Daimler gears up in Hungary

(CNN) -- As the car industry suffers declining sales and excess production, luxury brand Mercedes-Benz is making a billion dollar bet on a niche slice of the market.

Mercedes-Benz, the luxury car brand owned by Daimler, is increasing its production of premium compact cars by investing in a state-of-the-art plant in Hungary.

Mercedes-Benz is battling its luxury brand competitors, BMW and Audi, for market share of the chic, small, car market -- a style which appeals to a younger demographic.

The company's Kecskemet plant, an hour from Budapest, has been rolling out production of its B-Class compact car since March.

Frank Klein, the plant manager in Kecskemet, said the move was a reaction to a change in the customer base: "It has become younger and they want more sporty, more attractive cars," he said. "With this model I think we can meet all the demands that the customer expects from a premium brand."

Daimler's Hungarian assembly line

Mercedes-Benz set up in Hungary after looking at locations where it could increase its capacity but keep costs down.

"There was a long evaluation process at the beginning of this project phase," Klein said. "We had 15 different sites to select from and there were a lot of different criteria, including the logistics costs and the availability of a qualified workforce."

Mercedes-Benz follows Volkswagen's Audi unit, which opened its first car plant in Hungary in 1994. The country's appeal lies in its skilled labor and low costs.

Research from Professor Ferdinand Dudenhoffer, head of the Centre Automotive Research Unit at the University of Duisburg-Essen, shows car plant workers in Hungary are paid a fifth of their German neighbors.

Hungary also has cheaper taxes and less regulation than its neighbor, according to Dudenhoffer. He estimates the cost of making a Mercedes-Benz B-Class in Hungary is around $2500 cheaper than making it in Germany.

According to Daimler, these savings per car could be even higher, with Klein estimating overall production costs at 30% less in the Hungarian plant.

Michael Tyndall, an auto analyst and director of research at Barclays Capital, is unsurprised at Mercedez-Benz's move. "The main failing of the European industry is it hasn't really adjusted its production footprint to the underlying financial or economics of the industry," he said.

"Consumers are getting cars cheaper in real terms and getting cars with more content, but at the same time labor costs and raw materials are going up, so somewhere something has to be squeezed -- and at the moment that is the bottom line for the car makers," he added.

Daimler's hope is that the plant will reduce production costs but also -- given new innovations and technologies -- improve productivity and efficiency.

Michael Tyndall believes it's a good strategy for saving on production costs, "but the actual success of it is contingent on the success of the cars," he said. "It's about what the consumer wants, and the consumer wants smaller premium cars, so in that sense Mercedes is definitely doing the right thing."

CNN's Anna's Stewart contributed to this story