Mercedes-Benz Considering Manufacturing In Russia Amid Political Uncertainties

The Russian economy has been struggling lately amid geopolitical issues with Ukraine. The U.S. and the European Union issued sanctions against Russia for supporting separatist rebels in Ukraine, an accusation denied by Russia. In the wake of a possible new set of sanctions on the Eurasian country, we take a look at the impact of the ongoing Crimean crisis on the automotive industry. Russia is the world’s sixth largest vehicle market, which suffered a 5.7% decline in annual sales to around 2.6 million units last year, following three consecutive years of growth, owing to a slowing economy and negative consumer sentiment. Due to the continual weakening of domestic demand and high levels of inflation, and with the Western countries looking to tighten restrictions on Russia’s financial, defense and energy sectors, the International Monetary Fund lowered its outlook on the country’s GDP growth rate to 0.2% this year and 1% in 2015, down from the previously estimated growth rates of 1.3% and 2.3% in 2014 and 2015 respectively. ^[1] A possible spillover of the political tensions onto the automotive market could hamper operations of the German companies Volkswagen AG (OTCMKTS:VLKAY), Daimler AG and BMW in Russia.

In a bid to protect domestic vehicle and spare-parts manufacturers amid concerns over declining vehicles sales, and as a possible retaliation of the U.S. and European Union’s sanctions, Russia could ban import of cars into the country. If this goes into effect, Daimler’s luxury division Mercedes-Benz could suffer a blow, as the brand imports all of its vehicles into Russia, unlike compatriots Volkswagen’s Audi and BMW, who assemble their models in the country itself. However, Mercedes is also planning to commence local production in the country to compete better with its rivals.

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Mercedes-Benz Tops Luxury Vehicle Sales In Russia

Mercedes-Benz sold 44,376 units in Russia in 2013, 2305 units more than the volume sales for BMW in the country. ^[2] Audi stood at the third position in the Eurasian country, selling 36,150 vehicles. Despite tough economic conditions that resulted in a decline in the overall vehicle market, premium vehicle sales surged due to low luxury vehicle penetration levels and lesser impact of high interest rates and inflation on the affluent customers, the target base for luxury vehicle manufacturers. While Audi volumes rose 12% year-over-year, Mercedes’ volumes increased 19% last year in Russia. Mercedes is the preferred vehicle for state agencies, and as Russia looks to ban state purchases of imported cars unless built locally in completely-knocked-down (CKD) units, with a localization level of 50% and above, the automaker’s volumes in the country could drastically decline. ^[3] Although Russia represented only 3% of the net volumes for Mercedes in 2013, the luxury maker is looking to derive high growth from the BRIC nation in the coming years to compete better with BMW and Audi on a global front.

Mercedes lost its worldwide luxury vehicle sales lead to BMW in 2005, and is now the third highest-selling premium brand behind both BMW and Audi. Russia sales could also be somewhat crucial as Mercedes looks to retake the global luxury lead by the end of the decade. Motorization rate (number of vehicles per 1000 inhabitants) in the country is still less than half the rate of roughly 800 vehicles per 1000 inhabitants in the U.S., and luxury volumes still form a very small portion of the overall vehicle market. The three German luxury automakers, which form bulk of the luxury volumes in Russia, constituted roughly 4% of the net volumes in the country last year.

Mercedes-Benz Looking To Start Producing Cars In Russia

As the Russian passenger vehicle market continues to struggle due to the ongoing geopolitical tensions, negative consumer sentiment, high inflation and a weak ruble, foreign automakers estimate this market to decline by 14-18% this year. ^[4] Despite the fall in overall industry volumes, Mercedes-Benz reported another strong half in Russia, with sales rising 20% year-over-year. ^[5] However, according to Dieter Zetsche, Chairman of Daimler AG, unfavorable macroeconomic conditions seem to have caught up with the country’s luxury vehicle market as well, as volumes are now beginning to decline. ^[6] Now that Russia could ban import of cars or impose restrictions on state agencies to purchase only locally built vehicles, Mercedes’ exports could suffer. This could prompt the luxury car division to move ahead with plans of producing vehicles in Russia itself. In addition to evading the possible import ban, local production is expected to improve Mercedes’ competitiveness in the country.

• Benefits From Synergies Between The Trucks And Cars Division

Daimler already has joint ventures Mercedes-Benz Trucks Vostok OAO and Fuso Kamaz Trucks Rus Ltd., formed in partnership with the Russian truck manufacturer Kamaz OAO. These joint ventures produce and distribute Mercedes-Benz and FUSO trucks and distribute Mercedes-Benz and Setra buses in Russia, from the plant at Naberezhnye Chelny. In addition, Mercedes-Benz Vans also started producing the Sprinter Classic, in cooperation with the commercial vehicle manufacturer Gaz Group, in the second half of 2013. Mercedes is now planning to assemble the large-sedan S-Class in Naberezhnye Chelny, extending its partnership with Kamaz. ((Assembly of S-Class Mercedes-Benz can start in Russia, autostat.ru)) By leveraging its already established partnership with Kamaz, and manufacturing in Naberezhnye Chelny itself, Mercedes-Benz could benefit from synergies and possibly lower initial setup costs.

• Stiffer Competition To Audi And BMW By Adding A Local Facility

Unlike Mercedes-Benz, both BMW and Audi assemble their luxury vehicle offerings in Russia. BMW assembles its models at a plant in Kaliningrad, in partnership with the Russian company Avtotor. Back in 2012, both BMW and Avtotor planned to invest 50 million euros each to construct a new assembly plant and double the production capacity. ^[7] Expanding the local base could bring BMW’s localization level to 48%, reducing transportation costs and costs of sourcing raw materials, and could thereby drag down model prices. On the other hand, Audi also started assembling its A6, A7, A8L, Q5 and Q7 models in a semi-knocked-down (SKD) facility at Kaluga, Russia, last year. Volkswagen and Skoda models were already built in Kaluga since 2007. Audi is also looking to expand further in Russia and improve its localization levels. By setting-up production in Russia, Mercedes-Benz could also reduce the added costs of exporting, making the popular luxury brand relatively more affordable. But more importantly, in the event of a possible ban on imported vehicles, Mercedes-Benz would not witness a steep decline in Russia volumes owing to local production.

Mercedes is also exposed to risks of unfavorable foreign currency translations as it exports all of its vehicles to Russia. The Russian ruble depreciated by around 13% against the U.S. dollar from 2013 to mid-2014, and continues to be volatile amid uncertainties in the political environment. ^[8] On account of local production, Mercedes would protect itself from any drastic movements in the ruble. Price-points are expected to be crucial driver in the Russian luxury vehicle market going forward, as weakening economic conditions might restrict disposable income growth and consumers might look to avoid unnecessary expenditures.

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1. IMF cuts Russia’s GDP growth rate forecast, en.itar-tass.com [↩]
2. Daimler mulls production of Mercedes cars in Russia, autonews.com [↩]
3. Russia could ban state purchases of imported cars [↩]
4. Citroen, Volkswagen, Nissan forecast Russia’s 2014 car market fall, itar-tass.com [↩]
5. Daimler shines on Mercedes S-Class sales [↩]
6. Ukraine crisis slows Daimler’s Russian growth, reuters.com [↩]
7. BMW and Avtotor expand production in Kaliningrad, wsj.com [↩]
8. Russian ruble against the U.S. dollar [↩]