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International Graduate School of Management

University of Navarra
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VOLKSWAGEN AND THE EUROPEAN

AUTOMOBILE INDUSTRY IN 1993

In January 1993, Ferdinand Pich took over as the new President of Volkswagen,
AG, the largest European car manufacturer. In 1992, after several years of growth
worldwide, the German manufacturer had suffered losses of around 900 million DM. The
problem was partly explained by the fall in demand for cars and the high manufacturing costs
in Germany.
A few days after taking over his new job, Pich declared he was ready to turn
Volkswagen around, get out the hatchet to reduce costs, cut back on unnecessary investments,
and face up to the Japanese manufacturers. Ever since his appointment, Pich had been
playing with the idea of contracting Iaki Lpez de Arriorta, Vice President of Purchasing at
General Motors in the USA. Iaki Lpez de Arriorta had acquired a growing reputation as a
specialist in cutting costs and simplifying production processes, first at General Motors in
Europe and since 1992 at General Motors in the US. After a bit of to-ing and fro-ing, Lpez
de Arriorta joined Volkswagen as Director of Purchasing and Production, which made him
the number two in the German company.
If Volkswagens 1992 results were negative, the prospects for 1993 were even
gloomier. The situation in the industry at the European level did not give much to laugh
about.

The European industry

The car industry in Europe in 1992 had seen a worsening of certain critical weak
points and a need for serious restructuring measures from the large manufacturers. In turn,
this all had a very negative effect on companies working in the components industries.
Case produced by the Research Department at IESE.
Prepared by Professor Jordi Canals and Germn Gimnez (MBA-93). January 1994. Revised in July 1999.
Copyright 1994, IESE.
No part of this publication may be reproduced without the written permission of IESE.
Last revised: 9/13/99

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During the 1980s and early 1990s, six large groups dominated the European car
market. Their relative positions changed over the decade (Exhibit 1). At the beginning of the
1980s, the dominant group was Fiat, with a market share of 13.8%, followed by the VW
group and Renault. By the end of 1992, Volkswagen headed the European list, with 17.5% of
the market, followed by the General Motors-Opel Group, PSA, Fiat, Ford and Renault.
The transition to democracy in Eastern Europe opened up new prospects. Many
manufacturers thought that some of the Eastern European countries could be attractive
markets both for maintaining their sales and for investing in production plants with low
labour costs. However, most car manufacturers had been reluctant to invest in the region on
account of the political uncertainty.
The total value of car production in Europe had been estimated at 8.7% of the ECs total
industrial output, with around two million jobs generated directly by the industry and another
five million in auxiliary industries. The major groups were huge employers: the total workforce
of the VW group, including Audi, VW, Seat and Skoda, amounted to 280,000 workers.
The single market was to have an important effect on the sector. Some industry
analysts estimated that production and logistical costs would be reduced as a result of the
more efficient siting of production installations and the concentration and reduction of stocks.
The programme affected the car industry most directly in five respects:
Harmonization of standards and technical regulations. The 1992 programme
reduced the various national regulations and standards to just one group of rules (the WVTA:
Whole Vehicle Type Approval).
Harmonization of tax and VAT (1). VAT rates varied widely, from 33% in Spain,
28% in France, 18% in Italy, 15% in United Kingdom (2) and Germany, to 6% in Greece.
Furthermore, some countries such as Ireland, Belgium and Denmark added heavy taxes on
top of VAT, as an additional source of income. The programme of European Union tried to
harmonize VAT rates.
Restrictions on anti-competitive distribution practices. In North America, antitrust regulations had prevented the manufacturers enforcing exclusivity clauses in their
franchises to concessionaries. In Europe, however, concessionaries were exclusive and had
helped to maintain a segmented European market, with different prices for the same model
from one country to another.
Restrictions on foreign trade. In 1991, the EU countries had an average tariff of
10.3% on car imports from other countries. Nevertheless, the different countries had
established additional quotas on the import of Japanese cars. These varied between 2% in the
Italian market, 3% in France, 11% in Britain and 15% in Germany. In 1991, the European
Commission negotiated a voluntary export restriction agreement with the Japanese
government so that the market share of Japanese imports would rise gradually from 15% in
1991 to 20% in the year 2000.
Some groups pressed strongly in 1991 for a strict upper limit of 10% market share
in Europe for Japanese manufacturers; others were even more aggressive, such as the
president of the Peugeot group, Jacques Calvet, who criticized the British position of
(1) VAT (Value Added Tax) is a sales tax paid by purchasers of goods and services.
(2) VAT is currently 17.5% in the UK.

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accepting direct Japanese investment. Britain was likened to a giant Japanese aircraft
carrier anchored just off the European coast. Calvet called for new protective measures to
be adopted by the Commission, to include a ban on new Japanese production plants in
Europe.
State subsidies. There was a long history of state support for the European
car industry. Almost all the large car manufacturers in Europe had at some time or
other received aid to avoid bankruptcy. The Rover group and its predecessor British Leyland
received around $5 billion in subsidies from the British government between 1975 and
1983. Between 1973 and 1982 Renault had probably received a similar amount from the
French government. Seat had received $2 billion from the Spanish government between
1980 and 1984. Peugeot received vital aid of $300 million in 1983-1984. Fiat had received
some $3 billion in the 1980s.

Structural changes in the industry

For several decades, the different national markets in Europe had been closed to
outside competition. Almost all the larger countries had one or more domestic vehicle
manufacturers. On the other hand, the governments had stimulated foreign investment in their
countries since the car industry employed many thousands of workers.
Traditionally, manufacturers with production centres in various countries had
decentralized decisions on purchasing, manufacturing, promotion and distribution. Thus,
Ford in Spain had a certain degree of autonomy in relation to Ford Germany or Ford
England.
The unstoppable force of globalization, the growing investment required, the
improvements in production processes and the stagnation in demand led to brutal changes in
the sector. It was to be expected that some of the large European manufacturers would
disappear. Furthermore, the manufacturers would contribute a smaller and smaller percentage
of the value of the cars, while the larger component suppliers would contribute more. R&D
and purchasing would be concentrated in the manufacturers headquarters.
Alliances between manufacturers proliferated in the 1980s owing to the high and
rising cost of developing new models and components. In many cases, the alliances enabled
one of the companies to obtain the resources it lacked and that the other company possessed.
Many of the alliances were agreements between rival companies, such as General Motors and
Toyota, VW and Ford, or Volvo and Renault.
The suppliers also underwent important changes. The smallest disappeared, while the
largest were to become first line suppliers who would supply the car manufacturer with
the necessary components and parts. These suppliers were large companies such as Bosch,
Valeo or Lucas. Some of them subcontracted to second or third line suppliers.
All this gave rise to talk of a potential car plant where the different suppliers (150
compared to 2,000 in the 1980s) would be integrated into the production line and would
finance part of the assembly plant. The car manufacturer would provide the assembly, the
brand and the know-how, and would coordinate the suppliers and the shareholders of
the projects. This was in response to the innovations introduced with such success by the
Japanese manufacturers.

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The supposed stagnation in demand for cars throughout the industrial world was
seen by some as a problem for the manufacturers. Others, like Iaki Lpez de Arriorta, said
that what the public wanted was smaller, more comfortable and cheaper cars. It was
necessary to find out how much a customer was prepared to pay for a car, what quality
was desired, and to achieve it all at a lower cost. The traditional policy of setting the price as
a function of the costs had to be abandoned as a matter of urgency.
In order to reduce costs, the manufacturers considered investing in more efficient
and productive plants as well as striking a proper balance between three variables: wages,
efficient work hours and productivity. The PICOS system (Purchase Input Concept
Optimization) originated by Lpez de Arriorta at GM was a procedure for achieving
reductions in costs, stocks and working space.
An interesting point is that car prices had never stopped increasing. It was estimated
that between 1982 and 1992 the average price of a car had doubled. In contrast, in 1992
a Macintosh computer cost a fifth of what it cost in 1984, with better capabilities. In 1992, a
video recorder cost a third of what it cost in 1984. Some people wondered why the same did
not happen in the car sector. Would cars become just another consumer product? Would it be
the customer who called the shots? At the same time, there were other factors that heralded
changes for the manufacturers. One of them was the faster and faster updating of models. A
new and attractive model was fundamental for increasing sales. The so-called time to
market had to be reduced if the manufacturers wanted to remain competitive. And to do that
the cost of developing new products had to be reduced.
However, updating models was becoming more and more difficult because of
increasing demands from the purchasers. Design on a model would start four or five years
before its launch. During that time the customers preferences could change, which is why it
was necessary to reduce development time. It was estimated that the design of a new
medium-sized vehicle cost around $1 billion in 1992.
Another important tendency was the reversal in the process of vertical integration of
car manufacturers. Up until the 1980s, 70% of a cars value was produced by the
manufacturer. In 1993, production targets were 30% manufacturer and 70% suppliers. There
were a number of reasons for this: a growing need for resources to be invested in components
and very diverse systems, a need for reductions in costs, the appearance of more efficient
specialist suppliers, etc.
In this context, manufacturers were turning into a nexus or interface between the
final customer and the suppliers of components. Their main responsibilities in this new
context would be innovations in the design of the car, the make, the coordination of suppliers
and the marketing. For their part, a few of the bigger suppliers were going to collaborate
with the manufacturers to make improvements to the vehicles. And in turn, these first line
suppliers would have second and third line suppliers to whom they would subcontract part of
the components.
A top director in one of the big manufacturers commented that the survival of the
manufacturers lay in passing on the problems and costs of R&D to the first line suppliers.
Growing competition on prices cars were becoming more and more of a consumer product
made it difficult for the manufacturer to reduce costs on his own since he had no margin left.
The manufacturers expected more and more from their suppliers. For example,
GM-Opel defined three types of requirement for its suppliers in 1992. Firstly, the technical