European Car Makers Eye Russia for Expansion

When Volkswagen Chairman Bernd Pischetrieder signed a contract with Russia's Trade and Ecomomic Ministry in May to build a 370 million euro ($475 million) plant in the Russian city of Kaluga, it may have been the death knell for Russian auto makers.

With the deal, most of the world's big auto companies will now be present in the largest of the former Soviet Union states. GM, Toyota, Ford, Nissan -- and now VW -- will avoid large tariffs on their cars, thus hastening the demise of the Russian standard bearer, Lada.

Russia doesn't excel in auto manufacturing, but it is tops in other areas. The country's great wealth in oil, natural gas, and metals, in addition to generating revenue for the government, is creating a new middle class that craves European, Japanese and American cars. Between 2003 and 2005, import makes more than doubled their market share, from 12 to 25 percent.

To increase that share, VW will start production of the compact Polo in Russia. The Russian-built variety will cost just shy of 10,000 euros, making it very competitive with the Russian Lada, a car plagued with reliability problems. Currently, VW sells around 40,000 cars in Russia. That is supposed to be ramped up to 150,000 by the end of 2010.

Strings attached to production

VW is not the only German maker taking a close look at the large -- and potentially very willing -- Russian market.

"We are conducting a feasibility study to see whether it makes sense for Audi to go there, and under which conditions," said Till Brauner, head of Audi Russia. Audi is a Volkswagen subsidiary.

Another VW subsidiary, Skoda, has plans to build the Octavia and Fabia models in Kaluga, some 160 kilometers southwest of Moscow.

But Moscow has not given the giant auto producers carte blanche to drive its automobile sector to ruin. To retain tariff advantages granted now, the foreign auto makers will, in future, have to use parts that are made in Russia. For the time being, VWs and Skodas will only be fitted together in Kaluga.

"Skoda's production system, much like VW's, is based on cooperation with just-in-time suppliers who deliver modules. So it will be mandatory that suppliers be nearby, otherwise the timing and the rhythm just won't function," said Skoda board member Horst Mühl.

Over time, should imports start selling briskly, German parts suppliers will have to move closer to Russian plants, or the carmakers will have to depend on Russian parts. Otherwise, they cannot sell their cars at competitive prices.

Not everyone rushing to Russia

Prices affordable for "normal" Russians will play a large role if a foreign carmaker wants to succeed in Russia. Car ownership is by no means as exotic as it was during the Soviet Union but Russia still lags behind its neighbors. According to the European Bank for Reconstruction and Development, Russia has about 157 cars per 1,000 people. Poland, in comparison, has 250.

In contrast to VW's grand plans, DaimlerChrysler has decided against the construction of a Mercedes plant in Russia. The conditions of local production have to be worth their while, says Daimler's head in Russia, Jürgen Sauer. For the time being, he says, conditions just don't make sense.

And anyway, for those Russians who have deep enough pockets to purchase luxury cars like a Mercedes, right now they prefer the "Made in Germany" label more than one that reads "Made in Russia."