Volkswagen fails to strike UAE deal

After months of tortuous negotiations, by early fall the Abu Dhabi government's push for a broad alliance with Volkswagen appeared to be stuck in neutral. And with each passing day, the chances of the two partners striking a large-scale alliance become more remote.

If the deal does ultimately fall apart, it will leave the German automaker in a more precarious position than ever. Just days after word got out that Abu Dhabi would not be seeking a 10 percent stake in Volkswagen - after the two sides could not agree on a price for the shares - came news that an 18-member VW delegation would be in the UAE to consider possible joint-manufacturing initiatives.

While the specifics were not available in mid-October, the team was to look at the feasibility of setting up an automotive assembly plant in Abu Dhabi. Another option was to base a spare parts facility in the emirate, which would make the most of the local energy and aluminum resources to make the project viable.

'There are many facets to our prospective partnership with Abu Dhabi,' said a senior spokesperson with Volkswagen in October. 'If one is ruled out, that does not automatically mean that other possible areas of cooperation will be disregarded as well.'

The UAE market accounts for an estimated 100,000 new vehicle sales annually, plus another 5,000 or so in the commercial vehicle category. Together, the six Gulf Cooperation Council (GCC) states represent annual new car sales of around 500,000 units.

Abu Dhabi plant nonsense

According to industry analysts, the numbers just don't add up; they say that creating a manufacturing facility in Abu Dhabi simply doesn't make economic sense.

'One needs to realise that, even in a market such as China, some of the biggest names in the automotive industry have yet to report a profit from their operations there,' said a top official with a rival German carmaker. 'Cheap energy availability cannot be the only basis to take a decision on setting up a plant in Abu Dhabi. That's just not a good enough reason.'

Despite some gains in the last two years, especially with its Polo and Golf models, Volkswagen is still a very marginal player in the region. The Middle East probably represents less than two percent of overall new vehicle sales for the company. And the region was never central to Volkswagen's plans in the past.

Rivals like DaimlerChrysler and BMW have built up a strong regional network from their offices in Dubai. Volkswagen, however, has still not set up a direct base here. Until very recently, VW distributors in the region often complained about not getting enough shipments. For the company to suddenly consider a manufacturing base in the UAE is indeed a leap of faith.

There are other reasons, equally compelling, why such a project may not be feasible. Import duties in the GCC markets are a flat five percent, following the creation of the customs union on January 1, 2003.

Given that fact, it generally makes more economic sense to import vehicles and parts to the region. Within the Middle East and North Africa region, some of the world's leading carmakers - including BMW and Nissan - do have assembly facilities in Egypt. But these are meant primarily for the domestic market; and one has to keep in mind that import duties in Egypt are in the three-digit territory, depending on the make.

As well, in these instances it is the distributor who is putting up the investment and running the plants. Recently, Land Rover entered a deal with its Jordan distributor for a facility in that country. Again, the high import tariffs have been a major factor behind the decision.

'Egypt, and to an extent Jordan, are exceptions. But for markets where the import duty is five percent, and in such a highly cyclical industry, manufacturing bases are just not required,' said the official with the German make.

So what explains Volkswagen's newfound interest in the region? And with the plan to allow Abu Dhabi to acquire 10 percent on the rocks, why is Volkswagen carrying on with the talks?

There is, of course, the joint venture with Abu Dhabi government-owned Mubadala Development Co. and Saudi Arabia's Olayan Group to acquire VW's auto leasing entity LeasePlan. Under the terms of the agreement, VW will hold a 50 percent share, while the two Gulf-based entities have an equal share of the rest.

Regulatory approval for the estimated 2 billion euro deal is currently pending. Today, Abu Dhabi is negotiating from a position of strength: it needs Volkswagen less than Volkswagen needs the emirate. The German automaker continues to struggle against leaner competition and has seen its earnings take a beating recently, especially in the US market.

The naming of Wolfgang Bernhard - a former DaimlerChrysler executive known for his cost-cutting - as the future boss of the company eased fears in the investment community about the long-term outlook, but serious doubts persist.

Bernhard will likely find cutting costs at VW an extraordinary challenge. The company is currently demanding a two-year freeze in wage negotiations, and says it must achieve 30 percent cuts in production costs by 2011. Volkswagen has enjoyed cordial relations with its unionised workforce in the past, but analysts say its production costs remain too high.

VW remains eager to get a cash injection; Abu Dhabi, it was hoped, would provide the medicine. If the deal does ultimately fall through, the German automaker will surely turn elsewhere - and sooner rather than later. The company's very future depends on it.