Major investment is now being made in the Russian automotive industry and the region looks set to become a force to contend with. But companies are still showing caution
Russia has been largely overlooked as a place of investment. It suffered from recession during the 1990s and global companies chose to focus on easer-to-tackle markets in China and Eastern Europe. Now, however, it is becoming difficult to ignore. The car market has surged in the last two years and the subsequent investment by global OEMs will see foreign capacity reach a million units by 2010. Nevertheless, Russia still has a reputation as a hostile place in which to do business and has a significant lowcost domestic industry. Global OEMs appear to be taking a very cautious approach and few have plans to install plants with more than 100,000 unit capacity. Some think the best approach is to partner with local companies, others are investing alone.
However, there appear to be considerable opportunities for suppliers and though the existing domestic industry is typically vertically integrated, it now needs to partner with suppliers to become more competitive. On top of this, foreign makes need to increase local content to bring costs down. So is Russia finally turning out to be the next big automotive investment opportunity?
Russia is set to exceed Brazil and become one of the top five fastest growing markets in the world in the next ten years. According to Roland Berger Strategy Consultants growth will average an additional 100,000 units a year though to 2014, ahead of India and Brazil.
The market is being driven by increasing income, as well as a renewal of the ageing car fleet. Car ownership is currently 180 cars per thousand of the population. This is well below that of other east European countries, such as Poland, where car density is currently 250 cars per thousand population. Annual per capita income (on a purchasing power parity basis) in Russia is currently less than $12,000, but it is forecast to rise to $16,000 by 2010 and $23,000 by 2016. Roland Berger is forecasting the car density to reach 235 units per thousand population in 2010 and 320 by 2016.
This is equivalent to a car parc of 44 million cars, up from 25.5 million in 2005.
The average age of the car fleet is currently in excess of 15 years (compared to eight years in Germany), so this means there is also significant replacement potential. Russian consumers are increasingly demanding higher levels of comfort and safety from their vehicles and this has already encouraged a surge in sales by import brands. Asian OEMs sold 377,000 cars in 2005 (23 per cent market share), while US OEMs sold 126,000 cars (9 per cent market share), and the Europeans 102,000 (7 per cent market share).
Overseas brands are accounting for all of the growth in the market and sales by domestic brands are stagnating. According to Roland Berger, domestic makes accounted for around 50 per cent of the market in 2005, around 0.8 million units sold out of a total market of 1.6m. By 2016, however, domestic makes are expected to account for just 0.7 million cars sold in Russia, out of a total market of 2.8 million units.
The largest producers in Russia are still the domestic makes but their models are old and unattractive, and the newest model – the Lada Kalina – is not much cheaper than the best-selling global OEM model, the Ford Focus, which is assembled locally.
Russian OEMs lost eleven percentage points of market share between 2004 and 2005, and their volume dropped by around 50,000 units. Nevertheless, they will have a future, according to Juergen Reers, a partner in the Roland Berger Automotive Competence Center, who has spent much time in Russia advising automotive customers. Domestic producers are implementing new business models, such as partnerships with international OEMs, and they are restructuring their businesses to take advantage of their experience of the Russian consumer, and their dealer networks.
Russian OEMs have partially modern production equipment but they need technology, particularly shared platform technology, and greater access to suppliers.
There is an absence of an independent supplier industry and domestic makes need to partners for access to the equipment and technology they need.
The government is putting pressure on the domestic industry to update itself quickly by bringing in new emissions and safety legislation. For example, plans are in place to introduce Euro 4 emissions standards by 2010. Euro 2 comes into force this year.
This is not a government that will protect domestic manufacturers, although it has overseen changes in management control at the two largest producers, GAZ and AvtoVAZ, to help ensure their future.
GAZ is now part of RusPromAvto, which is controlled by private equity firm, Basic Element. Lada producer, AvtoVAZ, the country’s largest carmaker, is now controlled by state-owned arms export company, Rosoboronexport and run by a personal friend of Russian President Vladimir Putin. It is applying for a $5 billion cash injection to help modernise its Togliatti plant.
The Russian government has stated that it sees that automotive industry as a key driver of the economy.
The industry and energy ministry estimates that it currently contributes around 2.5 per cent of GDP and expects this figure to rise to 4.3 per cent by 2010. During the same period it should create an additional 72,000 jobs, according to Viktor Khirstenko, Industry and Energy Minister.
Key to this growth is investment by foreign vehicle manufacturers and framework conditions for foreign investment have been improved. In early 2005 the government cut tariffs on components imported for use in assembly plants in Russia from 13 per cent to zero, where local content reached 30 per cent. Only Ford has reached this level so far, but it has incentivised other OEMs to step up their investment programmes.
Overseas manufacturers are also expected to become more price competitive with the low-cost, low-technology domestic makes as tougher emissions standards come into force. In addition, the government has improved the framework conditions for investment by suppliers that are key to creating a competitive automotive sector.
Many foreign OEMs have established plans for relatively low volume assembly in Russia, but combined, their plans amount to a total annual capacity of one million units. Interestingly, Roland Berger has conducted surveys of foreign investors in Russia and most have good experiences of investing there.
AvtoVAZ has an annual capacity of around 750,000 units. However, its models are old and unattractive, and the newest model, the Kalina, launched in 2005, is not much cheaper than the Ford Focus. Set up in collaboration with Fiat in the 1960s, the company’s huge Togliatti plant (in the Samara Oblast region) is said to feature over 140km of production lines and produces most of its own components in house.
The original Fiat 124-based cars, (known as Zhigulis until the late 1990s having been named after the nearby hills) are still in production. The official model name for these is VAZ-2101, although the last digits are changed on updated versions. Other cars produced include the Samara, Lada 110, and the Niva SUV.
The Lada name is for export only, although AvtoVAZ has withdrawn from many Western markets because the cars do not meet global emissions and safety standards.
The company built a new modern plant for the Kalina (also called Lada 1118) with capacity for up to 330,000 cars annually. The Lada 1117 is the station wagon version of the car and the Lada 1119 is the hatchback.
Some AvtoVAZ cars are assembled by other local assembly companies including IzhmMash and ZAZ. At the end of 2005 a new management team was elected, comprising managers from state-owned arms export company, Rosoboronexport and there are plans to turn it into a stand-alone national champion. Rosoboronexport has announced plans for a $5 billion shake-up of AvtoVAZ involving a new factory and several new models.
It is planning a number of new models and is reported to have been in discussions with Italian design studios, following an example set by the Chinese and Koreans. The first stage of investment will be in boosting production of the Kalina up to 300,000 cars by 2009.
General Motors and AvtoVAZ have a joint venture to assemble the Chevrolet Niva, and the Opel Astra, but the new AvtoVAZ management team has been seeking to end it. Separately it has entered into talks with Renault about a possible cooperation to assemble Logan cars. Renault already assembles the Dacia Logan from CKD kits at its Avtoframos plant in Moscow but it needs more capacity.
It was suggested that Renault might take a stake in AvtoVAZ, but despite its need for investment and Western expertise, AvtoVAZ appears determined to remain a Russian-owned national champion, and it now appears unlikely that Renault will take a stake.
PSA has also been reported to have been in talks with AvtoVAZ and at the time of writing there were reports that an agreement with Magna was imminent. Magna would be in a position to support the development of vehicles and manufacturing facitilites while allowing AvtoVAZ to remain independent.
GAZ, or the Gorky Automobile Plant, is located in Nizhny Novgorod and is another Soviet giant best known for the Volga cars, but is also a truck manufacturer.
Unlike AvtoVAZ it is no longer producing large volumes of cars. It produced 19,000 buses, 55,000 cars and 170,000 vans and trucks in 2005. It has registered an 18 per cent increase in sales up to September 2006.
The Volga is being phased out in favour of the Dodge Stratus/Chrysler Sebring, built under license since GAZ acquired the assembly line from DaimlerChrysler when the latter modernised its Sterling Heights Assembly plant in 2006. GAZ will also purchase engines from Chrysler’s Saltillo, Mexico plant.
A recent major development at GAZ is the acquisition of LDV, the UK-based van producer. It plans to assemble LDV’s new Maxus panel van in Russia, as well as increase production volumes in the UK. GAZ has appointed former head of Ford of Europe, Martin Leach, as Chairman of LDV, and former AT Kearney consultant, Steve Young, as CEO. They are known to be highly experienced in the automotive industry and are expected to bring some new strategic thinking to the GAZ group.
GAZ has also hired some other prominent automotive industry executives directly. They include Davis Eggers, formerly Financial Director at Ford of Russia, and Erick Eberhardson from Volvo, who is Deputy General Director for Strategic Development.
GAZ’s main shareholder is a Russian private equity fund called Basic Element, founded in 1997 by Russian oligarch Oleg Deripaska. Its combined asset value exceeds $14 billion, giving it the resources for considerable investment. Like AvtoVAZ, GAZ produces most of its components in-house and has iron and steel and non-ferrous foundries, forge, presses, wheel plant, engine and transmission plants, and plastics processing.
Ford was the first foreign OEM to open its own assembly plant in Russia when it started production of the Focus in July 2002 at is plant in Vsevolozhsk in St. Petersburg. The Focus is produced there in four body styles (3-door, 4-door, 5-door and wagon).
Following an initial investment of $150m in 2002 to start production, Ford has invested a further $80m in 2005 to increase annual capacity to 60,000 units. With production having already reached full capacity, it recently announced a further investment to increase capacity to 73,000 units by 2007 and add the Mondeo and Maverick to production.
Local press reports have also suggested that Ford has started construction of a facility adjacent to the existing plant to assemble Land Rover Freelanders. Assembly, which is due to begin in 2008, will be from CKD kits with a production rate of around 15,000 cars a year.
In addition to the Focus, Ford currently sells the following vehicles in Russia: Fusion, Fiesta and Mondeo cars; Galaxy van; Ranger compact pickup truck; Maverick, Explorer and Expedition SUVs; and Transit and Transit Connect commercial vehicles.
In 2005 it sold a total of 60,000 vehicles in Russia, but this year expects the figure to double to 120,000 vehicles. The Focus is currently the best-selling import car model in Russia. In the first five months of 2006 sales totaled 30,200 units, up 90 per cent on the first five months of 2005. A basic Focus model costs around $11,700 thanks to tax breaks worth a reported US$700 a car based on the fact that the cars contained around 40 per cent local content.
The tax break was withdrawn briefly in June this year because authorities said the car did not meet the required local content target, causing an interruption to production. However, Ford said the target has now been exceeded.
New tax breaks from August this year mean that cars produced at the plant no longer require customs clearance.
GM has several operations in Russia. Perhaps most importantly, it established a joint venture with AvtoVAZ in September 2002. Currently, the venture produces the Chevrolet-Niva (which is an improved version of the original VAZ-2123 model) and the Opel Astra, rebadged as the Chevrolet Viva. However, it appears to have hit problems. After taking control of AvtoVAZ late last year, Rosoboronexport attempted to renegotiate the terms of the cooperation with GM. Two weeks worth of production was lost before the two parties reached a compromise. Russian management has spoken of “unsolved technical problems”, possibly related to the fact that the Chevrolet Viva is based on the Astra T3000, and does not compete effectively with the Ford Focus.
GM and AvtoVAZ each hold 41.5 per cent stakes in the venture, while the European Bank for Reconstruction and Development (EBRD) holds the remaining 17 per cent.
Although GM management has said it is keen to continue with the joint venture sales decreased 4 per cent year on year to 51,819 cars in 2005. Output fell to 51,810 cars in 2005 from 57,737 cars in 2004. Capacity is 100,000 units.
Unwilling to place all its bets on AvtoVAZ, GM is pursuing other options for the region. In 2004 it started producing the Hummer H2 at Avtotor, an assembler located in Kaliningrad that also assembles the Chevrolet Tahoe and Trailblazer, as well as cars for Kia and BMW.
In June this year it also started producing the Hummer H3, and there have been reports that it may assemble some Korean-built Chevrolet models in the future.
GM is also building a €100m ($127m) greenfield plant in Shushary outside St Petersburg. The plant will go on stream in late 2008 with an initial full-year capacity of 25,000 units. It will produce Chevrolet Captiva SUVs and a new generation of compact cars from CKD kits.
Separately GM has also set up a separate SKD facility in the city of St Petersburg, which began operations in the autumn of 2006. This facility will assemble the Chevrolet Captiva until the Shushary facility begins production. Total investment in the new facilities amounts to $115m.
It is also worth noting here that GM has maintained a relationship in the Ukraine with AvtoZAZ, assembling various Opels and Chevrolets from CKD kits alongside AvtoZAZ’s self-developed Tavria hatchback range and a modified version of the Daewoo Lanos. AvtoZAZ is stateowned, and is part of UkrAvto, a vertically integrated group that includes car manufacturing, car sales and maintenance. AvtoZAZ is emerging as a major force in eastern Europe since acquiring Polish company FSO. The FSO plant needs product and GM is seeking capacity. FSO’s licence to build former Daewoo models runs out later this year.
Russia has become a major export market for both Hyundai and Kia, which have a combined market share of over 20 per cent. As low cost producers they may be able to compete more effectively than some Western OEMs as importers, but they are nevertheless localising production.
Hyundai assembles the previous versions of Accent, Sonata, Santa Fe at the assembler TAGAZ in Taganrog, with up to 100,000 units capacity (42,451 produced in 2005), and is reported to be considering other locations for future investment. As the largest import marque in Russia, Hyundai would be badly hit by an increase in import tariffs.
Kia has established local assembly with Avtotor in Kaliningrad, where the Sportage, Rio and Magentis are assembled from CKD kits (11,780 in 2005), and with IzhAvto, which assembles Kia’s best-selling model in Russia, the Spectra. Assembly by IzhAvto was just 3,000 units in 2005, but Kia sales in Russia have risen threefold this year, and Spectra sales were over 11,000 units in the first half of the year.
Fiat is aiming to sell 80,000 cars a year in Russia by 2010, up from less than a hundred units last year. This would be equivalent to a five per cent market share. It has an alliance with Severstal-Auto which will assemble the Albea and a new car code-named D200 at its plant in Naberezhniye Chelny from October 2007. These cars will be assembled from semi-knocked down kits imported from Fiat’s Turkish joint venture, Tofas. Production plans are for 40,000 units a year. Severstal also imports and distributes the Fiat Panda, Grande Punto, Croma and Doblo built in Italy. Fiat is also reported to be considering setting up sales channels for Alfa Romeo and Lancia cars.
Renault has a joint venture with the Moscow city government, called Avtoframos, which uses the facilities of the now bankrupt Moskvich company. It holds 93.4 per cent in Avtoframos, with the government holding the remainder. The venture started producing Clio cars from SKD kits, and started making the Logan from April 2005.
The Logan is badged Renault in Russia in contrast to the European markets, where it is badged Dacia.
Capacity is currently 60,000 units, but the joint venture is currently planning to increase this to 75,000 cars in 2007 and potentially further to 120,000 units. As noted above Renault has also been in discussion with AvtoVAZ about assembling the Logan in Togliatti. At the time of writing no deal has been reached.
Nissan is also building a plant in Russia and has signed an investment agreement with the city of St. Petersburg.
When fully operational, the plant will employ around 750 people and have an annual production capacity of up to 50,000 vehicles. Investments in the construction are expected to total $200m, with construction expected to start in March-May 2007 and production in 2009.
Toyota is also building a new plant in St. Petersburg due to become operational in 2007. Capacity is being installed for up to 50,000 units by 2009. Several suppliers are investing alongside the Japanese carmaker. Toyota Tsusho is supplying production equipment and will provide on-going maintenance and support, as well as be responsible for industrial waste disposal. Toyota Boshoku will supply seats. Kawasaki Kisen Kaisha and Mitsui are also establishing a presence.
Elsewhere, Volkswagen announced in June 2006 that it would build a new plant in Kaluga, Russia, with an investment of €370m ($470m). The plant is due open in the second half of 2007 with production initially focused on SKD assembly of the Skoda Octavia at a rate of around 20,000 units a year. Production will then be expanded to include the VW Polo, Passat and Touareg.
A body shop and paint shop are expected from 2009, allowing it to produce complete vehicles, at a rate of up to 115,000 vehicles annually. To complete the picture Avtotor assembles the 5-series for BMW.
PSA Peugeot Citroën is the most notable absentee of the major global OEMs in the Russian automotive industry. It has been researching sites for a reported €200m ($254m) investment in the country but at the time of writing no decision has been announced.
A major threat to the established vehicle manufacturers’ plans is the emergency of Chinese OEMs in Russia. Russia is a natural export market for the Chinese at the moment because of its lower emissions and safety standards.
The market is also still extremely price sensitive and the Chinese can offer basic models that compete well with the old Russian designs and at a lower price.
The most active Chinese company in Russia is Chery. Its cars are being assembled from CKD kits by Avtotor, the company that also assembles Kia, GM and BMW cars. Chery expects to sell 15,000 cars in Russia this year and plans to increase CKD capacity at Avtotor to 25,000 upa.
Another Russian assembler, Novosibirsk Automobile Factory (NAZ), has produced a batch of Chery cars, and is planning to establish volume production of up to 25,000 units a year. NAZ is a joint-venture enterprise established in 2005 by Chery Automobile and the TransService holding company, based in Novosibirsk.
Avtotor is also working with other Chinese makers. It has an agreement with Nanjing Yuejin to manufacture of 40,000 1-tonne trucks by 2010, and a deal with Zhongxing to assemble Admiral pick-up trucks and SUVs that could see production rising to 20,000 units a year.
Pick-up and SUV producer, Great Wall, is reportedly planning a $100m plant with an annual capacity of 50,000 units per year in the town of Yelabuga in Tatarstan. This was the site of a failed GM project to build Chevrolet 4x4s a decade ago. Great Wall is already selling vehicles in Russia; in 2005 it sold 6,600 cars. Great Wall is also reportedly in talks with Avtotor about assembly.
Unlike in western Europe, there is no shortage of distributors in Russia that are prepared to take on Chinese automakers. Irito Group, the biggest local GAZ distributor with dealerships across the country, has deals with several Chinese vehicle manufacturers including Xinkai, FAW, Great Wall and Byd. FAW is already selling imported trucks in Russia. Hebei Zhongxing is now being distributed by two companies in Russia. One of them in Siberia assembles Zhongxing pick-ups under the FAW banner. Its production in Russia could reach 6,000 SUVs and pick-ups this year and 10,000 in 2007.
Chinese makes were particularly prevalent at the Moscow International Motor Show in August. Amongst others, Chery showed its new V5 MPV and Tiggo NCV models, while FAW brought its recently launched Besturn (Benteng) and upcoming HQ3.
Indian manufacturer Tata is also displaying a strong interest in Russia, and is planning to enter the market with a range of light commercial vehicles as well as heavy trucks and buses. Russian company AMUR already assembles the Tata LPT 613 light commercial vehicle. “Russia is a focus market in Tata Motors’ global growth strategy,” said Head of Tata Motors' International Business P G Shankar in a recent press report. “We have decided to enter Russia not just to sell our vehicles but also to be part of the Russian economy and grow with our customers by offering the best value proposition through products and services.”
He went on to say that the company is also exploring opportunities for investments in product development, marketing and even manufacturing. Car assembly could be next, and Tata’s low cost car, which is still under development, could be targeted at Russia.
According to Roland Berger, the top 20 global suppliers have approximately 150 production locations in Central andEastern Europe but only a few in Russia.
Investment to date has been hampered by the low volumes available in Russia. Having already invested in eastern Europe as a low cost production location from which to supply western Europe, suppliers today are mainly interested in investing in Russia to tap in to the local market. Also, the business environment has not been favourable towards attracting investment, although as mentioned above, the framework conditions for foreign investment have improved.
Roland Berger is forecasting that the original equipment supply market is growing much faster than the vehicle market, at an average annual rate of more than 20 per cent.
It calculates that the market is currently worth less than €1 billion ($1.27 billion), but that by 2014 it will be worth over €5 billion ($6.4 billion). The main factor behind the growth is that suppliers are set to take a higher share of value creation in the future. On the one hand Russian OEMs are currently highly vertically integrated as stated, but they will need to source more from suppliers to become internationally competitive, raising opportunities for suppliers both in and out of Russia. Meanwhile, international OEMs will increasingly localise production.
At the moment Roland Berger estimates that local content at international OEMs averages at around 12 per cent, but that this will rise to around 36 per cent by 2010. While forecasts for the Russian domestic market are bullish, Russia remains a gamble for many OEMs, because of the highly competitive situation.