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Monday, November 26, 2012

Expansion at Volkswagen: Minimizing Risk in E.U.?

It is perhaps common among gigantic corporations, such as the major automobile manufacturers, to assume that current profitability is likely to be augmented by expansion. Economies of scale are presumed to outpace diseconomies as even a large company expands. At a more basic level, it is generally assumed that if a company is not expanding, it is necessarily facing its downfall. The notions of equilibrium and steady state are fundamentally at odds with the more, more, more mantra of mammon. Accordingly, it can be asked whether efforts to strengthen a company’s equilibrium are more in line with long-term profitability. The very expression, strengthening an equilibrium is étranger or foreign to business parlance.

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                                                      A car is assembled in the E.U. in 2012, potentially countering austerity measures in some states.   AP

By the end of 2012, Volkswagen had announced plans to invest €50 billion ($65 billion) in the global operations over the next three years. Much of the money was directed to expand the company’s operations outside of Europe. Two other European auto companies, BMW and Daimler, were also engaged in record investment programs outside of Europe. Taking advantage of greater-than-expected auto sales in North America and China can be a good way to limit the recessionary impact of the European debt-crisis and the related “austerity” budget-cuts at the state level. I say “can be” because assessing the automobile market in China from Europe involves risk. The workings of the Chinese government are not exactly transparent and the Chinese culture is not necessarily well-understood by Europeans (or Americans), so the Chinese auto market could quickly shift in quantity and even desired type of cars being sought without European managers seeing it coming. Even so, shifting operations globally away from problematic countries is generally a benefit of being a multinational corporation in terms of reducing the recessionary head-winds facing the company. This requires that the “flaps” on “both wings” shift so the entire plane can turn decisively.
However, if the motive is expansion per se, the international strategy is not one primarily of hedging risk. That is, the hedging effect can be muted. In fact, there could be little impact on risk-exposure, or it could actually increase. Of the €50 billion oriented to international expansion at Volkswagen, €23 billion was to be directed, en fait, to modernizing and expanding plants as well as research and development sites in the E.U. While of benefit to the E.U. in countering the recessionary impact of budget cuts in some states (though expanding in the state of Germany while Greece and Spain continue to founder could further compromise European integration), expanding in the E.U. effectively undercuts the hedging function of expanding abroad. Moreover, the underlying motive can be said to be expansion rather than reducing risk.
Whereas reducing overall risk strengthens or reinforces a company’s equilibrium, expansion taken as an end in itself, going outward as if the spray shooting out of a shotgun, can actually increase the risk because more is at stake. Expansion, being inherently general, can obfuscate efforts to be strategic. Furthermore, once the economies of scale in being a major multinational corporation have been achieved, further expansion risks triggering diseconomies of scale outpacing any additional economies from a still-larger scale. So it might be worth pondering how an equilibrium can be strengthened in a way that does not simply feed the urge for more, more, more—an instinct that can be counter-productive in the long term.  

Source:
Vanessa Fuhrmans, “German Car Makers Hit Road,” The Wall Street Journal, November 25, 2012.