Save $5,000 to $10,000! Up to 40 percent off on Mercedes-Benz and BMW!

Advertisements touting the prospect of substantial savings for luxury European automobiles are luring increasing numbers of car buyers into what has become a flourishing gray market in the past year or so.

Also known as the parallel market, or direct imports, the term refers to the importation and modification of vehicles that do not conform to U.S. standards by customers or agents other than franchised dealers. The gray marketeers are able to offer discounts ranging from 15 percent to 40 percent over the prices charged by authorized dealers because many of them are small-time operators who buy cars more cheaply abroad, keep no inventory, have no showroom, servicing or parts, and offer no manufacturer's warranty or recall notices. Others have some inventory, but offer fewer options and sometimes take lower profits. The actual savings also depends on how good a deal the customer can cut, as well as his or her willingness to take care of the red tape involved.

For example, Eurocars International in Upper Marlboro, Md., sells a Mercedes 500 SEC that lists in the United States at $56,800 for $49,500, a 13 percent savings. A $31,940 300D sells for $25,500, or 20 percent off. The price includes everything except title and tags (because neither sales tax nor dealer prep is included in the list price, the saving for the gray market customer actually is larger).

David Harris Ltd., a national importer, sells the 500 SEC for $41,000, a 28 percent reduction. The Harris car is the European model without the options offered on models manufactured for sale in the United States, such as anti-lock brakes, alloy wheel covers, air conditioning, leather interior, power windows, central locking and stereo.

What four years ago was a trickle of non-conforming imports has now become "a virtual tidal wave," in the words of the National Automobile Dealers Association. Concerned about the impact of such cars on the environment and highway safety as well as the bureaucratic backlog in approving the cars for U.S. use, the federal government is now preparing to staunch the flow.

Since the mid-1960s, there has been a loophole in federal law to allow returning diplomats, military personnel, tourists and a few others to bring in non-conforming vehicles on bond.

In the first year, 1,500 cars were imported. The loophole has now become a wide-open gate through which an estimated 35,000 autos will be driven this year. Almost three times as many gray market cars will be imported this year as were imported in 1983.

Almost half (46 percent) of the cars brought in last year were five years old or more and could qualify for an exemption from emissions control standards that went into effect in 1980, a concern for the Environmental Protection Agency.

According to Department of Transportation records, Mercedes-Benz accounted for 64 percent of the imports this year; BMW and Porsche, 11 percent each; Ferrari, 3 percent; Rolls Royce, 1 percent; and others, 9 percent. There is no breakdown between new and used cars, but a spokesman said that this year, new cars have become predominant.

That works out to about 22,000 gray market Mercedes-Benz cars this year compared with an estimated 79,000 cars imported through franchised dealers in 1984. In the past year, imports by Mercedes-Benz franchisees rose about 7 percent, but the number of gray market Mercedes-Benz autos rose more than 150 percent. In other words, unauthorized agents selling at discount prices have now captured more than a fifth of the entire Mercedes market in the United States.

The reason, says James A. Mateyka, auto analyst with Booz Allen & Hamilton Inc., is that "German manufacturers have kept demand high by keeping the pipeline pretty slim."

They have tried to "create an illusion of scarcity to enhance the price of their product. That makes the Mercedes a luxury car here whereas it is not there."

Karl-Heinz Faber, vice president of product compliance and service administration of Mercedes-Benz North America Inc., has denied that its dealers are losing any sales to the gray market. "All of our dealers are selling every car in their inventory," he told the Oklahoma Motor Vehicle Commission last October.

Nevertheless, Faber urged the commission to take action against gray marketeers. Besides health and safety concerns caused by faulty conversions, he cited soured customer relations.

The gray market, he said, is "anti-competitive. That is not free enterprise, but the age-old trick of using another person's investment to your advantage and the customer's misfortune."

Michael Jackson, senior vice president of Euro Motorcars Bethesda Inc., a Mercedes-Benz franchisee, denied that the gray market had any effect on the six authorized dealers in this area. "Business has never been better. Prices have not been affected." He added that a price freeze announced for 1985 models by Mercedes Benz NA reflects the increase in the price of dollars against marks, not competition from the gray market.

However, Mark White, vice president of Eurocars International, the area's largest direct importer, feels that competition has forced prices down. He claims to know of authorized dealers who are discounting a $32,000 Mercedes-Benz 300D to $28,000.

The "list price" of a 1984 gray market 300D is $26,500, according to Ben Jackson, who heads the Automobile Importers Compliance Association, the trade group for some 200 direct importers, shippers, modifiers and testers.

As a result, a two-tiered market in luxury European imports has developed. Indeed, some franchised dealers are said to have a foot in both markets.

White and Peter Lissiuk, president of Emerald City Design in Gaithersburg, a converter, both speak of being approached by local authorized dealers who want either to buy their converted cars wholesale or have them convert cars the dealers buy themselves in Germany.

They said the dealers were driven either by need to supplement their inventories or greed to make a bigger profit. (A 72-day strike this year by German metalworkers cut back supplies and may have been another factor in the increase in gray market Mercedes-Benz cars as customers elected to buy used cars rather than wait.)

"Sure, I'm short of cars. The easiest thing would be to get them to convert cars. But I won't do it," said Mike Jackson, "because I'm in business for the long haul. I don't want customer complaints." He reports seeing 50 cars brought in for service at his dealership with poor pollution and safety modifications or none at all.

Dealers insist that retrofitted cars are never as good mechanically as factory export models. Among the difficulties or hazards cited by Faber of Mercedes-Benz NA are different compression ratios, which eventually lead to knocking and pinging; weak side door reinforcements; and catalytic converters installed too close to the fuel lines, risking fire. Although most converters insist they do quality work, AICA's Jackson admits some lack the necessary skills.

Quite a few are former garage mechanics who worked on foreign cars before getting into the more lucrative business of importation and modification. AICA says gray market profits range from 10 percent to 30 percent per car, the same as dealers get, although the dollar amount is smaller.

A customer survey by Eurocars International notes that 80 percent of the buyers are price sensitive; 20 percent deal in the gray market because the models they desire are not exported here.

The argument used most frequently by dealers is that gray marketeers are endangering the reputation of Mercedes-Benz as a quality car. Morton Zetlin, general partner of the American Service Center in Arlington, grumbles about creating "Mickey Mouse" or jerry-built Mercedes-Benz cars that will disappoint customers and deter them from buying in the future.

Dealers say they service gray market cars reluctantly for fear of liability suits, but none questioned refused to work on them. Some say they refuse to take a gray market car in trade, while others will, but, they say, not for resale to their customers. This allows them to give a lower price on a trade-in. Independent car dealers offer more. Generally speaking, gray market cars retain almost as high a percentage of their original price as export models.

The gray market has become "a huge mess," in the words of an EPA spokesman. The National Highway Transportation Safety Administration devotes 25 percent of its budget to compliance. Customers complain that the average processing time is now about 6 1/2 months and that it can take up to a year before the paperwork is done and the bond released.

This fall the president signed into law the Motor Vehicle Theft Law Enforcement Act. It outlaws the importation of non-conforming cars under bond and calls for vehicle identification numbers to be affixed on parts by the manufacturer. NHTSA must now decide whether only original manufacturers will be permitted to affix anti-theft numbers or whether converters, here or abroad, will be considered manufacturers under the law. Should the agency designate only original manufacturers, the gray market could not survive.

Meanwhile, the EPA is preparing to issue a proposal this month that also would affect the market. The alternatives are said to include an outright ban on non-conforming vehicles or certification that all importers, not just authorized dealers, meet all environmental standards. The second choice would mean that jobbers would have to meet the same fleet requirements as dealers. The approximate cost of certification would be $50,000 per model of car per importer.

Eurocars International said it would pay whatever is necessary to stay in business.

But the AICA expects a massive consolidation of smaller importers. "I'm committed to $500,000 in debt to expand. I'd lose everything [if certification is required]," Lissiuk said. CAPTION: Picture, Mercedez-Benz 300D model, which lists for $31.940, is sold for $25,000 by some unauthorized U.S. dealers. Mercedes-Benz of North America