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"But the worry is that BMW is trapped in a 21st century Catch-22 -- how to make its high-performance cars more efficient and boost profits at the same time.

Caught off guard by the rising popularity of Toyota (TM) and Lexus hybrid models, BMW is now trying to catch up with its own fuel-saving innovations tailored to combustion engines. Research and development spending rose 14% in the second quarter to $645 million. Installing the innovations across its entire model range is not cheap.

And so far consumers are not willing to pay a premium for a fuel-efficient BMW, analysts note. As a result, BMW's costs are going up, but the price of its cars do not recapture the investment in fuel-efficiency innovations. "Our first experience with [new technologies to boost efficiency] is that it gives us competitive advantage, but pricing remains a challenge," admits Krause. "Over time we will solve it."

Catching Up with Lexus' Hybrid

BMW Chief Executive Norbert Reithofer, who took control 11 months ago, is all too aware of the profit conundrum and has been huddling regularly with his top lieutenants on how to fuel earnings growth amid environmental challenges. During mini-retreats at a Bavarian lake called Tegernsee, an hour's drive from headquarters, the 51-year-old former production chief provokes intense debate on everything from engine technology to climate change. This fall Reithofer will present the results of the high-powered confabs: a 10-year strategic plan designed to boost profits and keep up the Bavarian automaker's growth trajectory.

That plan is likely to include a road map for future models that can compete with Toyota's hybrid juggernaut, cost-cutting measures to polish margins, and details on shifting more production to BMW's U.S. plant in Spartanburg, S.C., as a currency hedge. "The Lexus LS600 hybrid is a very sophisticated evolution of a hybrid. It caught BMW flat-footed. BMW will have to spend a lot to catch up," says Thomas Aney, analyst at Dresdner Kleinwort in Frankfurt.


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