In Puebla we trust: VW launches New Jetta/Bora to spur export growth.

Volkswagen de Mexico (VWM) has been designated as the sole global production site for the technologically sophisticated New Jetta. This vehicle has been designed specifically for the U.S. market. It is equipped with an upgraded 2.5L engine that unleashes 150HP and is 10 inches longer than its predecessor.

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It is roughly the size of a Honda Civic, Toyota Corolla and Mazda3, leaders in the U.S. small car segment. Base prices for all these vehicles, including the New Jetta, are around US$18,000.

The New Jetta holds the key to Volkswagen's success in the United States, where it accounts for approximately 40 percent of VW sales.

Indeed, Volkswagen is optimistic that the model will help reverse the company's financial tailspin in the United States, a crucial market that represents almost 60 percent of North American sales.

During the first nine months of 2004, operating profits in North America revealed a loss of 614 million euros or US$768 million. Even so, company executives and industry analysts expect the yearly figures to surpass 900 million euros or US$1.1 billion, when they are disclosed at the end of March.

Since Nafta was launched in 1994, VWM--like most other leading automotive manufacturers--has used Mexico as an export platform to the United States. For example, in 2004, 72 percent of the firm's output was exported--52 percent to the U.S./Canada market and 18 percent to Europe.

By contrast, only 28 percent of production was for the Mexican (domestic) market. Although the New Jetta is targeted primarily for the United States, it also will be sold in Europe and Mexico, where it will be marketed as a Bora.

Mexico Is Key Player

Mexico is Volkswagen's only production site in North America and the company's ninth-largest market in terms of unit sales. The value of its total sales (domestic and export markets) is approximately US$6 billion. It is a key player in the Volkswagen universe, laden with tradition and nostalgia.

Throughout the 1970s and 1980s, hundreds of thousands of two-door VW sedans (Bugs and Beetles), affectionately called Vochos, rolled off the assembly lines. These vehicles were Mexico's best sellers and omnipresent as taxicabs that wove impertinently through the city's increasingly congested streets and perifericos.

While VW Sedans were eclipsed in the 1990s by more sophisticated entry-level vehicles, the original model evoked such a profound sense of nostalgia that the company's hottest young designer, J. Mays, was given the mission of transforming it into a state-of-the-art passenger car.

In 1998, the new version was launched in Mexico and dubbed the new Beetle.

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VW selected Puebla as the world's sole manufacturing site of the New Beetle, a privilege now shared with the New Jetta.

In the United States, the Jetta is marketed as a small, upscale passenger car, but in Mexico it is an aspirational vehicle and it dominates Mexico's compact family sedan segment with a 33-percent share.

Before presenting an interview conceded by Otto Lindner, the CEO of VWM, in which he shared his outlook for his company and the role of the New Jetta, it is useful to provide a brief profile of Volkswagen's global operations.

Global Sales Profile

Volkswagen (VW) is the world's fourth-largest vehicle manufacturer.

In 2004, it produced and sold slightly more than 5 million units, mostly passenger cars. When revenue and net income figures for the year are revealed, they are likely to approximate the most recently published 12-month trailing numbers for the October 2003-September 2004 period. During this time frame, global revenues totaled US$117 billion and net income US$973 million.

Based on Volkswagen's figures for the first nine months of 2004, it is clear the company's future financial results are dependent primarily on performance in two regional markets--Europe and North America.

While Europe has provided VW with the lion's share of its revenues and earnings, North America, particularly the United States, has produced staggering losses.

Europe and Germany

The company's manufacturing and sales strategies are dominated by Europe, primarily centered in Germany.

However, production sites and consumer targets in the Asia-Pacific region (especially China), the Americas (particularly the United States), and South America (with primary focus on Brazil) are becoming increasingly important.

For instance, in 2004, Europe represented 61 percent of Volkswagen's global sales.

In unit terms, the company sold more than 3 million vehicles there, up a scant 1.3 percent in Europe's hypercompetitive business environment. Germany alone, Volkswagen's most important market, accounted for 19 percent of global sales (954,000 units).

From the vantage point of value, measured in euros and U.S. dollars, Europe is even more important.

For the first nine months of 2004, 73 percent of Volkswagen's revenues were earned there and virtually all of its operating profits. During this period, revenues and operating profits in Europe totaled 49.4 billion euros (US$61.8 billion) and 1.9 billion euros (US$2.4 billion), respectively.

North America

In 2004, North American sales amounted to 572,000 units, or 11.3 percent of the global total. The United States accounted for 334,000 (6.6 percent), Mexico 201,000 (4 percent) and Canada 37,000 (0.7 percent) vehicles.

During the first nine months of 2004, the Americas ranked No. 2 in terms of revenue contribution and No. 1 in operating losses! During this period, North America produced revenues of 9.6 billion euros, or US$11.9 billion, 14.2 percent of the world total.

Asia-Pacific Region

By comparison, Asia Pacific, the company's second-leading market, declined by 6.3 percent in 2004, as new entrants continued piling into China.

Although the country is one of the world's fastest growing economies, increasing inflation and sharp reductions in consumer credit last year triggered overproduction, high inventory levels and price wars among VW and its major competitors--General Motors, Toyota and Nissan.

In 2004, VW sold 757,000 vehicles in the Asia-Pacific region. These units represented 15 percent of global sales.

More importantly, excluding China, Asia Pacific contributed 17 percent of Volkswagen's worldwide operating profits during the first nine months of the year (206 million euros or US$258 million), but only 6.8 percent (4.6 billion euros, or US$5.8 billion) of total revenues.

China itself produced 266 million euros (US$333 million) in operating profits during the same period.

Because Volkswagen's Chinese operations are joint ventures, financial performance is reported by using the equity method of accounting (pro rata ownership stake), and not consolidated with other Asia-Pacific results.

VW SALES BY REGION AND COUNTRY
(TOTAL FIGURES ROUNDED TO NEAREST THOUSAND)*

               2004       2003       2004 Share

Europe         3,085,000  3,045,000   60.7%
Germany          954,000    943,000   18.8%
Asia Pacific     757,000    808,000   14.9%
China            655,000    691,000   12.9%
North America    572,000    631,000   11.3%
United States    334,000    389,000    6.6%
South America    533,000    426,000   10.5%
Brazil           362,000    315,000    7.1%
Total          5,079,000  5,015,000  100%

Source: Volkswagen *Sales are wholesale, but U.S. sales are retail.

RELATED ARTICLE: VW CEO Speaks Out

Otto Lindner chatted with BUSINESS MEXICO in mid-January, confident that VW's US$2 billion investment in Mexico will pay dividends as it battles back from a difficult year. Lindner expects the New Jetta to play a significant role in VW's global strategy, referring to it as Volkswagen's "bread-and-butter vehicle."

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How many New Jettas (Boras) do you plan to produce in 2005?

We expect to manufacture and sell more than 200,000 units.

What are the major target markets?

Sixty percent will be allocated to the United States and Canada, and 40 percent to Mexico and Europe.

When will these vehicles actually be launched?

Mexican dealers will receive them first, on February 15, and in March they will be available for sale in the United States. What remains unclear and is being negotiated as we speak is the European launch. We must make a strategic decision--to make the Bora part of a Pan-European launch, or to begin the introduction in Germany and then roll out the vehicle throughout Europe.

Regardless of the strategic choice, when will the European Bora be launched?

Perhaps it will be introduced in September at the Frankfurt Auto Show.

Are the New Jettas that will be sold in the United States and Canada essentially the same vehicles as the Boras that will be marketed in Europe and Mexico?

Yes.

Where will the New Jettas/Boras be produced?

They will be manufactured only in Mexico. The previous model was produced in Wolfsburg (Germany), as well as Mexico.

What will happen with the old Jettas?

We will continue producing them in Mexico for the local market and for Argentina. Last year, we shipped 3,000 of them to Argentina and believe the market for them will remain strong in Mexico, too.

What are the essential differences between the Jetta and the New Jetta?

The differences are in the technology and standard equipment. For instance, the New Jettas are all equipped with more powerful 2.5L five-cylinder engines that turn out 150HP and airbags are standard. They are also nearly a foot longer than their predecessors and roomier in the interior, especially in the rear, which now comfortably seats three passengers. And, finally the suspension is stiffer and affords better handling.

Although prices have not been revealed in Mexico, VW officials at the recent Detroit Auto Show suggested that U.S. prices would barely exceed those of the Jetta. In other words, between about US$18,000 and US$21,800. Will Mexican prices be competitive?

Yes, they will.

How important is the New Jetta to VWM?

It is hard to overestimate the New Jetta's significance because it is our bread-and-butter vehicle. Last year, almost 65 percent (145,000) of the 225,000 units we produced were Jettas.

How is VW positioning the New Jetta/Bora in its vehicle lineup?

It is positioned between the lower-end Golf and the upmarket Passat.

What is Volkswagen's planned total investment in Mexico for the 2003-2008 period, and how much will be absorbed by the New Jetta program?

Our total investment is programmed for US$2 billion. The New Jetta and the Variant (New Jetta Stationwagon) to be introduced in 2006 will absorb 70 percent of the investment. The rest will be dedicated to plant modernization and logistics.

What other vehicles do you make in Mexico?

We also produce the New Beetle--hardtops and convertibles. In 2004, 36 percent (81,000 units) of our output were New Beetles. The convertibles now outsell the hardtops. They have proven to be a great innovation and have extended the brand's longevity significantly.

How many New Beetles do you expect to produce in 2005?

Probably the same number as last year.

What percentage of the company's output is produced for export?

We manufacture more than 70 percent of our vehicles for export, mostly for the United States, but a growing percentage will be targeted for Europe.

What is Volkswagen's installed capacity?

Our capacity is about 400,000 units in two shifts, but can be extended easily to 480,000 when we work three shifts or add a sixth day. We just introduced a third shift for the New Jetta launch.

What was your capacity utilization rate last year?

We utilized slightly more than 56 percent of our capacity.

In 2000, you produced more than 400,000 vehicles and operated at full capacity. What caused the sharp drop since then?

There are several key factors. First, our two main products--Jetta and New Beetle--have aged. Second, the sharp appreciation of the euro against the U.S. dollar has made our vehicles less competitive, especially in export markets. And third, we lost a lot of production last year due to the conversion of the plant to production of the New Jetta.

When do you anticipate returning to producing 400,000 units annually?

Our plan calls for a return to full capacity in 2007, but we will need to add another vehicle, the Variant. This station wagon will be targeted at Europe, not the United States. In other words, we practically will double output in three years and most of the increases will be for the New Jetta/Bora. This year, we should produce more than 300,000 units and by 2007 we will add another 100,000.

Turning to the Mexican market, what models are the best sellers?

Our best-selling models in 2004 were subcompact Pointers. We sold 65,000 of these, or about 33 percent of our total domestic sales. Our second leading model was the Jetta. We sold 57,000 of them, 29 percent of our Mexican sales. However, the Jetta is our top revenue producer because it is much more expensive than the Pointer.

What other vehicles do you import?

In 2004, we imported 22,700 Seat models (Leon, Cordoba and Alhambra) from Spain. These units are mostly sporty and appeal to younger drivers, but the Alhambra is a full-size multipurpose minivan. In addition, we imported Passat (1,344) and Golf (2,468) passenger cars from Germany and Sharan (640) minivans from Portugal.

What percentage of your Mexican sales were imports?

Last year, we imported about 70 percent of the vehicles we sold domestically.

How many suppliers does VWM have?

We have a total of 270, but only 50-60 are Tier 1, world-class suppliers.

How many of these are European?

Approximately 30 percent are European and work with us globally.

There has been a lot of talk lately about modularization and the growing importance of locating suppliers within the assembly plant itself or in a nearby supplier park. How is the Puebla operation organized?

We have more than a dozen top suppliers who are located less than a kilometer from the vehicle plant. They deliver key modules like seats and cockpits to our assembly line.

What percentage of your factory is robotized or automatic?

The body shop is over 80 percent automatic; the paint shop over 95 percent.

Obviously, in this age of globalization, auto-makers are operating in low-cost countries in order to gain competitive advantages against their rivals. How do Mexican costs compare with Eastern Europe's?

Mexico's costs are more expensive than in Eastern Europe, but less than those in Southern Europe.

It is difficult to discuss Mexico's competitiveness without some mention of China, India and Asia Pacific. How does VW view the opportunities there?

China is already a crucial country for us, and it will become more important for us in the future. From the vantage point of sales, China is exceeded only by Germany, and from the perspective of earnings it produces higher operating profits than any country outside of Europe. Although Mexico is the sole production site for the New Jetta, China will be assembling a Bora shortly using Mexican parts. In addition, India will become an important site for us in the next two to three years.

How is VWM organized today?

As of January 1, 2005, Bernd Pischetsrieder, Volkswagen's CEO, has been given responsibility for VW operations in Mexico and the United States. Our operations are now moving toward a matrix organization that simultaneously focuses on strengthening our brands (Volkswagen and Audi) and integrating them more tightly with our management of sales. The VW brands are being managed from Ingolstadt, Austria, and Audi brands from Wolfsburg, Germany.

Where are VW's biggest challenges?

Our biggest challenges are in the United States and Europe, where competition is fiercest.

How will you attack these challenges?

We will respond as our CEO Bernd Pischetsrieder has suggested, by introducing 20 new models in 2005, led by the New Jetta/Bora and Passat.

Marc N. Scheinman is a professor of international marketing at Pace University (N.Y.) and a Fulbright professor in Mexico, Brazil and Argentina. He has covered the auto industry for the past 15 years, primarily in Mexico and Brazil.