FRANKFURT -- Volkswagen Group plans to reduce costs at its namesake passenger cars brand by 5 billion euros ($6.8 billion) by 2017 and boost productivity as it seeks to lift sagging profitability.
Efficiency gains have failed to keep pace with rising r&d and labor costs, CEO Martin Winterkorn said in an internal presentation to company managers.
The VW brand, the carmaker's biggest division by revenue and deliveries, has profit margins lower than rivals because of fixed costs that VW said are high relative to Toyota.
The brand's 2013 profit margin was 2.9 percent, compared with auto division margins of 8.8 percent at Toyota and 9 percent at Hyundai Motor. The unit's operating margin dropped to 1.8 percent of sales in the first quarter from 2.4 percent a year ago. The company's target for the VW brand is a 6 percent margin.
VW's profitability gains are disappointing given its steady expansion, analysts say.
"Let's be honest: We have a lot of catching up to do with our core competitors," Winterkorn wrote in a letter to VW managers. "That is why we must now take action that is clear, effective and sometimes painful," he said, pointing out that r&d costs had surged 80 percent across the multi-brand group since 2010.
VW employs nearly 575,000 people, more than any other carmaker. Much of VW's production is in its home market of Germany, where workers secured a significant pay increase last year. The company has sought to offset its heavy wage bill by sharing parts and development costs among its portfolio of 12 vehicle brands.
High labor costs
Winterkorn said production of an additional variant of the VW Tiguan SUV was determined to be “not economically feasible” to produce in Germany and such setbacks need to be addressed. "Our shared task is to create the ability to profitably produce these vehicles here in Germany."
Auto workers in VW’s home country cost 48.40 euros per hour last year, the highest in the world, according to data from Berlin-based auto-industry group VDA. That compares with 25.63 euros in the United States and 29.96 euros in Japan.
VW’s top labor representative said he supports the push to lift earnings and demanded that benefits determined in collective bargaining agreements remain untouched by cutbacks.
"Regarding productivity, the board and the management have to finally do their job,” Bernd Osterloh, head of VW’s workers council, said in an internal newsletter to employees obtained by Bloomberg News. “It’s right that Winterkorn finally makes it clear that management has to fix its own mistakes."
Osterloh and other labor representatives account for half of VW’s supervisory board seats and have veto rights on important company decisions.
VW toned down its 2014 profit outlook in February, saying core profit may only improve if economic conditions, especially in Europe where VW Group sells about 40 percent of its vehicles, improve more than expected.
To boost efficiency across its 310-model empire, Europe's biggest automotive group is reviewing its strategy. A post-2018 plan dubbed "Future Tracks" will set out priorities on technology and model policy and may be outlined later this year.
"VW's and Audi's product momentum remains tough for 2015," said Arndt Ellinghorst, London-based analyst at investment researchers ISI Group. "We see a real chance that margins keep slipping."
Winterkorn said VW brand may decide to stop making non-profitable models, citing convertible cars. Other steps may include lowering purchasing expenses, reducing complexity, cutting factory expenses and improving sales channels.
While VW plans to intensify efforts in areas poised to shape future mobility like connected vehicles and electric cars, it intends to outsource production of components that can be produced more profitably by suppliers.
"This is not about cosmetic change," Winterkorn said. “This is about asking fundamental questions.”
VW brand accounted for more than a third of the group's 47.8 billion euros in first-quarter revenue but only about 15 percent of operating profit. VW brand's global sales rose 4 percent to 3.07 million in the first half.
Separately, VW declined comment on a report by Germany's Manager Magazin published on Tuesday saying that Winterkorn had agreed with leaders of the supervisory board to extend his contract by two years until 2018.
Bloomberg and Reuters contributed to this report