VW crushing competitors in Europe with financing edge; expect long term price pressure, report says

Here’s another theory seeking to explain Volkswagen of Germany’s domination of European car sales: cheap financing and strong second-hand values.

Earlier this year Bernstein Research alleged VW, which now has almost 24 per cent of the West European market, was using massive profits from its China business to subsidise a price war to relentlessly build market share at the expense of its weak competitors.

In the first half of 2012, VW raised its market share in Western Europe to almost 24 per cent, up from 22.4 per cent in the same period of 2011, more than twice its nearest competitor Peugeot-Citroen of France. Some experts think this might accelerate on to 30 per cent. VW is making impressive profits – a margin of 6.8 per cent in the first half, while its mass market competitors – GM Europe’s Opel-Vauxhall, Ford Europe, Peugeot Citroen and Italy’s Fiat – totter in the face of huge losses. (France’s Renault, thanks in part to a successful cheap car subsidiary Dacia, is keeping its head above water.) Sales in recession-hit Western Europe slumped by nearly seven per cent in the first half to just under 6.5 million. So how come VW booms while its competitors fester?

Firstly of course, VW is big in Germany, which still boasts a sound economy. Is it also unfairly using Chinese profits to undermine the competition?

No, says a report from investment banker Morgan Stanley. It is much simpler and more basic than that.

“We think VW’s market share success is due in large part to the simple fact that its cars are cheaper to own,” said Morgan Stanley analyst Stuart Pearson.

Pearson said the secret of VW’s success may lie in a low total cost of ownership and slower depreciation which makes owning a VW five per cent cheaper than a comparable vehicle, with only Hyundai consistently cheaper. VW is leveraging its access to cheap finance to offer cheaper prices.

“VW funds itself at rates up to 400 basis points below peers, yet reports the lowest returns in its Finco (finance subsidiary). We think VW is using its growing funding cost advantage to effectively subsidize vehicle pricing without hurting industrial margins,” Pearson said.

Pearson said VW is able to raise funds for vehicle financing for less than two per cent, while competitors like Peugeot-Citroen pay closer to five per cent. This gap allows VW to save $1,900 on a financed vehicle over three years or eight per cent.

“VW is thus in theory able to charge up to eight per cent lower for cars it sells with finance than its peers, with no cost to margins (at least relative to peers),” Pearson said.

And that’s not the least of VW’s advantages. It’s new best-selling Golf small family car, which will debut at the Paris Car Show next month, is produced using VW’s new engineering module. This increases standardisation of parts and in theory should save a huge amount of money.

“We estimate gross annual savings of ($17.6 billion) from this tool kit by 2019, of which we expect two thirds to be reinvested into content and/or pricing. VW’s impressive market share gains may thus continue a while yet,” Pearson said.