Big risks on the autobahn: for many years, German automakers have seemed invincible. BMW still is on a roll. But Porsche and Volkswagen are facing challenges. Porsche underestimated the threat to its sports cars. And Volkswagen is pushing into the high-end market with a brand name that isn't known for luxury.

Porsche, one of the world's last independent sports-car makers, isn't exactly having a fun ride these days. Demand for its aging 911 series and even its newer Boxster is shrivelling. Porsche finds itself betting on a sports utility vehicle, of all things, to help it escape another brush with disaster, such as the one it faced some 10 years ago. The previous drama nearly bankrupted the Stuttgart-based company and almost delivered it into the hands of neighbor and competitor Daimler-Benz, now known as DaimlerChrysler.

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Then, as now, the U.S. dollar was falling against the Deutschemark and Porsche's model mix was weak. A string of losses was beginning to upset the company's key shareholders, the Porsche and Piech families, who own all of the voting stock.

But then, Wendelin Wiedeking wasn't running the company.

Asked in late 1992 by then supervisory board chairman Ferdinand Piech to rescue Porsche, Wiedeking knew he was being offered a job that already chewed up two CEOs. Moreover, he knew that Piech, at the time also the CEO of Audi and the owner of a substantial stake in Porsche, was a hands-on chairman whose idea of supervision was likely to clash with his own.

Yet Wiedeking took the job and ran with it. He radically altered the model range, shutting down the unprofitable 928 and 944 lines and shelving a luxury limousine project. He cut production costs by ramming through Japanese lean production methods, put out several upgrades of the 40-year-old 911 model and launched the entry-level Boxster car, outsourcing it almost completely to a Finnish carmaker, Valmet. His latest project, the Cayenne SUV, cost Porsche about a billion euros to develop and took Wiedeking's full persuasive power to get the supervisory board to agree. "It was not very simple to convince the supervisory board that we need to build an SUV," he concedes. "And if we hadn't succeeded, the situation at Porsche would have looked quite different."

Under his relentless prodding. Porsche was re-engineered from a loss-making takeover candidate into the world's most profitable carmaker, with a mouth-watering 17 percent pretax return on sales in the fiscal year ended July 31, compared with a measly 0.5 percent return in its first full year with Wiedeking as CEO. And the company, valued at 300 million euros on the stock exchange at the time he took over, is now worth over 8 billion euros.

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Even hard-to-please Piech is impressed. "I have to admit that Wiedeking's courage to change things so radically has amazed me. I'm not sure I would have trusted myself to do that." he wrote recently in his autobiography.

But the roller-coaster ride continues. Porsche is facing another valley of shadows, while the man behind its steering wheel tries not to lose sight of his goal. "All we're doing is aimed at keeping us independent," insists Wiedeking. "We want to remain independent."

The latest figures are enough to cause sleepless nights even to this poker-faced executive with a military moustache and a taste for Hermes ties. At the annual general meeting in late January, he told shareholders that worldwide sales of Porsche's sports cars were going to tank by almost 30 percent in the first half of the current fiscal year, or by the end of January. The only bright spot was the Cayenne. Launched only in late 2002, it accounts now for more than half of all Porsche cars sold worldwide and has proven to be the company's main profit driver, boosting net earnings by almost 16 percent and sales by 28 percent.

Why such a collapse in the sales of the Boxster and 911 models? Hans Riedel, head of sales and marketing and a Porsche board member, says it's more than just their age. "When we entered the Boxster segment, there was no one in our price class." he explains. "Now, competition has also discovered that you can make money there."

Moreover, the 911 is under pressure from such competitors as Audi/Lamborghini's Gallardo, the BMW 6 Series and the SL-McLarren Mercedes, says Professor Ferdinand Dudenh"ffer, head of the center for automobile research at the Gelsenkirchen University. "Plus, the 911 community is waiting for the new 911, which won't come for a couple of years."

However, Wiedeking argues that the company had expected a decline. "This is a part of our strategy, the Boxster and 911 are somewhat older and therefore losing sales and that's okay, because that was our intention." he says enthusiastically. "It is the Cayenne era."

But the Cayenne could also become Porsche's undoing, warns Dudenh"ffer. "Porsche benefits from its image of self-sufficiency and exclusivity," he argues. "But if you look at Cayenne and see that its chassis and V6 engine come from VW, then you have to consider the fact that Cayenne has been largely put together from parts developed by someone else, so that the self-sufficiency principle doesn't work here. Long term, it could dilute and devalue the Porsche brand."

That's message some investment analysts are picking up. Fabian Kania, an auto industry analyst with Helaba Trust, a large regional bank, says Porsche is running the risk of losing its exclusive cachet by venturing into already populated markets. "Porsche used to be quite an exclusive product that you couldn't find anywhere else," he told a TV stock market show. "Now, customers are beginning to wonder what's so exclusive about it if there are so many cars on the road with a Porsche logo."

In addition, says Kania, the entry into the hotly contested SUV market has exposed Porsche to competitive challenges it has never faced before.

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But marketing boss Riedel says Porsche has had to expand into other market segments because of the change in demand. "We had to move away from singular dependency on this volatile sports car market and move into a market that has greater potential in terms of both volume and growth without jeopardizing our sales and cannibalizing our products." Riedel says.

He figures that for Boxsler-type cars, the market potential is 200,000 cars a year; for roadsters, convertibles and sports coupes--the market that 911 has served for 40 years--the market potential for Porsche is about 650,000 cars a year. "And this pie is growing. But not as fast as the sports utility market--here we're talking about the greatest potential for the future," he says.

Riedel and the rest of Porsche's top brass see the United States as the greatest shopping mall of the world. Already accounting for more than 40 percent of Porsche's overall revenue, Americans have been gobbling up Cayennes at a rate that the cautious Porsche management couldn't have even hoped for. "Cayenne has exceeded our expectations and has become a sales hit in North America," Peter Schwarzenbauer, head of Porsche Cars North America, proudly told the Detroit Motor Show in January. He says Porsche has a lot to offer the 7.3 million American households shopping for a luxury vehicle and predicts overall Porsche sales will rise in the U.S. and Canada by more than 16 percent this year.

Even the weak dollar isn't hurting Porsche because the company has learned from its past mistakes. The diving dollar in the early 1990s boosted Porsche car prices in the U.S. by more than 20 percent. At the time, the company wasn't hedged against foreign currency fluctuations. But it's different now. "We're fully hedged in the dollar through 2007," says Porsche CFO Holger Harter. Porsche even developed its own hedging instruments, spending "less than $50 million" to protect the income from its $2 billion U.S. revenue stream.

Harter figures his job now is to keep fixed costs going down and productivity going up. "Our internal goal is to raise productivity by 6 to 8 percent a year and cut fixed costs in R & D and logistics. We also aim to improve production organization and integrate IT. There's really no end to additional savings from improved organization."

To reduce fixed costs. Porsche has been relentlessly cutting in-house production, which has reached 10 percent in Leipzig and 20 percent in Zuffenhausen. "Including Valmet, our goal is to keep it between 10 percent and 15 percent," says Harter.

Consistently outsourcing everything Porsche cannot do better or cheaper or faster helped it last year when the demand for Boxster shriveled. Porsche immediately slashed production by several thousand cars--mostly at its contract supplier Valmet. "Cutting production like this would have killed us in the past," admits marketing boss Riedel.

But outsourcing too much could be a double-edged sword, warns car expert Dudenh"ffer. "Porsche's policy to drive the costs down and keep lean production is certainly good, but when you outsource too much, long term you're risking that same margin that you earn by outsourcing because as soon as you depend on others for innovation, you're no longer self-sufficient," he says. "Besides, it could look as if Porsche were slowly turning into a VW outlet."

Wiedeking doesn't deny that Volkswagen and Porsche are working closely together, but he insists Porsche will remain independent. "Our relationship with VW is at the moment more intense than it was in the past, but to us it's just a supplier-customer relationship. We are in no way bound to VW, and we can cooperate worldwide with any other company."

That outsourcing, combined with a 2 billion-euro-plus cash pile that Porsche is sitting on, will allow the company to do what it does best: make sports cars, Wiedeking believes. "Now that Cayenne has met and exceeded its targets we can go back to the sports car range. This way we achieve growth for the entire company and secure its independence," he says.

One trump card still up Porsche's sleeve is the fourth model line that has been rumored for more than a year. The word is that it will it be a sports sedan to compete against the Mercedes E-class or BMW 5 Series. Wiedeking says the decision to build it hasn't been made yet, but points out that the new model, whatever it is, will have to have very low development and production costs. "Two conditions must be met," he says. "One, the new model range must be plausible, which is very important to maintain the market's trust in Porsche, and second, we have to be able to finance it ourselves. We're not going to ask any bankers for a loan. This means we'll do only what we can finance with our own cash."

Then he grows pensive: "At our 50th anniversary in Pebble Beach, California, I saw so many wonderful, noble car brands parading through the grounds--all gone because their makers couldn't earn enough money to secure their future." That's the specter haunting Wendelin Wiedeking.

Sales Revenue

          (Euros)

FY 00     3,647
FY 01     4,441
FY 02     4,857
FY 03     5,582
FY 04     6,416*

Fiscal year ended July 31
Source: Company reports, *Merrill Lynch estimates

Note: Table made from bar graph.

New Vehicle Sales

          (Units)

FY 00     48,797
FY 01     54,586
FY 02     54,234
FY 03     66,803
FY 04     73,280*

Fiscal year ended July 31
Source: Company reports, *Merrill Lynch estimates

Note: Table made from bar graph.