REGIONAL INTEGRATION IN THE AMERICAS:
Texas A&M, ITAM, and Carleton Universities
Dr.’s Studer, Eden, and Molot
ASSIGNMENT 3
Group 3:
Patrick Buzzard
Jesse Czelusta
Ignacio Godinez
Jamie Koumanokos
Jorge Madrigal
Derek Steingarten

VOLKSWAGEN SINCE NAFTA
INTRODUCTION
Implementation of the North American Free Trade Agreement (NAFTA) has had a dramatic impact on the automobile industry in North America. The provisions of the NAFTA have led to significant changes in the nature of automobile production and purchasing within Canada, the United States, and Mexico.
Volkswagen's North America unit has faced a number of challenges in recent years, some of which have been related to NAFTA and to developments within the NAFTA countries. The purpose of this analysis is to present a clear picture of Volkswagen's North American operations, to examine the expected effects of NAFTA on Volkswagen, and to describe the strategies that Volkswagen has developed in order to improve its position in North America.
This paper is divided into three sections. The first section provides brief background information on Volkswagen’s global operations, with a particular emphasis on Volkswagen in North America. The second section presents a discussion of the issues affecting Volkswagen as a result of NAFTA. The final section highlights Volkswagen strategies, especially with respect to Volkswagen’s position in North America.

DE***ION OF FIRM
Size, Growth Rates, and Main Products
In 1996, Volkswagen sold 3,617,000 vehicles worldwide, and sales in 1997 amounted to $52.85 billion. Volkswagen is headquartered in Germany, and the European Community (EC) represents by far the largest market for Volkswagens, with sales to EC countries comprising nearly 60% of Volkswagen’s global sales. Sales in Germany (27%) and Brazil (14%) account for the most significant segments of Volkswagen’s total sales. The U.S., Mexico, and Canada are, respectively, the seventh, thirteenth, and eighteenth largest markets for Volkswagen vehicles, with North Americans purchasing around 6% of all Volkswagens sold. [Auto Case 2000]
Last year, the firm's global advertising budget was $1.1 billion, with non-U.S. advertising at $933 million. This contrasts heavily with the global balance of advertising outlays for many automobile firms. For example, Toyota has an advertising budget of $1.7 billion, with non-U.S. spending of $989 million. [Automotive News, 08/25/97] Volkswagen’s proportionally smaller marketing focus within the U.S. serves to illustrate the relative unimportance of the U.S. to Volkswagen from a global perspective.
However, the importance of North American markets has been increasing. In 1997, Volkswagen enjoyed its best year in the United States since 1988. It sold 137,885 cars compared with 135,907 in 1996, representing sales growth of 1.5%. The automaker predicts total sales of 180,000 in 1998 in the U.S., and envisions a steady double-digit growth pattern in Canada and U.S. in the coming years. [Automotive News, 02/16/98] NAFTA will almost certainly act as a catalyzing factor in this growth.
Volkswagen products sold in North America include the Passat, the Jetta, the Golf, the old Beetle (only in Mexico) and the new Beetle. The Jetta is Volkswagen's best seller in the United States and Canada (roughly 90,000 sales in 1997). [Automotive News, 02/16/98] Sales of the Passat, which is now in the same price range as vehicles produced by BMW and Mercedes, are predicted to soar in U.S. and Canadian markets. Likewise, the new Beetle is slated to be a rising star for the firm.

Plant Locations
Mexico
Presently, Volkswagen's only assembly plant in North America is located in Puebla, Mexico. The Puebla plant produces Golfs and Jettas for the U.S. and Canada, as well as "old" Beetles for the Mexican market. In addition, the Puebla plant is the center for production of the new Beetle. With recent upgrades, it has enormous capacity at 380,000 vehicles per year. [Automotive News, 07/28/97] However, as late as 1995 it was only operating at 84.6% of capacity. [100 Year Almanac (1996)] The plant employs roughly 12,000 workers, up from around 8,000 just four year ago (Auto Case 2000). The Puebla plant sells vehicles largely to the North American market, exporting 187,000 vehicles to the U.S. and Canada in 1997, and selling 66,000 vehicles within Mexico [Auto Case 2000].
Canada
Volkswagen has a parts plant in Barrie, Ontario that produces engines, exhaust systems and other products such as wheels. This plant has roughly 500 employees, and produces parts exclusively for VW and no other automaker. Most of the parts produced at this plant are used in the assembly of vehicles at the Volkswagen plant in Mexico.
United States
As of now, the only role played by the U.S. in the production of Volkswagen’s is that of providing parts for the assembly of Volkswagens. Prior to NAFTA, "U.S. … parts (had) not been high on VW’s priority list." [Chappell] However, the supply of parts flowing from the U.S. has taken on greater significance since the implementation of NAFTA, as a result of domestic content requirements. Volkswagen’s reliance on U.S. parts suppliers is expected to continue to expand as the domestic content requirement is phased in.
In March of 1997, Volkswagen announced that it was looking in five states in the southeastern region of the U.S. for a possible manufacturing site. Reasons cited for this include "the South offering cheaper labor, a largely union-free environment and juicy tax breaks and incentives." In addition, this region offers nearby ports for exporting, proximity to parts plants, political clout in the U.S., and protection from currency fluctuations. Locating a plant in this region would mimic the successful example set by Volkswagen's competitors [Jaffe and Suris (1997)]. This search was named Project Greystone, and it was apparently stopped in July with the announcement of a $750 million Volkswagen and Audi plant in Brazil that is scheduled to start production in 1999. Audi's Mr. Clark did not completely rule out a future plant in the U.S., stating that "exploration for sites is something we do constantly all across the globe," especially with "a now-established supplier base and ease of exporting cars to Europe. [Gepfert (1997)]
In fact, it seems that Volkswagen has now made a decision to open a new assembly plant with an annual capacity of 200 to 300 thousand vehicles in North America, although not necessarily in the U.S. This decision has come about as a result of strong North American sales over the past few years and forecasted growth in demand for Volkswagen vehicles. As of now, Puebla has been mentioned as a potential site for this plant, but it appears that the firm is remaining open to locations in the U.S. as well. [Ward's Automotive Reports (2/16/98)]
Relative Importance of Canada, U.S., and Mexico
Canada
As Volkswagen’s North American production is centered in Mexico, Canada's importance to the firm lies principally in its distribution network and consumer market. In Canada, Volkswagen holds a 3.3% automobile market share. Because only 0.2% of trucks sold in Canada are produced by Volkswagen, the firm's market share in 1996 for all vehicles sold was 2.0% [Auto Case 2000].
In the broad scheme of things, Canada’s significance as a consumer market for Volkswagens is relatively minimal. Canada accounts for only slightly more than 0.5% of Volkswagen’s total sales, and for about 10% of Volkswagen’s North American sales. [Auto Case 2000] However, it may well be the case that NAFTA, in conjunction with a strong North American economy and heightened North American production, will increase the importance of Canada to Volkswagen.
United States
Volkswagen holds market shares of 1.5% of automobiles, 0% of trucks and 0.9% of all vehicles sold in the U.S. The importance of the United States to the firm lies in the fact that Volkswagen has enjoyed a huge comeback in the U.S. market after the firm's sales dwindled to nearly nothing in the early 1990's. [Auto Case 2000] "By 1993, VW sales hit a low of 49,533 and Audi sales plateaued at around 12,000. A strike at VW's assembly plant in Puebla, Mexico, that year made matters worse by crippling the launch of the new Golf and Jetta cars." [Stern, (1997)]
The situation was so bad that the corporate executives in Germany actually discussed pulling out of the US, but they were afraid that this would run counter to their plans for global-expansion and weaken their position in the global market. With a cost-cutting strategy and very successful "Drivers Wanted" marketing campaign, VW turned their slump around, and their sales rose over 18% in 1996 to 135,097. [Stern (1997)] With the introduction of the new Beetle, Volkswagen is seeking to build upon its successful reentry into the highly competitive and growing U.S. small car market that the firm established in the last few years with the Quattro, Jetta, and Golf. Volkswagen believes that they may be poised to capture another generation, and to recapture old customers with the new Beetle--and the payoff may be huge [Volkswagen Home Page].
Mexico
In Mexico, Volkswagen holds 27.3% of the consumer market for automobiles, (27% of car production) and a 2.5% market share of trucks (1.2% of truck production) [AMIA], for an overall share of around 23%. [Auto Case 2000] The Volkswagen Beetle is the most popular vehicle sold in Mexico, accounting for nearly one out of every four cars sold. [New York Times] It should be noted however, that Mexico accounts for less than 1% of Volkswagen’s global sales, and only about 17% of Volkswagen’s North American sales. [Auto Case 2000] This is due in large part to the fact that while there are 560 vehicles for each 1,000 citizens in the U.S., there are only 120 vehicles per 1,000 people in Mexico. [The Economist] If the economic status of Mexico continues to improve, then we can expect to see a corresponding enhancement in Mexico’s potential as a purchaser of Volkswagens.
The primary importance of Mexico to Volkswagen stems from its suitability as a production site. The Puebla plant is responsible for the production of most of the Volkswagens on the road in North America, with labor costs that are a small fraction (about 12.5%--$5/hr. in Mexico versus $41/hr. in the U.S.) of those in the U.S. [Auto Case 2000] If Puebla is eventually chosen as the site for the new North American plant, then production of Volkswagens in Mexico will nearly double and so will the importance of Mexico as a producer of Volkswagens.

EXPECTED IMPACT OF NAFTA ON VOLKSWAGEN
The Threat of Competition
Possibly the largest challenge facing Volkswagen as a result of the NAFTA is the reality of increased competition in Mexico from North American competitors―namely General Motors, Ford, Chrysler, and Nissan. For the first eight years of the NAFTA (until 2002), firms that do not assemble cars in Mexico will be prevented from importing, leaving these five firms to battle for market share in Mexico. Heightened competition for Mexican market share was in fact predicted in 1992 by then president of Volkswagen's North American Operations, John Kerr. [Chappell] The scenario which he described has come to fruition, partly as a result of the NAFTA, and partly because of the Mexican peso crisis.
In 1991, Volkswagen's share of the Mexican market stood at 38%, with Volkswagen holding a strong lead over its competitors. [Chappell] However, NAFTA appears to have had an immediate impact, contributing to a tenfold increase in sales (when compared to the same month from the previous year) from the Big Three during its first month in effect. [Versical] By 1995, when Mexico was in the throes of currency devaluation, Volkswagen had fallen to fourth, behind General Motors, Ford, and Nissan. [Ramirez]
Volkswagen's market share has recovered somehow
hat since, amounting to 23.1% in 1997, second only to General Motors at 26.7%. [AMIA] However, competition in Mexico from firms that prior to NAFTA had not placed much emphasis on the Mexican market remains a significant threat to the success of Volkswagen in North America.

Domestic Content Requirements
Another challenge confronting Volkswagen deals with the issue of parts sourcing. Presently, only automobiles that meet a standard of 56% North American content under the NAFTA rules of origin may be shipped duty free, and this standard will be increased in another four years to a permanent level of 62.5%. [Gates] Although Volkswagen did not have a great deal of trouble meeting the initial standard of 50% North American content (largely because it already faced a 36% Mexican content requirement prior to NAFTA), complying with the higher 56 and 62.5% standards has and will continue to affect the firm. This requirement has forced Volkswagen to adjust its sourcing practices, causing it to rely more heavily on parts suppliers within the U.S. and Canada, rather than on the German sources that have historically supplied the largest portion of parts to the Puebla plant. If Volkswagen is unable to meet the stronger domestic content requirements, then it will face the significant competitive disadvantage of having to pay a 2.5% duty on exports to the U.S. [Chappell]

Labor Issues
Although it is speculation at this point to discuss the potential impact of NAFTA provisions pertaining to labor, there is the possibility that these measures will have an impact on Volkswagen’s operations in Mexico. The Puebla plant has already experienced its share of labor difficulties, suffering through a major strike that crippled production for a time in 1993. While it is unclear whether or not a problem still exists today, the possibility of proceedings being initiated under the auspices of the NAFTA Labor Commission remains. Despite the Labor Commission’s lack of direct authority, public pressure brought to bear within Mexico could in turn influence the Mexican government and Volkswagen’s standards for the treatment of workers.

North American Opportunities
At the same time as it is facing the difficulties presented by the NAFTA, Volkswagen is also confronting opportunities for increased exports of its vehicles from Mexico to the U.S. and Canada. In 1993, it was forecast by Gustavo Saavedra of the Mexican Automobile Industry Association that exports of Mexican automobiles could increase from 400,000 to 700,000 by the year 2,000. [SourceMex] Regardless of the accuracy of this prediction, the elimination of tariffs under NAFTA will certainly allow Volkswagen to increase its exports to the U.S. and Canada, ceteris paribus. And in fact exports have increased since NAFTA was implemented. It is difficult to say, however, how much of this increase was due to NAFTA, and how much was due simply to the peso crisis and to the strength of the U.S. and Canadian economies.
It can also be argued that NAFTA has played a role in Volkswagen’s recent decision to locate a new plant in North America. While there are many factors involved in where to locate a new plant, a thriving U.S. economy and the non-existence of tariffs make Mexico or certain parts of the U.S. look more appealing as potential sites. It is not possible to say that this plant would not have been proposed if it weren’t for NAFTA, but the fact remains that NAFTA gave the U.S. and Mexico an additional edge in the search for possible plant locations.

VOLKSWAGEN STRATEGY
This section will outline a number of actions that have been taken by Volkswagen in recent years. The emphasis here is on North America, with only brief attention paid to Volkswagen strategy throughout the rest of the world.
Fluctuating Market Presence in North America
In the 1960s, Volkswagen captured the North American market for the small, inexpensive automobile with the original Beetle, and soon established a Beetle assembly plant in Westmorland, Pennsylvania. However, with the rise of Japanese and other Asian manufacturers in the entry-level market during the 1970s and 1980s, Volkswagen saw its market share in North America fall precipitously. Also facing more stringent environmental and safety standards in the US and Canada, (but despite a government-assisted plan to upgrade the Westmorland assembly plant), in 1986 Volkswagen decided to cease all assembly operations in the U.S. and Canada and rely entirely on imports to service the market. Not facing the same constraints in Mexico, production of the Beetle continued at the Puebla plant, just as it does today.
As stated previously, the relative importance of North America has been on the rise in recent years. This is largely due to the strength of the U.S. economy, but also to Volkswagen’s success in promoting sales of its more expensive vehicles in the U.S. and Canada. Maintaining a strong focus on sales of higher-end vehicles (which carry with them higher profit margins) is a priority for Volkswagen at this time. Accordingly, Volkswagen plans to continue to aim a sizable proportion of its advertising dollars in North America at the sale of its more upscale cars, promising not commit more than one-third of its approximately $100 million U.S. advertising budget to the new Beetle. [Beatty]
Emphasis on Europe
From the mid-1980s Volkswagen's global strategy hinged on (1) continued growth in production and demand for the Beetle in emerging markets (especially Latin America) and (2) a concentration on the European market as the motor of growth in innovative product lines. (Volkswagen ceased producing Beetles in Germany in 1974, relying entirely on overseas production, mostly in Mexico and Brazil.) [Automotive News, 12/08/97] Indeed, the European market dominates Volkswagen's global sales. Not only has Volkswagen emerged as a leader in Europe, but in the post-Soviet era, Volkswagen has made considerable inroads in expanding production and sales throughout Eastern Europe, partly through its acquisition of Skoda. [Automotive News, 06/09/97]
Renewed North American Focus
During the 1980s and 1990s growth in VW's European market share required that VW rely on Mexican capacity to meet demand in North America. This renewed emphasis on Mexican production was also fuelled by a recognition of VW's price sensitivity in the U.S. market due to the depreciation in the dollar. [Automotive News, 06/30/97] (At current exchange rates, Mexican production is cost-competitive with production in Germany.) However, the most important aspect of Volkswagen's new strategy centers on the need for a strong presence in North America in the contest over global automobile markets. Part of this presence will take the form of imports from Europe (like the new Golf), but increased production in North America is also essential. Accordingly, Volkswagen has raised its level of production in North America by 34% in the past two years. [AMIA]
In synch with this strategy, Volkswagen’s chairman Ferdinand Peich points out that his firm is not content to rest on its position as the number one automaker in China, Europe, and Latin America. He emphasizes Volkswagen’s focus on expanding into new export markets, which is taking place through Volkswagen's extensive marketing research. One of the primary areas of intended market expansion is indeed North America. As evidence of this intention, the establishment of a new assembly plant North America will be the most significant aspect of Volkswagen strategy in North America for some time to come. Building this facility will allow Volkswagen to take full advantage of North American free trade and to expand its market presence in North America. [Deep]

Parts Sourcing
Volkswagen has historically relied on a system of global sourcing to supply parts to its assembly plants. In Mexico this has changed, however, as a direct result of the domestic content requirements of NAFTA. The purchase of parts form within North America, and particularly from the U.S. has expanded in order to meet the requirements of the NAFTA. Continuing to develop a network of North American parts suppliers will remain an integral part of Volkswagen’s North American strategy, especially in light of the proposal to locate a new assembly plant in North America.
Production Techniques
Volkswagen has kept up with industry wide trends towards increased use of new organizational orientations and methods of "just in time" production. Volkswagen has focused resources on its labor training programs, seeking to facilitate the rotation of work functions amongst employees. This development has allowed increased flexibility in the production of vehicles by ensuring that qualified personnel are available to accomplish a variety of tasks within their respective production segments. Volkswagen has also focused on reducing inventories through the use of "just in time" production, which has led to the creation of much closer ties between parts suppliers and assembly plants.
The New Beetle
A good sense of the Volkswagen's new marketing strategy can be derived from the high-profile launch of the new Beetle in 1998. Seeking to stage a "convincing comeback based on the needs and wants of U.S. customers", and unlike the entry-level Beetle of the 1960's, the 1999 Beetle is a modern car that is marketed to more affluent consumers whose preferences can be swayed on the basis of both performance and nostalgia. This is reflected in the new Beetle's sticker price of $15,700 U.S. for the base model, which is priced above the Golf but below the Jetta. [Automotive News, 11/24/97 & 01/19/98]
Volkswagen's plant in Puebla is the sole global source of Beetle production, which began in December 1997. Volkswagen invested 1 billion dollars for development of the new Beetle and for plant preparation in Mexico. [Automotive News, 10/06/97] In addition to the new Beetle, the Puebla plant will continue to produce North America's Jettas and the old Beetle for sale in Mexico. However, new Beetle production in Puebla has meant that Golf production has returned to Germany. Volkswagen initially expected annual sales of 100,000 Beetles beginning in 1999, but due to high demand, this estimate has been increased to 130,000 annually. [Automotive News, 02/16/98] In contrast to lower levels of capacity utilization in the past, this high level of production will require maximum capacity output at the Puebla plant, at least until a new North American facility is constructed.
Fostering an Upscale Image
While the arrival of the new Beetle promises to bring increases in sales of Volkswagens, the firm is emphasizing its desire to continue to improve sales of its upscale vehicles, like the Passat and the new W-12 sports car (Germany). Maintaining this focus on developing an image as a car maker that is a rival to BMW and Mercedes is particularly important in the U.S., where expanding into the upscale market will carry with it substantial long-term gains. Accordingly, Volkswagen plans to ensure the health of its U.S. advertising budget for these vehicles, even as the ad campaign for the new Beetle is launched. [Mitchener]
New Supplier Strategy
Purchasing costs represent approximately 60% of the cost of production for Volkswagen cars, with 60-65% of parts coming from outside suppliers. (Of these suppliers, 80% produce in Germany, and 15-18% in rest of Europe, with the remainder elsewhere in North America and Asia.) [Automotive News, 07/07/97] In a project launched two years ago at its Recende, Brazil plant, Volkswagen has begun to include suppliers in the assembly process itself. By directly employing only engineers, managers and supervisors, and requiring suppliers to employ their own workers in the assembly plant, Volkswagen hopes to facilitate the development of new components and models. According to this new supplier strategy, parts suppliers are also expected to shoulder part of the financial burden of building the assembly plant itself. As a result, Volkswagen expects unprecedented productivity gains. If it proves effective, Volkswagen will use the strategy in production in North America and around the world.

CONCLUSION
Relative to its own production and sales throughout the world, Volkswagen’s dealings in North America have historically represented a fairly insignificant part of its overall operations. However, North America is likely to play a substantial role as a source of growth for Volkswagen over the next few decades. This growth will occur on two fronts, with Volkswagen seeking to capitalize on strong demand from North American consumers, while at the same time expanding its capacity for production within Mexico and possibly the United States. This trend can already be witnessed, with sales of Volkswagens in North America on the rise, and plans for the establishment of a new North American assembly plant in the works.
NAFTA has definitely played a part in shaping the future of Volkswagen in North America. By eliminating tariffs and placing restrictions on the content of vehicles, NAFTA has in part pushed and in part pulled Volkswagen towards the promise of an expanded North American market. The strategies of Volkswagen with respect to North America partially reflect the influence of NAFTA. However, the long-run impact of NAFTA on Volkswagen remains to be seen.

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