Volkswagen (VLKAY)

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Volkswagen AG (FRA:VOW) is an automobile manufacturer based in Germany. Volkswagen controls 9 percent of the world market share in the automotive industry, with strong footholds in most of Europe, especially Germany, and also a growing market presence in China.^[1]

Concern about global warming, and U.S. and E.U. government legislation will drive an increasing demand for smaller, more fuel efficient vehicles, thus benefiting Volkswagen and its relatively environmentally-friendly cars. Despite this, the global auto industry remains plagued by over capacity (making it highly competitive) and Volkswagen's larely unionized work face means the company will face significant hurdles in attempts to improve effiency and reduce costs.

Company Overview

Volkswagen currently produces everything from cheap small cars to super high-end luxury automobiles, also boasting an impressive commercial wing that produces everything from pick-up trucks and buses to heavy trucks. In addition to factories in twelve European countries, Volkswagen currently has production plants in North America, South America, Africa, and Asia. Volkswagen finances the purchase and lease of its vehicles through a successful financial services division. Volkswagen's business focus continues to be largely European, and the country has traditionally struggled in the US. Volkwagen's North American operations are more of a struggle for the company, with the exception of the Audi brand. The VW brand has limited North American product offerings that are expensive compared to similar products from Japanese automakers, partially because of the currency effects of importing cars from Europe. The company's offerings also largely ignore the small SUV, truck, and minivan segments. Conversely, the company's offerings match consumer expectations much better in Europe, where the company continues to be highly successful.

Volkswagen sells vehicles under the following automotive brands^[2]:

Business Segments

Volkswagen Passenger Vehicles

The auto industry, both in the EU and N. America, has too much capacity compared to demand in its light vehicle sector. As seen in the graph, this trend is increasing. Sooner or later, the auto industry will either need to size down to increase utilization, or increase demand. As for Volkswagen, it hopes to achieve the latter by introducing Up! Source:PricewaterhouseCoopers^[3]

Volkswagen focuses largely on smaller, no-frills vehicles for mass consumption. Volkswagen's introduction of Up! is consistent with other automakers that have realized that using profits from bigger cars to subsidize smaller ones presents long-term profitability issues in the face of changing demand. For example, GM plans to adopt low-cost manufacturing techniques by not installing unnecessary technology in its cheap cars.^[3] On the other hand, Lewis Booth, Ford’s CFO, plans to make small cars that are as good to drive as bigger ones and charge accordingly.^[3]

Audi produces upscale vehicles engineered for greater driving precision. In recent, Audi has expanded its product range to include the new Audi A3 Cabriolet and Audi Q5 models.

Bentley is a super-luxe division based in Britain that produces 7 models.

SEAT vehicles are simple and designed for mass consumption, with sales heavily focused in Spain and Latin America albeit expanding in Northern and Eastern Europe.

Škoda vehicles, known for reliability and simplicity, are moderately priced compared to VW's other lineups.

Volkswagen Commercial Vehicles produces eight models that include light commercial vehicles, heavy trucks, and buses, which are marketed globally.

The company employs roughly 329,000 workers worldwide employed at 48 manufacturing facilities located throughout nineteen different countries.^[4] Volkswagen's products are marketed in 154 countries.^[5]

Financial Services

Financing is essential to the company's operations in developed markets. For example, 70-80% of cars marketed in western markets are financed, either through loans or leasing.^[6] This division is also issues insurance and handles the fleet management business.

Emerging Markets

Although the recent economic downturn has left most automakers thinking more about survival than growth, the long-term growth potential for car sales remains Brazil, Russia, India and China - BRIC countries. VW has done better than most in tapping these growing markets. For example, projections indicate that overall car sales in India will triple over the next ten years, and VW currently has two factories there, and markets Audi, Skoda, and the VW brands therein.^[7] VW organized many years two major joint ventures to produce and market its vehicles in China, today these two companies control about 20% of the Chinese market.^[8][9]

Automotive sales in emerging markets has changed considerably over the last several years. Whereas most major automakers once took legacy models from the US or Europe, and simply started manufacturing and selling them in the lower income country, this method is no longer viable as emerging market consumers increasingly expect the most up-to-date technology and models that fit the specific driving needs of their country.^[10] And with increasing competition in the industry, they have become increasingly able to satisfy this desire.

Key Trends and Forces

VW's Consumer Trends are Fickle Due to its Huge Diversity of Brands

Consumer demand is finicky and hard to predict. As gas prices continue to rise and the US (CAFE Standards, which require average fleet efficiencies of 35 mpg by 2020) and European Unions (EU series 5 emissions regulation) enacted a variety of stricter emissions standards, most people assumed that car buyers everywhere would want smaller, less powerful cars. In a study recently conducted by J.D. Power and Associates to determine automobile environmental impact, Volkswagen's European pedigree of small, moderately powered cars allowed it to rank highest of the AEI nameplates.^[11] Three of its models were listed in the survey's 30 most environmentally friendly vehicles (the new Beetle, the Jetta, and the Golf).^[12] While Volkswagen ideally hopes to pair high fuel efficiency with relatively low selling prices, combining an appeal to environmental sensibilities with a more pragmatic, price-conscious attraction, as oil prices have plunged the profitability of such a scheme has become less sure.

Another possible problem is Volkswagen's huge diversity of brands that literally range from the absolute cheapest to the most outrageously expensive cars sold today. Meeting such a wide range of customers' demands is a tall order, that one wonders if any company could satisfy. One is reminded of General Motors (GM) once huge diversity of brands and its ultimate inability to make any of these successful.

As a Multi-National Firm, VW is Sensitive to Fluctuating Exchange rates

Monetary exchange rates have a significant impact on international companies. Volkswagen's large-scale global operations makes it particularly sensitive to fluctuations in the strength of the euro relative to other currencies. As the Euro has been strong over the past several years, the company ends up paying a significant portion of production costs in the relatively more valuable euros. When these same cars are sold in other countries in prices denominated in relatively less valuable currencies, Volkswagen makes less of a profit than it would had these cars had been paid for in euros.

The CEO of Audi (one of Volkwagen's subsidiaries) claimed that the whole company could benefit "tremendously" from the construction of a production facility in North America by mitigating the effects of the strong euro. Volkswagen has since announced plans to build a new manufacturing plant for the North American market in Tennessee, with plans to begin production by 2011.^[13]

Commodity Prices Play an Integral Role in VW's Cost of Goods

Commodity Price trends threaten to drive up the cost of both car manufacturing and car ownership.

• Steel: One of the main ingredients in cars is steel, so increases in steel prices reduce VW's margins. Volkswagen cannot easily substitute another material for steel to reduce its costs, unlike almost any other input into car production, even labor.

• Aluminum also affect the company's margins as this metal is also a significant production input, accounting for around 300 pounds of a new car's weight.

• Oil prices: Increases in the cost of gasoline inflate the day-to-day cost of car ownership. Since consumers buy cars only infrequently, rising oil prices have only a limited impact on year-to-year car sales, but over time they cut into the industry's sales, and force companies to design more fuel-efficient fleets.

VW is Susceptible to Inflexible Labor Due to its Heavy Concentration of German Workers

53.3% of Volkswagen's labor base is in Germany, heavily unionized, and entrenched by some of the world's most strict labor regulations.^[14] This, and the fact that employees elect half of the VW's Supervisory Board, makes difficult any efforts by the company to cut costs, increase efficiency or downsize the labor force.^[15]

As the Largest Foreign Automaker in China, VW has a Large Stake in Chinese Economic and Currency Fluctuations

Volkswagen is currently China's largest foreign automaker, and China is also Volkswagen's greatest market. As such, this interdependent relationship means that VW's profitability responds sensitivity to China's economic situation.

VW uses third-degree price determination to capture the largest market share. VW's Audi brand represents its luxury brand, while VW represents its lower-end car. Furthermore, Volkswagen plans to invest 4.4 billion euros ($5.5 billion) to expand production capacity and introduce new models in the country.^[16] While VW has about 3.1% market share in the US, VW has about 16.6% market share in the Chinese auto market.^[17][18] As such, an appreciation of the yuan will boost VW's income sheet.

References

1. ↑ Volkswagen 2009 Annual Report, Pg 91
2. ↑ Volkswagen: Group Portrait
3. ↑ ^{3.0 3.1 3.2}
4. ↑ Volkswagen 2009 Form 10-K, Page 2
5. ↑ Volkswagen 2009 Form 10-K, Page 2
6. ↑ Volkswagen 2009 Form 10-K, Page 54
7. ↑ Volkswagen 2009 Form 10-K, Page 61
8. ↑ Wikipedia: Volkswagen Group China
9. ↑ Volkswagen 2009 Form 10-K, Page 79
10. ↑ Economist: A survey of cars in emerging markets.
11. ↑ Indiacar.com: Volkswagen Ranks High in J.D. Power Automotive Environmental Index
12. ↑ Indiacar.com: Volkswagen Ranks High in J.D. Power Automotive Environmental Index
13. ↑ VW Picks Tenn. for 1st U.S. car plant since '88
14. ↑ Volkswagen 2009 Form 10-K, Page 81-91
15. ↑ Volkswagen 2009 Form 10-K, Page 106
16. ↑ Volkswagen Group First-Half Sales Increase 46% in China, Led by Audi Brand
17. ↑ Volkswagen aims for 4% U.S. market share by 2012
18. ↑ VW Seeks China Chief as GM, Hyundai Steps Up Rivalry