What recession?

To call Marcus Breitschwerdt, the head of Mercedes-Benz Canada, an auto industry anomaly would be an understatement. He isn’t just a happy auto executive, he oozes confidence. Ask him about the downturn that has decimated his industry and sent some competitors to the brink of bankruptcy and he’ll tell you the troubles are being blown out of proportion. The Canadian economy is on solid ground, he says. Look no further than the rising sales Mercedes posted in each of the first three months of this year.

That’s not all. Breitschwerdt will even tell you that a recession is a good thing. “They help you to get rid of the not-competitive parts of the economy,” he says, sitting in his office overlooking a dealership in a small strip mall in uptown Toronto. While he’s reluctant to talk specifically about other carmakers like General Motors or Chrysler, he will say that he’s not a fan of government bailouts to underperforming companies.

For Mercedes, and other luxury brands like Audi and BMW, the downturn in Canada has—at least so far—not been a catastrophe at all. Each of the major German carmakers boasted record sales last year and continue to post upbeat, slump-defying numbers. Mercedes’ sales are up nearly 10 per cent so far in 2009, compared to an overall market decline of 22 per cent. Audi Canada said this month that it had its best quarter ever in Canada. BMW’s sales were up seven per cent in March. While the domestic carmakers are stuck in the basement, the foreign luxury brands are talking about gaining ground on their once-formidable rivals. “The total industry goes down, but our market share goes significantly up,” says Martin Sander, the president and CEO of Audi Canada. “We haven’t reached the ceiling.”

This improbable trend may lend some credence to some of the rosier outlooks that have been offered up on the strength of the Canadian economy compared to the U.S. Thousands of Canadians, after all, still have the confidence to put down $40,000 or more on a premium car, despite all the bad economic news. But more importantly, it reflects some critical changes that have been brewing in the luxury car market over the past decade—ones that have seen automakers push to extend their sought-after luxury brands to a market of more modest means. Analysts caution that this trend could slam into a brick wall if the economy in Canada continues to sink. But Breitschwerdt, for one, isn’t worried. “We like the overall developments very much.”

The demand for luxury across a host of industries has been growing steadily since the mid-1990s, in step with the booming economy, easy credit and a population that felt richer as the values of their homes soared. “All those factored into a dramatic run-up in household wealth, which translated into buying a luxury vehicle,” says Rebecca Lindland, an auto analyst with IHS Global Insight. Basic luxury cars like the BMW 3 Series and Audi A4 became symbols not so much of exclusivity but of middle-management success. They appealed to a broad customer base, including the kinds of people who might have once bought domestic cars like Buicks and Lincolns. In Canada, the luxury car market nearly doubled, to a high of about seven per cent of the market in 2008, from four per cent in 2000, according to IHS Global.

The real trick, however, is keeping that upward momentum alive at a time when household net worth is shrinking fast and people are delaying major purchases of all kinds. This year, Mercedes introduced the GLK, a $40,000 crossover. That’s not cheap, but it is competitive with SUVs like the Ford Explorer and Chevrolet TrailBlazer. Mercedes also sells its small B-Class car in Canada—a bubblish-looking cross between a luxury and compact car that goes for about $30,000. “We want to convince more Canadians that Mercedes is affordable for them,” says Breitschwerdt. Last year, BMW rolled out a hatchback, the 1 Series. It sells for $34,000. Compared to the average price of a car in Canada (about $30,000), “it’s not that much of a stretch,” says Kevin Marcotte, the director of marketing at BMW Group Canada. Audi isn’t actively going after the mid-market buyer in the same way, but it sees an advantage in its reputation as the least showy of the luxury brands, says Sander. And it is shifting its focus toward offering price-conscious buyers more fuel-efficient cars, he adds.

If there’s an ace up the sleeve of the luxury brands, they argue, it’s their ability to sell buyers on quality. U.S. automakers like GM and Chrysler have struggled for years with their reputation for shoddy engineering and design. And though it is widely acknowledged that quality among the Detroit Three has vastly improved, it has still been difficult for them to fully solve their image problems. Luxury automakers say that in these times, people want to buy something that they know will work and last. “With the consumer mindset focused more on the rational than the emotional, we need to be very convincing,” says BMW’s Marcotte. That means focusing on things like quality and reliability rather than, say, status and sex appeal.

None of this is to say, however, that luxury brand sales are immune from harsh economic realities. In the United States, where the recession began earlier and has fallen off more sharply, the luxury brands have struggled along with the rest of the industry. The decline in housing values and the disappearance of easy credit and jobs have combined to expose the Achilles heel of runaway growth in the luxury market: a lot of people who bought into it really couldn’t afford the cars. Audi, which is a division of Volkswagen, saw a 25 per cent sales drop in the first two months of this year in the U.S. That’s led to some speculation that Canada will, sooner or later, end up in the same sinking boat. “All the luxury players are going to have a difficult year,” predicts Canadian auto analyst Dennis DesRosiers. Some of the positive numbers thus far are a reflection of the companies’ healthy leasing programs, he adds.

There are other challenges, too. Both Mercedes and BMW are launching new models of their priciest, flagship luxury cars this year—the E-Class (which will sell for upward of $65,000) and 7 Series (over $100,000), respectively. The increasing focus on executive pay and pressure on companies to restrain corporate perks may well cut into the appeal of such extravagant rides. Still, the automakers are quick to downplay the unfortunate timing of the releases. Designing and building a new car costs hundreds of millions of dollars and takes over five years, so carmakers can’t plan their releases for the market’s ups and downs. Breitschwerdt chalks it up to the reality of building and selling cars. Audi’s Sander says that it will do “nothing significantly different than we would have done two years ago” in marketing its new SUV, the Q5. BMW admits selling the 7 Series will be a challenge, but it expects that when leases on older 7 Series are up, many will still opt for the new model. And at the end of the day these models aren’t going to make or break the year. “It’s a small percentage of our overall volume,” says Marcotte.

BMW is the most cautious of the three in its outlook. “We’ve had a pretty volatile 18 months,” says Marcotte, who notes that higher sales have been driven by lower prices, especially since the Canadian dollar reached parity with the U.S. greenback, putting companies under pressure to match prices south of the border. And though BMW is faring better than most in the industry, its Canadian sales did fall slightly at the end of last year and in January.

Still, auto sales are in large part a relative game. Market share is important, and the premium brands appear poised to emerge from the downturn in an enviable position and with a larger slice of the market. Breitschwerdt says that while Asian carmakers like Toyota and Honda have taken market share from the Detroit Three, the luxury carmakers are taking share from the Japanese. Even in the troubled U.S. market, the declines in luxury sales appear to be hitting higher-end domestic brands, like GM’s Cadillac, harder than the foreign brands, says Lindland.

This probably isn’t just a passing fancy, Lindland says. Looking beyond the current funk, demographic trends could end up fuelling longer-term growth in the high end of the car universe. In coming years, the population will continue to age—and it’s the over-40 set that typically buys Mercedes, BMW and Audi. So while these high-end brands might suffer in the short term, they would appear to have much to look forward to. And that’s the kind of forecast a lot of carmakers these days would die for.