What happens when you cross a Volkswagen with a Rolls Royce? VW is hoping for bigger market share

By BARRY HILLENBRAND /LONDON

ome brand names begin life decidedly upscale. Rolls-Royce, for example, was founded in 1904 by Charles Rolls and Henry Royce for the purpose of building "the best car in the world." They succeeded spectacularly. Down the years the name Rolls-Royce came to be synonymous with quality and excellence.

Other brands, like Volkswagen, have humbler origins. VW started in 1938 as the "people's car" and ended up becoming famous for producing a supremely common auto which was so odd-looking that it become known as the Beetle. VW made a virtue--and a fortune--out of the style. Last week in one of those ironic twists of business history, VW, the former ugly duckling but now Europe's largest automaker, plunked down $703 million in cash to buy Rolls-Royce Motor Cars from the British engineering company Vickers, which acquired the prestigious marque in 1979.

The deal has advantages for both sides. Says Georg Sturzer, an auto analyst at the Bayerische Vereinsbank, "Practically overnight Volkswagen has acquired the luxury image it has longed for"--although VW has still to formally secure the right to use the famous logo and trademark held by the Rolls-Royce company which makes aircraft engines. The new partnership with VW will give Rolls-Royce Motor Cars access to pockets deep enough to undertake the capital-intensive business of developing and marketing luxury cars. The sale follows the pattern of a continuing realignment of auto brands across international borders in complex, often confusing, arrangements. Ford owns Jaguar and a hunk of Mazda. BMW bought Rover, while GM has purchased half of Saab. Last month, in a spectacular move, Chrysler merged with Daimler-Benz.

But for all its logic, the Rolls-VW pact did not come easy. Rolls-Royce was an attractive prize for most major automakers. True, Rolls-Royce's sales of fewer than 2,000 cars annually are minuscule in comparison to the millions sold by the likes of VW, but the prestige value of owning rights to the cars with the Spirit of Ecstasy posed gracefully on their radiators is considerable. In October 1997, Rolls' owners, Vickers, started a bidding war by announcing that BMW had agreed to pay $554 million to acquire the British automaker. A group of Rolls-Royce enthusiasts in Britain quickly organized a consortium to make a counteroffer to keep the last British-owned commercial automaker from falling into foreign hands. They fought a valiant rearguard action, supported by some individual Vickers shareholders. But balance sheets, not patriotism, won the day for VW. Institutional investors, who hold most of the Vickers stock, were ultimately won over by the financial heft of the VW offer.

BMW was unwilling to increase the size of its original bid, but it did apply other leverage. BMW is now making engines for some Rolls-Royce models. If Rolls is sold to another major manufacturer, BMW warned, the delivery of those engines might stop. To counter the threat, VW made a bid for Cosworth, a high quality British engine maker which already produces some engines for Rolls-Royce and would be capable of filling the void should BMW back out of its contract.

Rolls Royce fits neatly into VW's long-range planning. Says Peter Wells, senior research fellow at the Cardiff Business School: "Volkswagen is obviously thinking it needs a broader range." In addition to peddling bread-and-butter cars like Golf and Polo, Volkswagen has moved into the lower-priced field by selling cars made by Skoda, a Czech auto company VW purchased in the early '90s. VW chairman Ferdinand Piech has taken its Audi group upmarket with the introduction of its A8 model and has recently entered into an agreement with Porsche to build a new sports utility vehicle. With the purchase of Rolls, Piech now has a car at the top of the market that can do battle with the Mercedes S-Class. He has promised to push annual production of Rolls-Royces and Bentley, the Rolls' sporty and slightly lower-priced sister, up over 5,000 annually.

But is there a large enough market out there for all those high-priced luxury cars? Some experts wonder. The Asian market has softened so that even in Hong Kong, with more Rolls per capita than anywhere else in the world, peddling the newly released Silver Seraph can be something of a trial. "Even the rich and famous are beginning to look on the world slightly differently these days," says Wells. "In an environment-conscious world, Rolls-Royce is perhaps something of an anachronism." But VW's Piech is nothing if not a shrewd marketer. VW recently introduced a new version of the Beetle for which demand is already outstripping supply. Any company which has twice popularized a car as unorthodox--and anachronistic--as the Beetle will no doubt be able to find a way to market glorious Rolls-Royces.

--With Reporting by Kate Noble /London and Peggy Salz-Trautman /Bonn