Why Skoda's fast rise helps and hurts parent VW Group

Editor's note: Some sentences in the previous version of this story were repeated. Those sentences have been removed.

Success can breed jealousy, and unfortunately for Skoda, Volkswagen Group’s Czech subsidiary, business is booming. Meanwhile, Skoda’s far larger and better-known sibling, the VW brand, struggles to digest heavy investments from which the Bohemian carmaker profits. Last year marked a record for Skoda with volumes rising 13 percent to hit the seven-digit-mark for the first time in its history. Operating profit at the value brand surged by more than half, and its margin expanded by nearly two full percentage points to 7 percent.

Skoda plans to roll out a new or refreshed model every six months underpinned by the ultra-flexible MQB platform, and its biggest product offensive to date is paying dividends. The recently launched third generation of its flagship, the Superb midsize sedan, offers the roominess of a BMW 5 series at a price that undercuts the VW Passat. Next up is a new seven-seat crossover known internally as the “A-Plus SUV,” which debuts next year. By comparison, the VW brand saw its already weak profitability deteriorate even further amid stagnant revenue even though it is typically priced at a premium over volume rivals in Europe.

‘Quicker & better’

While former VW Group Chairman Ferdinand Piech encouraged internal competition as a motivational tactic to ensure no VW Group brand rested on its laurels, times are changing now that he has resigned. Skoda’s string of success is attracting the wrong kind of attention at VW Group headquarters in Wolfsburg. Plans are now being forged to centralize more decisions in Germany -- a move that could stifle Skoda’s growth, analysts fear. The carmaker’s high profits and fat margins contrast starkly with the ongoing problems at the much larger VW brand, which achieved a 2.5 percent return on sales last year -- in part due to costs from developing the MQB architecture that is extensively used by Skoda.

“Skoda is definitely a challenger for the VW brand that must be taken seriously -- that is simply the case,” said a corporate consultant for the auto industry, who asked not to be named since VW is a client. “It’s not just the products that are ‘simply clever’ [which is the tagline Skoda uses on its advertising]. The people at Skoda think quicker and better than many of the people in Wolfsburg, who are too slow and traditional. Many of them could learn from Skoda.”

Fresh from surviving a power struggle with Piech that nearly cost him his job, VW Group CEO Martin Winterkorn told shareholders in early May that VW’s altruistic investments in platform-sharing helped other brands like Skoda disproportionately.

“The speed at which the advantages make themselves felt will vary. At the VW brand, for instance, we are currently only producing around 20 percent of the volume using MQB. But at Skoda the share is already almost double that figure,” he said at the company’s annual general meeting. “This is something that is also reflected in the [Skoda] brand’s outstanding earnings.”

Winterkorn, who this month relinquished day-to-day operational responsibility for the namesake marque to new VW brand chief Herbert Diess, aims to announce a new management structure by October. As a result Skoda may end up being put into a holding of the group’s volume brands that Diess would manage. This has some longtime VW analysts worried that Winterkorn, under pressure to act, ultimately may try to conceal flaws at the VW brand within an opaque holding similar to the brand-group structure his predecessor already employed prior to Piech removing him in 2006.

“There is a risk of that at least. It is really important to have each brand in the market publicly reporting results separately, because it forces management to improve their performance, and you would not have this pressure under a holding,” said Arndt Ellinghorst, who is head of global automotive research at Evercore ISI. “Let’s just agree that Skoda doesn’t have a problem, VW does, and this array of problems that need to be addressed are independent from any bundling. So for Skoda it can’t be anything good really.”

110 years of car building

Skoda, which is celebrating its 110th anniversary building automobiles this year, attracted VW Group’s attention after the Iron Curtain fell because of its good infrastructure, low wage costs and the high skills of its employees. Roughly a quarter century since VW Group took its first stake in the company, Skoda, now a fully owned subsidiary, builds seven model lines and more than 40 different variants. Its Czech plants are also important to VW as a low-cost manufacturing site for other group subsidiaries. Spanish sister brand Seat, for example, has contracted Skoda to build its forthcoming compact crossover, which is due next year, at its Kvasiny plant while the Seat Toledo sedan is currently produced in Mlada Boleslav.

Over many years Skoda has cultivated an image as the smart, rational choice for practical car buyers, focusing on high build quality and functionality, with class-leading luggage space and a roomy interior all at an affordable price. Unlike direct competitors such as Korean automakers Hyundai and Kia, Skoda also offers all-wheel drive in the compact sedan/station wagon segment with the Octavia. Prices for a 4x4 start as low as 25,430 euros with tax in Germany, which is Skoda’s second-largest global market behind China. The added traction on snow and ice is particularly beloved in colder climates, and has helped make Skoda the No. 4 seller overall in the lucrative Swiss market last year behind only VW, BMW and Audi.

Seeking sportiness

While a lot of car is offered in a package for little money, sportiness and emotion have not been selling points of the brand. Due to low demand it scrapped its performance hatchback, the Fabia RS, when it launched the latest generation of the subcompact in Europe last November. While other rivals often develop expensive niche models such as cabriolets as halo cars to bolster their image, Skoda doesn’t produce a single convertible. CEO Winfried Vahland has all but sworn that as long as he is boss, it never will. Experts argue however that Skoda must begin evolving further upmarket, away from its price-sensitive customers that in the future may be attracted to lower sticker prices found on Dacia budget cars or Chinese imports.

“Skoda cannot afford to remain mainly a value proposition in the European market, they’ve got to move on and up, and redefine the brand,” UBS analyst Philippe Houchois said.

Troubles to tackle

Skoda, however, does have a number of problems to tackle. To cope with industry challenges like the digital revolution and new stricter emissions rules, Skoda’s finance chief Winfried Krause told investors last month the carmaker was now analyzing which parts of its business were no longer considered core as part of its Project High Performance Organization, or HPO. While the company said it is not looking to cut costs or reduce headcount, Skoda’s human resources chief Bohdan Wojnar warned in March that “he who does not adapt, will be made to adapt,” amid ongoing talks with its unions. “I am sometimes asked whether the company needs to concern itself at all with this project (HPO) in the current ‘good times’. The answer is clear – we need to take advantage of these good times to prepare ourselves for the new challenges,” he said at the time.

Skoda’s other weakness is its dependence on Europe and China. It is virtually absent from the Americas and Vahland recently confirmed that he had no plans to enter the U.S.

Skoda also has been struggling in Russia and India, two key growth markets. Together with China, the three so-called “RIC” markets are supposed to more than double their 2012 contribution to the automaker’s sales to about 810,000 vehicles by 2018.

As a result of the problems in Russia and India, Eichhorn told Automotive News Europe that his target of selling 1.5 million cars by 2018 could take an additional year to achieve. Market researchers at IHS Automotive, however, do not see sales coming anywhere close to that as it predicts a volume of less than 1.1 million for Skoda in 2018.

Evercore ISI’s Ellinghorst remains concerned that VW Group’s plans for bundling the company’s portfolio of volume brands may come at the expense of further growth at the automaker. “Skoda is a great example of a brand that is fighting to be faster and smarter than others,” he said. “They built a very successful and very profitable business, and I would always have a problem holding back a successful brand such as Skoda to protect a less successful one like VW.”