Volkswagen AG – The German Car Manufacturer and its Road to Internationalization

Table of Content

1. Introduction

2. VW’s Internationalization Strategy and China

3. Volkswagen in China – An Institution-Based View
3.1. Opportunities for Volkswagen in China
3.2. Challenges for Volkswagen in China

4. The OLI Paradigm and its Applicability for VW in China

5. Conclusion:

1. Introduction

During the last decades the rapidly increasing pace of globalization created opportunities as well as challenges for many corporations all over the world. Among other industries, this process has also heavily affected car manufactures.

From a first idea about a “Volkswagen” in 1904, the Volkswagen Group has grown to one of the largest and most successful car manufacturers worldwide ranked 17th among the world’s biggest corporations by Forbes (Forbes, 2012; Volkswagen Group, 2012). Fuelled by the economic rebuilding of Europe as well as the attempts of several third world countries to gain economic influence, Volkswagen started its road to internationalization around 1950 to 1960 resulting in a breakthrough in Europe, the United States as well as Africa. Continuing this process Volkswagen later discovered the Chinese market in the 1980s (Volkswagen Group, 2012). On the one hand this internationalization was favoured by opportunities but on the other hand different countries come along with issues that are unlike of those in their home market in Germany. This essay will investigate which main opportunities and challenges VW particularly faced in the Chinese market starting from the beginning of its operations in 1985 to the early 21st century using an institution - based view. Moreover, it will also critically analyse the applicability of Dunning’s OLI paradigm for Volkswagen’s internationalization strategy in China.

2. VW’s Internationalization Strategy and China

Appendix 1 provides an up to date company profile with an overview about VW brands and operations today and VW’s financial figures from 2011.

Concerning VW internationalization strategy Pries argues that VW can be called a distribution oriented multinational corporation from the beginning of its operations and therefore started its internationalization earlier than many of its competitors (Pries, 2003). Appendix 2 presents a table, which classifies VW internationalization process into three stages. After the 2nd World War, VW early began to export their model Beetle to the US-American market in 1949 and shortly after to Mexico. Phase 1 is mainly characterized by exports although VW already owned production facilities in other countries. Within its second phase VW was finally transformed to a production oriented multinational corporation due to the opening of much more factories all over the world, which produced different kind of components. This aspect created a worldwide production network. From the beginning of the 1980s VW has started to further change its operations showing more and more characteristics of a transnational corporation (Pries, 2003) This is underlined by appendix 3, which provides an overview of all production capabilities per region as well as a list of the location of production facilities around the world for the concerned time frame. VW’s market entry in China exemplifies one of this step towards a transnational corporation by setting up two joint ventures, Shanghai Volkswagen Automotive Co. in 1985 as well as FAW-Volkswagen Automotive Co. Ltd in 1991 (Mull, 2012)

3. Volkswagen in China – An Institution-Based View

The underlying concepts of the institution-based view and institutional frameworks have mainly been shaped by the two scholars Douglass North as well as Richard Scott (North, 1990; Scott, 1995) and have further been used by scholars to analysis various different business topics including HR, FDI, strategy or international business in emerging markets (Buckley et al., 2012; Clark & Lengnick-Hall, 2012; Jiang et al., 2008; Peng et al., 2009) North identifies institutions as the “the rules of the game” (North, 1990, p.3) by dividing them into formal and informal institutions that create order and therefore decrease uncertainty and transaction costs (North, 1991). As Peng argues, Scott’s definition of institutions as “regulative, normative, and cognitive structures and activities that provide stability and meaning to social behavior” (Scott, 1995, p.3) draws a similar picture, which combined constitute the term institution-based view (Peng et al., 2009). Appendix 4 provides an overview of examples in which areas institutions matter.

In terms of Volkswagen’s internationalization process in China and the associated opportunities and challenges it is important to identify how well developed the institutional framework in China was when Volkswagen entered the Chinese market as well as in the continuing time frame. Concerning this topic there is a general consensus among scholars that China’s institutional environment has lacked important formal institutions e.g. in terms of the establishment of effective courts or the protection of IPR, hence differed significantly to Western economies (Jiang et al., 2008; Peng, 1999; Peng, 2012; Zimmermann, 2012; Child & Tsai, 2005; Martinsons, 1999) Therefore, as Peng et al. and later Yin and Zhang argue informal institutions like culture or personal relations have become more important (Yin & Zhang, 2012; Peng et al., 2009).

3.1. Opportunities for Volkswagen in China

Before VW entered the Chinese market in the 1980s a major economical switch resulting from a policy change has taken place in China and as Child and Tse argue “has dismantled many barriers to modern business operations” (Child & Tse, 2001, p.6). The introduction of the Open Door Policy by Deng Xiaoping in 1978 has started a transition from a planned economy to a market economy (Zimmermann, 2012; Yin & Zhang, 2012; Peng, 1999). This switch of opening the Chinese economy to markets as well as the incentives established by the Chinese government to attract FDI were major opportunities for car manufacturers worldwide (Gan, 2003; APCO worldwide, 2010). Child and Tse highlight that this shift made the Chinese market more efficient resulting in decreasing transaction costs and increased resource availability for firms. Furthermore, they argue that companies have been able to operate in an increasingly transparent institutional framework, which is similar compared to their home market making business easier and more predictable (Child & Tse, 2001). Martinsons even reasons that China’s economy has increasingly been converging with Western ideas and norms (Martinsons, 1999).

The Chinese car industry at that time was mainly relying on imports due to the fact that domestic production was not able to meet growing demand. The Chinese government tried to stop this process by allowing and setting up joint ventures with foreign car manufactures, including VW (Harwitt, 2001). Therefore, this decrease of entry barriers enabled VW to gain easier access to a market, which showed significant opportunities. As appendix 5 illustrates, Chinese economy at that time put forward steady increasing GDP per capita from 379.6 RMB in 1978 to 7,850.6 RMB in 2000, which is connected to an increasing middle class and living standard boosting demand for high quality transportation (Gan, 2003).

Another major opportunity for VW in the Chinese market was the combination of its competitive advantages like high technological standard with low cost production resulting in profit margins of around 25% compared to 3-6% in home markets (Gan, 2003). Various different aspects that can be derived from institutional rules favoured these low production costs. On the one hand the lack of laws enhancing corporate social responsibility or in general environmental constraints in comparison to western countries were underdeveloped or not apparent in China until recent times (Yin & Zhang, 2012; Child & Tsai, 2005). On the other hand VW was able to benefit from cheap labour costs due to overall low wages compared to western standards (Zhang, 2001) as well as the absence of costs for health care or pension funds (Tao, 2009). Both factors decreased costs for VW and represented opportunities in the Chinese market.

3.2. Challenges for Volkswagen in China

As Child and Tse argue the Chinese institutional transition made business for companies like VW easier and more predictable (Child & Tse, 2001). However, this opinion can be challenged by several obstacles that Volkswagen has had to face during their internationalization process in China.

Even though China opened its economy to markets, government support as well as government intervention have remained common (Cai et al., 2010). Additionally, it has long been unclear at which pace the reforming process continues creating uncertainty for companies like VW (Child & Tse, 2001). Furthermore, with continuing strong government intervention there is always a certain threat that the government changes his policies again, which recently happened in 2012, when the Chinese government announced to stop supporting foreign car manufactures to help local companies (Euromonitor International , 2012).

Another challenge that Volkswagen has had to face is the inconsistent development of institutions within China. Additional to what Martinsons calls “institutional inadequacies” (Martinsons, 1999, p.122), those existing formal institutions differ from region to region. This results on the one hand from the process that the central government has shifted parts of its power to local governments (Cai et al., 2010; Martinsons, 1999) and on the other hands from the latter’s residency to policies imposed by the central government (Child & Tse, 2001). For example it could be the case that it depends on the location of the company what kind of legal protection it gets (Cai et al., 2010). This inconsistency leads to uncertainty for VW, which, according to definition by North, increases transaction costs.

The issue of intellectual property rights (IPR) protection is connected to the inconsistent system of legal protection. Even though China has made several actions towards an improvement of IPR from the early 1990s on including laws and regulations, memberships in organizations like the World Intellectual Property Organization (WIPO) or mutual agreements with individual countries like the United States, various scholars argue that the enforcement of these protections has remained problematic (Zimmermann, 2012; Peng, 2012). This lack of enforcement is often resulting from “the absence of a fully independent judicial system, and provincial officials’ often protective attitude towards local job creating counterfeiting industries” (APCO worldwide, 2010, p.16). However, this has had a major negative impact on VW’s business because it looses “control of key technologies” (Martinsons, 1999) which is one of their competitive advantages. Without proper protection of key technologies domestic competitors are able to copy VW’s products, while at the same time selling it at lower prices resulting in increasing competition. This stated an on-going problem during the start of VW’s business in China as exemplified by Frost and Sullivan arguing that in 2004 revenues of $11.53 billion were still generated with counterfeit car parts in China (Frost and Sullivan, 2006).

As stated earlier the lack of formal institutions in China increases the importance of informal institutions. In this matter there are especially two major parts that have widely been discussed among scholars: the importance of personal relationships called guanxi (Shou et al., 2012; Cai et al., 2010; Bruton & Ahlstrom, 2003) and the connected topic of different cultures and its effect on business negotiations as well as marketing (Buttery & Leung, 1998; Boeing, 2012; de Mooij & Hofstede, 2010). By definition guanxi refers to “the system of social networks and influential relationships which facilitate business and other dealings” (Oxford Dictionaries, 2010). As compared to European countries like Germany, “Chinese do not rely so heavily on laws, regulations and contracts” (Bruton & Ahlstrom, 2003, p.248) emphasizing the importance of guanxi. However, as Shou et. al argue domestic Chinese companies are used to develop or already possess these relationships, whereas foreign companies struggle or need significant more time to acquire them (Shou et al., 2012). Hence, VW were not able to work in conditions being regulatory equal but had to build up guanxi capabilities from scratch.

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