Hypersonic

Skoda, a Joke No More, Joins Audi in Driving Volkswagen Profit

By Chad Thomas and Andrea Dudikova
Feb. 8 (Bloomberg) -- Volkswagen AG executives used to consider Skoda cars so dangerous they refused to drive them.

At a meeting 15 years ago, after Volkswagen took control of Skoda Auto AS, top managers sent the Czech carmaker's engineers home to design a better car, recalls Detlef Wittig, a VW executive at the time who now runs Skoda.
``We told them this is either the end of the story, or you do your job,'' Wittig says.

Skoda executives heeded the criticism and returned months later with a better-engineered car. It was the first step in Skoda's decade-long transformation from an object of Communist- era derision into Volkswagen's most profitable unit after the Audi brand. That success is helping boost VW's share price as the parent company trims jobs in Germany.

"Skoda used to be seen as a poor car at best and at worst the butt of many cruel jokes,'' says Stephen Pope, London-based head of equity research at Cantor Fitzgerald Europe. "This baby has come a long way.''

In response to the brand's growing popularity, Skoda will introduce an updated version of the Fabia compact at the Geneva International Car Show, which begins March 8. Skoda forecasts 2007 sales will rise at least 5.5 percent on demand for the Fabia and Roomster multipurpose vehicle. Wittig says stepped-up production in India and China will help increase sales by 45 percent to 800,000 vehicles within five years.

Last Laugh
Those expansion plans mean that Wittig, 64, can have the last laugh, amusing visitors with his collection of old jokes about the brand. His favorite: "What's the best way to double the value of a Skoda car? Fill up the tank.''
Skoda, based in Mlada Boleslav, 60 kilometers (37 miles) northeast of Prague, holds an outsized role in the fortunes of both its parent company and homeland.

In 2005, Skoda sold 492,111 cars and posted record net income of 7.9 billion Czech koruna ($360 million), making the unit responsible for more than 25 percent of Wolfsburg, Germany- based VW's profit. In 2001, the first year VW wholly owned the unit, Skoda generated just 2.3 percent of net income.
In addition, Skoda accounts for about 3 percent of the Czech Republic's gross domestic product, says David Marek, chief economist at Prague-based Patria Finance AS.

The unit's newfound prominence has prompted some analysts to ask whether the lower-priced cars made by Skoda and VW's Spanish unit, Seat, are siphoning sales away from the Volkswagen brand.
'Cannibalizing' VW?

Patrick Juchemich, an auto industry analyst at Sal Oppenheim in Frankfurt, says consumers are increasingly turning to mid- priced Skodas to get features and engine quality usually found in more expensive Volkswagen models.

In Germany, a Skoda Octavia costs 14,790 euros ($19,265), about 4,000 euros less than a comparable VW Golf, and its larger interior rivals that of the mid-size VW Passat.

"I don't believe the company's argument that there is no danger of cannibalization,'' says Juchemich, who has a "neutral'' rating on Volkswagen shares. "I am not sure there is really a client differentiation between the potential customers for an entry-level Passat and the Octavia.''
Wittig says market research shows that Skoda and Seat cars appeal to different types of drivers.

"We don't have this famous question of are we cannibalizing our sales within the Volkswagen group,'' Wittig says. "We have family-type buyers with Skoda and singles and mainly yuppies with Seat.''

Few predicted that VW, Europe's largest carmaker, would face such a dilemma at the start of its involvement with Skoda. After the Velvet Revolution that ousted Czechoslovakia's communist regime in 1989, the new government started selling state assets. At the time, Skoda made a single model, a family car called the Favorit.

548 Changes
The government's search for a partner led to a venture with Volkswagen in April 1991. Over the next decade, VW increased its stake in exchange for investments, gaining full control in 2000. In total, Volkswagen paid about 2.05 billion deutsche marks ($1.25 billion) to take over Skoda.
In 1994, Skoda started making a redesigned small compact named the Felicia, with a sleeker look and a more responsive engine than the Favorit, in an effort to appeal to Western European consumers. A marketing campaign featured the slogan "548 changes'' -- boasting the number of improvements made to the old Favorit.

Skoda began selling its first all-new model -- the Octavia hatchback -- in November 1996. The Octavia was the first Skoda to use a VW powertrain and frame, and it offered more interior space than the Golf, its Volkswagen equivalent. Octavia sales rose to 270,274 vehicles last year, from 47,876 in 1997.

Red Buttons
At the same time, Skoda began pushing workers to pay more attention to detail, offering bonuses for meeting quality standards.
"Someone could push a little red button and halt the assembly line if something wasn't according to quality standards and quality levels,'' Wittig says. "The awareness that there is a button that I can push and I can stop the assembly line was something that never existed before.''

Skoda's profits are boosted by labor costs that are about 20 percent of those in Western Europe, the company says. Competition for low-wage workers may grow now that Toyota Motor Corp. and PSA Peugeot Citroen have established a joint factory in the Czech Republic, says Marek of Patria Finance.

Return to Roots
In some ways, Skoda's renaissance was a return to its roots.
Vaclav Laurin and Vaclav Klement made their first car at Mlada Boleslav in 1905, a decade after establishing the company as a maker of bicycles and motorcycles. In 1925, it merged with the Plzen-based engineering firm Skoda and adopted the brand name for the company's sedans. Today, the top-equipped versions of the Octavia family car and Superb luxury model bear a "Laurin & Klement'' emblem.

In the mid-1990s, Skoda engineers gave the company's own cars a 5 rating for quality, the lowest on their five-point scale. Two years after the Octavia was introduced the grade had risen to 3, or satisfactory. Today, Skoda models get an average rating of 1.1, compared with 1.8 for their competitors.
"This is beyond imagination,'' says Wittig, a former VW sales executive who joined Skoda in 1995 and became chief executive officer almost three years ago. "In early 1991, there was just one target: surviving.''

Today, it's VW that's struggling to control production costs and trim its workforce.

Volkswagen-brand plants operate at just 80 percent of capacity, compared with 97 percent at Bayerische Motoren Werke AG and 93 percent at Toyota. VW factories in western Germany lost several hundred million euros in 2005, the company said last February, declining to be more specific.
VW Job Cuts

The company plans to cut 20,000 jobs, or 20 percent of its workforce in western Germany, and has reached an agreement with employees to lengthen the workweek for no additional pay. VW shares have risen 67 percent to 84.56 euros since the job cuts were announced on Feb. 10, 2006. That compares with a 27 percent gain in the eight-member Bloomberg Europe Autos Index.

Martin Winterkorn, VW's new CEO, said in November he aims to beat a target of increasing the group's pretax profit to 5.1 billion euros in 2008 from 1.1 billion euros in 2004.

Meanwhile, Skoda is expanding in emerging markets. It plans to start making the Octavia at a VW plant in China later this year, and will eventually produce the Fabia and Superb in the world's fastest-growing economy. In Russia, a joint Skoda-VW factory will help the carmaker avoid the 25 percent tax on imported vehicles.

The production push, along with introduction of the Yeti, a sport-utility vehicle to be rolled out in 2009, may help the carmaker meet its sales goals.
Skoda's reputation for quality and reasonable prices are luring buyers such as Mihael Stanic, a logistics company worker from Nersingen, Germany, who traded his Golf for a Fabia compact.

"At Skoda, you get better service, the electronics are much better,'' says Stanic, 23. "At Volkswagen, you pay for the brand.''

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Mirage77

I have immense respect for Skoda. They're like VWs on a budget without being cheapened.

martinbo

Nice chair in your avatar Rob - Charles Rennie MacIntosh?

(I know absolutely bugger all on interior and contemporary design so that's all I have to say!)

Hypersonic

He he , much later than Mackintosh Martinbo -- it was designed in 1983 by a well known Italian designer and intellectual called Michele De Lucchi.

Hypersonic

And that's the problem James, they are harming VWs sales.

Mirage77

And that's why VW is moving upmarket.

Hypersonic

Well, yes ...I guess you are correct ...but the problem is Audi already covers that end of the market for the VW group. Lets face it James, the Golf (for example) is pretty expensive when compared to its Japanese, Italian, and French competitors.

Mirage77

I was thinking of the intermediate market - not quite Audi and not quite VW's territory either. That's where we see Volvo and SAAB.

I think the Golf is worth the premium.

Hypersonic

I do agree with you Mirage, VW does offer excellent quality ...but still, Skoda is able to offer similar levels of quality for a much better price -- the reality is, the reason VWs cost more is because they are made in Germany -- as it said in the article, Eastern European wages are 20% of those in Western Europe --VWs prices come down to production costs much more than product superiority -- it is the same for many other German-made products. German labour and industrial regulations are just so damn expensive.

Kowalski

Look at the pics below to see how Skoda has come a long way.





From this steaming pile of cow dung:




To this understated high performance bargain:




Thank you very much Mr. Volkswagen!