Audi targets volume brands as luxury demand slows

Audi expects to offset softening demand for large luxury cars in China by winning sales from volume brands. Executives at Volkswagen AG’s luxury unit say the slowdown in China is leading to lower capacity utilization of its two local plants, rising incentive spending on older models and a shift away from lucrative upper-segment models such as the long-wheelbase A6 sedan.

Audi believes it is well placed to gain market share as the brand introduces smaller sedans and crossovers.

But the risk remains that the deterioration in the sales mix — paired with the recent emergence of discounting — means premium brands will must rely on sales growth to maintain profits.

Speaking during the Consumer Electronics Show Asia in Shanghai earlier this month, Audi executives confirmed downbeat comments in March from their BMW peers, who said that the days of high profit margins in China were over.

China’s car market used to be an exception, but now “it’s become more normal,” said Audi sales chief Luca de Meo, referring to the loss of unusually high profits earned per car by the industry in China.

China had long been a seller’s market for carmakers as output continually lagged behind demand. The hardest part was building enough models and avoiding production bottlenecks. The easy part was selling cars, since demand remained consistently strong even for models due for replacement.

Audi executives now speak about “lifecycle management,” a euphemism for successively raising discounts or adding more free content as a product grows older. “For me the turning point was when Mercedes heavily discounted the S class in the first quarter of 2012,” said Dietmar Voggenreiter, who has run Audi’s China operations since 2007.

Audi’s vehicles sales have increased nearly sixfold since 2007 to almost 580,000 cars last year. Audi remains China’s top-selling premium brand ahead of rivals BMW and Mercedes-Benz. China is also Audi’s largest single market, more than twice as big as Germany.

The sales growth was due in part to a massive government stimulus introduced in 2009 to encourage domestic spending, maintain employment and offset the sharp drop in exports caused by the global financial crisis.

Audi’s expansion has slowed each month this year from 15 percent in January to just 0.2 percent in April. The company has forecast that sales will surpass 600,000 units this year, which could mean a growth rate of as little as 3.6 percent.

The company declined to be more specific, saying its main aim is to continue increasing its share of China’s luxury market, which amounted to a third of the 1.68 million premium cars sold last year.

Audi says it is growing in China partly at the expense of mass-market brands – just like in Europe. Young consumers who might have bought a midsize car from a volume marque are opting for compact premium cars such as the A3 Sportback.

As sales of compact luxury cars grow, Audi executives expect pricey models such as the long-wheelbase A6 will generate a smaller market share. But China’s upper luxury segment remains an attractive target.

The segments in which the A6 and A8 compete accounts for 45 to 50 percent of China’s luxury market, according to Audi. In more mature markets like Europe and the United States, those segments represent only 35 to 40 percent of luxury sales.

After selling nearly 42,000 compact cars in the first four months – up 72 percent — Audi believes it is ideally placed to benefit from the trend. It is the only premium brand to build three compact models in China, which allows it to circumvent 25 percent tariffs.

This means that the four-door A3 Sportback built in China costs the same as the smaller, imported Audi A1 two-door hatchback.

Voggenreiter said utilization rates at its two local plants are shrinking, but he notes that unwanted side effects can arise when a factory consistently runs overtime. Audi’s plants now operate 270 days a year, rather than 310 days.

That’s “a more normal level,” Voggenreiter said. “I am quite happy with that. Before, we would work 13 days in a row and only have time for one day to maintain the equipment. If we kept that up, it may eventually have led to quality problems.”

Volkswagen’s joint venture with FAW currently builds six different Audi models. The Foshan plant manufactures sedan and Sportback wagon versions of the Audi A3. And the Changhun facility produces the long-wheelbase A6 and A4 sedans, plus the Q5 and Q3 crossovers.

Local production allows Audi to be more competitive. Last year, Audi China sold 500,000 locally built cars plus 80,000 imported models. By contrast, only half of the 280,000 Mercedes cars sold in China were manufactured there as well.

Despite the slowdown, Audi is convinced that the luxury car segments will once more outpace the overall Chinese market once real estate prices in the major cities rebound and corporate profits rebound.

“One key effect of the urbanization trend in China is the growing upper middle class,” said Voggenreiter. “This is one of the factors that will really drive the premium segment’s share of the total market from 9 percent today.”