China Deal

Volkswagen Hits a Speed Bump

VW_corbis2
German engineering, Shanghai-style.
  • Why it matters

    Why it matters

    China accounts for a third of Volkswagen’s total sales and its joint ventures there are highly profitable. But the company is facing sluggish markets at home and risks putting all its eggs in one basket.

  • Facts

    Facts

    • Volkswagen has had a presence in China since the 1980s.
    • The company sold three million vehicles in the country last year.
    • It is increasing its investment and building a test track in the politically unstable Xinjiang province.
  • Audio

    Audio

  • Pdf

The state visit to Berlin by China’s Premier Li Keqiang last weekend brought a measure of relief to Volkswagen Group Chairman Martin Winterkorn.

After months of negotiations, his company extended its partnership with the Chinese carmaker First Automotive Works (FAW) for another 25 years, to 2041.

Though Mr. Winterkorn had stressed that talks with the company’s Chinese partners required time and patience, doubts were surfacing about whether Volkswagen could conclude a favorable agreement, particularly after FAW stalled the deal to gain the upper hand on several disputed issues.

And despite pushing through the deal, Volkswagen failed in its bid to increase its stake in the joint venture from 40 percent to 50 percent. The matter is still being discussed, however.

Volkswagen wants a bigger slice of the pie because the FAW deal is highly profitable, generating operating profits of €9.6 billion ($12.18 billion) – just €2 billion below the earnings of the entire German company. The larger the percentage in the venture, the larger the amount of cash pumped into the coffers of the Wolfsburg-based company.

FAW has all the disadvantages of a state-owned company. Its management is dominated by members of the ruling Communist party and, therefore, is susceptible to bribery and political influence

China is, by far, the largest market for Volkswagen. The company sold 3.3 million vehicles there last year, one-third of its total output. Vehicles are produced in two joint ventures: FAW-Volkswagen and Shanghai Volkswagen. Volkswagen operates the latter together with a local partner, SAIC, another state-owned car manufacturer.

Of the two joint ventures, FAW-Volkswagen is the more significant because it produces higher-end Audi cars, which generate much higher profit margins.

Volkswagen and FAW want to develop more vehicles together in China, with a focus reportedly on new types such as electric and hybrid cars. Both are said to be planning an investment of some €20 billion to increase annual production in China to four million cars by 2018. Volkswagen needs to invest to compensate for the weaknesses of its core brand.

Yet operations in China are not without complications. FAW executives are building a test and development facility in the Xinjiang province, a politically unstable region that is home to the Uighur people, an indigenous Muslim ethnic minority, who view the Beijing government as a foreign occupier. There have been dozens of arrests in the province over the past few months.

Yet Chinese authorities have pressured FAW to build there, largely to underscore the communist government’s claim that it’s providing jobs and economic growth in the region. With Volkswagen having been active in China since the 1980s, Chinese partners have high expectations of the company’s willingness to cooperate.

FAW has all the disadvantages of a state-owned company. Its management is dominated by members of the ruling Communist party and, therefore, is susceptible to bribery and political influence. As recently as August, investigations were launched into the activities of two executives in the joint venture as part of a large-scale campaign against corruption.

But Volkswagen, and other German firms, do not seem particularly unnerved by such difficulties. Mr. Li’s visit to Berlin also proved profitable for Daimler, Deutsche Telekom and Airbus, which all negotiated new deals with China.

Daimler and its partner, Beijing Automotive (BAIC), signed an agreement to expand production in Beijing by €1 billion. Deutsche Telekom formed a joint venture with the state-owned China Mobile to create a network that will allow cars to have access to the Internet and in-car wireless technology such as music streaming services. And Airbus sold 70 of its A320 airplanes, consummating a deal that had already been in the works.

It seems concluding contract deals like these are part and parcel of doing business with authoritarian states.

 

Finn Mayer-Kuckuk is Handelsblatt’s East Asian correspondent in Beijing. Martin Murphy is an editor focusing on the car, steel and defense industries. To contact the authors: mayer@handelsblatt.com, murphy@handelsblatt.com

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