INSEAD

MBA PROGRAMME P3, February 2003

Main Project
Innovation Strategy and Entrepreneurship
Professor Ron Adner



The SMART



Group 4, Section A
Salah Belkhayat
Gokhan Gunes
Ana Fontes
Ricardo Camilher Gomes
David Doral
Abdulmonem Suliman



SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 2
TABLE OF CONTENTS

EXECUTIVE SUMMARY.................................................................................................3
SMART IN CONTEXT.......................................................................................................4
SMART at Birth...........................................................................................................4
Affected Markets..........................................................................................................4
Initial Expectations: Timing & Size ............................................................................5
The State of the Automotive Industry..........................................................................6
SMART MARKET DYNAMICS........................................................................................7
Demand Side................................................................................................................7
Value Proposition and Differentiation.........................................................................8
SMART APPROACHES TO INNOVATION....................................................................9
Product/Design innovation...........................................................................................9
Supply Chain/Process Innovation..............................................................................10
Distribution ................................................................................................................13
EVOLUTION OF PRODUCT AND LESSONS LEARNED ...........................................14
Todays Situation.......................................................................................................14
Expectations and the Creation of New Markets.........................................................15
Why did MCC build an expensive car? .....................................................................16
Future Strategy...........................................................................................................17
Did Mercedes Over -reach? ........................................................................................18
Resource Commitment and Reversibility ..................................................................19
Conclusion .........................................................................................................................20
REFERENCES ..................................................................................................................21
Appendix 1 SMART Chronology...................................................................................22
Appendix 2: Prices and characteristics of substitutes ........................................................24
Appendix 3: Sales figures for the Mini-car segment .........................................................27
Appendix 4: Passenger Car Production in Western Europe by Segment ..........................28
Appendix 5: Mobility Offerings and Partnerships ............................................................29
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 3
EXECUTIVE SUMMARY

Towards the end of 1980s, Nicholas Hayek, who was behind the success of Swatch
watches, came up with the concept of the SMART car. He wanted to change the way
people buy cars and incorporate Swatch-like values of affordable fashion and lifestyle
into a car concept. Hayek partnered with DaimlerChrysler in a joint venture called Micro
Compact Car (MCC) to develop a product that would create a unique value proposition
for the automobile industry.

From its design to its supply chain, production, marketing and distribution processes, the
SMART was a true innovation. The SMART project was developed in a totally new site,
the so-called SMARTville, in the French village of Hambach. By forming various
partnerships with suppliers and dealers, MCC challenged the existing rules of the car
industry with a breakthrough product and new processes along the value chain.

The SMART was intended to be a modern, ecologically conscious car mainly targeted at
a growing segment: urban young consumers and dinks (double income no kid
couples). One of the principal value propositions of the SMART was its mobility
concept: its small size and special services would address increasing concerns of lack of
space in the European urban centers.

Unlike the Swatch watches, the SMART car failed to reach the critical mass. Six years
after its launch, the breakeven point of the SMART project is still at least two years down
the road and there are serious questions arising on whether the project should be
discontinued or not.

The implementers of the SMART project are currently struggling to make it profitable
and have added new models that deviated from the initial SMART concept. The tradeoff
that managers are facing today is to make the SMART more acceptable to the mass
market without erroding the original concept that differentiated their offering from other
small cars..

In this report we will analyze the innovations proposed by the SMART project in terms
of its design, supply chain, production, marketing and distribution processes. We will
also analyze what values were delivered by the product, how the market perceived these
values and whether management expectations were reasonable. SMART is currently
marketed in twenty eight countries. This report will mainly focus on Western Europe,
SMARTs core market.

SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 4
SMART IN CONTEXT
SMART at Birth
It all began in 1989, eight years before the first SMART car would come off production
lines. Nicholas Hayek, founder and CEO of the Swatch Group, the Swiss manufacturer of
watches, was trying to revolutionize the automotive industry in the same way that he did
with the Swatch watches. In 1983, he had proposed the idea of launching a low cost, high
tech and emotional watch to compete with the low cost watches manufactured in Asia.
Eleven years later, the Swatch had sold more than 150 million units and Swatch Group
accounted for 25% of watches sold in the world. Coming back to the car, his idea was to
offer an ecologically friendly car for two adults and imitate the Swatch idea with low
price, high quality, special design and innovation. He also wanted to enhance the
purchasing experience by placing show rooms in shopping malls and airports. In 1991,
Swatch signed a deal with Volkswagen to develop the car, but a year later, the
partnership was ended because the newly-appointed CEO of Volkswagen did not believe
in the concept.

In the meantime, Mercedez-Benz, the passenger car and truck brand of DaimlerChrysler
Group, had already tried to enter in the mini car segment in the 70s and 80s but did not go
beyond the concept phase because it was too busy fighting strong competition from the
Japanese manufacturers in the luxury sedan market. Also, Mercedes-Benz was concerned
about its image because the average age of its drivers was fifty three. Realizing that it
needed to react to stiff competition, the company continued to look for new market
segments in order to increase its business and extend its brand image. At that moment,
the company turned its attention to the small car market. The entrance in this market
posed two main issues to Mercedez-Benz: 1) technological: the company had always
produced large and rear wheel cars in contrast with the small front wheel cars; and 2)
financial: beside the high risk for taking on small car projects that were outside the
companys core business, the small car market was known for its low margins and strong
competition.

In 1994, after considering its debut in the mini car segment, Mercedez-Benz signed a
partnership agreement with Swatch and founded MCC. Under this partnership, Mercedes
would be in charge of the production and Swatch would take care of the marketing. In the
same year they chose the factory site. It was a 173-acre area outside the French village of
Hambach. In 1997, the factory was inaugurated and the project received investments of
around 2.5 billion in production and marketing.

Affected Markets
Although the original concept was marketed as a brand new mode of urban transportation
revolutionizing the automotive industry, SMART was initially going to compete within
the small car market. The small car market has been defined in the industry as composed
of two segments:

SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 5

Mini (A) Small (B)
Engine Less than 1000 cc 1000 1500 cc
Body Style Miniature, 2 doors Variety of trims, 2 & 4 doors
Length Less than 3m (10 ft) Less than 3.745 m (12.5 ft)
Available
Brands 1998
Fiat Seicento, Ford Ka, Suzuki
Alto and Daewoo Matiz.
Ford Fiesta, Renault Clio, Nissan
Micra, Peugeot 206

The small and mini cars had enjoyed strong sales in the Western European market (see
appendix 3 for sales figures of mini cars in western Europe). While the B segment
accounted for around 25% of Western Europeannew car demand, the A segment claimed
under 5%. However the A segment was predicted to grow faster than the B segment
taking share mainly from the B segment with total market share of A and B remaining
fairly flat around 30%. Appendix 4 shows actual and projected production for 1998 and
2004 respectively for all segments in Western Europe.

The first mini cars were mainly sold to lower income groups who were looking for
inexpensive and low maintenance cars. Italy represented the biggest market in Europe
65% of the European market for mini cars. In the late 1980s and early 1990s, the A and B
segments had to respond to the evolution of a new customer segment. The se new
customers were now looking for style and similar performance in terms of quality and
safety as that of the large r automobiles.

Initial Expectations: Timing & Size
The SMART car was initially planed to be launched in March 1998. At that time,
managers at Mercedes were expecting very optimistic sales of 200,000 cars per year. The
200,000 cars per year sales would be enough to breakeven the plant. Sales were targeted
at 300,000. More recently, breakeven was expected to be reached in 2004.



1994
Estimated Break-Even: 200,000 units
Target Sales: 300,000 units
Expected
launch of
the SMART
Expected
Break-Even
Mercedes and the
Swatch Group
agree on the
creation of the joint
venture
1998 2004
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 6
The State of the Automotive Industry
At the time of the launch of the SMART, the automotive industry was marked by
consolidation of car markers, outsourcing of suppliers, lean manufacturing and low
growth prospects.

Consolidation of car makers

Industrial consolidation was a key trend in the global automotive industry. Shortly after
the launch of the SMART, Nissan and Renault agreed to tie-up by Renault taking a
minority stake in the Nissan. Volkswagen had acquired Seat in 1986 and Skoda in 1990.
BMW purchased Rover in 1994.

Outsourcing and consolidation of the supply industry

As car makers seeked to cut costs, they outsourced more and more to the supply industry.
Outsourcing of suppliers allowed greater economies of specialization and scale, since
suppliers were more experienced in certain functions and could supply several carmakers.
Consolidation of suppliers was also expected to intensify under cost pressure from the
automakers.

Lean manufacturing

Following the 80s automation trend, the automotive industry adopted the Japanese
model of lean manufacturing seeking to reduce waste through the best possible
utilization of resources (human resources, capital investment, factory space and
materials)

Low Growth Prospects

The financial crisis in Asia, South America and Russia crisis led to an expected decline to
13.8m unit sales in Western Europe in 1999 and a further more decline in 2000.



SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 7
SMART MARKET DYNAMICS
Demand Side
Hayeks vision for the SMART was an ecological, trendy, urban and affordable car. The
primary target market was the urban young consumers and dinks (double income no
kid couples). MCC also planned to sell the SMART to families as a second or third car,
as well as young-at-heart senior citizens and businesses in general.

Given the offering and the target customer, we can argue that SMART was fighting for
buyers of class A and B vehicles, and maybe also for some sort of potential buyers of a
brand new sub-segment between those cars and other 2-3 wheel city vehicles like
scooters.

According to EIU Motor Business International the buying decision for small cars was
driven by the following main reasons:

Space Confined city centers required small cars which are easy to park and
manoeuvre.

Price Small cars were usually the first car purchase for many young customers
especially in Europe where car s are very expensive. Auto makers considered the mini
cars as an entry point for customers who would later upgrade to larger (and more
profitable) models.

Other factors included lower fuel consumption and lower excise taxes.

Most new car buyers were bypassing the mini (A) segment and moving straight to the
small (B) segment. Surveys had shown that one reason for this move was the perceived
lack of safety when sharing lanes with larger SUVs and MPVs (please refer to appendix
4). The small price difference between the minis and the smalls also blurred the
distinction between these two categories.

Overall, the total volume of A and B class cars sold in Western Europe was not expected
to change. However, class A segment was expected to grow and steal market share from
the class B segment. European car manufacturers that catered to both markets with a
single model were starting to introduce new models (e.g., Renault added Twingo below
Clio, VW introduced Lupo below the Polo).

From 1995 to 1998 European mini-car sales hadgrown from 500,000 units to 1,031
million surpassing the Japanese market as the biggest market for mini cars. Italy, France
and Germany were the main markets accounting for 70.4% of mini-car sales. From 1998
on, the mini cars segment was expected to grow 38% until 2004. The main players in this
market were the Ford KA, Renault Twingo and Fiat Seicento.

SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 8
As we can see, the SMART was up against strong competition and a variety of potential
substitutes, and the initial expectations of sales of 300,000 cars a year, or 30% of the
small car segment, seemed a little bit too ambitious for a market which main driver, price,
was not exactly SMARTs strength.

Value Proposition and Differentiation
The SMART marketing team knew that style and fashion were not enough to distinguish
their offering from the competition. To differentiate itself from the small car pack, MCC
offered the mobility concept in addition to the SMART car. Mobility referred to a set
of services ranging from discounted rental car rates to train tickets for SMART owners. It
also included preferred rates for parking garages as well as ferries and other means of
transporting the SMART car between cities (see appendix 5 for a sample of current
mobility offerings). These services were marketed as a complete lifestyle package
designed for the modern, ecologically conscious European urban dweller.

As we will analyze in coming sections, SMART experienced production delays and
disappointing first sales, as well as problems negotiating and building the mobility
network of agreements with mass transportation authorities and parking garages. In
response, the management decided to change the marketing message during the re-launch
of 1999. The message was going to focus on the unique technology of the cars rather than
the mobility concept.
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 9
SMART APPROACHES TO INNOVATION
Product/Design innovation
The SMART is based on a rigid integral body frame / safety cell (called TRIDION) to
which such flexible body panels as doors, the front and rear panels and (the optional
glass) roof are attached. The final buyer can customize the product by combining two
colours of the frame (black and silver) with the different colors of the body panels.
Despite a high customization perception there is low variation in production.

Initially, the SMART was equipped with a basic 600cc, 3-cylinder engine in two tuning
levels that provided 45hp (33.5KW) and 55 (41KW) respectively. This engine evolved
into a more powerful one with three power variants: 50hp (37KW), 61hp (45KW) and
75hp (55KW). Also, a diesel engine was added with 800cc and 41hp (30.5KW).

The engines can be combined with either a half-automatic transmission, the denominated
softip that allows to change gears with a tap on the gearshift without using the clutch, or a
full-automatic transmission, the softouch, with a kickdown function that allows to change
down one or two gears simultaneously by pressing the accelerator to the floor when extra
power is needed, for instance in overtaking maneuvers. Both are based on the same six-
speed sequential gearbox.

Initially, three variants were available to the client (SMART & Pure, SMART &
Pulse and a SMART & Passion). The variations differ in interior trim, body colours,
comfort features and engine power. To these variants, a sporty version was added later
on, the Brabus. The modular product layout enables MCC to supply customer choice with
minimum product complexity.

As most of the features are easy to add, both at the assembly line and during the life span
of the car, variation in customer demand hardly interferes with production processes. For
example, the interior trim (fabric and color) consists of exchangeable panels, easy to
mount at the assembly line and even easy to be exchanged by the owner afterwards.
Moreover, features as ABS or electric windows might have disturbed production if made
optional, but they were integrated as standards in the car. The after sales extras include a
wide range of easy to attach peripherals such as CD player, GPS navigator , etc.

On top of the above-mentioned customisation, the modular concept enables the customer
completely to renew and upgrade the product during its lifetime. Product features can be
added and body parts (more colors!) can be changed in the SMART-centre. Moreover,
the modular concept makes it possible for the designers and engineers of MCC and its
suppliers quickly to develop and implement minor and major product redesigns.
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 10
For example, within six months after the introduction of the car, the first extension of the
product offering was already introduced. Two additional colors (on top of the various
basic ones) were introduced. The trick here is to use a form of cubic printing. This
technique uses not only a basic color but adds a color film on top of it (orange and green
in this case) in a random pattern (like the spots on a cow), making each panel unique. The
input of Swatch in the concept development is clearly visible here. Within the existing
product architecture of easy-to-assemble products, new options and features are
introduced at a rapid pace. This adds to the fashionable character of the product: constant
change and improvement.

The modular concept has also allowedengineers to extend the product line within limited
time span, by changing the form of body panels and interior components while keeping
the basis of the car (the TRIDION safety cell) unchanged. This modular approach is not
new in other fields, like the software industry, with the Object Oriented programming
philosophy, which is one of the main features of languages like JAVA. However, the
attempt to apply this concept to the automotive industry was pioneered by SMART.

In sum, through smart product development, the engineers of MCC have achieved (the
perceived) customization, while at the same time, limiting product variation and
production complexity.

Supply Chain/Process Innovation
The modular concept, as well as, technological innovations has enabled MCC to produce
a car from no more than 40 to 50 modules and parts.

The SMART's manufacturing process is just as unique as the product itself. The
partnership model practicedin Hambach, the assembly plant in France, embodies the
logical development of the conventional manufacturer/supplier relationship. Thus the
carmaker bears overall responsibility and is also the module system integrator, process
manager and manufacturer. At the same time, however, each system partner also shares a
considerable amount of responsibility. The advantage of this modern form of co-
operation is that it motivates the partners to contribute to the success and the achievement
of the corporate goals by means of their own input and ideas.

The production system, known as smart-Plus, is in the shape of a cross. This layout
enables maximum flexibility with excellent quality. The SMART production system is
held in high esteem by relevant experts. Only 4.5 hours are required for the final
assembly of a SMART.

Apart from the body, the TRIDION, the car consists of several main modules, namely:
the rear module including the driveline, the doors and the cockpit, each containing sub-
modules and components. The modules are supplied in sequence for final assembly, by a
small number of first tier suppliers, of who seven are fully integrated in the final
assembly site.

SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 11
Modules are bought by the MCC only as they are needed in the final assembly process.
For example, a complete rear module, including among other things: rear axles,
transmission, sus pension and engine, is pre-assembled by one supplier who starts
assembling the module only upon demand by MCC and not earlier than one and half hour
before the module is needed on the final assembly line. The same is true of the doors (3-
hour lead-time) and the dashboard system (1-hour lead-time).

To ensure a smooth flow of goods within the plant, the car is moved along the work
stations of the assembly line, which is laid out in the form of a cross (see exhibit 1).


Exhibit 1: The SMART plant lay out
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 12
Arguments for this plant layout were to permit high-frequency deliveries at a large
number of offloading ramps, while keeping transport to a minimum. Sub-sections can
also work independently to avoid system disruptions in case of malfunction at one
particular point along the assembly line. Furthermore integrated suppliers are able to
supply their finished products directly to the final assembly line or on a conveyor system.
In the SMART-ville the manufacturing process starts with Magna assembling the
TRIDION body in white. This process is highly automated and standardised; Magna
employs 130 robots. In fact, this is one of the very few automated process steps.

Operators mostly perform subsequent steps. The finished body in white is then passed on
to the next partner in the adjoining, connected facility. In that step Surtema (an
Eisenmann subsidiary) primes and paints the body using paint tunnels for each of the two
colours (black and silver/grey). The process is based at powder-coating; it has been
developed especially for SMART and is environment friendly. After painting, the body is
transferred by conveyor belt to the beginning of the cross shaped assembly line. Starting
at the top of the cross, Siemens VDO assembles cockpits and mounts them to the body. In
the three other sections of the cross MCC goes on assembling the car, starting with the
mechanics and chassis, followed by external and internal trim assembly, inspection and
testing. The rear module (including the drive train) is pre-assembled by Krupp Hoesch
and undergoes several additional assembly tasks by workers of MCC on a small island
adjacent to the cross. Following assembly, the rear module is brought to the line on a
telescopic carrier that raises it to shoulder height, enabling operators to guide it into the
car.

During the assembly process, modules and components are delivered line-side (within 10
metres from the workstation) on a just-in-time basis. For example, complete front-end
and rear-end modules are delivered by Bosch and Krupp, respectively. Dynamit Nobel
delivers the plastic outer body panels molded on site. The door panels are delivered to
Magna Door Systems who pre-assembles the panels to complete doors, before delivering
them line-side.

The seven integrated suppliers are responsible for the supply of around 70% of the
volume and 30-40% of the value of the finished product. In addition, 16 non-integrated
suppliers deliver sub-modules and parts to both MCC and the integrated suppliers.
These non-integrated suppliers add about another 20% of the volume to the car. Their
supplies include seats, wheels, windows, etc. and are delivered to the relevant docking
station of the assembly line, at a maximum distance of 10 meters. The remaining 10% of
the volume consist of standard and small parts not linked to a particular module, which
are stored in an on-site warehouse, operated by a third party.

Although integration with suppliers is up to some extent always accomplished by todays
car manufacturers, this level of integration, both physically (MCC and suppliers work in
the same building) and value-wise, (the in-house manufacturing rate is less than six
percent - a figure which is unsurpassed in Europe) is on of MCCs major production
breakthroughs
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 13
MCC is also setting standards in terms of environmental compatibility at its plant in
Hambach. Stringent regulations to protect water, soil, air and the surrounding landscape
and also relating to energy saving and the protection of resources have been in force since
production started. Environmental protection is also extremely high on the agenda in the
development, use and also, ultimately, the recycling of SMART cars
Distribution
The first SMARTs were launched in Austria, Benelux, France, Germany, Italy, Spain,
and Switzerland. Subsequent geographical expansion included Portugal, Scandinavia,
UK, Taiwan, Japan, Hungary, Tchek Republic, and Croatia.

Mercedes decided to build a new distribution channel exclusively dedicated to the
SMART project. The main motivation behind this move was to isolate the luxury car and
SMART brands and avoid the potential erosion of sales if these two were to share the
same retail space.

The dealers were selected from a mix of existing Mercedes Benz dealers, dealers for
other brands and newcomers to auto dealers hip. The franchise dealers were given
exclusive territory rights but were expected to sell around 1500 cars.

The SMART distribution concept was based on sales towers, the SMART centers,
located near the big shopping centers. The costumer should be able to see his car, decide
to buy it and take it away immediately.


Exhibit 2: Example of SMART centers.

The decision to go for an independent distribution channel ended-up adding considerable
costs to the project. MCC initially planned to build 100 SMART centers and the
necessary investment was around US$ 2.5 to 3 million per tower.


SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 14
EVOLUTION OF PRODUCT AND LESSONS LEARNED
Todays Situation
The SMART is currently 100% owned by DaimlerChrysler. At the end of 1998
DaimlerChrysler took over the interest of The Swatch Group Ltd. in the joint venture. In
September 2002, SMART was repositioned from being an independent company and
became the small car brand of Mercede s-Benz.

Since 1998, the SMART division and the Mercedes Group have had disappointing
results. Both Mercedes Group and the SMART division replaced their CEOs. A number
of restructuring plans have revised breakeven expectations and lowered sales and profits
targets.

In the mean time, other automotive companies launched cars that compete with the
SMART in the market of small trendy cars: the VW New Beetle and the BMW Mini.
Although these two models can be included in the mini car segment, they are
significantly bigger than the SMART.

After six years on the market, SMART has not yet reached break-even leading to
speculation -- denied by the company -- that DaimlerChrysler might sell or close the unit.

SMART unit sales
1998 1999 2000 2001 2002 2003 2004
20,000 80,000 101,000 116,000 122,300 115,000 140,000
Source: Mercedes Benz company releases.

Analysts at the US investment bank Morgan Stanley claim that SMART loses more per
car than any other volume brand in recent history, except Rover , and that restructuring or
closing the division would be a "high-return investment" and the situation of BMW-
Rover cars in 2000 should be studied in order to learn from others mistakes and the way
they solved them.

Making the SMART profitable is the top priority for newly appointed head of Mercedes-
Benz division, Eckhard Cordes. Eckhard became head of the division in October 2004
and at the end of the year ordered a complete review of the SMART line.

Under the new strategic plan the SMART division should start to make pr ofits within
three or four years. SMART originally hoped to be profitable by the financial year 2004,
an objective put back to 2006 in October of last year.

Launch of
the
SMART
Break-
Even
Mercedes and the
Swatch Group agree
on the creation of
the joint venture
Expected
2006
Actual
Oct98
1994 Mar98 2004
Launch of
the
SMART
Break-
Even
Mercedes and the
Swatch Group agree
on the creation of
the joint venture
Expected
2006
Actual
Oct98
1994 Mar98 2004
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 15
Expectations and the Creation of New Markets

The SMART sales have not met expectations. Sales in 2004 are still more than 60,000
units short from the break-even figure of 200,000 units, and the promise to reach
profitability has been postponed another two years.

Were the original expectations too high?

The main feature of the SMART was its reduced dimensions and its trendy look. This
should have appealed to potential customers as a very convenient and fashionable way of
driving and parking in highly congested cities, while providing more comfort and safety
than a motorbike.

We believe that MCC overestimated the demand for an extra-small trendy urban car. The
target sales figure (300,000 units according to the automotive press) was 30% of the
European mini car market. MCC was obviously not planning to instantly capture that
much market share from the existing segment. The management must have planned to
grow the market by creating new demand. One can put forward some reasons why
demand may have been lower than expected:

Parking may be a problem in crowded cities, but it is not a strong enough reason
to drive the purchase of an extra small car. Even though it provides an
improvement, the SMART does not completely solve the parking problem.
SMART is very small. In a two-seater, a couple cannot take along a friend, a
child, or a few pieces of luggage for a short road trip.
A lot of reviews complained about a perception of exposure when driving
alongside bigger cars and buses.


Did SMART fail to differentiate itself?

The SMART had many close substitutes. Even though SMART was marketed as a
revolutionary product, it was introduced in a crowded and competitive market. The A and
B segments were extremely price sensitive, and the buyers needed a lot of added value if
they had to pay a price premium for a small car.

SMART packed a lot of sophisticated features for a tiny car. It was relatively expensive
compared to other small cars such as Ford Ka, Peugeot 106 and Citroen C2 (See
Appendix 2 for sample pricing for small cars). In that respect it was stuck in the middle
of a price-sensitive small car market and the expensive sport luxury market. We see here
some sort of awkward compromise among three main factors that usually drive the
purchase of a car: functionality, price and social status (or style). SMART wanted to
achieve status symbol (with a trendy design), and function (practical urban mobility) in
order to justify its steep price for a tiny car and may have failed to do so.
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 16
The mobility concept also failed to differentiate the offering. The SMART was conceived
to be more than a car: it tried to be a new means of transportation for young and
environment conscious urban people. The initial plan shaped by Hayek, Swatch founder,
included a set of services and partnerships designed to meet all the transportation needs
of the SMART owners (see Appendix 5).

But this mobility idea, far from crystallizing as an intrinsic part of the SMART concept,
simply became another add-on that was not even available at all in most of the countries
where the SMART was launched. Arranging extensive agreements with rental car
companies, parking garages, airlines and train services turned out to be much more
complex than expected. After all, it was completely out of the core competences of both
partners, Swatch and Daimler, and was not developed enough to attract additional
customers. The concept was later taken out of the marketing message and replaced with
an emphasis on the technical features of the car.


Why did MCC build an expensive car?

There can be some reasons why MCC ended up building a car more expensive than
expected.

Modularity: Even though Daimler top management states that the modular
production concept provides cost savings, we argue that it introduces enough
complexity to negate the cost savings of plain mass production. Eliminating the
customizable offering could have reduced the trendiness, but in return the final
price could have been reduced too. As argued before, we consider price a more
powerful driver in buying a small car than nice looks.

Sophistication: Daimler probably pushed for that sophistication, afraid of being
related with a cheap car. Thus, all the SMART models feature a host of safety
features as standard. In addition to an electronic stability control system, all
SMARTs feature ABS, electronic brake power distribution, full size driver and
passenger airbags, seatbelt tensioners and belt force limiters. Another example of
that quality commitment over other drivers like price is the extra 150million
Daimler was forced to invest to solve some safety issues raised when the car
flipped over during extreme maneuvering tests
1
, a very similar case to what the
Mercedes A class had to go through. Daimler finally created a tiny car with more
and better technical features than the typical segment A car, and it give the
SMART and overall perception of stylish design. All of those came at a cost,
which raised the price too much, and the new tiny segment finally did not have a
tiny price, something that seemed to be part of the core original idea.


1
http://news.bbc.co.uk/1/hi/oldbusiness/40900.stm
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 17
Lack of synergies: Although the initial partnership of MCC with
DaimlerChrysler was supposed to provide experience and know how in the whole
production process, the typical synergies given in the industry when whole
platforms are shared by several models or even brands did not take place here.
The SMART platform was designed from scratch and has not been shared across
by any other product. In fact, the SMART forfour launched later on is based on a
Mitsubishi platform. A good example of these synergies we mention here are
exactly what Peugeot, Citroen and Toyota are taking advantage of with their new
A segment models, to be launched in June 2005 (see future substitutes in
Appendix 2).



Future Strategy
In the struggle to make the SMART a profitable venture, the management of the
company has added new models to the SMART line that modify the initial concept of the
car. The tradeoff being faced by managers is to make the SMART more acceptable to
mass markets without diluting the original concept.

In this effort, the Mercedes Group is now promoting a second, larger SMART sedan
(called the ForFour) based on a Mitsubishi platform (Daimler owns t he Japanese
carmaker).

The new model deviate from the initial concept for the following reasons:
1. While the original SMART is only 2.4m long, the ForFour is the size of a
small/medium car. The initial innovative concept of an urban tiny car fades away with
these models
2. Mitsubishi has not been a quality king and the trendy price premium will be hard to
justify
3. The new cars are being released with manual gearbox rather than the complex,
compromised auto/sequential manual cog shifters

We see point one as a major breach of the initial strategy pursued with the original
SMART city coupe (fortwo). Although the For Four can be seen as an attempt to
diversify the product offering, the fact that both cars do not share a platform will increase
development and production costs significantly.

On the diversification front DaimlerChrysler froze plans for a sports utility vehicle to be
launched (SMART SUV) and decided to continue the development of the next generation
of its original 2-seater ForTwo.

SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 18


SMART ForMore SMART ForFour
Exhibit 3: Extending the SMART
Line


Launching the SMART in the US has been always considered a possibility to
DaimlerChrysler. Selling the SMART in the US is a challenging venture: it would be
feasible only in a few metropolitan areas as fuel economy and narrow roads are not a
concern in general in the US. In the beginning of February 2005, after revealing that the
SMART division lost 600 million in 2004 (and total losses of 2 billion since launch in
1998) , the Mercedes Group announced that the group was working on a "long-term
business model" for the SMART that includes reviewing possible partnerships. It was
also announced that a restructuring plan should be ready in April
2
.

Did Mercedes Over-reach?

At the conception of the SMART, the core luxury passenger car business of Mercedes
was profitable but the company was facing increasing competition from Japanese luxury
brands, and an overall trend of consolidation in the automotive sector was taking place.
Placing the company on the reach quadrant
3
we can argue that the SMART venture was
a risky proposition since the mini car market was uncharted territory for Mercedes and
required changes to the core capabilities. SMART was not a simple extension of context
for Mercedes. Mercedes tried to mitigate this risk by initially setting up a separate joint
venture (MCC). However, this venture was soon bought out and SMART became a
wholly owned brand of Mercedes.

2
http://www.dw-world.de/dw/article/0,1564,1488809,00.html
3
Rangan and Adner, Profits and the Internet: Seven Misconception, 2001.
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 19

primarily
context
primarily
core
relatively
attractive
relatively
unattractive
The companys
current business
prospects are
The elements of
the business
model that might
change in pursuit
of reach are
MB
primarily
context
primarily
core
relatively
attractive
relatively
unattractive
The companys
current business
prospects are
The elements of
the business
model that might
change in pursuit
of reach are
MB

Exhibit 4: The Market Reach Quadrant

Resource Commitment and Reversibility
The initial resource commitment by MCC was very low given the size and complexity of
the project. A large share of investment was contributed by suppliers backed by strong
supply agreements that guaranteed compensation in case contracts were terminated and in
case production volume agreed upon was not met. MCC also significantly transferred
unfinished goods inventory related costs to suppliers. Except for inexpensive and
standard parts, MCC pays its supplies only when a car is complete with the module built
in.

At the launch of the product a total of 424 million had been invested in developing and
building a factory. MCC invested approximately 228 million, its suppliers and partners
about 197 million. On top of the investment in the factory, MCC invested 358 million
in the development of the car and in machinery and 256 million in establishing a dealer
and distribution organization. Suppliers in machinery and facilities in the proximity of the
Hambach location invested a total of 153 million. Total investment before the launch of
the car reached 1.2 billion.

Initial Investments in the SMARTville and in the launch of the SMART
Amounts in million


Development
and building of
factory
Machinery
and facilities
in the
proximity
Development of
the car
Dealer and
Distribution Total
MCC 228 358 256 841
Suppliers 197 153 350
Total 424 153 358 256 1 191

SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 20
We may argue that one of the reasons Daimler accepted the project was the relatively low
commitment from the investment point of view. MCC invested a little bit over 200
million in the SMARTville production plant, slightly more but very close to what the
suppliers did. Additionally, the French government contributed enough to own 25% of
the facilities. It provided funding to the project sponsors expecting to generate 2,000
direct jobs over three years in the region of the city of Hambach. Also, the suppliers took
care of 85% of the working capital needed to keep the assembly line going. This was a
big plus for MCC and Daimler, as the financial burden was much less severe than what a
regular project might have brought for a car manufacturer.

But all those prerogatives did not come without a price: suppliers accepted to take risks
only to a certain point, and MCC was forced to sign compensation clauses by which it
was forced to pay high sums of money to the suppliers if the production expectations
were not met, as it finally happened. All added together meant that another extra
1billion (apart from the 1billion already invested) would be needed by Daimler to exit
the SMART production according to 2000 estimates.

Not only financial, MCC made also political commitments. The project received French
government funding and was considered a public symbol of German-French cooperation.
Shutting the plant and laying off close to 2000 workers from DaimlerChrysler and
suppliers would be politically complicated.

Conclusion

The SMART car ventur e has not been a success. Six years after its launch MCC is still
struggling to reach break-even sales of 200,000 units and is far from reaching its initial
annual sales target of 300,000 units.

In our opinion, the lessons learned from the analysis of the venture are:
It is key to understand what drives the willingness to pay of your target segment
in order to deliver true value to customers. A more complex, sophisticated product
may not necessarily be what your costumer is looking for. Features expected to be
competitive advantage may be only perceived as add-ons to a customer.
Expanding reach is risky. SMART venture was a risky proposition since the mini
car market was uncharted territory for Mercedes and required changes to the core
capabilities. SMART was not a simple extension of context for Mercedes.
Reducing initial commitment by transferring risks to suppliers and governments
usually do not come without a cost. Low initial investments may be attractive at
start but may compromise the reversibility of the project.
Exiting a project and leaving behind huge investments takes a lot of discipline,
but constant discrepancies between expectations and actual sales should be
enough to show a project is not sustainable. Shutting down the project may be a
costly and tough decision, but pushing it even further by widening the offering
may not only deviate from the initial concept but also enlarge the already high
losses.
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 21
REFERENCES

Rangan and Adner, Profits and the Internet: Seven Misconception, 2001.

Trends and drivers of change in the European automotive industry: Mapping report,
European Foundation for the Improvement of Living and Working Conditions, 2004.

Flint J., Backseat Driver Not So SMART, Forbes Magazine, February 2, 2005.

Flint J., Thinking Small, Forbes Magazine, February 3, 2004.

Power, S., The SMART Car Stalls --- DaimlerChrysler Promotes Tiny Car as Next
Big Thing, But Buying Won't Be Easy, The Wall Street Journal, January 11, 2005.
11 January 2005

Kurylko, D., SMART's US debut may be killed; DaimlerChrysler's small-car brand is
a money-loser, Automotive News Europe, January 24, 2005

German-U.S. DaimlerChrysler's SMART Unit Sees No Profit Before 2008, German
News Digest, January 17, 2005

EIU Motor Business Europe, 2
nd
Quarter 1999

EIU Motor Business Europe, 3
rd
Quarter 1999

Promotex online research available at
http://www.promotex.ca/articles/cawthon/2004/2004-01-05_article.html
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 22

Appendix 1 SMART Chronology

01/93: Start of a feasibility study at Mercedes-Benz regarding the development of
a small car
04/03/1994 Press conference: Planned joint venture between Mercedes-Benz and SMH
(today: The Swatch Group Ltd.)
04/1994: Establishment of Micro Compact Car AG, Biel (Switzerland)
12/1994: Location chosen: Hambach in Europle de Sarreguemines (France)
09/1995: SMART concept study at the IAA in Frankfurt (Germany)
14.10.1995: Foundation stone laid in SMARTville
28.11.1995: Foundation of the company Micro Compact Car France in Hambach
(France)
12.06.1997: Inauguration of the SMART engine plant in the (then) Daimler-Benz AG in
Berlin (Germany)
09/1997: World premire of the SMART city-coup at the IAA in Frankfur t
(Germany)
27.10.1997: Inauguration of SMARTville
01.07.1998: Production of the SMART city-coup begins.
10.07.1998: Beginning of advance sales in the SMART Centres
10/1998: Market launch of the SMART city-coup in nine European countries
(Belgium, Germany, France, Italy, Luxembourg, Austria, Switzerland,
Spain and the Netherlands)
01/11/1998 100% take-over of MCC by the (then) Daimler-Benz AG
01/01/1999 Transfer of business activities from Biel (Switzerland) to Renningen
(Germany). Micro Compact Car GmbH renamed Micro Compact Car
SMART GmbH
12/1999: Market launch of the SMART cdi in nine European countries (Belgium,
Germany, France, Italy, Luxembourg, Austria, Switzerland, Spain and the
Netherlands)
12/1999: MCC SMART is the first manufacturer to sell cars via the internet
12/1999: In Hambach, the 100,000th SMART city-coup rolls off the production line
03/2000: Market launch of the SMART cabrio in nine European countries (Belgium,
Germany, France, Italy, Luxembourg, Austria, Switzerland, Spain and the
Netherlands)
09/2000: MCC SMART is the first manufacturer to install internet access in cars,
beginning of internet services at wap.smart.com
03/2001: Market launch of the SMART cabrio cdi
10/2001: Market launch of the SMART city-coup (RHD), SMART cabrio (RHD) in
Great Britain (UK)
11/2001: Market launch of the SMART city-coup (RHD), SMART cabrio (RHD)
and SMART k (RHD) - (japan.: kei-jidousha, "light vehicles") - in Japan
03/2002: Presentation of the SMART crossblade as a production car at the
International Motor Show in Geneva in 2002
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 23
06/2002: Market launch of the SMART crossblade in Belgium, Germany, France,
Great Britain, Italy, Japan, Luxembourg, the Netherlands, Austria, Portugal,
Sweden, Switzerland, Spain, Taiwan, Hungary, the Czech Republic and the
Slovak Republic
09/2002: Micro Compact Car smart GmbH renamed smart GmbH:
09/2002: Establishment of the "SMART mall", the new production line for the
SMART roadster and SMART roadster-coup models in Hambach
10/2002: Fifth anniversary of the plant in Hambach, with a total of 430,000 vehicles
produced since operations commenced
04/2003: Market launch of the SMART roadster, SMART roadster-coup, SMART
city-coup BRABUS and SMART cabrio BRABUS models throughout
Europe
Source: company website

SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 24
Appendix 2: Prices and characteristics of substitutes
Parker independent price lists and reviews as of February 2, 2005.
(sources http://www.parkers.co.uk/ http://www.km77.comhttp://elmundomotor.elmundo.es )

Citroen C2: Cheap and really quite funky, 1.1 is a bit breathless and noisy at speed.
Price range: 10,000-12,000

Ford Ka: Stylish, cheap to run, fun to drive, Limited rear accommodation
Price range: 9,000-15,000

Mini One/C. Hatchback: Slick handling, cool image, Poor rear space, pricey,
waiting list
Price range: 15,000-27,000
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 25


SMART fortwo coupe: Teeny-weeny, anyone can park one, Pricey for what it is,
no fun on motorways.
Price range: 10,500-15,000

Daewoo Matiz: Style, space, equipment, cheap, Needs more power on motorways
Price range: 8,500-9,000



SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 26
Future substitutes


Peugeot 107, Toyota Aygo and Citron C1: based on the same platform and to be
launched in June 2005

Price range: 7,500



Also, Renault has released in February 2005 a new concept, the Z17. It is just a concept
car which production is not decided yet but if approved, its launch could represent the
closest attempt to do something similar to SMART, while keeping two important
differences:
o It has been shown that cars carry only 1.4 people on average, but two seat interiors
are perceived as a constraint. Z17 is therefore a genuine three-seater complete with
a boot located behind the driver's seat, all built into a compact architecture.
o Although no price estimation is known yet, it would probably try to beat the prices
of cars already in the market or just about to be launched, i.e. less than 7,500.


SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 27
Appendix 3: Sales figures for the Mini-car segment

Mini-Car Sales Segment by Model (Western Europe Market:1995-1998)
Manufacturer Model 1995 % 1996 % 1997 % 1998 %
Ford Ka

- 0.0%

25,194 4.3%

202,337 22.9%

266,137 25.8%
Renault Twingo

227,944 40.6%

214,063 36.3%

208,533 23.6%

199,148 19.3%
Lancia Ypsilon

59,187 10.5%

80,907 13.7%

135,571 15.3%

145,507 14.1%
Fiat Panda

66,750 11.9%

63,901 10.8%

126,861 14.3%

130,943 12.7%
Fiat Seicento

- 0.0%

- 0.0% 0.0%

82,166 8.0%
Fiat Cinquecento

146,535 26.1%

145,408 24.6%

154,265 17.4%

77,316 7.5%
Seat Arosa

- 0.0%

- 0.0%

- 0.0%

46,375 4.5%
Daewoo Matiz

- 0.0%

- 0.0%

- 0.0%

23,186 2.2%
MCC SMART

- 0.0%

- 0.0%

52 0.0%

20,000 1.9%
Suzuki Alto

16,020 2.9%

16,020 2.7%

20,330 2.3%

16,908 1.6%
Daihatsu Cuore

7,541 1.3%

7,541 1.3%

7,511 0.8%

9,281 0.9%
Rover Mini

9,980 1.8%

9,980 1.7%

6,486 0.7%

7,517 0.7%
Seat Marbella

22,426 4.0%

22,426 3.8%

18,021 2.0%

5,204 0.5%
Subaru Vivio

2,684 0.5%

2,684 0.5%

2,993 0.3%

1,752 0.2%
Hyundai Atoz

- 0.0%

- 0.0%

- 0.0% n.a. -
Total

561,062 100.0%

590,120 100.0%

884,957 100.0%

1,033,438 100.0%

Source: EIU Motor Business Europe, 2
nd
Quarter 1999

SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 28

Appendix 4: Passenger Car Production in Western
Europe by Segment
Segment Brands units % units %
A Ford Ka 629,384 4.3% 772,054 5.3%
B Peugeot 206 3,743,542 25.6% 3,569,852 24.4%
C VW Golf 4,424,434 30.3% 4,409,949 30.2%
D Ford Mondeo 3,289,172 22.5% 3,097,645 21.2%
E VW Passat 1,385,577 9.5% 1,590,017 10.9%
F MB S-Class 153,771 1.1% 141,353 1.0%
G Jaguar XJS 199,887 1.4% 172,368 1.2%
LCV VW Caravan 181,728 1.2% 192,833 1.3%
MPV Chrysler Minivan 348,849 2.4% 320,165 2.2%
SUV Ford Explorer 258,925 1.8% 354,868 2.4%
Total 14,615,269 100% 14,621,104 100%
1998 2004

Source: Motor Business International 3
rd
Quarter 1999.
SMART Main Project Group 4, Section A
Innovation Strategy and Entrepreneurship 29
Appendix 5: Mobility Offerings and Partnerships

Accor Hotels
The Accor Hotel Group with Sofitel, Novotel and Mercure hotels, provide attractive
and comfortable hotels. smart drivers benefit from special smart rates in selected hotels
worldwide.

APCOA Autoparking GmbH/VUP GmbH
APCOA has provided the first 3m parking spaces for smart fortwo coup/cabrio drivers
in Germany and Austria. VUP GmbH, which operates in Germany, is also doing the
same. This ensures that not only can smart fortwo coup/cabrio drivers find a parking
space more easily, they can often benefit from special smart prices too.

AVIS Europe
Avis has the largest rental car service network in Europe. smart drivers can rent cars at
favourable rates in all western European countries and in many other countries too.

Deutsche Bahn AG
DB AutoZug will transport your smart fortwo coup/cabrio to around 18 interesting
destinations at home and abroad. smart fortwo coup/cabrio customers are entitled to
special smart rates.

DFDS Seaways, Hoverspeed, Color Line, Scandlines, SeaFrance, Bodensee-
Schiffsbetriebe GmbH, Schweizerische Bodensee-Schiffahrtsgesellschaft AG.
The road sometimes comes to an end at a large expanse of water - then the ferry is the
only means of transport available. But this can be a real pleasure - some smartmove
ferries cross attractive routes on the Baltic Sea and the North Sea, Lake Constance and
Lake Zurich. And you can take your smart at special rates.

Bundesverband CarSharing (bcs)
bcs provides all classes of vehicles in more than 200 German towns and cities in
accordance with the principle of car sharing. smart drivers are offered free membership
for the first year.

Conoco Jet, Shell, Migrol, BP, COVA, Wash One
In some European countries smart fortwo coups are that little bit cleaner than in other
places. This is because of the smartmove Wash partners, Conoco Jet, Shell, Migrol,
BP, COVA, Wash One who offer reduced rates for washing a smart fortwo coup.

RailLink AG
Together with RailLink AG and Swiss Railways (SBB), smart completes the mobility
chain at railway stations. RailLink members can use a smart fortwo coup at all larger
stations in Switzerland, and they have access to the Mobility CarSharing fleet at many
further locations.

CineMaxX AG
With 49 central cinema centres, CinemaxX AG is the market leader in Germany. The
CinemaxXCard offers cinema fans discounts and special offers for cinema tickets and
related products and services. smart drivers can buy this card at a special price.
Source: company website