Volkswagen Budget Offering Not Without Risks

BMI View : VW's plan to possibly release a budget brand in the Indian auto market in three to four years time will help the automaker better compete with other volume players, which have more affordable offerings in the segment. However, this strategy is not without its challenges as the previous struggles of other low-cost cars such as the Tata Nano highlight.

German carmaker Volkswagen AG (VW) has announced that it is considering a budget brand for the Indian market, in a similar strategy to the one pursued in China. According to the Economic Times, a decision is likely within the next year and if the firm goes ahead, the model can be expected to be released in three to four years time.

We previously highlighted that VW faces tough competition in the domestic volume market due to its models being priced at a premium compared with similar offerings from market leader Maruti Suzuki ( see 'Greater Localisation To Make VW More Competitive', May 21).

We see this strategy of introducing a more affordable brand in the mass market as a pivot in the right direction, helping the firm better target value-oriented customers. Furthermore, should the company go ahead with its plan for a budget brand, its introduction will come at a time when the carmaker is aiming to have increased its localisation rate to 90% from 70% currently, which will then allow it to further reduce the manufacturing costs of its cars.

Some of the reasons cited by the automaker for developing a more affordable brand for the domestic market include a slowing economy (which in turn has depressed vehicle sales) and high interest rates, which are also some of the headwinds we have been emphasising over the past year ( see 'Turning Bearish On Autos', August 14 2013).

That said, we emphasise that we see a pickup in vehicle sales in FY2014/15 (April-March), after the industry suffered a precipitous decline in FY2013/14. Moreover, we forecast auto sales growth to average 6.1% over the FY2015/16 to FY2018/19 period.

However, despite our expectations for strong sales growth over the coming years, we believe that there will continue to be a large market for affordable volume brands. Cars remain an aspirational good for many consumers and the arrival of newly minted middle-class consumers every year will spur demand for mass market brands.

Budget Positioning Not Without Challenges

A bigger challenge we see for VW's budget brand will be its brand positioning. Tata Motors has struggled to boost sales of its low-priced Nano car since its launch in 2009. Despite being known as the 'world's cheapest car', it has received a tepid reaction from consumers thus far. Some of the reasons for this include the pricing out of potential and existing two-wheeler customers, who may have been looking to upgrade, as well as the negative perception among some consumers of the brand's austere image.

On the other hand, the revival of budget brand Datsun by Nissan Motor has seen the automaker's fortunes surge over the past few months. Nissan's domestic sales in India more than doubled in May 2014 to 5,021 units, of which the newly launched Datsun GO car contributed 1,992 units.

In our opinion, the divergent fortunes of these two budget car models highlight the considerations, which VW will need to take into account, if it plans to create a brand to target the lower end of the volume segment.

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Related sectors of this article: Autos, Dealerships, Production - Autos, Passenger Vehicles, Companies - Autos
Geography: India

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