle platforms to produce 4 million vehicles annually. It used to need 20.

BMW AG's 3-Series is another example of how German automakers may manage to make a buck and still be price-competitive without the most efficient manufacturing: In just the U.S. and Germany, it offers 26 versions of the same car, from the $23,870 4-cyl. 318ti hatchback to the $46,470 M3 convertible.