As Russia works through the impact of its market crash, domestic OEMs such as GAZ Group have found contract manufacturing to be a viable option to keep profits steady, if not on the rise.
Despite unfavourable conditions stemming from currency depreciation and political turmoil, VW and Skoda have continued to produce cars at the GAZ factory in Nizhny Novgorod through their existing contract manufacturing arrangements.
Russian market shows potential, but it’s not straight forward
This initially began with contract manufacture of the Skoda Yeti in October 2011. The VW Jetta followed in March 2013, and then the Skoda Octavia in May that year. A significant overhaul of the plant in Nizhny Novgorod was undertaken to kit out the location to VW’s standards. Previously, the general assembly site was used for the short-lived Volga Siber project in 2009, and most of this equipment was modernised. The body shop, however, was a brand new greenfield development.
attended by (from left) Günther Heiden, Chief Operating Officer GAZ Group, Vadim Sorokin, President GAZ Group Sören Häse, Head of Mercedes-Benz Vans Russia and Rene Mack, Director Sales & Marketing Mercedes-Benz Vans
Günther Heiden, who was appointed as Chief Operating Officer at GAZ Group in December 2013 after more than 20 years at Magna, notes that currently, the market situation for VW – and everybody – “is difficult. We have a maximum capacity of 110,000 cars per year, and of course we want to utilise all of that.”
GAZ also manufactures the Mercedes-Benz Sprinter T1N van for Daimler. “The market is there, and we sold over 6,400 units last year,” explains Marco Wildgrube, Head of Quality, T1N, Mercedes-Benz Russia. “I would say it is a huge investment, but of course we want to stay,” he adds.
Production has been scaled back since the project started two years ago. Before the crisis, a two-shift operation produced around 70 vehicles per day. Currently, five vehicles are produced per hour, equating to a daily output of 40 vehicles in one shift. Currently, the plant is operating at below-capacity levels, but Wildgrube is quick to point out the risks of over-production in the current economic climate: “It is almost a target to not produce more than the demand because we want to avoid the problems associated with high inventory.”
As it stands, the plant’s maximum annual production capacity is just over 15,000 units. Despite adjusting production, the 10,000th Sprinter rolled off the line in June 2015, 23 months after production began in July 2013.
Why have global OEMs VW and Mercedes opted for contract manufacturing operations within an emerging market such as Russia?
A balancing act
Andrew Bergbaum, Managing Director, Automotive at business advisory firm AlixPartners explains that the additional benefit of contract manufacturing in low cost countries, “is the proximity to a low-cost base for all of the large components that are expensive to ship.” However, he points out that all of this then has to be balanced against the cost to ship out the finished product, as well as “the additional cost of engineering due to building a car not in the OEM’s own factories.”
Bergbaum lists the levels of over-capacity in the BRIC markets: Russia at just 35% factory utilisation, India at 54%, China at a healthier 76% and Brazil at 51%. “Only a select few OEMs actually need additional capacity. When they do need it, these regions probably only make sense if there is a local market to deliver to,” he explains.
For VW’s Russian operations, materials are brought in from Mexico, the Czech Republic, and Europe, before being delivered to one of GAZ’s central warehouses.
As for whether the partnership with VW will stay steady with three models, or expand to include a greater model range in future, Heiden explains that it is up to VW, but reinforced that from his experience, contract manufacturing is “not just something you do for one or two years, it’s long term.”
Risk management
Mercedes-Benz also has contracts with Magna International’s Austria-based subsidiary Magna Steyr, which manufactures complete vehicles for a range of global OEMs. Karl Stracke, President Fahrzeugtechnik & Engineering describes the supplier’s involvement in contract manufacturing as “being in the service industry” to its OEM customers.
“Sometimes, if the customer goes with a new product and there is a higher risk for them in the market, they will use the contract manufacturing business model as a first step, and then look to whether they can invest by themselves internally,” he adds. This, he says, effectively limits risk for the OEM: “On a competitive level it is a better deal for the OEM to go with the contract manufacturer first, before putting all of the structure and fixed costs down into their own operations.”
But reputation, says Stracke, is crucial when it comes to contract manufacturing. And reputation has clearly played its part for Magna Steyr: the Graz plant in Austria has been producing Mercedes-Benz’s G-Class for 35 years, as well as models for Aston Martin, Audi, BMW, Chrysler and Peugeot, amongst others. “If you do not have a good image in the market, you don’t get the job. You need to have excellent quality, a highly engaged, motivated and well educated team, and the right footprint,” he explains.
Mexico and India showing promise
Magna Steyr sees potential in expanding its contract manufacturing footprint, with Mexico high on the list. “Mexico is also an ideal hub to export cars to global automotive markets, including China, and at least in the past, South America. This is why we think it is not just because of the low labour costs, it is also because of good conditions to export cars around the globe. We also see some requests from Chinese OEMs that are interested in that hub, so we are working to help them export their vehicles down the road to emerging markets, but then also to mature markets,” explains Stracke.
Jaguar Land Rover recently entered a contact manufacturing agreement with Magna Steyr for this reason. The rationale behind this agreement is to create additional volumes needed to support its plans for further growth.
In India, OEMs have been carrying out temporary suspensions in production in order to keep inventory levels in check. In such situations, contract manufacturing is a good option for OEMs because of the flexibility it brings. Indian automotive components manufacturer Omax Autos says it has completed deliveries of an order for 20 vehicles to an unnamed OEM. Volvo too has considered looking to India for a local contract manufacturing partner through either Hindustan Motors, Mahindra & Mahindra or General Motors.
Get your wallet out
When considering setting up contract manufacturing operations from scratch in an emerging market, Dave Andrea, Senior Vice President and Chief Economist at Michigan-based Original Equipment Suppliers Association (OESA), points out that there is a significant investment required. A plant – whether refurbished or completely greenfield – requires “all of the systems and controls any OEM would have, but the plant layouts don’t include the same fixed investment that you might have for running a 300,000 unit vehicle through.”
However, “to get the kind of flexibility to be able to run three shifts or to run six different models down the same line, the capital investment needed for that flexibility either remains the same or increases.”
Freddie Holmes
