Mercedes-Benz’s Luxury Pitch Needs Tougher Road Testing

At a strategy day near Monaco Thursday, Mercedes laid out a plan to change the investor mind-set. It committed to selling more top-end vehicles—those that cost upward of 100,000 euros, or $106,000—and fewer, better entry-level ones at higher prices. It also aims to build on the high selling prices it has achieved during the recent period oflimited semiconductor supplies and vehicle production.

The payoff, it hopes, will be higher, more resilient profit margins. In benign market conditions, Mercedes expects to make an operating profit margin of 14% in its flagship car division, which now accounts for the vast bulk of the company. Even in bad conditions it would expect one no lower than 8%.

This is well below the level of the most exclusive listed car maker, Ferrari (25.9% in the first quarter), or car-tech pioneer Tesla (19.2%). It is also below the kind of operating margins made by other upscale manufacturers, such as handbag-to-champagne giant LVMH —a company Mercedes used to match in market value—or Apple.

Still, if successful, the Mercedes plan would set a new financial benchmark for what the automotive industry usually calls a “premium” brand—one that is classy but widely owned. The company, whose stock currently trades on under six times forward earnings, might then be rewarded with a higher valuation.

Mr. Källenius, unlike his predecessors, is intently focused on questions of market value. As a symbolic gesture of the company’s commitment to stricter capital allocation, he even announced Thursday the sale for charity of a single historic Mercedes from the company’s vast collection for €135 million—making it by far the most expensive car ever sold.

While the strategy makes sense, its success is far from certain. Shifting the model portfolio upmarket seems within Mercedes’ control; retaining the benefits of today’s scarcity-induced pricing less so. The company will be swimming against the tide as industry production normalizes, and it still wants to grow sales by about 5% a year.

A lesson from the likes of LVMH, Apple and now Tesla is that having tight control over the distribution of your products helps generate the pricing discipline, the bond with consumers and the cost efficiencies on which superior margins are built. Mercedes is moving rapidly to a direct-to-consumer sales model in Europe, but laws protecting the independence of dealerships make this difficult to replicate in the U.S.

There is also the question of electric vehicles, which for everyone but Tesla aren’t very profitable. At 16.4%, Mercedes made an even higher operating margin in the first quarter than it now expects in good times, but just 4% of the cars it sold were fully electric. If this rises fast it will hit the group margin. If it doesn’t, the company might lose customers to Tesla.

Mercedes stock fell 2% Thursday, even as those of its traditional peer BMW remained more or less flat. Investors were likely disappointed by the 14% long-term margin ambition following the blowout first quarter. Watching and waiting for a downturn also seems to be the dominant investor position across the sector, and this wasn’t something Mr. Källenius could hope to address.

Only consistent results, particularly through tougher times, will prove that Mercedes is becoming a quality company as well as a quality brand. With recession risks rising, his pitch might be put to the test sooner rather than later.

Write to Stephen Wilmot at [email protected]