* VW launches upgrade of all-time No.2 bestseller on July 3
* Revamped Passat to take on BMW, Mercedes premium models
* VW tackling mid-market problems in drive to be world No.1
By Andreas Cremer
BERLIN, July 2 (Reuters) - Volkswagen is steering the Passat upscale, aiming to lift its No.2 selling model clear of a struggling market for mid-priced cars without alienating its core family customers.
With low-cost brands adding frills to appeal to more affluent drivers, and premium carmakers pushing their models into more affordable categories, the middle market has borne the brunt of a six-year slump in European car sales.
From 2009-2013, when European car sales tumbled 15 percent, the major mid-market carmakers' share of that shrinking market fell to 44 percent from 48 percent, according to industry data. The main premium brands' combined share, meanwhile, rose to 17 percent from 13 percent.
Though Volkswagen (VW), Europe's biggest carmaker, makes most of its money from upmarket Audis and has prospered from the surge in popularity of sport utility vehicles (SUV), the German group can't afford to ignore the mass market if it is to reach its goal of overtaking General Motors and Toyota to become world No.1 by 2018.
Analysts said it made sense for VW to move upscale with the Passat, which has racked up over 22 million sales since its 1973 launch, when it unveils the latest model in Berlin on Thursday.
"The mid-market is a fiercely fought segment and competition is anything but letting up. Stretching further into luxury territory is a sensible step," said Stefan Bratzel, head of the Center of Automotive Management think-tank.
But there are risks.
VW will have to deliver improved safety and so-called infotainment features for the Passat without either pushing the price of the saloon beyond many of its core family customers, or further squeezing margins at its VW passenger car division.
Gazing at sketches of the new Passat in a Berlin showroom, Wolfgang Mertens, a 58-year-old accountant who has driven VW-badged cars for three decades, remained to be convinced.
"The Passat is a common-sense car," he said, referring to a vehicle whose popularity has historically rested on its fuel-efficiency, spacious interiors and strong resale value. "They (VW) have enough luxury on offer, why push it upmarket?"
Sales of the Passat have been declining, especially in VW's German home market where deliveries of the model slumped 24 percent to 72,048 vehicles last year from 94,523 in 2008, according to the Federal Motor Transport Authority (KBA).
Adding upscale tweaks could help the Passat compete against luxury marques BMW and Mercedes-Benz, while staying ahead of rivals Peugeot, Renault and Ford which have pledged to step up the pressure on VW with plusher trim, better gadgets and near-premium model versions.
Among its extras, the new Passat offers a novel system to assist reverse driving with a trailer, an emergency-braking function that reacts to pedestrians and cars, as well as a sensor-based automatic locking mechanism for the estate version.
The new car is expected to hit showrooms in November.
At about 26,000 euros ($35,500), it will be priced only slightly above the current version, a company source said, but come in below BMW's 3-Series at 29,350 euros and the Mercedes-Benz C-Class at 33,558 euros.
Ernst-Robert Nouvertne, who runs two VW dealerships near Cologne in Germany, was optimistic.
"We expect higher deliveries as the new Passat will be a cut above its predecessor but sell for about the same price," he said. "There's a good chance to win premium buyers."
Importantly, analysts said it was unlikely the Passat, VW's second-best selling car of all-time behind the Golf, would steal sales from stable-mate Audi. The four-cylinder Passat lacks the driver appeal of a six-cylinder Audi A4, they said.
Estimates from research firm IHS Automotive suggest the plan could pay off. Deliveries of the Passat will increase almost 10 percent to 601,729 cars by 2020, from an estimated 549,552 this year, it forecast. That compares with its projections for a 3.3 percent rise to 431,956 cars for BMW's 3-Series and a 3 percent increase to 358,690 for the Mercedes C-Class.
The Passat will be based on VW's so-called MQB modular platform, which is aimed at cutting costs and improving profitability by using more common parts in its cars.
But there is a long way to go to improve profit margins at the VW passenger car division, the group's largest, whose 2.9 percent margin lags a long-term goal of more than 6 percent.
Jan-Philipp Hasenberg, automotive expert at Roland Berger Strategy Consultants, said that even if a pick up in Passat sales helped to boost margins, it might not last for long.
"Competition is so intense that such (margin) improvements are most often short-lived," he said.
VW's upscale ambitions for the Passat in Europe contrast with its recent strategy for the model in the United States.
Battling American perceptions of lower value for money, VW in 2011 launched a cheaper, simplified Passat. After surging in the first year, sales of the model slipped into decline, contributing to the 2013 ouster of VW's U.S. chief.
"World markets have their peculiarities," said Arndt Ellinghorst, an analyst at investment researchers ISI Group. "But in the embattled European (mass) market, the VW brand has no choice but to go more premium."
($1 = 0.7331 Euros) (Editing by Mark Potter)