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In tandem (at last)
posted by admin on 26/06/06

A big merger between Daimler-Benz and Chrysler is finally starting to work 

Marriage made in heaven—or hell 

When the marriage of Daimler-Benz and Chrysler was announced in May 1998, it was the biggest cross-border industrial merger ever. More than any other, it was the deal that gave a practical meaning to globalisation. A leading car company in Europe and one in America acknowledged that it could not prosper without acquiring greater scale to deal with the consequences of the globalisation of its industry. It was the biggest upheaval that the car industry had seen, and was soon to inspire the equally globe-spanning alliance of Renault and Nissan. 

When the deal was consummated later that year it created an industrial giant with global sales of more than $150 billion and a group that ranked fifth among car manufacturers. No longer was Chrysler to be the straggling third of the Detroit Big Three; no longer was Daimler-Benz a specialist producer of premium saloons struggling to widen its product range. Their combined strengths would make the group fit to take on the world.
That was the theory. The practice has proved much messier. DaimlerChrysler's share price fell from a peak of $108 in January 1999 to $38 by November 2000. The combined group was worth barely the value of Daimler-Benz before the merger. Today the price is still only half the level reached in the post-deal euphoria. The marriage made in heaven soon turned into the hitch-up from hell, as billions of dollars of shareholder value was destroyed. Soon, new problems at Chrysler were adding to investors' concerns that integrating the two companies was hard. 

From the start, the combined company was wracked by divisions at all levels. Neither side could agree on whether this was a genuine merger of equals or a quiet takeover of an American company by a financially stronger German one. For at least a year the group had two chairmen, Mr Schrempp from Daimler and Bob Eaton, who had been boss of Chrysler. Mr Eaton was weakened after he said he would retire early, making him a lame duck from the outset. 

Despite months of meticulous planning and years of effort, the integration of two very different ways of working has still not fully taken place. True, the Germans learnt to be less formal and to cut back on their proclivity for piles of paperwork, while the Americans learnt more discipline in their decision-making and meetings. One mistake the Germans made was to keep away from Detroit—one reason why head office in Stuttgart was slow to grasp that the American end was going awry. Rather as BMW bosses failed to get to grips with Rover after the German company bought the ailing British volume car producer in 1994, so the Germans of Daimler were probably anxious not to be seen to be heavy-handed. 

The first couple of years were consumed by struggles over who was really in control and over how the combined companies were to be run. Although billed as a merger of equals, it was nothing of the sort—as later became clear. Daimler could not afford to choose a merger formula, for instance, with a jointly owned company based in the Netherlands, since that would have triggered a huge tax charge. So Chrysler had to become part of a German Aktiengesellshaft. In compensation for this agreed takeover, the Chrysler shareholders were paid a 28% premium over the then market price (even though managers maintained the “merger” fiction resolutely thereafter). 

In time, these inevitable barriers to integration might have been surmounted smoothly. But the group ran into difficulties on both sides of the Atlantic. Although Chrysler had been the most profitable car company in the world in the mid-1990s, weaknesses surfaced like rust on an ageing car body shortly after it merged with Daimler. 

Within a year of the deal taking effect in November 1998, the American boss of Chrysler was fired. His successor lasted barely a year, as Chrysler swung from a profit of $2.5 billion in the first half of the year to a loss of $2 billion in the second. Tougher market conditions had exposed shortcomings in the company's product line, which failed to offer enough models to cover increasingly fragmented demand. Mr Zetsche and Wolfgang Bernhard were flown in from Germany to wield the axe. 

Nobody foresaw that it would take a crisis at Chrysler to catalyse the belated integration of the two companies. First a crack German executive had to be imported to sort out the American company; now the same man, with five years' experience in America under his belt, has moved back to Germany to run both the whole group and the Mercedes division.
“You can see now that it clearly was a takeover,” quips Mr Zetsche, “now that a Chrysler guy is running the show here in Stuttgart.” Such a joke would have been seen as too sensitive even a year ago. Now it is one indication that the two companies have finally become one. 

Toil and trouble 

Mr Zetsche recalls that on arriving in Chrysler's headquarters in Auburn Hills outside Detroit, he found a company with problems in every department: “Chrysler in 2000 was a company that had lost it.” Productivity was hopelessly out of touch with the industry's norms. Each vehicle took Chrysler around 40 hours to make, compared with 20 or so for the American factories of competitors such as Honda and Toyota. Purchasing was inefficient and fixed costs were far too high for a company of its size. Investment was running at 10% of sales but, even then, was failing to fill the gaps in a weak product line. Quality control was a constant problem. Worse, says Mr Zetsche, “there was no glide path towards fixing these things.” Tom LaSorda, who succeeded Mr Zetsche as boss of the Chrysler division, recalls the crisis even more bluntly: “We were investing more than GM, even though they were twice the size; it was a path towards going bankrupt, and we are still paying for some of those expenses.” 

The Zetsche recovery plan set a target of 30 hours a vehicle by 2007; last year the time was down to 33.6 hours and the latest figure, due out in June, will show further improvement. A five-year capital-spending plan of $42 billion was slashed to $29 billion, but the number of new products in development rose by 50%, because capital was deployed so much more efficiently. The time to bring forward new models fell from two years to only 17 months. Some big costs such as body-stamping dies were slashed by 40%, says Mr LaSorda. Chrysler shrank to fit the number of cars it could sell: it shut six factories and cut 45,000 jobs, a third of the total. 

Chrysler also began to benefit from Mercedes's technology. According to Frank Klegon, head of product development at Chrysler, technology-sharing among engineers started right after the merger, despite integration problems in top management. The biggest pay-off has been in the Chrysler 300 model, which has been a runaway success. With its German rear-wheel-drive technology, it even feels like a Mercedes to drive. Not only have its soaring sales boosted revenues and profits, but its stylish and raunchy image has done wonders for the Chrysler brand, moving it upmarket. The car deliberately draws on Chrysler's 1960s heritage of big muscular cars and powerful, smooth engines. The Dodge Charger, the Jeep Commander and the Dodge Ram Mega Cab were among 15 new products to be launched in the past two years; a further ten are to hit the market this year. 

A new dawn 

Today Chrysler is the healthiest of the car companies in Detroit, with a brand that has moved upmarket even as surplus capacity and workers were shed. The Mercedes division is now undergoing the same tough restructuring. Mr Zetsche took the top job in January, having made his reputation turning around Chrysler. He is also chief executive of the Mercedes car group, charged with the attempt to recover its status as Germany's leading luxury car brand—a title ceded to BMW a couple of years ago. 

But such is competition in the American market, where Chrysler sells most of its 2.8m vehicles a year, that even its newly strong product line is facing problems. People in the industry estimate that Chrysler will have had to slash production by 10-13% in the first quarter, compared with a year earlier, because its inventories have built up. Chrysler's healthy profit increase last year was boosted by exceptional factors, and the underlying profit in the fourth quarter fell. The company is talking to the unions about further cuts in health-care costs. Chrysler has a better record than its bigger rivals, GM and Ford, when it comes to negotiations with the unions. It should reap benefits from the concessions those two companies are now beginning to win from the United Auto Workers union. The signs are that the UAW is frightened enough by the dismal prospects of the Detroit Big Three that it is prepared to make concessions even before the company contracts come up for renewal next year. 

Walk round the big Mercedes car factory at Sindelfingen outside Stuttgart and the scene looks like any other. The vast complex churns out 2,100 cars a day and employs more than 42,000 people. But the pace is relaxed. Mercedes luxury cars are available in so many specifications that no two cars going down the line are the same. Mercedes uses thousands of robots to cut expensive manpower. You see the same red robots, made by a German supplier, in Chrysler's American factories: bulk buying like this is one practical way to take advantage of the quadrupling of vehicle output that came with the merger of the two companies. With BMW expanding and Volkswagen eating into its sales with trendy upmarket Audi models, Mercedes now has to cut costs to become profitable again. A plan started last year should produce €1.5 billion of annual cost savings and more are in the works. Already, more than 5,000 workers at its German factories have taken voluntary redundancy or retirement packages. A further 3,500 are to go by September this year. 

With the savings coming from a single head office and more efficient Mercedes production, DaimlerChrysler is now focusing on its remaining problem, the Smart car brand. Mercedes joined forces with the inventor of Swatch watches more than ten years ago to produce cute little town cars, using revolutionary techniques. An aluminium space frame forms the core of the vehicle, with pre-painted plastic panels hung around it. But the Smart vehicles have never fulfilled their designers' hopes and the division is a perennial loss-maker. A “For Sale” notice was pinned on it last year, but for the moment no takers have stepped forward. The product range is being pared back, with the end of a four-seater Smart model. Mr Zetsche is redoubling efforts to make the group profitable by next year, saying he will do whatever it takes for this to happen. After allowing about €1 billion for provisions to cover cut-backs and losses last year, DaimlerChrsyler announced at the end of March that it is pouring as much again this year into fixing Smart.
Another post-merger crisis to dog Mr Schrempp emerged in Asia. Nissan became available as a potential partner in early 1999, but after some talks the Germans decided they had enough on their plates absorbing Chrysler. Nevertheless, a year later DaimlerChrysler did invest €2.1 billion for a 34% stake in Mitsubishi Motors. But, after a scandal erupted at the small Japanese manufacturer over concealed quality problems, the DaimlerChrysler board rejected Mr Schrempp's call for them to invest more money in a re-financing of Mitsubishi. The result was a total exit from the Japanese company last November. Unfortunately, this has resulted in the almost complete collapse of Mr Schrempp's Asia strategy, leaving DaimlerChrysler scrambling to catch up in markets such as China where it has been slow to take advantage of growth. 

You can run 

The big lesson of the formation of DaimlerChrysler is that grand strategy is never going to shield a company from problems, whether these are the consequences of something as ambitious as a transatlantic merger, or the weaknesses of parts of the business. With hindsight, it is clear that when Daimler-Benz went into the merger it was gloriously unaware of the fragility of Chrysler's apparently stellar performance in the late 1990s. In America in 2000, as soon as the Asian brands became rival suppliers of the light trucks and SUVs on which the company made all its money, Chrysler's profits collapsed. 

After two wasted years before getting to grips with Chrysler's woes, Daimler people neglected growing problems back home in Germany, where the once-unassailable tri-star brand was losing its lustre. When managers tackled that from 2003 onwards, they neglected the loss of competitiveness in a European market where rivals were staking out claims to traditional Mercedes territory. 

But none of that should obscure the vindication of Mr Schrempp's chief insight. Without Daimler, Chrysler would be in liquidation; and without Chrysler, Mercedes would be confined to a limited future of narrowing horizons, as rivals encroached on the luxury market. Strategic mergers may sometimes be necessary, even if they are mighty hard to pull off. 

Adapted from the Economist

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