Volkswagen leads the way in the FDI decision race

Foreign Direct Investment (FDI) is ‘The purchase of physical assets or a significant amount of ownership of a company in another country to gain a measure of management control’ (Wild, Wild & Han, 2004).  There are commonly two types of FDI which can be categorised as Greenfield investment or International mergers and acquisitions activity.  Greenfield investment is when a company solely enters a market and invests in offices, buildings or other physical assets.  Conversely International mergers and acquisitions is when a company joins forces with an international business or businesses.

FDI has been the biggest flow of resources into developing countries in the last 20 years.  Much of this has been driven by the growth in international technology advancements and the desire of large domestic companies to make the step to become multinational.  It could be argued we are part of a ‘multinational era’ where almost all large firms have operations all around the world which originated from significant FDI.  In recent years the most rapidly increasing inflow area for FDI has been south-east Asia.  But why do firms decide to employ FDI in the first place?

·         Market – firms may be facing domestic saturation or could see an international market as a growing source of demand.

·         Raw materials – international regions may have high levels of natural resources that are essential to a firms output and hence it makes sense to get closer to them.

·         Product efficiency – a business may employ FDI to make their business more efficient.  This could be by seeking technology or, more commonly, lower labour costs.

·         Knowledge – it may be that international countries have specific knowledge bases that could be exploited to aid the growth of a business.

The reasons outlined to explain FDI are generic principals often outlined in academic texts.  In reality the reason depends entirely on the motive of the firm in question.  For example fast food chain McDonald’s expansion into the Asian market in the late 70’s and 80’s was largely driven by the rapidly expanding market for fast food in the region.  Conversely UK and US service sector industries often locate their call centres in countries like India and the Philippines to take advantage primarily of the cheap labour force that is available.  However I would expect that within any motivation the overriding desire is to maximise growth and ultimately increase profits.

German company Volkswagen is the world’s second largest motor vehicle manufacturer and the biggest in Europe.  The group also owns well know automobile companies Audi, Seat and Skoda.  In 2011 the company’s profits more than doubled to €15.8bn as they delivered a record 8.2 million vehicles.  These impressive figures have been underpinned by their strong performance in the three biggest growth areas; China, Brazil and India.  Volkswagen is popular in these areas, and all around the world, due to their flexible strategy; they make cars to fit local tastes and needs and price the vehicles to suit the finances in the market place.  For example in China Volkswagen focus on small vehicles like the Polo to suit the busy roads and have been known to lower their prices to make them more available to the masses that have little disposable income.  But these cars are no longer being imported from factories in Germany; the growth has been supported by notable spurts of FDI.

Volkswagen targeted China over a quarter of a century ago with a joint venture in 1984, the Shanghai Volkswagen Automotive Company Ltd.  This was shortly followed by the Volkswagen Automotive Company Ltd in Changchun in 1990.  This was seen as incredibly risky by analysts as China was still in the throes of a cultural and economic revolution at the time and uncertainty still clouded the region.

China is now, and has been since 2008, the largest car producer in the world.  In 1990 China produced less than a million vehicles a year but now produces over 20 million annually.  Over 50% of this production is undertaken by foreign companies of which Volkswagen is the largest.  Volkswagen’s Chinese subsidiaries are now wholly independent of their German roots and control the entire value chain; from design and production right through to sales and service.  This is an example of an incredibly successful piece of FDI with the company taking advantage of a fast growing consumer market coupled with the country’s low cost labour and now highly advanced infrastructure.  What makes this all the more impressive is that the world’s leading motor vehicle manufacturer, General Motors, did not invest in China until as late as 1997 in a joint venture with Shanghai Motors.  This highlights Volkswagen’s notable foresight in investing so early and gaining a firm footing in the market before its main competitors.

However in December 2011 a joint announcement by the Ministry of Commerce and the National Reform and Development Commission in China stated it would ‘withdraw support for foreign investment in the country's car industry to encourage domestic carmakers’.  This is a fair decision in a struggling world economy as the government simply wants to support domestic businesses by stimulating local production.  But where does this leave Volkswagen? If they want to continue their worldwide expansion surely they will have to find somewhere new in which to invest?

The answer is that they already have - India.  Volkswagen has invested €580m in India since 2006; Volkswagen India Private Limited has a large production facility in the northern state of Punjab which produces 110,000 units annually.

India is currently the second fastest growing motor vehicle market and is likely to become the fastest growing in the next 20 years.  It is expected that domestic demand will outstrip that of the USA by 2035 and China by 2050.  Volkswagen sales in India were up 18% in 2011 and the head of the passenger car division of Volkswagen India, Neeraj Garg, told the BBC that he ‘expected the same compounded interest over the next four to five years’.  All in all this makes it an essential market to have an influence in.

Volkswagen has displayed their investment foresight once again and has taken advantage of the significant benefits of FDI in India.  Firstly, as discussed, it is a rapidly expanding market and it seems logical for cars destined for India to be produced within the country.  Also India has a vast, knowledgeable workforce which remains cheap to employ.  In the past the poor infrastructure in India has limited the extent of FDI flowing into the country.  However as the economy expands, currently the second fastest growing economy after China, the infrastructure is rapidly improving.  As time progresses more and more manufacturing and production companies will look to invest in India.

In the case of Volkswagen it looks like they have implemented FDI with seemingly perfect timing.  They entered China before the boom and then expanded abroad, to India, as the Chinese market seems to have reached saturation point and the Indian market is in the infancy of what is expected to be a rapid development.  Whatever the future holds for the car manufacturing industry it appears Volkswagen will be at the forefront.  Whether the next boom area is Russia, Brazil, Africa or somewhere different altogether it is likely Volkswagen will already be there ready and waiting.