German auto maker BMW AG BMW.XE 0.78% expects profit margins on the cars it sells in China to decline "gradually and very slowly" in coming years, according to a top executive, underscoring the growing challenges faced by global auto makers in what is widely expected to become the world's largest market for luxury cars.
Karsten Engel, president and chief executive of BMW's China region, said in an interview this week he foresees margins eroding by between 1% and 2% annually due to a customer trend toward smaller premium cars.
Net profit margin for premium brands including BMW, Audi NSU.XE 1.80% and Mercedes-Benz typically ranges between 15% and 20% in China, according to Lin Huaibin, an analyst at research firm IHS.
Chinese luxury-car buyers, who have tended to prefer bigger and better-equipped cars, have been the source of outsize profits for luxury-car brands. Car makers have long cautioned soaring sales and profits in China would slow to a steadier pace in the coming years. How quickly growth levels off in China will have a big influence on bottom lines.
Mr. Engel said such a reduction was expected as China evolved into a "normal" large market like the U.S. "It is not a problem—it is in our plan," he said on the sidelines of the China launch of the BMW 3-series GT in the eastern Chinese city of Hangzhou.
"The days of breakneck growth are over," he added.
His remarks come at a time when growth in demand for luxury cars in China has fallen dramatically amid growing uncertainty about China's economy and a government crackdown on conspicuous consumption. Shrinking margins could hurt a growing source of profits for global luxury-auto makers.
"The Chinese margins simply have to come down—it is the law of gravity," said Bernstein Research auto analyst Max Warburton. "Margins for everyone have been supernormal and remain hugely elevated. We're now seeing Chinese buyers sober up and buy smaller engines and high-end consumption slow right down."
A host of global luxury brands including Jaguar Land Rover, a unit of India's Tata Motors Ltd., 500570.BY-0.86% and Zhejiang Geely Holding Group Co.'s Volvo Car have announced plans to add capacity in China. General Motors Co. GM 1.69% said last week it aims to quadruple its now-small share of the Chinese market for luxury vehicles by the end of this decade, assisted by a new $1.3 billion plant in Shanghai that will produce premium-brand Cadillacs.
In March, consultancy McKinsey & Co. predicted China could overtake the U.S. to become the largest luxury-car market as early as 2016. Automotive expert Michael Dunne predicts China's premium-car market could reach 1.4 million vehicles this year and 2.6 million in 2017.
Still, China's luxury-auto market is showing signs of slowing compared with the broader market. In the first five months of this year, sales of passenger cars in China totaled 7.26 million vehicles, up 15% compared with a year earlier, according to semiofficial data from China Association of Automobile Manufacturers.
In the first five months of this year BMW sales, which include the BMW and Mini brands, grew by 9.8% over a year earlier to 148,319 vehicles, versus a 34% gain in the year-earlier period. Daimler AG DAI.XE 1.67% sold 79,365 Mercedes-Benz cars, down 3.8%. Only market leader Audi AG came close to growth rates for the broader car market. It sold 183,660 vehicles in the country, up 14%—much less than the 42% year-over-year rise in Audi sales in the first five months of 2012.
In this year's first quarter, China accounted for around 19% of BMW's global auto sales, largely unchanged from the same period a year earlier. Analysts estimate China accounts for between 20% and 30% of BMW's profit.
Mr. Engel said BMW had been growing "too much" in China in recent years when it was clocking up annual sales growth averaging about 40%. He said the company was projecting growth rates for the rest of the year in China of high single digits—unchanged from forecasts made by BMW senior management in April.
He said that a period of slower growth would allow the company to focus on addressing issues at its dealer networks, such as improving aftersales, increasing sales of used cars and expansion of financial services.
Demand for ultraluxury cars priced 1.5 million yuan ($230,000) and greater was "much slower," he said, but noted such cars account for only around 3% of BMW's sales in China on a vehicle basis.
"Our long-term perspective is absolutely positive," said Mr. Engel. "We expect the market to grow strongly."
BMW's marketing targets the 15 million Chinese households with annual income of $80,000 or more, he said. "This number is expected to triple to 45 million in the next 15 years," he added, citing government forecasts.
As part of a plan to tap China's luxury-car market, BMW is planning to add 60 new dealers in China by the end of this year, bringing the total to 420. BMW will add more than 10,000 members to its dealer organization, which currently totals 12,000. The company has also 13,000 car plant workers in China.
Prices for the newly launched BMW model, which will be imported into China, begin at 445,000 yuan.