Among the dry, scrub-covered hills outside the Mexican town of San Jose Chiapa, a plot of land the size of 45 football fields will soon give Volkswagen AG (VOW) a boost in its effort to become the world’s biggest automaker.
There, executives from VW’s Audi luxury unit tomorrow plan to break ground on a $1.3 billion factory with a capacity of some 150,000 cars a year. With its German facilities running flat-out, the plant will be instrumental in Audi’s push to topple Bayerische Motoren Werke AG (BMW) as the leading auto brand for wealthy drivers.
The investment in the dusty town of 5,000 between Mexico City and the port of Veracruz will let Audi boost production of sport-utility vehicles, key to its effort to catch its German luxury rivals in the U.S. Last year it sold about half as many cars in the country as BMW and Daimler AG (DAI)’s Mercedes-Benz.
“The new Mexican plant plays a very important role for Audi, because Audi can produce in North America independent of U.S. dollar currency swings,” VW Chief Executive Officer Martin Winterkorn said on the sidelines of an industry conference in Vienna last week.
In San Jose Chiapa, about 35 miles from a VW factory in Puebla, Audi plans to start production of the Q5 SUV from 2016 for the U.S. and other markets. The company is also planning three new sporty SUVs by 2020, a person familiar with the situation said in February, though Audi hasn’t said where those cars will be built.
Profit from Audi funds Volkswagen’s drive to overtake General Motors Co. (GM:US) and Toyota Motor Corp. (7203) as the world’s biggest automaker by 2018. First-quarter deliveries at VW reached 2.27 million vehicles, in third place globally behind GM with 2.36 million and Toyota and its subsidiaries with 2.43 million.
Audi accounted for 56 percent of first-quarter operating profit for VW, based in Wolfsburg, Germany. This year, Audi is forecast to generate 5 billion euros, or 42 percent, of the parent company’s operating earnings as an aging model lineup and spending on expansion cut into margins, UBS predicts.
“Audi’s winning in other markets such as China, and there is no reason why they should not be able to repeat this in North America,” said Christian Stadler, a management professor at the University of Warwick in Coventry, England. “Getting closer to the market in terms of production should help them.”
Audi became the world’s second-largest luxury brand based largely on sales in Europe and an early entry into China. Until four years ago, Audi built three-quarters of its vehicles in the German cities of Ingolstadt and Neckarsulm. By 2017, the German plants will make 45 percent of Audi’s global total as annual production rises to 1.9 million vehicles from 1.5 million last year, according to data from IHS Automotive.
That means Audi will need to pay particular attention to maintaining the quality of its vehicles as production moves farther from its home base. That’s an especially acute issue in the U.S., the world’s biggest market for high-end cars, where Audi’s image was scarred in the 1980s by unsubstantiated reports of accidental acceleration in one model.
Winterkorn insists Audi’s Mexican workers will be just as vigilant as those in Germany. Otherwise, “we wouldn’t do it,” he said. With VW operations in Mexico dating from 1964 and a plant in Tennessee that opened in 2011, “we have already proven that we can produce successfully in the dollar region.”
In the first four months of 2013, Audi’s U.S. sales rose 15 percent, to 47,343 cars. Still, that’s far behind its two main rivals. Mercedes sold 92,822 vehicles to lead the U.S. luxury segment, while BMW delivered 88,127.
Globally, Audi in 2011 surpassed Mercedes and it’s closing in on BMW. Worldwide deliveries in the first quarter rose 6.8 percent to 369,500 vehicles, trailing the BMW brand by 11,900 and widening the gap over Mercedes to 44,600. Volkswagen’s shares have dropped 12 percent this year, valuing it at 69 billion euros. BMW is down 3.5 percent and Daimler is up 2.3 percent.
Volkswagen is betting on inexpensive Mexican labor to further pad Audi’s profit margins, which already beat BMW and Mercedes. The VW unit reported operating profit that was 11.1 percent of revenue in the first quarter, versus BMW’s 9.9 percent margin and 3.3 percent for Mercedes.
Auto workers in Mexico are about 20 percent cheaper than in the U.S. and Canada, according to Luis Lozano, lead automotive partner at PriceWaterhouseCoopers LLP in Mexico City.
Producing in Mexico will also help VW protect itself from big swings in the value of the euro versus the dollar, since many supplier contracts are paid in the U.S. currency and the factory will largely supply American dealerships. For similar reasons, Mercedes operates a factory in Alabama and BMW makes sport-utility vehicles in South Carolina. Over the past year, the euro has bounced between $1.21 and $1.36 and yesterday traded at just under $1.31.
Under Winterkorn, first as Audi chief and then as Volkswagen CEO, the company has poured more than 20 billion euros into the brand’s research and development, helping Audi double deliveries in the last 10 years. Audi now sells 12 model lines, twice what it had in 2003, including three SUVs, the A1 compact and the R8 sports car.
Audi’s new models will face plenty of competition. BMW plans to roll out 25 new models by the end of next year, 10 of them vehicles with no predecessor. Mercedes is bringing out 13 all-new models by the end of the decade.
“Audi will benefit from ramping up its SUV model offerings in the U.S. market,” said Tim Urquhart, an analyst at researcher IHS in London, who expects Audi to gain on its rivals in the U.S. but not catch them in the next five years. “BMW and Mercedes-Benz are not standing still.”
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