Waiting for the big hit

In the third week of December each year, some 2,000 executives who work at Volkswagen’s passenger car business across the globe fly to Dresden for a day-long meet called the VW Management-Konferenz or MMK. Here, tactics in countries where the auto giant operates are discussed, giving every executive a glimpse of how the company works around the world. At the 2010 meet, when the Volkswagen India team presented, colleagues from all over were wowed by the feats pulled off during the launch of the Polo earlier that year—talking ads in newspapers (a photodiode that responded to light and activated a recorded voice was stuck to the back page), helicopters that flew blue and white balloons (Volkswagen’s colours) over Indian cities, etc. The heavily marketed Polo launch, which underscored the merits of German engineering, resonated well with young India, already captivated by innovative cars such as the Rs 1 lakh Nano.

Volkswagen’s India strategy was mostly top down: It launched the Passat (2007), then the Jetta (2008), then the Polo hatch (2010), and finally the Vento (2010). By 2010, sales grew to 30,000 cars, up 180% over the previous year. The following year, the number touched 80,000, making Volkswagen the fastest growing car maker in India in a decade.

Volkswagen had already publicly stated that it wanted to become the world’s largest auto company by 2018, overtaking Toyota. Implicit in that was the assumption that India would deliver decent numbers, in the range of 500,000 cars. Part of those big numbers would come from the Polo and the Vento. Indeed, events company officials would regularly talk about Volkswagen selling 100,000 cars within a couple years of the Polo and Vento launches. Volkswagen had already invested Rs 3,800 crore in its factory in Chakan (near Pune), which could make 130,000 vehicles.

It was an audacious projection, given that it took Hyundai, second only to Maruti Suzuki, six years to sell 120,000 vehicles. It meant that in eight years (2010-18) Volkswagen would grow at 42% annualised. But then, what was the big deal? This was after all Volkswagen, the world’s most feted auto maker. And it promised to reshape the Indian auto industry.

None of that happened. In the last three years, Volkswagen has sold 197,000 cars; throw in Škoda, from the same group, and the number rises to around 300,000. Volkswagen’s market share has dropped by close to 1% between 2011 (when its share was a high of 3%) and 2013.
This hasn’t affected Volkswagen AG’s performance in any way. It closed 2013 at €197 billion (Rs 16.5 lakh crore), or a 2% growth, in line with analysts’ expectations. The stock, at €179 (translating to a €88.1 billion market cap) is among the better performers in the global auto industry. Volkswagen’s plans to become the world’s largest auto company seem to be on track.

Yet, Volkswagen’s poor showing here is instructive. It’s the latest in a long line of companies, particularly multinationals, that have completely misjudged the local consumer, relying more on might than insight. Volkswagen makes great cars, but hasn’t been able to sell too many. Equally, it demonstrates an organisation’s vulnerability to local conditions, and just how much the environment impacts business. It also exposes a peculiarity of the Indian auto business—the extent to which everything rides on a single bestseller—and why it’s important to build a business around it.

Mahesh Kodumudi, president and managing director of Volkswagen India, says, “In the entire VW world, the most difficult and the most different market is India.” He characterises it as a “brutal retail market”, where it’s “very difficult to succeed”. Volkswagen has, according to him, entered a “period of consolidation, after having gone through an earlier stage of soaking in how business was done here”.

Some changes are already visible. There are more Indians in the senior management; at Chakan, the number of foreign employees has been cut by half to 150; in Mumbai, Volkswagen’s offices have been moved from the more expensive Bandra Kurla Complex to the much cheaper Andheri Kurla Road; and so on. Meanwhile, Kodumudi is looking at exports, particularly of the Vento, to offset slow sales. Exports have risen from some 7% to almost 40%, with most cars going to Mexico. This could potentially reach 50% or more in the next two years.

Senior managers say that Wolfsburg, Germany, where Volkswagen is headquartered, is paying greater attention to India. While revenues from here may still not matter, the world’s most profitable automaker can’t lose face in India. There’s talk of a ‘special plan’ in the works. Pressed for details, Kodumudi only says, “There absolutely is a transformational plan,” and refuses to elaborate. He does, however, set the expectations: “I don’t think we can aim for a double-digit target anymore, but we can achieve higher single digits.”

AUTOMOBILE companies that have succeeded in India have all had at least one model that’s been a bestseller. The reason Maruti continues at the top of the heap has everything to do with the cars it makes. Last year, the Alto sold 260,000 units, the Swift 185,000, the WagonR 136,000, and the Swift Dzire 170,000. In the 1990s, Hyundai emerged as a player to reckon with on the back of the Santro and the Accent. While everyday opinion is that you must make a success of a ‘small’ car (a 1200 cc engine or less) first, that’s not necessarily true. Toyota made a go of the Qualis, while Honda made it big with the City before launching any small car.

Sandeep Singh, deputy managing director and COO, marketing and commercial, Toyota India, says that a company has to continuously follow up on its products. “If it isn’t received well, we go back to the customer, check on various factors such as production, distribution, pricing, and after sales service,” he says.

But what auto makers really need is that one blockbuster. For example, after a disastrous launch, Ford came back with the Ikon. But once Ikon’s sales started slowing, Ford found itself in difficult terrain, till it launched the Figo.

While there is no magic number that qualifies for a blockbuster (since that varies segment-wise), Abdul Majeed, national automotive leader at PricewaterhouseCoopers, says that any car company selling less than 140,000 cars a year “can’t be making money”.

In private, most auto company executives agree; the corollary is that it’s going to be easier for a company to hit that benchmark if there’s a small car in the line-up. Majeed says that even in a good year, like 2010, when it is assumed that larger cars sell well, between 70% and 75% of a market of some 2.5 million cars can be classified as small cars.

In Volkswagen’s scheme of things, the Polo was meant to be the volume car. The business case for a car like that works like this: The base expenses include costs for material, logistics, labour, and so on. A base cost is tabulated for a production target of 50,000 cars a year, considering future volumes. Savings vary depending on which factor you choose. For example, the rule of thumb in material costs is that there’s a 10% reduction in costs when volumes double. For depreciation, it’ll be a different number, for labour something else and so on. But generally, if Volkswagen were to sell 200,000 Polos, material costs would come down by 20%. If it sells 300,000, there will be a further 10% drop. Overall costs would come down by a fifth if it were to sell 100,000 cars and more than a third if it were to sell 200,000 cars a year.

The Polo, however, never lived up to its billing. Since its launch, around 95,000 units have been sold. It wasn’t as if Volkswagen hadn’t researched the Indian market. As Fortune India wrote earlier (‘The Volkswagen Edge’; April 2011) nearly 36 months of study preceded the Polo’s launch, and the company paid attention to tiny details like loud horns and space for an idol on the dashboard. But the verdict on the street is that it’s a great car but too expensive for its category.

Volkswagen dealers say that the company doesn’t discount, and so, in a market where everyone else does, it’s difficult to sell. A former Volkswagen employee who asked not to be named says that internal discussions often revolved around pricing.

Arvind Saxena, former managing director of Volkswagen Passenger Cars and head of NSC, Volkswagen’s national sales company, who quit this March to join General Motors, says that his brief was to improve customer satisfaction, groom and develop the sales force, and improve the existing dealer network. The big challenge, he admits candidly, was in trying to establish a brand in a price-sensitive market. As Majeed says, in India every little bit counts: “Slash the price of a car by Rs 25,000 and you will see sales increase overnight.”

Saxena says that Volkswagen doesn’t compromise on the quality of steel, engines and transmissions, and advanced manufacturing. But not everyone follows that approach. “We really don’t look at what positions we can play in the market. Our position is satisfying the customer, and that’s the driving force every time we plan or roll out a car,” says Hironori Kanayama, president and CEO of Honda Cars India.

Kodumudi says he’s doing what he can to build the foundation for cheaper cars—working with Indian suppliers to get them up to speed with global quality levels, pushing to make engines locally (this may happen by the end of the year), etc. Of Volkswagen’s 120 suppliers, 70 are Indian, but often, the right quality or materials aren’t available here. The foam for the seats, for example, has to be such that there are no noxious fumes or impact on the environment. This has to be imported. The carpets have to be of a certain quality; vibration and acoustic damping also have to meet specifications. “We spent much time improving quality among suppliers,” says Kodumudi.

Until five years ago, Volkswagen was even importing the seat fabric. Then it started working with Bhilwara to develop abrasion-resistant fabrics. These will be introduced in the newer variants of the Polo and Vento that are to be launched this year. “That’s how deep we are now going with localisation,” says Kodumudi. With both the Polo and the Vento, Volkswagen is hoping to reach localisation levels of 90% by year end, up from the current 70%.

Volkswagen also worked with Tata Steel to develop certain kinds of steel that weren’t available before, even though other car manufacturers were already buying steel from Tata.

Localisation should allow Volkswagen to reduce prices or at least improve margins. Equally, it needs to launch newer models to keep the excitement around the brand going. ‘Honeymoons’ for car sales have gotten shorter. One VW dealer says that the first three or four months of any car launch sees substantial demand, but it’s the year that follows that determines how successful the model will be. The honeymoon shrinks if a competitor launches a contender within a few months. General Motors’ Chevrolet Beat saw strong bookings in its early months, but lost momentum after Ford launched the Figo.

Joginder Singh, director-corporate strategy, Ford Motor Company, U.S., says Ford defines a hit car as one where the product and price connect with the customer so well that it gives the manufacturer the confidence to invest further and bring in more products.

But even if a car is a hit, “you shouldn’t expect it to sell like hot cakes for more than one or two years [from three or four years earlier]”, says Vinay Sanghi, the entrepreneur who started Mahindra FirstChoice and now runs a B2B portal called CarTrade.com.

Dinesh Jain, former CEO of Hover Automotive, the company that once ran Nissan India’s marketing and distribution, says no company in the world can succeed here without a robust line-up. “You launch 10 cars and will likely have two hits. It’s that simple.”

If you leave aside the more expensive 1.6 litre-plus vehicles, which are assembled, for all its new variants and modifications and upgrades, the Polo and the Vento are the only two cars the company will be selling between 2010 and 2016, making VW’s locally manufactured product range the smallest in the country. “We will announce a compact car by 2016,” Kodamudi says. “I’d do it tomorrow if I could, but financials and logistics have to be worked out.”

To be fair, the local management did try to get more for their customers. Before Kodumudi and Saxena took charge, the India management would talk to their global bosses every three or four months and make requests for new cars. Former employees say that they requested smaller hatches, and ‘new small family’ models such as the VW Up, and even Goal, the electric car.

India’s managers, including the head of NSC, and the finance head, would discuss which car to launch here. Once they agreed on a model, they would pitch it to Wolfsburg with suggested price points for variants, features they thought would work, and so on. Headquarters, in turn, would run a feasibility study on the economics of bringing in such a car. Requests were made for refreshed iterations of vehicles and price points but were consistently declined because the numbers didn’t make sense.

Did the Indian team push hard enough? Equally, in the bigger picture, is India still too small a market for Volkswagen to look at more seriously? “For European manufacturers, any market becomes interesting only when average product prices start from $10,000,” says Vikas Sehgal, managing director and global head, automotive, at Britain-based investment banking company Rothschild & Sons. His point: Anything below that is a market no leading European player is really geared to operate in.

Separately, in 2009, Jochem Heizmann, member of the board of management at Volkswagen AG, announced at a press conference in Pune that the partnership between Suzuki and VW was a long-term one with implications for India. The underpinnings of that strategy were further sketched out in 2010 when Christian Klingler, a VW board member, announced that Maruti would help develop a new small car. When Suzuki chief Osamu Suzuki visited India, he confirmed that the two companies were looking at ways to synergise operations after VW bought a 20% stake in the Japanese company. The idea was for VW to learn about making small petrol engines, while Suzuki would get access to far-flung European markets and know how on diesel technologies. But within 20 months, the alliance unwound.

IN ALL THIS there is an alternate, ‘what if’ narrative. What if Volkswagen had entered India before Škoda? Once a home-grown Czech brand, Škoda was acquired by Volkswagen in 1994. In most countries, VW enters first. In India, a board member pushed for Škoda to launch first, in the late 1990s.

Would Volkswagen have fared better had it come to India before Škoda? “I’m sure VW would have been seen very differently,” Kodumudi admits. He’s not alone in that view. Sudhir Rao, MD of Škoda Auto India, says that because they got here first, Škoda has been able to maintain its premium positioning in the sedan segment. An auto analyst says the decision to stop production of the Škoda Fabia in August 2013 after a 20% price cut was a clear sign that the group wanted to stifle Škoda to prop up the Polo.

For Škoda, the Fabia, which was selling some 15,000 units, accounted for almost 40% of its total annual volumes, so it’s anybody’s guess why production was stopped. Rao defends the move saying it was an internal decision, given that the new Fabia would be launched globally at the end of 2014 and in India thereafter. While Rao may have a point, it is rare for manufacturers to stop selling older models two years before a new version is launched.

Be that as it may, Kodumudi thinks there’s still space for both badges in the market, but clearly Škoda is perceived as more premium. Combined sales of the Škoda Laura and the newly launched Škoda Octavia came to 4,000 units, while that of Volkswagen’s Passat and Jetta was some 3,000 units.

Will Volkswagen change things dramatically? Unlikely. The company believes that it’s creating a market for better engineered cars, even if they are a tad expensive—and sooner or later they will hit pay dirt. Ultimately, perhaps, it boils down to ideology.