Shifting Production To Central And Eastern Europe Could Boost Profits Of German Automakers

Large European automakers Volkswagen AG (OTCMKTS:VLKAY) and Daimler AG have in the last few years expanded production in countries outside of Europe, particularly Germany, to reach a wider consumer base and meet the growing vehicle demand across the globe. A broader production network also helps companies evade import taxes and other tariffs, transportation and shipment costs, thereby maintaining cost stability. Especially in emerging economies, automakers are raising investment levels, bolstered by lower production and operational costs in these countries. Some governments also provide incentives to manufacturers, as construction and functioning of large-scale auto production and assembly plants require thousands of workers, which in turn boosts employment levels and consumer spending in these countries. In addition to increasing production in the BRIC countries, both Volkswagen and Daimler are also investing in low-cost central and eastern European countries and little-by-little are shifting operations previously centered in western Europe. Reduced variable costs due to lower raw material costs and lower fixed costs due to lower wages will improve profitability for automakers, going forward.

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Low Costs In Central And Eastern Europe Could Fuel Production Growth

Central and eastern Europe constituted 37% of overall vehicle sales in Europe in 2013, by our estimates. ^{[1] [2]} Eastern Europe accounts for around 20% of all vehicles produced in Europe presently. ^[3] With central and eastern Europe most hit by the double-dip recession, vehicle sales in the region also fell. However, as economic activity begins to pick up in the region, coupled with lower vehicle ownership rates, vehicle sales could grow in the next couple of years. Motorization rates in countries such as Hungary and Romania stand at 342 and 240 vehicles per 1,000 inhabitants, respectively, lower than the 550+ vehicles per 1,000 people for most western European countries. ^[4] Even though vehicle demand in central and eastern Europe doesn’t grow significantly, increasing production capacity in the region provides the incentive of lower labor costs. According to the CEO of Audi, while hourly labor costs in Germany range from €40-€52, the costs decrease to €13 per hour in Hungary, and to below €5 per hour in Romania and Bulgaria. ^[1]

Almost one-fourth of Volkswagen’s vehicles, which are sold in 153 countries, are produced in Germany itself. With growing vehicle demand around the world, there is a need for setting up factories outside the domestic market and source a higher proportion of vehicles and their components closer to the final customer, reducing costs for vehicle manufacturers. Volkswagen and Daimler, as well as major Japanese automakers such as Toyota, previously relied only on exports to various countries, thereby controlling quality and ensuring optimum facility utilization. However, with large vehicle volumes exported outside domestic markets, taxes as well as transportation and shipping costs significantly increase. Setting up new production facilities and maintaining quality has also somewhat become easier for automakers, with technological developments and integration of vehicle platforms. For example, in 2012, Volkswagen introduced the modular transverse toolkit (MQB), which created an extremely flexible vehicle architecture, making it possible to produce different models of various brands in different quantities in the same production unit. Platform consolidation allows automakers to maintain quality and standardize products, irrespective of the country they are produced in. This also means that developmental costs for building a production or assembly plant could decrease, acting as an added incentive for setting up production outside the domestic market.

Volkswagen, Daimler Expand Production In Central And Eastern Europe

The Hungary division of Audi, Volkswagen’s luxury brand, manufactures the entire lineup of Volkswagen vehicles as well as produces the new compact sedan A3 in the Györ plant. The production capacity at the Györ plant rose to 125,000 units, from less than 35,000 units manufactured in 2012. ^[5] In addition, Skoda, which saw sales rise 26.2% in the major Central European markets in May, is also expanding its plant in Kvasiny, Czech Republic, to produce a large new sports utility vehicle (SUV). ^[6] The successor model to the Volkswagen Transporter and Crafter will be produced in Poland, after the collaboration between Mercedes and Volkswagen for manufacturing these commercial vehicle models ends in 2016. For this purpose, a plant will be built at Wrzesnia, Poland, providing 2,300 jobs.

On the other hand, Daimler is also looking to outsource production activities from Germany to countries with lower labor costs. The company expanded its production activities in central and eastern Europe in 2012, with production of compact luxury cars Mercedes B-Class and CLA-Class at the Hungary plant which employs 3,000 workers. Daimler’s Mercedes has only four production locations outside Europe and 11 locations within Europe, with Germany being the major manufacturing site. While overall vehicle production in Germany rose by only 1.2%, production in Romania and Hungary combined grew by 14% in 2013. ^[7] However, Germany still manufactures almost five times the number of vehicles produced in Romania, Hungary and Poland combined. Higher production in low-cost central and eastern European countries could boost profitability for the automaker. Mercedes’ operating margin stood at 7% in the first quarter of 2014, trailing Audi’s 10%. In addition to expanding production in China and Brazil, shifting operations to central and eastern European countries with lower wages might increase profits for Mercedes, going forward.

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1. Global vehicle sales [↩] [↩]
2. Western Europe vehicle sales [↩]
3. European automakers outsource production to eastern Europe and China, wsws.org [↩]
4. Vehicles in use [↩]
5. Audi Gyor plants stats [↩]
6. Skoda may sales [↩]
7. Vehicle production globally [↩]