In September 1936, the motor sport body AIACR laid down the Grand Prix formula specifications that were to apply from 1938. The key points were a maximum displacement of 3 litres for mechanically supercharged engines and 4.5 litres for naturally aspirated engines, and weight from a minimum of 400 kilograms to a maximum of 850 kilograms, according to displacement. These specifications necessitated a completely new car, so the 1937 season was still in full swing when the Mercedes-Benz designers finalised their car for the next racing season.
There was certainly no shortage of ideas in the racing design department: they considered using a W 24 naturally aspirated engine with three banks of eight cylinders each, a rear-positioned engine, direct petrol injection and a fully streamlined body. Mainly for heat reasons, they ultimately opted for a V12 configuration with a V angle of 60 degrees, developed at Daimler-Benz by the old master Albert Heess. The steel cylinders were combined in groups of three in welded-on steel plate cooling jackets, with non-removable heads. Powerful pumps propelled 100 litres of oil per minute through the approx. 250-kilogram engine. Compression was provided initially by two single-stage superchargers, which were replaced in 1939 with a single two-stage unit.
The engine was run on the test bench from January 1938. Then during its first virtually problem-free trial run on 7 February it developed 314 kW at 8000 rpm. The power available to the driver was 316 kW in the first half of the season, climbing to over 344 kW by the end of the racing year. The most powerful version of the engine was the 349 kW unit used by Hermann Lang in Reims, where his W 154 hurtled down the straight sections at a speed of 283 km/h at 7500 rpm. This was also the first Mercedes-Benz racing car to have a five-speed gearbox.
The changes made for the W 125 by chassis designer Max Wagner were much less extensive - the chassis was virtually unchanged from the previous year, although he did take the opportunity to increase the frame's torsional rigidity by 30 per cent. The V12 engine was deeply recessed, with the carburettor air inlets positioned in the middle of the radiator. The radiator grille became ever wider as the beginning of the season approached. The driver sat on the right, beside the propeller shaft. The W 154 crouched low over the asphalt, with the tops of the wheels well above the contours of the body. As well as enhancing the dynamic look of the car, this substantially lowered the centre of gravity. The racing drivers, as chief designer Rudolf Uhlenhaut's implicitly trusted consultants, were immediately impressed with the road-holding qualities of the new racer.
The W 154 was indeed able to outdo the exploits of its predecessor: this Silver Arrow gave the Mercedes-Benz racing department its greatest number of victories during this era. The first race of the new season ended in disappointment, as the car was unable to display its full potential on the twisting circuit in Pau, France, and was set back by a refuelling stop. But things rapidly improved thereafter. The Tripoli Grand Prix resulted in a triple victory for Lang, von Brauchitsch and Caracciola, a feat repeated at the French Grand Prix in the sequence von Brauchitsch, Caracciola and Lang. The British driver Richard Seaman, who had joined the team in 1937, won the German Grand Prix at the Nürburgring ahead of the car driven jointly by Caracciola and Lang, while Hermann Lang took the Coppa Ciano in Livorno and Rudolf Caracciola the Coppa Acerbo at Pescara. At the Swiss Grand Prix, the W 154 again filled all three places (Caracciola, Seaman, and von Brauchitsch). Rudolf Caracciola became European champion for the third time. Weakened by the death of its top driver Bernd Rosemeyer during record-breaking attempts in January 1938, Auto Union was unable to post any successes until towards the end of the season.