Magazine

Detroit East


In the Verdant Hills north of Bratislava, the capital of Slovakia, workers at the sprawling Volkswagen plant turn out efficiency-boosting ideas as steadily as the Polo compacts and Touareg sport-utility vehicles gliding off the production line. One recent suggestion was to bring emergency repair teams inside the factory instead of housing them outside in a separate building. Body-shop manager Holger Nestler quickly gave the idea a green light, setting up eight glass offices near the robots that each SWAT team tends. With the repair staff a mere shout away from the site of breakdowns, downtime has been slashed. Back at VW headquarters in Wolfsburg, Germany, union bosses rejected the same idea for German plants.

All the better for Bratislava. The Slovaks recently won the bid to produce Audi's new Q7 SUV, beating out VW's west European plants for the job. The Bratislava factory, which now churns out 250,000 cars a year, is the most profitable of 42 Volkswagen plants worldwide, thanks to low labor costs, flexible manufacturing, and a motivated workforce. "The secret is the mindset of the 10,000 employees. It's a culture of fighting to win," says Thomas Schmall, the 40-year-old German chairman of Volkswagen Slovakia. "The unions come and ask us how we can increase business and how they can help create jobs."

That's not the attitude of VW's truculent German unions, which have saddled Volkswagen with the highest labor costs in the industry -- close to $50 an hour for a 28-hour workweek, some 20% over the already high average wage for German auto workers. In contrast, Slovaks cost $6 an hour and work a 40-hour week, netting VW annual personnel cost savings of $1.8 billion, according to analysts at Germany's Bank Sal. Oppenheim. If Schmall needs to boost production suddenly to meet a surge in demand, the new shifts can be arranged overnight. In Germany, negotiations with unions to alter work-time models can take up to six months and cost more in overtime premiums.

For Europe's auto industry, the old Iron Curtain countries are turning into an investment paradise. Skilled labor is cheap and flexible. Factories are allowed to run normal shifts 24 hours a day, seven days a week without expensive overtime. And government officials vie to offer investors the most alluring conditions. One telling statistic: The French and Germans work 1,440 hours a year, compared with nearly 2000 hours in Slovakia, the Czech Republic, and Poland.

The East's first new auto plants, like VW Bratislava or General Motors Corp.'s (GM) Opel factory in Gliwice, Poland, were built or retooled in the 1990s and have since become performance benchmarks for those manufacturers. Now a second wave of car factories is coming on line, adding almost 1 million vehicles in new capacity in the next 12 months. On May 30, Toyota Motor Corp. (TM) and PSA Peugeot Citroën (PEUGY) inaugurated a $1.8 billion joint factory to produce 300,000 cars a year in Kolin, a city of almost 30,000 about an hour's drive east of Prague in the Czech Republic. The plant will employ 3,000 workers. "When it reaches [full capacity], Kolin will be Toyota's most efficient factory in the world," says Shinichi Sasaki, president and CEO of Toyota Motor Europe.

GROWTH MARKETS

Toyota is in good company. Its partner PSA will open another $1.3 billion small-car plant in Trnava, Slovakia, next year with annual output of 300,000, thus creating 3,000 jobs. Hyundai Motor Co. is investing $1.3 billion in a similar-size plant in Zilina, Slovakia, for its Kia brand, which will open in 2006 and employ 2,400 workers. Suppliers investing near Kia are expected to employ 4,000 more.

Some are calling this super-concentration of carmaking Detroit East. The low-cost corridor from Warsaw to Bucharest is one of the world's fastest-growing centers of auto manufacturing, second only to China. Since 1995 auto makers and suppliers have pumped more than $24 billion into plants in East Europe, mainly in the Czech Republic, Slovakia, Hungary, Poland, and Romania. These are all growth markets where auto purchases are rising. The real goal of the buildup, though, is to provide low-cost plants that can ship cars to Western Europe, where consumers buy 14.5 million cars a year, compared with 1 million in Central and Eastern Europe.

Most auto makers boast at least one factory in Eastern Europe or Turkey, which is fast becoming an adjacent car-manufacturing hub. Next year auto factories in East Europe and Turkey will turn out some 2.3 million vehicles, including midsize cars, SUVs, and even premium models. By 2010 the number is expected to grow to 3.8 million, or more than 20% of Western Europe's production, industry experts say. "All new plants built in Europe will be built in Central or Eastern Europe," says Louis Schweitzer, chairman of French auto giant Renault, which rolled out its $6,000 Romania-built sedan, the Logan, across Western Europe in June to brisk demand. Ultimately the East may claim as much as 60% of Europe's total automotive production, including supplier output, says Josep Fornos, vice-president and general manager of Tenneco Automotive's (TEN) European shock-absorber business.

"HOLLYWOOD HILLS"

The Czech Republic and Slovakia are the hub of Detroit East. By the end of 2006 the two small countries will be producing some 2 million cars a year, compared with a mere 170,000 in 1990. Slovakia alone, with its tiny population of 5.4 million, will produce nearly half the total, or one for every six residents, the highest car output per capita in the world. After losing out in the first stage of investments in the 1990s, Slovakia offered attractive conditions to investors, including low corporate taxes and a commitment to improve the country's highways. Its skilled worker base helped, too.

Across the entire region, the auto industry is quickly becoming a growth engine. Volkswagen, which has invested $1.8 billion in Slovakia, is the country's largest exporter. In the Czech Republic, autos represent 20% of industrial output. The auto-driven boom is also changing the landscape. Roads are being paved and widened, new hyperstores are being built, and factories are mushrooming. Ten minutes from VW's Bratislava plant is a housing enclave dubbed "Hollywood Hills" by the locals. There prosperous new managers live in gracious homes with neatly manicured gardens. Near the VW plant is a posh private club with a swimming pool, tennis courts, and an upscale restaurant. VW employees, who can rise through the ranks and increase their monthly salary from $420 a month to as much as $840, nearly double the country's average income, are focused on education, career moves, and mortgages. "We couldn't advance in the past," says Peter Slovik, a team leader for component production in Bratislava. "Now it's finally possible."

No question, moving east requires big investments in training. Getting a factory up to full efficiency and quality levels can take a year or two, managers on the ground say. But the investment pays off, since Eastern workers are well educated and highly ambitious. "These people are really hungry. They want to improve their lives and buy cars and houses," says Stefaan Vandevelde, head of Delphi Corp.'s (DPH) electric and electronics business for Europe.

The opening of this low-cost production zone will not just change Eastern Europe. It will spark a dramatic overhaul of Western Europe's largest industry. Auto makers and their suppliers fuel a hefty 3% of Western Europe's gross domestic product, employing more than 3 million workers directly and another 12 million indirectly. Yet West European labor costs in the industry, at an average $29 per hour, are among the highest in the world. In Central and Eastern Europe, they are $3 to $6 an hour. And the competition is about to become even more pitiless as the first China-built cars from Honda Motor Co. (HMC) arrive on Western Europe's shores. "People are waking up. This isn't about competition between Slovakia and Germany. It's also about competition between China and Europe," says VW's Schmall. "The only chance for Europe to compete against the U.S. and China is to use advantages offered by Central Europe."

Will auto makers shutter whole plants in the West as they move east? That hasn't happened yet. Those rushing to build new factories in East Europe, from Toyota and Hyundai to Peugeot and Renault, are the fittest players in the West and for now can keep all their factories humming. But in any future crunch, analysts say, it is the less efficient western plants that will get the ax. Within 18 to 24 months, PSA will be making some 500,000 of its 3.3 million cars in East Europe, up from zero. The Kolin and Trnava plants should translate into aftertax labor savings of $187 million for the French auto maker, calculates Sal. Oppenheim bank analyst Patrick Juchemich.

What's more, the rise of Detroit East is giving carmakers a powerful hand to play in their negotiations with unions in Western Europe. It's no secret for GM's German workers that the Gliwice plant in Poland can turn out the same cars for $600 to $700 less per vehicle. Worried that management would transfer production of the new Zafira minivan to Poland, labor leaders at Opel's Bochum factory last year agreed to freeze pay levels until 2010. In return, GM kept the bulk of Zafira production in Germany -- but still added 700 jobs in Poland for a new Zafira line. "Things are happening in Western Europe that you couldn't imagine two years ago," says Volker Barth, president of Delphi's European operations. "Without [demanding higher wages], people are willing to talk about working Saturdays and Sundays."

For now such concessions are helping to save jobs in the West. But the gap between East and West remains huge. "Western factories have two or three years to become competitive. If the West does not get flexible, companies will go where there are competitive conditions," says Hari N. Nair, managing director of Tenneco Automotive in Europe. The real shakeout will come as investment decisions are made for next-generation models and managers see the success of rivals' East Europe strategies. "It will not be a sudden shock, but a succession of smaller shocks. The first wave will start when the small cars from Kolin hit the Western markets," says Robert Weissbarth, a principal at Booz Allen Hamilton. "Then there [will be] a huge incentive for other manufacturers to do the same."

Europe's $160 billion auto-supply industry has begun to lead the exodus. Germany alone has lost some 100,000 jobs to East Europe, market analysts say. While labor makes up 10% to 15% of auto makers' costs, it's a huge 20% to 40% for suppliers. Pressed relentlessly by carmakers to lower prices by an average 5% a year on everything from airbags to antilock brake systems, most suppliers see little alternative but to go east. Ailing auto makers such as Volkswagen and Opel won't even accept bids from suppliers if their parts are made in Western Europe, insisting they can buy them cheaper from factories in the East, suppliers say. "With labor-intensive jobs, we [Germany] have no chance against countries like Romania or China," says Manfred Wennemer, CEO of the $15 billion German auto-electronics and tire specialist Continental (CTTAY).

SHREDDING RED TAPE

Delphi and Visteon, like other suppliers, are feeling the squeeze. CEO Barth has boosted its Eastern Europe production to 30% of the total, up from 15% in 2000, closing five factories along the way in Britain, France, Spain, and Portugal and setting up 15 plants in Eastern Europe. "I have to adapt to the rules of the game. If someone can produce cheaper, we will lose the business," Barth said at a recent industry conference in Barcelona sponsored by Automotive News. Visteon has a big plant in Hluk, Czech Republic, that employs 4,000 and makes lighting and climate-control units.

The drive for savings is pushing carmakers and their suppliers ever farther east. In Sibiu, Romania, Continental found a mayor eager to accommodate new investors, a pool of skilled industrial workers, a university with engineering talent, affordable land, and wages that rival those in China. The Hanover giant decided in September, 2003, to invest $24 million in an automotive electronics plant and an adjacent engineering lab.

Permits were granted overnight, and the city upgraded systems for water, electricity, and gas. The tiny local airport quickly added daily flights to Munich and Vienna. "My task was to build the fastest factory Continental had ever built," says Andreas Brand, general manager of Continental Automotive Systems. Brand achieved his goal in a record 6 1/2 months, thanks to workers who toiled three shifts a day through a bitter Romania winter. The factory opened in April, 2004, and is expanding from three production lines to seven. It employs 300 workers and runs seven days a week, 24 hours a day. "What you see here is world-class," says Brand, as white-gowned workers in clean rooms test circuit boards and electronic controls for door windows.

Auto makers and suppliers are not only transferring production to Eastern Europe but are also tapping into a rich reserve of brainy graduates from Warsaw to Bucharest. Even during the sharp economic contractions that followed the collapse of communism, top-flight mathematicians, physicists, and engineers continued to graduate from East Bloc universities. Delphi has over 1,000 engineers in Eastern Europe. Its Gdansk factory started as a low-cost site but now produces complex products such as steering-wheel switches packed with electronics.

Continental has snapped up 200 engineers in Romania and is aiming to fill 900 jobs by yearend at a new development center adjacent to its electronics plant. Brand also teamed up with Professor Ioan P. Mihu, head of the electronic engineering department at the University of Sibiu, to found Conti Lab. The company provides the lab equipment and its own engineers or invites German professors to train the students and buff their skills in integrated circuit design. In return, Continental gets workers as skilled as those in Western Europe, or better.

Of course, the cost advantage of producing in the East won't last forever. Over the next 10 to 15 years wages will rise there, and the gap with Western Europe will narrow. Suppliers such as Delphi and Nuremberg-based Leoni already are setting up shop in Ukraine, Belarus, and Russia for labor-intensive products such as wire harnesses, which are no longer economical to make in the Czech Republic. Czech labor costs have been rising 10% a year. They are more than three times higher than the Ukraine's $1.80 per hour. But industry bosses say the vital gains in flexibility and longer working hours at their new East European factories won't disappear quickly. New greenfield plants boasting the latest improvements in manufacturing design also will give East Europe a boost for years to come.

The full impact of Detroit East's manufacturing muscle will hit Western Europe around 2008. That's when the plants will reach peak capacity, flooding the Western market with cars that enjoy a newfound pricing advantage. The surge will occur just as Chinese imports start to accelerate. The combined effect on prices will make it increasingly difficult for laggards like Fiat, Opel, and Volkswagen to maintain expensive, excess capacity in the West, and may well force auto makers to shut down Western factories. Wolfgang Bernhard, the new manager of the Volkswagen brand, has already warned that closing plants is no longer taboo. The collapse of the Iron Curtain brought about a political revolution in Europe. With the rise of Detroit East, it has produced a manufacturing revolution as well.

By Gail Edmondson, with William Boston in Hodkivice and Andrea Zammert in Franfurt


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