East to Eclipse West, Industry Trend Suggests

True to form, the sun is rising in the East and – industry insiders fear – setting in the West.

As the European market grows more crowded, led by Asian-based auto makers that enjoy lower labor costs, new manufacturing centers are emerging while old business models are vanishing into the dusk.

As 2007 approaches, Eastern Europe’s auto industry has on its horizon the pending investment of more than €3.4 billion ($4.3 billion) by Volkswagen AG, Suzuki Motor Corp., PSA Peugeot Citroen, Kia Motors Corp. and Renault SA.

Marcello Malentacchi

“In the past, we used to see that there is a cycle,” says Marcello Malentacchi, general secretary of the International Metalworkers Federation, an umbrella organization for dominant auto industry labor unions such as IG Metall and Amicus.

“You would have slow times, but we could expect in one or two years to come back again,” he says. “This is not going to happen anymore. Unless we develop the market on some other continent.”

Malentacchi mentions Africa, Latin America and the Indian subcontinent. But he admits their economies are not developed sufficiently to support imports from Western Europe.

What remains, he tells Ward’s, is “one of the worst” climates he has seen in the auto industry. “The situation with respect to the major companies is very tense. There is a lot of potential for conflict.”

At the center of the storm is Volkswagen. The auto maker’s core-brand operations are the target of aggressive rollbacks championed by Wolfgang Bernhard, now entering his third year as CEO of the VW brand.

For the hard-line IG Metall union, the coming year will bring the aftermath of a deal negotiated by Bernhard. Using the promise of new production programs as a lever, the former Chrysler Group chief operating officer persuaded the union to accept an agreement that creates a flexible workweek of 25 to 33 hours at six German plants.

Meanwhile, dark clouds are gathering over Western Europe in the form of downsizing and the resulting threat of labor strife.

This comes on the heels of a similar accord reached last year guaranteeing the auto maker’s Wolfsburg plant will build VW’s all-new Tiguan cross/utility vehicle, scheduled to debut in 2008.

Yet analysts remain unappeased. “We viewed VW’s recent labor agreement with IG Metall as slightly disappointing,” says an Oct. 18 research note published by JP Morgan. Expectations were talks would produce still greater productivity improvements.

The eastern half of the continent enjoys a compensation rate that is two-thirds less than levels paid in the West, according to the Federation of European Employers. For auto workers, that means €9.17 ($11.57) per hour vs. €27.50 ($34.70), and some auto makers are using every means possible to exploit this advantage.

“As far as a place for manufacturing is concerned, we are basically benefiting through our suppliers,” says Dieter Zetsche, chairman of DaimlerChrysler AG and head of the auto maker’s Mercedes-Benz Car Group.

Such opportunities are increasing almost daily. A partner of TRW Automotive Holding Corp. revealed in September the Tier 1 supplier has chosen a greenfield site in Slovakia for a 3-phase, €40.5 million ($51.1 million) complex that will launch production in first-half 2007.

The wage gap also is prompting competition between Western European countries. Belgium, for example, whose auto industry expects to benefit from €453 million ($571 million) in 2007, recently restructured its payroll taxes to ensure auto workers are paid €1 ($1.26) less per hour than those in Germany.

Tier 1 suppliers and OEMs are not the only industry players swept up by the winds of change. Lower-tier suppliers such as Jabil, a consumer electronics component builder with designs on more automotive business, have jumped on the Eastern Europe bandwagon.

Among its 16 European plants are four in Eastern Europe, including a 1.3-million-sq.-ft. (121,000-sq.-m.) site in Hungary. But the drive eastward doesn’t necessarily stop there.

“As people migrate to these low-cost countries, there’s always the next low-cost country,” says Terry Bishop, regional director in Jabil’s automotive group. “People are talking about Bulgaria and even further east. We’re actively looking at acquisitions there.”

Ford of Europe is looking beyond, as well, as Eastern Europe’s buying power improves with the auto industry’s expansion. Demand for the Ford Focus has forced the auto maker to increase capacity at its plant in St. Petersburg, Russia.

“We’ve sold about 65,000 (Focuses) this year in Russia, alone,” Stephen Odell, vice president-sales, service and marketing, says.

Return of Fiat's iconic Cinquecento to be inspired by Trepiuno concept car.

That is 5,000 units more than all the Ford vehicles sold in Russia last year, and the company expects to sell 120,000 vehicles this year. “It’s a bit like the Wild West,” Odell says, adding the Russian market is slowly maturing.

Analysts forecast Europe will enjoy a solid economy in 2007. “Strong employment growth, combined with an expected slight increase in wage growth, is likely to keep consumer spending growing at stable, if unexciting, rates,” says a Merrill Lynch report. “Business investment spending, meanwhile, is only at the beginning of a cyclical upswing.”

This bodes well for auto makers that are rolling out a plethora of key products next year, such as the Renault Twingo, Nissan Qashqai and Volvo C30. But none will be watched more closely than the return of the storied Fiat Cinquecento, which debuts next September.

Fiat SpA CEO Sergio Marchionne has his eye on about 120,000 unit sales.

“Not a big number in the scheme of things,” he tells Ward’s. “What is much more important is the iconic value of the car in the marketplace, because it represents a huge chunk of Fiat’s history.”

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