Can Ford Afford To Wait It Out In Russia?

Ford (NYSE:F) and General Motors (NYSE:GM) generally behave in a similar manner. Their performances in various geographies, save for China, are often broadly similar and they often tend to follow similar strategies to negotiate market conditions. However, their response to the threat the macroeconomic situation in Russia poses to their prospects in Europe could not be more different. The Russian economy has been struggling in recent quarters.  In 2015, GDP was down 3.7%, real incomes down 4% and unemployment higher by 7.4% on the back of falling oil prices and economic sanctions imposed by many countries in response to the country’s foreign policy in Ukraine. ^[1]

It was not long ago that Russia was set to overtake Germany as the biggest auto market in Europe. Russia is the most populous nation in Europe and its population is relatively under-penetrated in terms of vehicle ownership. Many predictions had the country as the fifth biggest car market by 2020. But now many companies are being forced to reconsider their strategy in the country. GM decided to stop selling Opel, its main European brand, and Chevrolet in the country in 2015. The Detroit based auto maker also shut down its St. Petersburg plant resulting in a $600 million special items charge for the company.

In contrast, Ford isn’t pulling out of Russia. Even though sales fell by 41% in 2015, the company is undertaking some changes to the way its business in the country is structured. ^[2] One of these changes involved the construction of a $275 million engine plant in the country earlier this year. ^[3] The goal of this plant was to increase the percentage of manufacturing cost of arising in Russia to 60% for vehicles for intended to the market. ^[4] This would allow Ford to qualify for lower import duties on a number of components used in its vehicles and equip many of its vehicles with locally built engines. It’s quite clear that Ford is banking on gaining market share in the country as it waits for the economy to recover. This could give the company an advantage over competitors like GM if they were to return provided the recovery happens.

Russia As Export Hub

Ford operates in Russia through a joint venture with a firm named Sollers. Mark Ovenden, head of Sollers, has stated that the company is looking at whether there is a possibility to export vehicles manufactured in Russia. In 2015, Ford sold 1.5 million new vehicles across 50 European markets, a 10% increase compared to its 2014 performance. ^[5] 1.3 million of these vehicles were sold in the 20 traditional European markets, representing an 11% increase.

Now Ford can produce as many as 350,000 units in Russia. It only sold 38,607 new vehicles in the country. Even if sales were to improve in 2016, there is still far more capacity in Ford’s plants in the country than demand for its products in the country. So Ford will have to sell these vehicles in the 20 traditional European markets, but it is hard to foresee the kind of demand in the near term needed to absorb excess capacity. In the near-term, the decision to keep manufacturing in Russia and use it as an export center is unlikely to be very profitable. In the longer term, the company is gambling on the sun shining on Russia the same way the markets thought it would in 2020 even if Ford might have to wait a little bit longer to realize the gains they expect.

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1. Russian GDP contracted 3.7% in 2015, Financial Times, January 2016 [↩]
2. Western automakers hit hard as Russia car sales fell 36% in 2015, Automotive News, January 2016 [↩]
3. Ford opens $275 million engine plant in Russia, Reuters, September 2015 [↩]
4. Ref: 3 [↩]
5. Ford’s Europe auto sales rise 10% in 2015, Market Watch, January 2016 [↩]