Dr.

Z's Waning Credibility

Dieter Zetsche, charged with smoothing the Chrysler-Mercedes alliance, has chalked up a
decidedly mixed report card

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Last fourth of July weekend, Dieter Zetsche flew from Stuttgart to the sweltering Daytona Beach
International Speedway in Florida to introduce Chrysler's "Dr. Z" ad campaign. It starred the
DaimlerChrysler (DCX ) chairman in TV spots and a dedicated Web site as an all-knowing,
German-accented wizard of the auto industry. The strategy was to communicate that Chrysler is
backed up by the same Teutonic know-how and discipline that has long made Mercedes-Benz
(DCX ) one of the world's most prestigious brands.

After NASCAR's Pepsi 400 race, in which driver Kasey Kahne--driving a Dodge (DCX ) with
Zetsche's face on the hood--disappointed by finishing 25th in a field of 43, Dr. Z flew to
Indianapolis for a Formula One race. He was rooting for a pair of McLaren Mercedes F1s in vain:
The two contenders smashed into each other 30 seconds after the green flag and failed to
complete the first lap. "This isn't going according to the script," Zetsche quipped at the time.

Nothing much is following the script at Chrysler these days. In fact, the whole dramatic story of
Zetsche's turnaround of the auto manufacturer, which he led from 2000 to 2005, is in rewrite. It
once read as a tale of triumph dramatic enough to get Zetsche the top job at DaimlerChrysler, a
post he assumed on Jan. 1, 2006. But now it seems a story of risky misjudgments and missed
opportunities. The way Chrysler boosted sales during his tenure by pushing far more vehicles on
dealers and rental fleets than the market demanded has been well documented. What isn't widely
appreciated is the rest of Zetsche's inconsistent legacy. While Zetsche was ahead of General
Motors Corp. (GM ) and Ford Motor Corp. (F ) in downsizing, slashing 42,000 jobs and five
assembly plants in five years, it is now clear that he did not cut nearly enough. And though
Zetsche championed the Chrysler 300, perhaps the biggest mass-market design success of the
last decade, the rest of his product line has been iffy. During the Zetsche era at Chrysler, "the
occasional success [has always been] followed by a profit hiccup," says Albrecht Denninghoff, an
analyst at Commerzbank in Frankfurt. "They go two steps forward and one step back. Then
forward one and two back."

DaimlerChrysler spokesman Jason Vines defended Zetsche's record. Chrysler is "back up on the
lifts but not with four blown tires. We don't have to change everything like we did six years ago."
Zetsche, who did not comment for this article but was questioned by reporters on Jan. 8 at the
Detroit auto show about his management legacy, argued the company "is in much better shape
than it was six years ago when you consider quality, productivity, and overseas growth."

The mess at Chrysler will necessitate the second billion-dollar-plus restructuring charge in seven
years, to be announced in February, on top of an estimated $1.2 billion loss for 2006. Morgan
Stanley (MS ) analyst Adam Jonas projects losses in 2007 of more than $1 billion. All in all, the
corrective restructuring charges and losses have wiped out all the paper gains Zetsche has
posted at Chrysler since his arrival in 2000. Many investors are questioning whether Chrysler and
Mercedes can ever prosper together. "We are in recovery mode again," said Zetsche at the North
American International Auto Show in Detroit on Jan. 8.

No kidding. Chrysler's market share has fallen, from 14.5% when Zetsche took over to 12.9% last
year. His profit target has been, and remains, a return on sales of 5%. Not only is that goal
elusive, but Chrysler hasn't really come near it since 2000. In 2002, when the figure was reported
to be 4.2%, its performance hinged on stuffing the sales pipeline with more vehicles than dealers
could handle (the company books revenue and profit when they ship to a dealer, not when the car
is sold to a consumer). Chrysler had to take a $1.25 billion charge in the second quarter of that
year, in part to write down the decreased value of unsold inventory.

Even though Zetsche said in 2003 that the overproduction of vehicles "would never happen
again," the same scenario did recur, only worse, at the end of 2005 and in 2006. The company
took a $1.45 billion charge in the third quarter to compensate for discounted inventories and
production cuts. And it will likely spend billions more this year helping dealers move its already
slow-selling models and covering the costs of cutting shifts at plants, since workers get paid
whether they build cars or not. Leases for Chrysler minivans are now going for $2,000 down and
less than $50 a month on some lots. "It's a disgrace," says one frustrated dealer who asked not to
be named.

That is hardly the only headache Zetsche has bequeathed to his successor, Chrysler Group CEO
Tom Lasorda. Although Zetsche closed five plants in fairly short order, he didn't seize the
opportunity to eliminate more excess vehicle assembly capacity in 2003 when the company last
negotiated with the United Auto Workers. DaimlerChrysler then was still clinging to the original
vision of the company as a "merger of equals" that was supposed to be yielding $15 billion in
profit by now. "The auto industry in the U.S. is forecasted to grow to some 20 million vehicles a
year by the middle of the next decade, and we believe we'll need the plants," said Zetsche in
2003.

At the time, he optimistically predicted Chrysler's new models would do so well that the company
would sell 3.2 million of them by 2010--up from the 2.7 million it sold in 2003. Chrysler finished
2006 at 2.69 million, with estimates that it pushed at least 400,000 to 500,000 vehicles to many
rental car fleets and reluctant dealers. Chrysler currently has at least two plants too many to meet
the demand for its vehicles, according to some critics. A spokesman acknowledges the carmaker
has too much capacity, but wouldn't specify how many plants need to be cut..

DISGRUNTLED DEALERS
Now, just as he is poised to slash more jobs and at least one assembly plant, Lasorda is asking a
reluctant UAW for big health-care givebacks it has already given to Ford and Chrysler. In
exchange for the concessions, however, the union wants Chrysler to give it the go-ahead to
organize Mercedes-Benz's nonunion assembly plant in Alabama, but Zetsche isn't warm to the
idea. It's yet another example of the uneasy marriage of the two companies.

Although Zetsche has made sizeable gains in productivity and quality, he has hurt Chrysler by
failing to update its antiquated system for ordering vehicles built at the plant to match consumer
specifications. It sounds mundane, but dealers have been complaining for years that Chrysler
does not send them vehicles with the equipment configurations they want. Instead, Chrysler's
finance and procurement departments order a mix of cars to be built at the factory to maximize
profit rather than closely following consumer preferences. "No question, when we order the
vehicles, it's not nearly as good as when the dealers order the cars," says Steve Landry,
Chrysler's vice-president for sales and field operation, whose job it is to patch things up with
franchisees. Dealers say they have Chrysler minivans, Dodge Ram pickups, and SUVs nosing
close to $40,000 without expected features like navigation systems. "This is basic to the car
business," says Tom Libby of Power Information Network (PIN), which tracks sales data. Toyota
Motor Corp. (TM ), by contrast, meets with some franchisees weekly to fine-tune vehicle orders,
Chrysler dealers say.

Both Zetsche and Lasorda deserve some blame for betting too heavily on gas-guzzling SUVs.
The company has added the Chrysler Aspen and Jeep Commander SUVs to a product plan top-
heavy with truck-based SUVs now falling out of fashion. Lasorda argues the company has no way
of foreseeing the spike in gas prices.

The duo has also bet on risky designs. Yes, the Chrysler 300 brought to market in 2004 has been
a runaway success, generating huge profits that have helped offset losses elsewhere. But overall
Zetsche, billed as a design maven with keen balance sheet discipline, has chalked up a mixed
report card. The Chrysler Crossfire coupe sports car was hailed as a great symbol of cooperation
between Mercedes and Chrysler because it is built on the Mercedes SLK platform. But it has sold
so poorly that it takes eight months for dealers to move the car. The Dodge Magnum, hailed by
Zetsche as the return of the European-styled sport wagon, has been a bust.

In 2003, says former ad chief Julie Roehm, a faction at Chrysler fought against developing the
recently introduced Chrysler Sebring, lambasted by many critics for its ungainly styling. But the
need to fill factories and achieve revenue targets wouldn't allow Chrysler to give up in a category
where it faces two juggernauts: the Toyota Camry and Honda Accord sedan.

Worst of all, 10 new models Chrysler began launching last September, such as the Dodge Nitro
and Sebring, which Lasorda is counting on to lift revenues and operating profit, are not being
ordered by dealers in sufficient numbers because they're still trying to clear the old models from
their lots. In mid-January, Chrysler met with dealers to pledge more financial support to lower
sales prices, clear the excess, and hopefully make room for the new models. It now takes
Chrysler and Dodge dealers nearly four months to sell a car, the worst rate in the industry. And
that's while Chrysler offers the highest cash incentives in the business, $3,500 per vehicle in
customer cash. That's about $850 per vehicle more than GM and $2,000 more than Toyota. "The
situation at Chrysler is dire," says PIN's Libby.

Chrysler's market share has been in free fall even as it spends big in incentives and creates more
niche models. "Chrysler is still built for a 16% market share and its profitable share is probably
around 10%," says James Schroer, former sales and marketing chief.

That may not be enough to sustain Chrysler's viability with shareholders and the DaimlerChrysler
supervisory board. Zetsche has acknowledged that the company's reliance on discounts has
prevented it from making much headway in improving the cachet and desirability of the Chrysler
and Dodge brands over the past six years. Strategic Vision Inc., for example, last year noted that
Chrysler and Dodge brands still scored about 50% below the industry average for "trust."

The Dr. Z campaign has been moth-balled. Eight years since the merger, most customers still
don't know Chrysler is owned by the same company that produces the Mercedes-Benz. They also
thought Zetsche was so smooth on screen--even to the point of head-butting a soccer ball
perfectly in one take--that he was an actor, not the real CEO. Seems Zetsche still has to prove
he's the real deal.

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