Twenty years after its risk-laden privatization, VW-owned carmaker Skoda is the engine of the Czech economy and a way of life in the town of Mlada Boleslav. Second in a series. From Respekt.by Tomas Sacher 23 February 2011
This is the second in a series of articles about businesses in TOL's coverage regions that have beaten the recession.
It’s an ugly town and something should be done about it. Normally, such a statement would make Raduan Nwelati jump out of his chair. This time, however, the mayor of Mlada Boleslav can’t hide his satisfaction. “They brought in major changes, and if it continues, I don’t have anything against it,” he says with a smile. The critical assessment of the town, which the newly appointed German head of the car manufacturer Skoda Auto, Winfried Vahland, reportedly said on first arriving in Mlada Boleslav has, on the whole justifiably, raised the expectations of Mayor Nwelati. The carmaker employs about half of this town’s 50,000 inhabitants, has invested in a university campus and a children’s playground, and contributes 50 million koruna (2 million euros) to the local football team.
“When there’s a need to arrange something really important, they are our key allies,” Nwelati says, nodding as he talks about this year’s jackpot of 400 million koruna for road repairs in the town. Although city hall formally requested the funds, the negotiations with the national government were carried out by the managers of the car manufacturer. “They use those roads and they managed to convince the politicians, crisis or no crisis,” explains the mayor, who, with an eye to further “cooperation” with the carmaker, recently set up a special commission for the development of the town which features an equal number of members each from the city hall and Skoda.
And the influence of the company on life in the Czech Republic does not end at the borders of this town. It is a key part of the domestic auto industry, which generates almost a 10th of this country’s gross domestic product. In addition to the 30,000 Skoda employees in Mlada Boleslav, Vrchlabi, and Kvasiny, the industry employs more than 120,000 people in auto parts manufacturing – and that’s not even counting the various services associated with the sector and its employees. And although the entire sector is still recovering from the global economic crisis, sales of Mlada Boleslav cars are breaking records. During the first three quarters of last year alone, the carmaker sold almost 570,000 Skoda cars, the most ever for any comparable time period. Net profits rose 115 per cent year on year, and just in the last five years, the Czech unit has earned its parent Volkswagen almost 50 billion koruna.
Even this brief list provides enough of an indication of the successes of this company, one of the three oldest existing car manufacturers in the world. It has been such a smooth ride for Skoda that even the heads of Volkswagen were recently reported to have been stricken by it. In tests by motoring journalists Skodas, which are generally cheaper and simpler cars than those that bear the well-known VW initials, outperformed those of Volkswagen proper in several categories. Even more unpleasantly for Volkswagen, they are drawing thousands of customers away from the more expensive – and therefore potentially more profitable – Volkswagen models. Czechs have grown used to the impressive balance sheet of Skoda’s achievements, just as they have become accustomed to statistics documenting the cooperation of their domestic “golden hands” – a traditional tag Czech ingenuity – with a neighboring country that is eight times bigger and richer. Joint Czech-German manufacturing now generates about one-third of the country’s foreign exports and German investment in the Czech economy now amounts to many billion euros. And if it had not been for a key Czech government decision dating back to December 1990, to definitively send Skoda into the embrace of Volkswagen, this success story might have turned out differently. Or perhaps not.
Skoda Auto representatives dismiss the stories about concerns in the Volkswagen management as a journalistic attempt to create an issue where none exists. But the headlines about unhealthy competition “within the family” or the “cannibalization” of the Volkswagen group continue to stir up passionate debate not only in the Czech Republic but in Germany as well. The German weekly Der Spiegel reported that dissatisfaction at Volkswagen over the manner in which Skoda Auto was being run led to the shake-up of the management team and the appointment of Germans to all key positions for the first time.
Shortly before that, the situation was most succinctly described by Germany’s most popular car trade magazine, Bild Auto, in its most recent article comparing Czech and German cars: “It simply gives you more for your money – many more features and even more space,” the magazine notes in its recommendation to German readers to buy the Skoda Superb built in Mlada Boleslav over the traditional favorite Passat. So in a way there is a logic to the unease among the managers at Volkswagen headquarters in Wolfsburg. As mentioned, Skoda’s sales have overcome the crisis and are now running at historic highs. In terms of profits, though, the firm has been hit by the strong Czech currency, which makes its products more expensive. When the rise in wages for Czech employees and the general decline in auto prices are factored in, Skoda’s actual situation becomes clearer. Until recently, Skoda was earning operating profits of more than 9 percent. Today it is around 3 percent. While no one at Volkswagen wants to comment on the numbers, the German press reported that a VW-commissioned study by the University of Duisburg-Essen found the Volkswagen brand is losing up to 500 million euros per year on the increased sales of Skodas and Seats.
Unfortunately, it’s impossible to have a conversation with the Mlada Boleslav-based managers of Skoda about how to deal with this situation or what they’ve been tasked with doing about the future of the most famous Czech carmaker. The new management team under Vahland, who until recently was the head of Volkswagen for the Chinese market, has started holding “information lunches” with selected Czech journalists, but they have refused to engage in more extensive interviews with reporters.
The best that can be done is to pick up on the hints dropped by the firm’s managers here and there. One suggests that Skoda will try to cut costs by, for instance, buying cheaper parts in India and China. On the other hand, it does not appear likely that the company is going to engage in a dramatic clipping of its own wings. According to recent reports, Skoda will begin producing a new urban minicar and, soon after that, an entirely new family car featuring a simpler design. No dramatic changes appear to be in store for the company’s existing models either, not even for the Superb model. On the contrary, Vahland has suggested that Skoda could even increase its existing range of models and gradually start to offer up to 10 different models, ranging from cheap minicars to the top-of-the-line Superb.
“In short, we’re moving forward,” Mayor Nwelati gushed following a series of discussions he held with the Skoda management. He notes that aside from the local university campus which will produce a thousand new engineers (most of whom will end up with jobs at Skoda) the company also opened a brand new technology center two years ago thanks to which Skoda now employs almost 1,600 highly qualified staff and is extending its links to the research and development of other industries across the country.
The center’s new building houses chassis designers, electronic component developers, and special rooms to conduct tests on the behavior of vehicles in all manner of weather conditions. “This is not just about Skoda. These teams will be available to for the entire Volkswagen group. The links with other research centers are functioning very closely today and Boleslav is starting to play an increasingly important role in this,” company spokesman Rudolf Dreithaler said.
The all-important brand that came as a forerunner of all this success may already have its best years behind it, but tens of thousands of them can still be seen on Czech highways. Production of the famed Skoda Favorit was launched just months before the November 1989 Velvet Revolution. By Czech standards of the time, it was an exceptional car. It was not just the unprecedented levels of passenger comfort for that time, a nimble engine, the soundproof interior and the fact that the engine was under the front hood, an unusual placement for Skoda cars at the time. The British newspaper Daily Telegraph noted at the time that the car had to be considered in the context of its surprisingly low price tag, adding that while a cheap price does not make a bad car good, the affordability of the Favorit made it a wonderful buy. The paper also noted that the unusual involvement of Italian automobile designers from the prestigious Bertone firm put this Czech car more or less in line with popular tastes of the day. The British journalist added with surprise that nothing creaked or fell off of this Skoda car when you drove it.
“The Favorit was the key to the firm’s future. Not that it matched the quality of Western European cars, but on the other hand this model ensured the survival of the firm in that stormy period,” notes Karel Beranek, one of the most widely respected automobile journalists in the Czech Republic. Aside from the production of this decent car, for which Skoda went into debt to the tune of what was then a breathtaking 2.5 billion koruna, the company also had experience on Eastern European markets, which had suddenly opened up to the West with the collapse of communism. Right after the revolution, all of this attracted the first groups interested in foreign investment in the Czech lands, something totally unheard of until then. “Skoda was not doing so badly but it was clear to all of us that without them [foreign investors], it would not be able to compete in the future,” says then Czech Industry Minister Jan Vrba, now 73 years old.
Many leading global car manufacturers expressed interest in Skoda. Managers from BMW and Volkswagen, the French heads of Citroen and Renault, the Italian executives of Fiat and the American managers of GM all made the rounds in Prague and Mlada Boleslav. The first list of potential partners featured the names of an incredible 24 firms.
But the foreign managers quickly realized that aside from a promising model, Skoda also harbored an array of unpleasant surprises. “On Tuesday, 2 January, they built 212 Favorit cars, on Wednesday five and on Thursday none,” writes the historian Jan Kralik in a book published on the occasion of the company’s 100th anniversary. The reason for this work ethic collapse was nothing other than the general amnesty decreed by President Vaclav Havel right after the revolution. “Almost 90 percent of the workers in the pressing shop walked off to a home with bars on the windows after their shift. The hundreds of convicts did not have far to walk – the auto maker had a prison built right outside the plant grounds in the 1970s,” the author writes in his description of the reality of the time. Added to this, there were more than 1,500 temporary workers from Vietnam who were brought to Mlada Boleslav at the end of the 1980s as part of the mutual aid promoted by socialist countries.
Statistics from the time indicate that fully 100 of the 350 auto bodies that were produced daily ended up as shoddily made rejects. In the end, the military had to step in with the immediate mobilization of several hundred soldiers to help deal with the critical situation following the departure of the “prisoners’ shift.”
JET TO GERMANY
Not even this deterred potential investors. By mid-1990, two finalists had emerged: the French carmaker Renault and the German Volkswagen. “Most of the other firms were not able to offer a clear vision of the future. Some of them weren’t even planning on keeping the Skoda brand as an independent manufacturer,” explains former Industry Minister Vrba.
Each finalist fulfilled the condition of keeping the brand, and they even put relatively clear plans on the table for what could be added to the already existing production of the Favorit. The French were planning to move part of the manufacturing of the successful Renault 19 model to Mlada Boleslav and the town was to become the production center for its new compact car, which was to come out later as the Renault Twingo. The representatives of the carmaker from Wolfsburg were planning to modernize the Favorit and turn it into a quality compact car but even more importantly, they wanted to develop an entirely new model for middle class customers. “And the most important thing was that while the Twingo was already developed, this new car was to be developed by Skoda developers right in Boleslav,” Vrba remembers.
The decision was made easier for the Czechs because, in contrast to Renault, a state-owned and subsidized company, the Germans had relatively recent experience with the purchase of foreign carmaker. In 1986, Volkswagen had bought the struggling Seat from the Spanish state. At the time of the 1989 Velvet Revolution in Czechoslovakia, Seat was going through a successful restructuring. “The German style of negotiating also contributed to the decision. They were very direct and understandable. The negotiations were up to certain standards,” Vrba adds.
An incident from the fall of 1990 provides further evidence for those standards. At the time, Volkswagen president Karl Hahn invited a small group of Czech journalists to come over for a tour of the plant in his private jet, which first flew from Prague to Wolfsburg. “The luxurious group lunch was followed by a flight to Barcelona and a tour of Seat. It all had one purpose: to demonstrate how great it could look in your country if the government decided in favor of Volkswagen,” remembers Karel Beranek, who took part in the trip.
The largest European carmaker’s wooing of the Czech media achieved its goal in December 1990 when the Czech government within the then-Czechoslovak federation approved the sale of Skoda to Hahn’s company. Volkswagen was to gradually pay 1.2 billion deutschemarks for a 70 percent stake. The rest was paid in 2000. Volkswagen was satisfied with just a two-year tax holiday, and in contrast to other similar major investments, this one was carried out without any further state support. (For comparison’s sake, the South Korean firm Hyundai agreed to its investment 15 years later only because of a tax holiday five times as long as Volkswagen’s and almost 15 billion koruna in state support).
“The whole sale played out within just half a year and the experience was so good that we wanted to do something similar in other cases as well,” Vrba says today. As we now know, no similar transaction was to take place in the Czech auto sector. Vaclav Klaus, who as Czechoslovak finance minister from 1990-1992 and then Czech prime minister from 1993-1997 served as the main driver of economic reforms in the country, gave priority to coupon privatization and the so-called Czech way, which enabled Czech managers to take over large companies.
This is a subject of debate to this day. Negotiations along the same lines as those in Mlada Boleslav took place after the revolution with Germany’s Mercedes over the Koprivnice-based carmaker Tatra as well as with Sweden’s Volvo over the truck manufacturer Liaz. A representative of the famous Japanese family Honda came in person for negotiations over the popular Czech motorcycle manufacturer Jawa. “In my opinion, the failure of those deals was a huge mistake. The feeling that this would amount to selling the national treasure won out,” Vrba says, noting that most of those companies ended up in bankruptcy and were only sold with difficulty and billions of koruna in losses.
BETTER THAN MERCEDES
Let’s get back to the fundamental issue, though, and that is the future of German capital in Mlada Boleslav. Those present at the time recall the first decision of the newly appointed management of Skoda, which was a total cleanup of the entire plant, including all the assembly halls and warehouses. The first few weeks witnessed a steady stream of trucks loaded with rubble and all sorts of other rubbish out of the plant. “The Germans brought in above all their traditional tidiness, but the real shift came with the totally new quality controls,” explains Skoda’s long-serving chairman of the board, Vratislav Kulhanek, who in those early post-revolution years headed one of Skoda’s main suppliers, a newly established plant owned by the German firm Bosch.
“Eight out of every 600 cars produced by each shift were pulled out and taken apart down to the last screw,” he says. There was certainly reason enough for a more comprehensive system of quality controls. As mentioned, the firm lacked qualified personnel, and customers of the key Favorit model filed complaints about an average of eight different flaws during the first year alone. (The comparable German Volkswagen Polo only had two flaws that caused an issue during the same period.)
“A system of grading was used like in school. The first test produced a grade of 4.8 [on a 1-to-5 scale with 5 indicating the worst mark],” Kulhanek continues, adding that today the same system awards cars from Mlada Boleslav a grade of 1.1. Boasting of the subsequent improvements in a massive 1993 ad campaign, the company declared that the Favorit was “548 times better than before.” In reality, it meant nothing other than the removal of several hundred flaws.
The Germans put in use assembly methods that had never been used in the Czech lands before. “The Volkswagen management decided to build up the plant in an entirely new spirit, so that it would rank among the most modern in Europe. The production technology, working conditions, environmental sensitivity and the structure itself was meant to be among the best in the industry and to set a tone,” Jan Kralik writes.
The biggest revolution, however, came with the use of shared platforms for several lines. The midsize Octavia was created on the same chassis already in use on the Volkswagen Golf and adopted for the Seat Toledo model. “The system of common platforms within the group proved to be a key condition for the future expansion of Volkswagen,” journalist Vladimir Rybecky says. “Now it’s practically the foundation for the operations of all major car manufacturers. An independent brand without a common multinational assembly has practically no chance of survival.”
Still, it would be a big mistake to describe the first Octavia as a Golf knockoff. The Germans supplied Mlada Boleslav with the foundation, but a large number of the structural elements saw the light of day during development in the Czech Republic – mainly what was at the time an extraordinarily powerful and fuel efficient engine and a novel design.
“That car has the most beautiful look of our group,” declared then Volkswagen head Ferdinand Piech at the model’s unveiling, and auto critics were not reticent in their praise either. “What was the result of our comparison of Octavia and Mercedes Benz class C? Let’s first answer the question as to whether the car that is twice as expensive is also twice as good. Not at all. Octavia even comes out a little bit ahead,” the Austrian trade magazine Alles Auto wrote.
In short, the Octavia surpassed all expectations in the mid-1990s. Those who recall the era however cannot agree to this day on the reasons for this success. Some see it as a result of the extraordinary determination of the original engineers and their effort to show what they could do to the new owners. Others say the key factor was the generous employment policies offering from the very beginning up to 50 percent higher wages than were common for Czech workers at the time. They enabled the plant to quickly attract an array of new high quality personnel. From today’s vantage point it may also seem important that dozens of promising managers from abroad were hired, thereby receiving their first opportunity to make use of their experience for work beyond Germany’s borders.
THE CZECH-GERMAN QUESTION AGAIN
“Volkswagen laid a quality foundation, but the way Boleslav managed to carry on the work with it was a pleasant surprise for the Germans,” long-time auto journalist Rybecky says. Kulhanek adds that it was precisely because of the Octavia that the central office in Wolfsburg gave Skoda a free hand in later development trials. “At the beginning, it was not at all clear that everything wouldn’t just remain at two models. After the success of Skoda Octavia, Volkswagen was much more open toward us and allowed us to work in a similar way with more expensive classes of cars,” he says, throwing light on the causes of the cannibalization of the Passat.
Still, the rise of the Mlada Boleslav firm was not entirely without problems in those first post-revolution years. While Wolfsburg promised to invest a breathtaking 9 billion marks into the Czech Republic by the end of the millennium, a mere few months after the transaction increasing calls were heard in Germany for more attention to be devoted to domestic industry, especially in the economically unstable post-communist eastern part of Germany. At the time, Volkswagen was even weighing the elimination of 12,000 jobs mostly in Germany due to a collapse in demand, the ongoing indebtedness of Seat, and above all plans for restructuring the entire firm.
Problems hit Mlada Boleslav as well right away in 1992 when plans for a massive investment in a new Skoda engine plant were cancelled at the last moment. From the previously announced 9 billion mark investment, Volkswagen ended up paying less than half that amount by 2000. While that result led to some speculation as to whether post-revolution privatization had been the right decision, the Czech government joined most informed observers at the turn of the 2000s in noting that it had been an extraordinary investment success as it approved the sale of the state’s remaining 30 percent stake in Skoda. This assessment turned out to be justified as today the total investment by Volkswagen comfortably exceeds the original privatization plans of 1990.
Even the nationalism that motivated some critics of the German takeover of the Czech “family silver” seems to have been overcome. “There was a strong national subtext here. The themes of World War II and fears of some kind of economic colonization resonated with surprising strength at the time,” Jan Vrba recalls. Many in the automobile industry were especially critical at the time of the so-called tandem system for Skoda managers, which saw 120 people from Germany hired to match 120 Czechs in key positions.
Such censure no longer awakens anywhere near the passions it once did. The fact that the most recent management changes at Skoda saw the entry of an entirely German group of managers into seats on the board went by practically without comment in the Czech media. Lower-level Skoda management is clearly dominated by Czechs, and the average autoworker’s monthly gross wage – something of particular importance for the locals – exceeds 27,000 korunas (1,100 euros), a fifth higher than the national average for all occupations.
A SYMBIOTIC RELATIONSHIP
As with the example of platform sharing among units of the group, VW employment policies could be an attractive model for Czech managers. “Volkswagen does a lot of alternating of executive positions and this can be an opportunity for Czechs. In Boleslav, a completely post-revolution generation is maturing who can speak different languages and are able to assert themselves,” says Martin Jahn, a former Czech deputy prime minister who was hired in 2008 to head VW’s Russian operations and who is slated to join the top ranks of VW managers in Wolfsburg when he finishes his stint in Moscow. Jahn notes the company’s practice of regularly sending young engineers on internships abroad with the group’s foreign units.
A similar hope for the future marks the thoughts of Mlada Boleslav Mayor Nwelati, even though the vision of a successful Boleslav “organism” definitely does not come without some snags. “Our dependence on Skoda is truly extensive, sometimes I myself say that it’s too much,” the mayor says with a nod. “We have even tried to attract firms from completely different sectors, but they’re not interested. We are approached practically exclusively by auto parts manufacturers.”
Naturally, such dominance comes with a whole range of risks. When the growing economic crisis hit, Skoda abruptly let go 2,000 workers from Vietnam and Mongolia, and thereby flooded the city with hundreds of unemployed foreigners with an uncertain future. From the vantage point of the city, the problem was relatively quickly “resolved” when within a couple of weeks most of them, according to the mayor, moved on to unknown destinations. Their subsequent fate is now known thanks to the media. A minority returned home indebted and disillusioned, while most ended up without valid visas in the hands of semi-legal employment agencies.
Skoda Auto still employs 2,000 agency workers, although today they are mostly “domestic” Czechs, Slovaks, and Poles. In any case, the car industry is particularly vulnerable to economic slumps, and anti-crisis cures tried out so far, such as cash-for-clunkers programs, offer no guarantees that future bumps will not force the firm into radical cost-saving measures. Many experts now predict that purchases of cheaper parts in markets like those of India and China will play an increasingly important role for European manufacturers. And while Skoda is bucking the trend with plans to increase production, the saturation of the European car market along with the growing demand in the East are increasingly being accompanied by suggestions to move production itself.
Clearly, such a development would not affect Mlada Boleslav alone. True, observers note that the Czech Republic’s dependence on four wheels is not at a critical level (car manufacturing in neighboring Slovakia, for instance, is almost twice as significant). Still, almost 10 percent of the country’s GDP rests on cars and every move up or down has an impact on the state of Czech public finances. “In short, we stand or fall with this German partnership,” Mayor Nwelati says. “But that’s how it’s been many times in the past and the key for me is that this current dependence is benefiting both sides.”