How VW is beating the slump in Europe

May 1, 2013: 8:48 AM ET

The German giant is still gunning to be number one in the world. The slowdown at home doesn't seem to be stopping it.

By Doron Levin

Bad boys: Martin Winterkorn and Ferdinand Piech.

Bad boys: Martin Winterkorn and Ferdinand Piech.

FORTUNE -- The Volkswagen AG juggernaut, which posted an uncharacteristic profit decline this week for its first quarter, won't be slowed by a weak European economy that has hurt auto sales.

To the contrary, the European slump may be hurting its weaker competitors more. Paradoxically, a period of economic weakness could help the German automaker strengthen its position relative to the rest of the field when the continent inevitably rebounds. VW, aiming to achieve global industry leadership by 2018, looks more likely than ever to achieve its goal, maybe earlier than planned.

The three automakers most vulnerable as a result of the European decline are Peugeot, Fiat, and Opel. Fiat, disproportionately reliant on Italy, has failed to keep up in terms of design and global scale. Likewise, French automaker Peugeot has failed to win enough non-French customers.

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Opel, a subsidiary of General Motors Co. (GM), has joined hands with Peugeot to share costs -- but it faces enormous capital costs, brand weakness and continued political difficulty shrinking its production capacity to match falling volume and market share. GM, as it tries to fix Opel, is holding fast to its dreams of one day turning Chevrolet and Cadillac into European-recognized brands.

Sergio Marchionne, chief executive of Fiat and Chrysler and an outspoken VW rival and critic, predicted on Monday that Europe will stay depressed for some time, according to a report in the New York Times. In an oblique reference to VW, he reportedly said "those who have claimed a Teflon approach are getting that coat taken off."

Fiat's profit for the quarter fell 88%, rendering it barely at break-even for the period.

VW's chief executive, Martin Winterkorn, remarked in a statement "the markets were sluggish, especially in Europe, and not least in Germany. But we remain confident overall that we can pick up speed over the rest of the year." VW affirmed its full-year financial forecast.

Profit for the German automaker and European market leader fell 38% to 1.95 billion Euros ($3.15 billion) from the same period a year ago. Revenues for the VW Group, which includes Audi, Skoda and Seat, fell 1.6% to 46.6 billion Euros. The revenue weakness was due to fewer vehicles sold as well as weaker prices.

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Innovative engineering, which allows VW to build a large number of models and brands worldwide on the same basic architecture, has kept capital expenditures from overwhelming earnings. The rise of VW's Audi luxury brand after years of development is also adding to the bottom line. And VW's prospects in North America are bright, as the automaker adds new models and manufacturing capacity to the region.

The wild card for the weaker players will be the extent to which governments decide to prop them up until demand grows stronger. Countries are exceptionally nationalistic and sentimental when it comes to their automakers, the U.S. no less than others. European Union rules preclude many forms of direct aid -- but the indirect ways to help limping automakers are many.

As GM and Toyota (TM) have discovered, global leadership can be a poisoned chalice -- somehow making its holder prone to all kinds of unanticipated reversals and disasters. VW isn't deterred; it intends to find out what No. 1 feels like and what advantages it might confer.

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