VW to build next gen Phaeton, even though it losses money & VW is slashings overall costs.

With Volkswagen having embarked on a big cost-cutting drive, industry experts are baffled why the "people's car" maker plans to spend millions of euros upgrading a money-losing luxury sedan.

The 76,000 euro ($86,000) Phaeton, a pet project of Chairman Ferdinand Piech, has never met VW's original sales target of 20,000 cars annually. Analysts say the upper-premium car, which cost more than 1 billion euros to develop and came out in 2002, should be axed.

But sources at VW told Reuters that the company is now planning a more advanced version of the Phaeton -- even though the first-generation car was ranked by Bernstein analyst Max Warburton as one of the three "most loss-making European cars of modern times."

The plans appear all the more perplexing to analysts as VW has pledged to make annual cost savings of 5 billion euros at its passenger-car brand by 2017, as the world's second-biggest carmaker by sales seeks to narrow the gap with global leader Toyota.

'Painful action'

Announcing the "efficiency program" last July, CEO Martin Winterkorn promised "painful action" to revive the core brand where profit margins have been languishing due to a proliferation of models and parts.

"It's no longer all about bigger, higher, further," the CEO told managers at a Dresden strategy conference in December. "Now it's about being leaner, faster, more efficient."

His comments echoed VW's plans to reduce the number of costly parts and drop some non-profitable variants from the German group's 310-model lineup as Europe's largest automaker shoulders costs of future growth and investments in lower-emissions technology.

Revamping the Phaeton will seems to contradict the CEO's cost-cutting drive, said Evercore ISI analyst Arndt Ellinghorst, adding that switching production of the model to VW's MLB modular platform could cost as much as 650 million euros.

"Economically speaking, it's the most irrational project," London-based Ellinghorst said. "Piech and Winterkorn simply cannot let go of their fondness for luxury products."

A new glass-walled factory, R&D outlays and low sales volume led VW to lose 28,000 euros on each Phaeton sold between 2002 and 2012, Warburton wrote in a September 2013 note.

Unfazed by the losses, VW aims to pit the next-generation model against the Mercedes' 80,920 euro S-class flagship, sources said, adding the car may hit dealerships in 2017-2018. A plug-in hybrid version is also planned.

VW confirmed it was planning a successor to the Phaeton but declined to comment on the details or costs. It also declined to comment on analysts' loss, cost and sales estimates for the existing version, but said the sedan helped to show off its technical prowess.

The company does not disclose sales data for individual brands, only production numbers, which show it produced 5,812 Phaetons in 2013 -- the most recent annual figures published.

High-end battle

Stefan Bratzel, head of the Center of Automotive Management think tank near Cologne, said another high-end luxury sedan may overstretch the VW brand, traditionally a mass-market division which in November released a more upmarket Passat.

A new Phaeton could also affect sales of VW's other premium offerings, especially the Audi's flagship A8 sedan, which may share MLB underpinnings with the VW-badged model, he said.

"It doesn't make much sense strategically," Bratzel said. "The business case is equally questionable."

A new Phaeton would struggle against its premium rivals, analysts say. Sales of the model will average no more than 11,900 cars a year in 2017-2020, up from 6,300 this year, according to estimates from research firm IHS Automotive.

That compares with annual averages of 85,000 units for the Mercedes S class, 64,000 for BMW's 7 series and 41,000 for Audi's A8 in the four-year period, according to IHS data.

Buyers will never warm up to the notion of an upper-premium sedan made by the "people's car" brand unless they get a huge discount, a former VW Group executive told Reuters.

"This is the inherent problem, which puts the car's price positioning and profitability at risk," he said.

The Phaeton is the brainchild of Piech, the mastermind of VW's global expansion and its former CEO, who is well known for outmaneuvering both rivals and allies.

Sacred project

A former Audi North American chief, Axel Mees, was forced to leave the company in 2004 after criticizing the Phaeton project and Piech in public, a source at Audi said.

Meanwhile, Michael Horn, VW's new U.S. boss is chasing a lofty sales target of 800,000 VW brand cars by 2018, more than double last year's tally.

Horn will be tasked with relaunching the next Phaeton in the U.S. after VW pulled the model from the world's biggest premium-car market in 2006 because of poor sales.

Horn struggled with the answer when asked by Reuters at the Detroit auto show what potential he sees for the model in the country.

"That's a dangerous question," he said. "It's an image bearer with no relevance for volume."