Investors.com - Geely's Volvo Management Challenge

Geely’s Volvo Management Challenge: Selling Made-In-China Volvos

By MIHO NAGANO, INVESTOR'S BUSINESS DAILY
Posted 07/16/2010 05:25 PM ET

If a strong brand name is key to business success, a critical event has happened: One of the world's most famous auto brands, Volvo of Sweden, is now owned by a little-known Chinese automaker named Geely.

This month, Zhejiang Geely Holding Group, China's biggest privately run carmaker, received EU approval for the $1.8 billion takeover of Ford's (F) Volvo car unit. It's the largest purchase to date of a foreign automaker by a Chinese company.

Geely, listed in Hong Kong, now faces big challenges: It needs to maintain Volvo's premier safety image. At the same time, it needs to cut costs to make loss-making Volvo profitable.

What's the strategy? The answers offer insights into how a pivotal Chinese carmaker aims to play a bigger role worldwide.

Making money in the Chinese market by selling Chinese-made Volvos is Geely's game plan, says auto industry analyst David Zhao of Frost & Sullivan. It will also sell Volvos globally.

Geely wants to sell Volvos to rich Chinese and especially government officials in China, at prices from $40,000 for basic models to $100,000 for high-end luxury models, Zhao says.

"They want to target government fleets which are dominated by Audi right now," he said.

Audi, owned by Volkswagen, is by far the No. 1 luxury vehicle brand in China, selling 157,188 units last year, surpassing Mercedes-Benz, BMW and Lexus.

If you see a black Audi on the street in Beijing, chances are government officials are riding inside, says Ray Ally, executive director of brand consultancy at Landor Associates in China.

Volkswagen was the first foreign automaker to set up a joint venture in China in 1984, long before others. As a result, Audi cars are viewed as a made-in-China luxury brand among government officials, experts say.

Entrepreneur Smarts

Li Shufu, Geely's chairman, founded the company as a motorcycle maker in 1986 and moved into automaking in 1997.

J.D. Power's Tim Dunne, director of global automotive operations, described Li as an "entrepreneur's entrepreneur" and a "fearless and optimistic" leader.

To grab market share from Audi, and to boost Volvo's China sales to over 200,000 units annually by 2015, Geely is expected to open a new Volvo plant with an annual production capacity of 300,000 units in Beijing — mainly to supply vehicles to government and army officials, Zhao says. "So these guys can showcase Volvo cars," he said.

Ally says Volvo's safety image will appeal to regular Chinese consumers too. He says many Chinese brands generally have poor reputations for quality and reliability in the local market.

Volvo posted a first-quarter pretax profit of $49 million in April, its first since 2007. Cutting production costs seems to be a must. Zhao said Geely plans to boost the share of Chinese sourced parts by 8% in the next five years to save $1.2 billion in costs.

But cost-cutting is tricky when Volvo is known for safety. If Geely shifts to use more Chinese-made auto parts in Volvo cars, and cut costs, would it tarnish Volvo's safety image?

"As long as they cut production costs, not safety and quality, the brand should be OK," said branding expert Ally. But he also warns: "China is known for the cheapest, quickest, sometimes poor-quality products. The biggest issue would be quality control. If that goes downhill, that would kill the brand."

Ally noted that all foreign-brand cars currently sold in China are made in China — including Mercedes and BMW. For Volvo this could be a positive because Chinese consumers would feel proud to buy a Chinese-made Volvo car.

Meanwhile, Geely sells subcompact cars in emerging markets like Russia, Turkey and Venezuela. It doesn't sell Geely-brand cars in the U.S. because its quality standards don't match U.S. safety and other standards, Ally says.

Geely's basic cars are sold for $6,000 each, and the company is still viewed as a low-end car maker. "It's well-known in China," Ally said, "but it doesn't have strong brand equity. If they buy a brand, they can get instant credibility."

It's the same strategy that Chinese computer maker Lenovo used when it bought IBM's (IBM) PC business and became a world-class player, Ally says.

Geely's market share in China is still small. In April, Geely had 2.4% of the domestic market, while domestic rival Chery Automobile had 4.3% and BYD had 5.4%, according to J.D. Power and Associates. The rest of the market is made up of foreigners like General Motors, which sells more cars in China than the U.S.

China is the world's biggest auto market with nearly 14 million cars sold last year. How would Geely manage two brands under one roof in such a crowded playing field?

"Geely's strategy is to keep Volvo as an independent brand," said Frost & Sullivan's Zhao.

Control From Above

In March, Geely Chairman Li Shufu said that Volvo would remain a separate company with its own management in Sweden. Auto analysts say this is a smart way to avoid a culture clash, while keeping control.

"But Geely will control the board. Volvo management would feel the pressure from above," Zhao said.

In June, Geely made its first management shake-up at Volvo by appointing Stefan Jacoby, the former chief of Volkswagen's U.S. unit, as Volvo's new CEO.

If Geely is astute enough to preserve Swedish management and culture in Volvo's carmaking, it will be successful, Ally says.

But the question still remains: Can Volvo's Swedish management oversee the quality of Volvo vehicles built in China?

Swedish companies are known for their precision and quality, and how Chinese and Swedish managers deal with quality control can be an issue, says Dianne Durkin, an M&A consultant and president of Loyalty Factor.

Geely also said it would sell a budget car in China called the Geely IG in 2012 with a price tag of around $2,250 — cheaper than India-based Tata Motors' (TTM) rival Nano — which is reputedly the world's cheapest car.

Tata cleared the way for Geely by showing that a low-end carmaker could revive luxury brands like Jaguar and Land Rover, which Tata bought from Ford, by upping sales at both.

But unlike Tata, China's government played a big role in the Geely-Volvo merger.

Geely's Volvo deal was backed by Beijing officials, and Chinese state investors provided nearly 40% of the financing for the deal.

Ally says China, not just Geely, wanted to be seen as owning a brand like Volvo that's known for its safety-conscious image. GM's sale of its gas-guzzling Hummer brand to Tengzhong, a Chinese machinery maker, failed to get government support. Experts say it was blocked because Hummer didn't fit China's push for fuel-efficient technology.

But Geely's venture has official approval. Geely's Li is also lauded as someone who knows the ins and outs of dealing with China's government. "Volvo cannot fail," said Zhao, noting that the government would lose face if Geely's acquisition proved unprofitable.