Skoda: Volkswagen's Hot Growth Engine

The Czech unit of VW has gone from post-Communist laughingstock to global success story. Next stop: Asia

German automaker Volkswagen (VOWG) is wielding a secret bullet to challenge rivals Toyota (TM) and General Motors (GM) in global markets—and it isn't a new small car. It's VW's Czech-built Skoda cars. Lower-priced and higher-quality than similar models built by Volkswagen, Skoda's automobiles are driving a global growth jag, with sales up 13.2% in the first half of 2006. "Skoda has become the true Volkswagen (people's car)," says Commerzbank (CBKG) auto analyst Albrecht Denninghoff.

Skoda's brash challenge to Japanese, Korean, and American automakers in emerging markets is new, and spotlights a savvy renaissance of the Czech automaker from regional player to global contender. This year, Skoda expects to sell 630,000 cars, and it's now targeting sales of 1 million by 2010. (Until recently, Skoda forecast reaching that goal by 2012.)

"We had no idea we could go global in the 1990s," says Skoda Chief Executive Detlef Wittig, who adds the original plan was to focus only on Europe. "The major potential is in Asia—and it's a huge potential."

Back in the Game

A strong player in Western Europe and a market leader in Central and Eastern Europe, Skoda is now speeding into Asia's emerging markets with a vengeance. Revenues hit $5.2 billion in 2006 as customers in 100 countries around the world snapped up its well-built cars, and profit jumped 22% to $491 million. A new Russian factory in Kaluga, south of Moscow, will start producing Skodas and VWs in October.

In India, Skoda has built its own assembly plant, separate from parent VW's Pune factory, where it aims to produce 30,000 cars a year. Skoda also assembles cars in China, Ukraine, Bosnia, and Kazakhstan—and is considering a lower-priced model that could go head-to-head with Renault's (RENA) no-frills Logan.

The Czech comeback has been driven by a combination of affordable prices, spacious interiors, and top quality. Skoda's cars share many modules, technology, and even platforms with Volkswagen. But a VW Golf compact starts at €16,000 ($22,240), while the comparable Skoda Octavia goes for €14,790 ($20,560).

Analysts say over time VW's management may consider letting Skoda become the larger-volume brand, while making Volkswagen's cars more upmarket to defend its margins. "So far, the only limit on Skoda's expansion has been the resources to grow—they have to do it on their own cash flow," says Denninghoff.

Quality Vehicles

Once the butt of jokes about its unreliable cars during the Czech Republic's Communist era, Skoda has now become synonymous with high quality. In the 2007 European consumer satisfaction and quality studies by market researcher J.D. Power & Associates (which, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP)), Skoda ranks among the top 10 in France and Germany; and in Britain it ranked No. 2 (tied with Honda), scoring just a fraction below Lexus. The Skoda Superb, a midsize sedan that starts at €21,990 ($30,570), ranked No. 2 in its class this year in the British survey.

Those scores are far above the quality rankings German parent Volkswagen achieves in J.D. Power's U.S. surveys. (Skoda does not sell in the U.S. market.) They are also a point of pride at the 112-year-old Czech automaker's headquarters in Mladá Boleslav. "We realized when we started to restructure Skoda that to fix its brand image we needed to go for top quality," says Wittig. "We needed to overshoot. For Skoda, the importance of quality for the turnaround was life or death. We can't allow failure, or the old image might come back."

Comeback Kid

Skoda designers have been on a winning streak, too. The new Fabia subcompact, unveiled in March at the Geneva Auto Salon, looks friendly—even huggable—echoing some of the lines of BMW Group's (BMWG) hot-selling Mini. Its flat roof gives the car a faintly similar silhouette to the Mini, and the roof can be ordered in contrasting white, another Mini feature.

Skoda's transformation went into turbo drive in the late 1990s when it introduced the Octavia and Fabia, the first Czech-built cars based on VW platforms. One of the world's oldest automakers, Skoda had been the industry leader in the Soviet bloc. But starved of resources, its quality was subpar and its technology hopelessly out of date. With anemic sales volume of 170,000 cars in 1990, Skoda faced extinction as the Communist economy collapsed. VW inked a joint venture in 1991 and took majority control in 2004, eventually pumping $14 billion into its revival.

That investment has more than paid off. Sales in Western Europe now represent 55% of total sales, and Wittig has nearly doubled Skoda's distribution network to 531 exclusive dealers. Skoda now makes up 7.3% of VW's group sales, and 12.6% of its operation profit. As Wittig moves from Skoda back to VW headquarters on Oct. 1 to take up a new global sales position, and VW's new management ponders how to challenge Toyota, the role of VW's Czech ace is only likely to grow. "Skoda already outperforms Toyota, relatively," says Wittig. "Our return on capital is 19% to 20%—Toyota's is 15% to 16%."

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