The many maladies of Mercedes by Alex Taylor III @FortuneMagazine November 15, 2012, 3:17 PM EDT E-mail Tweet Facebook Google Plus Linkedin Share icons Think Obama vs. Romney was a tight race? How about Mercedes-Benz’s fight with BMW for 2012 sales supremacy in the U.S.? Everyone from industry gurus to mere bystanders are following month-by-month sales unit-by-unit — even without tracking polls. Consider this recent sampling of automotive headlines: “Mercedes U.S. Sales Rise 7% to expand lead over BMW” “Strong BMW sales in October narrows Mercedes’ lead” “Mercedes Dangles $5,000 VIP Discounts to Hold U.S. Lead over BMW.” “BMW bets on 3 Series to outsell Mercedes-Benz” Neither of the German automakers is reluctant to use Election Day tactics to nudge the final results their way. Last year, both Mercedes and BMW delayed releasing their 2011 sales numbers for 24 hours in the hope of gaining the upper hand. BMW took the title by a narrow 2,700 vehicles after sweetening customer incentives by $200 in December. The luxury race should be even more interesting this year, with the prospect that thousands of unsold luxury cars from Europe and China could make their way to the U.S. and ignite an aggressive price war. MORE: 2014 cars: A very early preview But just as larger issues got lost when political reporters focus on the horse race, the preoccupation with who sells more units in a given calendar year is choking out coverage of some longer-cycle problems that are afflicting one of the contestants in particular: Mercedes-Benz. Mercedes likes to think of itself as the auto industry’s leader, hence its advertising tag line “The best or nothing.” Lately, critics have been focusing on the second half of that slogan. The Stuttgart giant has been wounded by a variety of woes, including an aging product line, a longstanding weakness in small cars, and abrupt slowdowns in export markets, notably China. But in recent days, analysts have been drilling down to three more fundamental issues: 1. Mercedes cars cost too much to make. 2. Mercedes is spending too much to attract customers. 3. Mercedes customers are shopping elsewhere anyway, indicating a loss of fascination in the three-pointed star. The signals are impossible to ignore. Consider profitability. For 2012’s third quarter, BMW reported a pre-tax profit margin on its auto business of 9.6%. That was below analysts’ estimates of 9.9% and well below the 11.9% of a year ago. But BMW was in high clover compared to Mercedes. Daimler, Mercedes’ corporate parent, reported a pre-tax margin on its auto business of just 6.4%, indicating Mercedes was spending too much and charging too little. Some analysts believe its operating margins are headed to 5% in short order. Mercedes’ profit problem is easy to diagnose: It has too many workers building too few cars. Credit Suisse analyst Arndt Ellinghorst, quoted in the Detroit News, said Mercedes needs 40% more workers to produce 20% fewer cars than BMW — an enormous disparity. The productivity difference shows up in labor costs measured as a percent of revenues. Ellinghorst figures labor costs at Daimler have reached 16.4% of sales versus 11.2% for BMW. Worse, Mercedes’ high-cost product line has a hard time attracting customers without heavy discounting. It has been cutting prices like Wal-mart in a downward spiral that has been worsening for a decade. Ten years ago, Mercedes discounted the sticker prices of its cars sold in the U.S by just 5.1%, according to data compiled by Edmunds.com. So far in 2012, Mercedes’ discounts have been running at 11% — not far from its all-time high of 12.8% in 2009. MORE: 4 new myths of the auto world BMW isn’t blameless — it has accelerated its discounting too. But Mercedes’ other luxury competitors are doing a better job of holding the line. Over the past decade, Lexus’ discounts have grown from 4% to 9% while Audi’s price-cutting has actually declined from 7.7% to 6.4% of sticker. While all that discounting has propped up sales, it hasn’t created much customer loyalty. After reviewing Edmuunds.com data on cross-shopping, Jessica Caldwell, who handles pricing and industry analysis for the car shopping site, noticed that Mercedes, as a brand, has a higher percentage of shoppers who look at competitive brands than competitive brand shoppers who look at Mercedes. Caldwell looked at cross-shop data during the last week of September for two key entry-level models, Mercedes’ C-class and BMW’s 3-series. She discovered the relationship between the two models was lopsided: Twice as many C-Class shoppers consider buying a 3-Series as vice-versa. Says Caldwell: “That is quite an imbalance in BMW’s favor.” Caldwell goes on: “Those are the volume models for both brands, and I thought it would be a closer relationship especially since Mercedes has introduced the trim levels for the C-class that can offer fairly compelling lease payments.” MORE: GM’s fearless bid to trounce BMW Is all this making too much of too little? After all, Mercedes didn’t get to be 126 years old by sitting on its hands, and Daimler chairman Dieter Zetsche, who also runs Mercedes, has launched an ambitious revival plan. Zetsche wants to more than double Mercedes sales to 2.7 million by 2020 in order to make it the world’s best-selling maker of premium automobiles. He’s also pledged that its operating profit margin would grow more than 10% in 2020. We’ll see. In October, Daimler lowered its forecast for 2012 and scrapped its 2013 profitability goals, which aimed to achieve a 10% operating margin for Mercedes. Analyst Ellinghorst was apoplectic: “I’m simply shocked … The management of Daimler is disappointing once more.” Either boosting sales or raising margins by themselves would be easy. Doing both is tough. Daimler has reportedly extended Zetsche’s contract three years to 2016, but it may be up to his successor to make good on his pledge. Meanwhile, here is horse race update: In U.S. sales through October, Mercedes led 232,671 to BMW’s 212,848. Stay tuned for a big December get-out-the-shoppers drive — followed by a January recount.