Foreign Carmakers Gain in Russia

The likes of Daewoo, Ford, Renault, and more can't produce fast enough

A few years ago, Victor Tsernialov, a 36-year-old Moscow software consultant, scraped together enough money -- $6,050 -- to buy a new car. He chose a 1999 Russian Lada -- and has regretted it ever since. The car had engine troubles on the drive home and cost him $1,800 in repair bills in the first year. "The servicing of Russian cars is very bad: 'Soviet' loutishness, poor quality spare parts, and high prices," he fumes. No wonder, then, that last year Tsernialov paid $14,800 in cash to buy one of the very first Focuses to roll off the line of Ford Motor Co.'s (F ) new factory in Vsevolozhsk, an hour's drive north of St. Petersburg.

The rising affluence of middle-class car lovers such as Tsernialov explains why Ford and other multinationals are doing a brisk business in Russia. Sales of new foreign cars were up by 40% last year, to 110,000. Daewoo was the No. 1 foreign make, at 12,418 cars, followed by Skoda, Renault, and Toyota (TM ). Ford, which invested $150 million to build its new plant, has had orders for 11,000 Focuses since production started last August. That's nearly three times the number of vehicles Ford sold in Russia in 2001 before the plant opened, and a year ahead of initial forecasts. "We have one major problem," says Murray Gilbert, manager of the new factory. "Our marketing and sales colleagues can sell more cars than I can make."

Ford's new local production gives it a big advantage over most foreign auto makers who ship their product in: It doesn't have to pay hefty 25% import duties. So far, the only other global carmaker to have invested in Russian production is General Motors Corp. (GM ), whose new factory, a joint venture with Russia's Avtovaz, opened last September. But other investors are following. On Feb. 26, Renault announced the biggest foreign investment yet seen in the Russian car industry. It's spending $250 million on a Moscow factory where Renault plans to produce 60,000 sedans a year starting in 2005. "Russians crave cars. They like cars. They want cars. And we believe we have a good product," says Renault CEO Louis Schweitzer.

It's easy to see why auto makers believe Russia is a good bet. Car ownership has doubled in the past decade, to 141 cars per 1,000 people, and it may double again in the next one. "Global manufacturers have to find new growth markets, and one of these is Russia," says Vladimir Savov, an analyst at Brunswick UBS Warburg. Russia's own car manufacturers -- notably Avtovaz, maker of the Lada -- still control some 90% of the market. But the Lada's poor reliability is legendary, and its appeal is fading fast. While demand for foreign cars is booming, sales of Russian cars slumped 10% in 2002.

There's a problem for foreign manufacturers, though: Many of the foreign autos sold in Russia are secondhand, which helps local dealers but does little for the auto makers. "It is the plague of the automotive industry here," says Heidi McCormack, general director of GM in Russia, who criticizes the favorable tax treatment given to secondhand imports. Used cars are subject to duties depending on age and engine size but are exempt from the 20% Value Added Tax if imported individually. Under pressure from struggling local carmakers, the government last year raised import duties on older cars. Industry insiders expect that these higher levies will be extended to all used cars over time.

Still, tariffs won't change the essential problem facing Western producers: Although affluence is rising, it still takes the average Russian the equivalent of five years' income to buy a Western-made car. That's why some foreign carmakers are building cheaper models. GM has adopted a local Russian design, the $8,000 Niva SUV, rather than introducing one of GM's own models. Renault will develop a new sedan targeted at low-income buyers in Russia and Eastern Europe.

Financing is another hurdle in a country where cheap credit is scarce. Carmakers are working with local banks to develop financing schemes. Ford owner Tsernialov points out that the interest on a car loan was 25% in 2001. Today, it's about 10%. Bit by bit, a modern auto market is taking shape.

By Jason Bush in Vsevolozhsk

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