Growth Engine

Rescued from communist-era ridicule by Volkswagen, Czech carmaker Skoda's stellar performance now outshines its German parent.
Jason KaraianApril 7, 2008

Last month, the executive team of Skoda gathered at the Czech carmaker’s headquarters in Mladá Boleslav, about an hour’s drive north-east of Prague, to unveil yet another batch of record-setting financial results. It was a wet, grey day that put the imposing concrete communist-era tower blocks which ring the factory in a particularly grim light. “While there is a storm outside, here at Skoda we have sunshine,” CFO Holger Kintscher quips. “Sometimes I worry that we are growing too fast,” he adds. “But for the time being, this is a good problem.”

Many executives would relish Kintscher’s problems. Since 1991, when it was bought by Volkswagen in one of the first privatisations in the former eastern block, Skoda has transformed itself into a global player with sales in 100 countries and a growing collection of awards for design, quality and customer satisfaction. Skoda is now a crucial source of growth for its German parent company, a remarkable turnaround from the days when the boxy, erratic cars that rattled out of plants in communist Czechoslovakia were the objects of widespread scorn in the West.

The Czech marque is also speeding ahead of Volkswagen’s other brands. Last year, Skoda grew the fastest out of the passenger-car brands in its stable — VW, Seat, Audi and Bentley. The company delivered 630,000 cars, a 15% increase on the previous year, with nearly 90% shipped outside of the Czech Republic. At CZK222 billion (€8 billion), its 2007 revenue was up 9% from the previous year. Operating profit, at CZK19.8 billion, grew 35%. (See charts at the end of this article.) Skoda accounted for 8% of Volkswagen’s group revenue and 14% of operating profit in 2007, despite the Czech crown’s rapid appreciation against the euro. At 9%, Skoda’s operating margin is three times that of the VW brand and even one percentage point higher than luxury brand, Audi. What’s more, in a global quality ranking across Volkswagen’s various factories, Skoda’s plant in Vrchlabí, near the Polish border, ranked first last year.

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How long will the good times last? With deliveries in January and February up nearly 18% on the year before — again setting the pace among Volkswagen’s brands — “I cannot see the end,” says Kintscher. The company plans to deliver at least 700,000 cars this year, with a “medium-term goal” — perhaps as early as 2010 — of 1m annual deliveries.

Despite Skoda’s growing confidence and ambition, the outlook may not be as relentlessly sunny as executives suggest. While “Skoda owes its position today to Volkswagen,” according to Karel Potmesil, an analyst at brokerage Cyrrus in Prague, in recent years the Czech carmaker has relied solely on its own cash flow to fund investments. As the brand gains followers and opens up new markets, will it get enough support from Volkswagen to fulfil its potential, or will the parent hold back the Czech marque in order to help its other brands?

Grow Without Growing

Before joining Skoda in 2005, Kintscher spent nearly 20 years in various group-level and business-unit finance roles at Volkswagen in Germany and Poland. After five years as head of controlling for Volkswagen’s commercial vehicle unit in Hanover, he got a call from Hans Dieter Pötsch, Volkswagen’s group finance chief. “Mr Pötsch asked me whether I’d go to the Czech Republic,” Kintscher recalls. “The only possible answer was yes.” Given Skoda’s performance since he joined, he is quick to add that “it was a very good decision.”

Since moving to Mladá Boleslav, the CFO has made it his mission to help the company “grow without growing” — that is, to drive higher sales and profits without succumbing to the bureaucracy and waste this often brings. And Kintscher wants finance to lead by example. He recently centralised the controlling function at headquarters, with one group managing domestic operations and another overseeing projects abroad. “Everybody is aware of the risks of expansion,” he says. Like any good finance chief, he is now preparing “a plan B for every possible situation,” he notes. “We can be profitable in the future without growth.”

For now, though, the “good problems” that come with rapid expansion are higher on the CFO’s list of concerns. For example, an unemployment rate of 2% in the region around Mladá Boleslav makes it difficult to attract and retain staff for the factory, finance and most other parts of the company. To help address this, Skoda Auto University, the country’s only company-owned college, was recently expanded to accommodate 750 full-time students and provide training for 3,400 employees. And Kintscher himself spends a great deal of time in lecture halls at other universities throughout the country, talking up career prospects at Skoda. But those efforts, to date, aren’t enough. “To be honest, I don’t have a solution,” Kintscher admits.

West Meets East

Under the strategy that Skoda’s executives call “Go East,” Kintscher could face more growth-related problems, both at home and abroad, as the company’s expansion quickens. In addition to ramping up capacity at its Indian plant, the company opened factories in Russia and China last year. According to Kintscher, Volkswagen is putting Skoda at the forefront of the group’s plans for these fast-growing markets, with plans this year to double the unit’s sales in 2007 of 67,000 cars in the three countries.

In some respects, directing Skoda’s focus eastwards helps Volkswagen prevent it from taking customers from other group brands, particularly its eponymous passenger-car unit, which shares parts and technology with the Czech marque. Consider the trends on Volkswagen’s own doorstep. Skoda deliveries in 2007 to car-mad Germany, its largest export market, increased 8% despite an overall decline of car sales in the country. Double-digit increases in deliveries also boosted Skoda’s modest market share in France, Italy and Belgium.

The Czech brand could grow further in these mature markets, if its parent would allow it. To compete meaningfully in western Europe, “Skoda needs more products,” says Walt Madeira, a London-based analyst at research firm CSM Worldwide. “Volkswagen is capable of investing more in them.” Skoda’s current practice of launching one new model every year is too limiting, Madeira reckons. After all, in November, when demand for the Skoda Octavia exceeded the company’s production capacity in the Czech Republic, Volkswagen had to shift production of the VW Polo away from its plant in Bratislava, Slovakia, to meet the excess Skoda orders.

“Skoda is doing all the right things, but it is limited by the aspirations of its parent,” notes Paul Newton, an auto analyst at market research firm Global Insight in London. “It could probably do better as an independent company, but it is completely reliant on Volkswagen for platforms and technology, so it’s a moot point.”

How will Volkswagen’s aspirations shape Skoda’s future fortunes? It’s hard to say, given Volkswagen’s unclear brand strategy. “Volkswagen seems to let its subsidiaries co-operate and compete at the same time,” notes Aswin van Oijen, a professor at Tilburg University in the Netherlands whose research focuses on the relationship between parent companies and their business units, one of the most fraught areas of modern corporate management. “Parents tend to prefer their children to get along instead of fight,” he adds, calling Volkswagen “a bit of an exception.” (See “Unit Trust” at the end of this article.)

The Parent Trap

For his part, Kintscher insists that “though there are some restrictions on producing new models and some restrictions on investments, the support is there, and we have a good relationship with Volkswagen.” What’s more, “as long as our performance is good, most decisions are under our control,” he says. “We hope it will stay that way.”

It may, but not without some speed bumps. When Skoda entered India in 2001, “we were positioned as a luxury car, and made good profits,” according to Kintscher. But last year the VW brand launched its Passat and Jetta models in the country, some of them assembled in the Skoda-owned factory in Aurangabad. Since then, Skoda has been “downsizing,” in Kintscher’s words, its marketing pitch as a premium brand in the country.

Rumoured plans for a new Skoda model based on the “Up!” concept car — a tiny, rear-engined model unveiled at the Frankfurt Motor Show last year — also seem designed to move the brand further away from VW. Expected to target China and India, the stripped-down model would be priced below Skoda’s current compact Fabia range.

Given the years of graft it took to shake the stigma from the tinny, unreliable models produced during the communist era, Skoda will need to tread carefully when developing such a car. “Our image is improving,” Kintscher notes, “so if we bring in a car below the Fabia, we will not compromise on quality or safety.” A decision on whether such a model can be produced profitably will be made in a few months, the CFO says.

Another decision, which could have an even bigger effect on Skoda, will be made later this month. At Volkswagen’s annual shareholders meeting, Porsche, the group’s largest shareholder, will seek to scrap the statutes that give the German state of Lower Saxony, its second-largest shareholder, de facto control over major decisions at the company. If Porsche gets its way, it says it will acquire a majority stake in Volkswagen.

So far, Volkswagen’s unique governance has ensured that the company is run as much in the interest of unions in its home state as its customers and shareholders. What will happen if Porsche, the world’s most profitable carmaker, is given free rein to manage Volkswagen’s overlapping portfolio of brands? Last month, Wendelin Wiedekin, Porsche’s CEO, pointedly said that there will be “no sacred cows” as the enlarged group seeks to improve performance.

For Skoda, the consequences of the battle for control of its parent company are difficult to predict. In the meantime, few doubt that the company will be fazed by the ructions among its current German owners. For more than 100 years, Skodas have rolled off assembly lines despite the competition or politics of the day. Throughout, the company has remained, to quote its current marketing slogan, “simply clever.”

Jason Karaian is deputy editor at CFO Europe.

Unit Trust

Last November, a motoring journalist for The Independent newspaper in the UK pit Skoda’s top-of-the-line Superb against the Phaeton, the flagship model from Volkswagen, Skoda’s parent company. The Phaeton costs more than twice as much as the Superb and is often considered to be a direct competitor of the Audi A8, another Volkswagen-owned brand. But, as the columnist concludes, “it’s not only feasible to slash your budget without feeling the pinch, but in many ways, going for the Czech-built alternative could actually be the preferred option.”

Having vanquished its laughing-stock image after decades of under-investment by the communists, Skoda’s current success nonetheless presents a dilemma for Volkswagen. If motorists don’t perceive a meaningful trade-off between a Skoda Superb and a VW Phaeton — or even an Audi A8 — the Volkswagen group will succumb to that most evocative of management phenomena: cannibalisation.

It’s an issue faced by many other multi-unit companies studied by Aswin van Oijen and Eric Dooms, professors at Tilburg University in the Netherlands. There are two key tensions every parent company needs to manage, van Oijen notes. First, parents need to “justify their existence,” he says. If there is no synergy between business units, the group should break itself up, eliminating the costs of the headquarters. But if a parent is too controlling and “turns its subsidiaries into mindless drones, it is not able to learn from the unique problems they face and the solutions they develop to deal with them,” he adds. The second tension involves finding an equitable way to manage a diverse collection of businesses. In theory, the incentives and autonomy granted to a unit should be finely tuned to its unique characteristics. However, the Tilburg professors’ analysis suggests that “control differentiation” often breeds resentment among unit managers, sometimes to the extent that they “sabotage co-operation with other parts of the firm.”

Mark Thomas, head of the strategy and marketing practice at management group PA Consulting in London, notes that “there are costs to internal competition, but also benefits.” It can “force a company to confront who is best at doing a certain thing,” he says. Arbitrarily favouring one unit due to size or history, or any other reason unrelated to performance, can dampen profits by awarding sales to a less efficient part of a business, he adds.

Van Oijen is currently looking into this very issue. “For companies like Volkswagen with a large market share, perhaps competition isn’t fierce enough,” he says. “Thus, they can keep sharp by driving up competition internally. That could be the reasoning, but I haven’t yet found it in other companies.”