Volkswagen Heads East Essay, Research Paper

Volkswagen Heads East (or Skoda Heads West)

Competition in the global auto industry has become increasingly fierce among the dozen surviving major manufacturers in the early 1990s. With the dramatic successes of the Japanese leaders (Toyota, Nissan, and Honda), both the North American and European industries have become subject to intense rivalry among U.S., Japanese, and European automakers. If we look at the Table 1, it shows the positions of major competitors in Western Europe during 1990. These conditions have led to calls for protection in the European Community against outside producers, as well as responses by the European car companies looking to solidify their positions.

The increasing intensify of competition in Europe appears to due to several factors. First and the most important, the Japanese firms expanded their local production aggressively in North America during the 1980s, and now they are looking to the European market as the last major target in the global industry where their positions are weak. The leading Japanese firms, with their high quality and low-cost cars, produced growing profits and market shares during the late 1980s at the same time as their U.S. and European rivals (broadly speaking) have faced declining shares, low profits and/or losses, and generally difficult conditions. Second, the opening of Eastern Europe that began with Soviet President Gorbachev s policy of perestroika has led to aggressive strategies by several firms to build business in Eastern Europe. And third, the European Community s goal of achieving much greater economic integration by the end of 1992 has led to Japanese and U.S. automakers to pursue more extensive local production in Europe. These firms want both to benefit from region from region-wide economies of scale that the reduced commercial barriers will allow and to avoid being excluded by whatever protectionism may occur against non-European firms after 1992.

One of the most active responses of the European firms has been to pursue business in Eastern Europe, in countries of the former communist bloc. Of course, the most rapid expansion has been into region that was formerly East Germany. There Volkswagen negotiated a joint production agreement with IFA Kombinat Personenkraftwagen to make Polos and Golfs (to replace the infamous two-stroke East German Trabant), Opel (part of General Motors) agreed to build a new assembly plant in Eisenach (to replace the East German Wartburg), BMW invested in machine tools and parts manufacturing, and Ford established an extensive dealer network-all by the end of 1990.

More than a dozen major investment contracts had been signed by the automakers by the end of 1990. This set of conditions provides the background to the decision of Czechoslovakia s Skoda auto works to sell part ownership to an outside automaker, so that Skoda could survive the opening of the Czechoslovak economy in the 1990s.

Table 1. Western Europe s Auto Market in 1990 (Jan.-Oct.)

Company Sales in Percent Change Market

$US Millions vs. Year Earlier Share

Volkswagen 1,739 +1.9% 15.2%

Fiat 1,684 -4.9% 14.2%

Peugeot Citroen 1,483 +1.0% 13.0%

General Motors 1,344 +2.7% 11.7%

Ford 1.324 -3.7% 11.6%

Renault 1,117 -5.0% 9.8%

Mercedes-Benz 373 +2.8% 3.3%

Rover 344 -5.8% 3.0%

BMW 314 -5.4% 2.7%

Volvo 204 -10.3% 1.8%

Japanese 1.339 +6.1% 11.7%

Others 235 -5.0% 2.0%

Total 11,440 -0.9% 100.00%

Skoda Automobile Company, Mlada, Boleslav

Skoda has been the main automobile manufacturer in Czechoslovakia and in East Europe. It was spun off in 1945 from the Skoda Industrial Works, which has been established in 1859. Skoda works, a top-caliber engineering company, competed on level terms with the finest German and American companies of the day. Skoda cars were popular on European roads between the two world wars.

Skoda s three assembly plants were producing about 185,000 cars per year in 1989. Only one model, the Favorit, based on the eight year-old design of the Italian Bertone, was in production at that time. The firm employed about 21,000 workers, of which 1600 were Soviet-style gulag prisoners, and sold $US 588 million of cars in 1989.

The Czechoslovak government, as owner of Skoda, faced a daunting task when the country became independent of Soviet Union in 1990. Because the cornerstone of reform was the establishment of a market-based economy, competitive firms would be necessary for the future. This implied that some of the main state-owned companies, that provided many jobs and significant income, would likely have to be privatized in some form or other.

The Czechoslovak government s main concern in selling Skoda to foreign buyer was that production in Czechoslovakia would not be reduced or terminated, but contrarily that it would be expanded and that jobs would be guaranteed. Since the local market will take several years to build up purchasing power relative to Western European countries, it was expected that the foreign buyer of Skoda would export a significant amount of the locally produced cars through its international dealership network. While the government wanted to maintain majority local ownership over Skoda, apparently this concern was not an overriding one.

The Competition Between Volkswagen and Renault/Volvo

In 1990, with the assistance of Waterhouse, the Czechoslovak government formally opened a bidding process for foreign purchase of part ownership in Skoda. Twenty-four foreign automakers examined the Skoda offer.

Renault and Volvo, both in fairly weak financial conditions at the time, offered to invest about FF 14 billion (just under $US 3 billion) in Czechoslovakia over 10 years. They agreed reluctantly to maintain the Skoda name and to export cars into the European Community market. The Renault/Volvo offer was dwarfed by Volkswagen s bid. VW agreed to invest DM 9.5 billion (about $US 6.5 billion) over 10 years, to guarantee jobs in Czechoslovakia, and to preserve Skoda as a separate division in Volkswagen (as had been done with the acquisition of Spain s SEAT in 1986). VW s stated intent was to place Skoda at the inexpensive end of its product line and to expand market share in that segment (along with sales from SEAT). Volkswagen planned to expand production in Czechoslovakia to double the current level of output by 1995.

Skoda s trade union, concerned over drastic layoffs by the Renault/Volvo consortium, demanded that Volkswagen be chosen as the partner, contending that it clearly offered better employment guarantees and fringe benefits. The Czech government denied this to be a factor in its final decision and stressed the generosity of the VW offer-, which in financial terms was equal to 1/10 of total Czechoslovakian GNP! The Czech Prime Minister, Peter Pithart, listed as the main reasons for choosing Volkswagen the proposed technology investments, impact on employment, willingness to respect the Skoda brand name, and VW s leading position in the European auto market.

Implications for Volkswagen

Volkswagen has now committed itself to huge capital investment in a politically unstable country with greatly limited purchasing power. In addition VW has agreed to preserve the jobs of the existing Skoda workers and to expand production (and presumably employment) during the 1990s. This commitment comes at the same time as the growth of competition in the European auto market and when VW has very limited market shares in North America and Japan.

In exchange for the costs of this agreement, Volkswagen received 31% ownership of Skoda in 1991 and an increasing share up to 70% ownership by 1995, as VW s capital investment increases. Tax treatment and other incentives are not publicly available at this time, but one might assume that the government offered some favorable treatment.

This strategy creates a huge risk for Volkswagen during the 1990s. If Skoda cannot be turned into a competitive international firm, VW will have used up precious resources at a time when the firm is already subject to serious competitive pressures in its traditional European domain.

Postscript: The Skoda joint venture and the acquisition of the East German Trabant s manufacturer are by no means the only VW initiatives in its quest to establish itself as the leader in the East European automobile industry. Since the Skoda bid, Volkswagen has also gained a majority stake in another Czechoslovakian automobile manufacturer for which it bid in competition with General Motors. With an initial investment of $US 35 million in 1991, Volkswagen will acquire an 80% stake in BAZ. The remaining 20% will belong to Czechoslovak government.