Volkswagen Waltzes Into Tennessee

In order to cap losses, the German automaker needs to build in the U.S. It's great news for Chattanooga, but another blow to the rust belt

Volkswagen (VOWG.DE) has selected Chattanooga as the site for a new U.S. assembly plant. Tennessee, the home of Jack Daniel's, beat out Alabama and Michigan for the investment and jobs that go along with it.

Volkswagen needs a plant stateside to combat the devastating effect of the weak U.S. dollar on its profits. The German automaker is currently forced to import all of the vehicles it sells in the U.S.—the primary reason its American operation has been averaging losses of $1 billion a year since 2004. Even vehicles made at VW's Mexican plants have been a drag on earnings because those cars have too many euro-denominated parts.

In an interview with BusinessWeek earlier this year, Volkswagen of America Chief Executive Stefan Jacoby said manufacturing in the U.S. is an imperative to staying viable. "The U.S. dollar, we think, could stay quite weak against the euro for some time, so we must build a big percentage of our vehicles here rather than rely on imports," Jacoby said.

VW's supervisory board approved an investment of as much as $1 billion in the new factory, which is scheduled to start production in early 2011. The company says a midsize sedan will be the first product in the new plant, priced between today's Passat and Jetta models. Though the company has not been specific about what models will be rolling off the Tennessee assembly line, VW executives have hinted for months that the car would be built off the Passat engineering platform, and designed to match U.S. tastes. There will likely be a crossover SUV built on the same engineering platform. Executives have also hinted that VW could shift production of the Jetta from Mexico to Tennessee. VW's sister company, Audi, is also looking at building a product at the plant.

An Audacious Plan

Volkswagen has a storied history in the U.S., going back to the days when it sold Beetles and Microbuses in the 1960s and 1970s. But today it has merely 2% of the U.S. market. Last year, the company sold just 231,000 Volkswagen-branded vehicles in the U.S., down more than 100,000 from four years earlier. This year, sales are flat—which is a pretty good performance compared with deep drops at General Motors (GM), Ford (F), and Chrysler, and better than some other imports, such as Toyota (TM) and BMW (BMWG.DE).

For Volkswagen, the Tennessee plant is the cornerstone of an audacious plan to build up to 1 million in U.S. sales by 2018 (the figure covers both the VW and Audi brands). Few automotive analysts believe VW will be able to reach that target, characterizing the forecast as propaganda. "A goal like that pushes the whole organization in the same direction internally, and shows enormous confidence to owners and car shoppers," says Los Angeles-based marketing consultant Dennis Keene. Jacoby told BusinessWeek: "We know it is an ambitious goal, but it is the one our company's management has set for us."

The Chattanooga operation will have an initial capacity of 150,000 vehicles and will include body production, a paint shop, and assembly operations, Volkswagen said. Most plants are built to expand to between 200,000 to 300,000. For purposes of comparison, Toyota spent $1.3 billion on its San Antonio plant, which began making pickup trucks in late 2006. That factory, which has a capacity of between 150,000 and 200,000 vehicles, employs 1,900 workers directly and supports additional jobs at 21 on-location suppliers. The VW plant will employ 2,000 initially, but may not generate as many supplier jobs. It remains to be seen whether supplier companies—now located in Alabama and Georgia to supply plants operated in Alabama by Mercedes-Benz (DAI), Honda (HMC), and Hyundai, as well as those supplying Nissan (NSANY) at its Tennessee plant—will build new facilities to service VW, or leverage the facilities they have and truck the parts to Chattanooga.

Leaving the Rust Belt

Chattanooga, looking to replace some of the textile industry jobs it has lost, presented VW with a compelling plant site. Off Interstate 75, the state and city had prepared a 1,350-acre "megasite" complete with its own exit and interchange off the highway, industrial utilities, and connecting rail line. The short-line rail tracks that roll into the site connect with both CSX and Norfolk Southern freight lines. "We have been pursuing an opportunity like this for a number of years, and we're ready," says Trevor Hamilton, vice-president of economic development at the Chattanooga Chamber of Commerce.

Officials declined to give any specifics about the incentives the state, city, and county offered. Jacoby, Volkswagen of America president, said the VW site assessment team was impressed with many "intangibles" about Chattanooga, including its livability, sustainability focus, mountain and river setting, and environmental record.

While a boon to Tennessee, VW's decision is another blow to America's rust belt—Wisconsin, Michigan, Ohio, Pennsylvania, Indiana—where Detroit's three automakers have been closing plants. Despite the ready workforce in those states, foreign automakers have mostly opted to build greenfield plants far away from the organizing bases of the United Auto Workers union. Toyota is building a plant that will make Prius hybrids in Mississippi where Nissan already has a plant. BMW's plant is in South Carolina. Kia Motors' new plant is in Georgia. But it's Alabama, which also was in contention for the VW plant, that has scored the most auto-related jobs in the last decade—30,000-plus. None of the foreign-owned plants, except for Mitsubishi's Illinois plant, has been organized by the UAW, and that arrangement dates back to when it was a joint-venture plant with Chrysler.

Volkswagen is now in the process of moving its U.S. headquarters from Auburn Hills, Mich., to Fairfax County, Va. The company has long bristled at being located in the shadow of Detroit's Big Three, and said it was moving to be closer to its customers in a coastal market.

This is not the first time VW will be building vehicles in the U.S. In the 1970s, the company opened a plant in Westmoreland, Pa., to build Rabbits and small Rabbit-based pickups. It had planned to open a plant in Sterling Heights, Mich., in the 1980s. But with its sales plunging, the company moved to shutter the Rabbit plant and sold the Sterling Heights location to Chrysler. Clearly the German carmaker hopes its newest American venture will meet with a better fortune.

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