RESEARCH & IDEAS

Porsche's Risky Roll on an SUV

Published: September 5, 2006 Author: Martha Lagace

Executive Summary:
Why would any company in the world want to locate in a high-cost, high-wage economy like Germany? Porsche's unusual answer in a globalizing auto industry has framed two case studies by HBS professor Jeffrey Fear and colleague Carin-Isabel Knoop. Key concepts include: In a remarkably globalized industry, Porsche is a rare example of a company staking its brand on the image of one particular country: Germany. Does location make a difference in a globalized world? Can products just be manufactured anywhere? Porsche's Cayenne manufacturing brings the company full circle in a return to its eastern European roots.

A decade ago, Porsche, the luxury car company, found itself at a crossroads. Renowned for its classy (and expensive) sports cars, the firm had taken a hit in the wake of the 1987 stock market crash and suffered in great part due to Porsche's dependence on the U.S. market. Sales through the mid-'90s were definitely slow-lane. So when the firm chose not one but two routes to recovery, Porsche caught industry watchers and Porsche enthusiasts by surprise. In addition to launching a new two-seater, the Boxster, in 1996, it decided to move into sport-utility vehicles, or SUVs, the popular but highly un-cool mode of transport for many American suburban families. Almost as radical was Porsche's choice of locations to build this SUV, named the Cayenne. Even though wages in Germany are a good six to seven times higher than in eastern Europe, where many other automakers have moved production, Porsche erected a small but substantial plant in Leipzig in eastern Germany. And unlike BMW or Daimler-Benz, Porsche did not move closer to the main U.S. market. The controversial Cayenne has turned out to be Porsche's best-selling automobile ever. Reflecting its success, Porsche held its annual shareholders' meeting in 2004 in Leipzig. While rival carmakers such as Ferrari, Aston Martin, Alfa Romeo, and Lamborghini have been happy to locate where labor costs are cheaper, Porsche wanted to ensure its "Made in Germany"

imprimatur. Porsche's risky moveswhich ultimately led to a successful turnaroundform the basis for a terrific debate on the importance of brand and location, according to Jeffrey Fear, an associate professor, and Carin-Isabel Knoop, executive director of the HBS Global Research Group. The two resulting cases, Dr. Ing. h.c. F. Porsche AG (A): True to Brand? and Dr. Ing. h.c. F. Porsche AG (B): Made in Germany, "really play off the idea of what exactly Porsche is and what it stands for," says Fear. Porsche CEO Wendelin Wiedeking's bet-the-company decision to branch out into SUVs, combined with opening the Leipzig plant, make for a study with rich complexity and broad implications for today. In a remarkably globalized industry, Porsche is a rare example of a company staking its brand, in this example the Cayenne, on the image of one particular country. Wiedeking, regularly ranked as one of Germany's top executives, is outspoken about the virtues of Germany, stakeholder value, and Germany's social market economy. The Cayenne inspired yet more controversy when one of Germany's leading economists argued that it did not deserve its "Made in Germany" label. A good portionwhat portion is the questionof the Cayenne shared components with the VW Touareg and was partially manufactured in VW's Bratislava, Slovakia plant. Then, as if that were not enough, Wiedeking shocked the investment world once again by purchasing roughly a 20 percent stake in VW, which led to major corporate governance debates largely due to Ferdinand Pich, one of the largest shareholders in both VW and Porsche, who sits in both supervisory boards.

How much are German companies as a whole going to be able to retain that brand premium?
"I think the central question posed by the casesand we can generalize this more broadly beyond Porscheis, what difference does location make in a globalized world? Can products just be manufactured anywhere?" One possible answer: Think about relative productivity costs. "In Germany in 2000, the labor costs were about 25-26 Euros per hour. In the Czech Republic it's about four Euros per hour. So it's quite dramatic. But how you assess these costs depends on productivity levels as well. And German firms are very, very productive."

The reputation of national products

German craftsmanship and quality are famous, and according to Fear, German companies generally compete as niche producers, particularly those that manufacture high-quality goods that demand a premium price. In 2004-2005 Germany became the number-one exporter of manufactured goods in the world, and its market share was around 10 percent, surpassing that of the United States. As German firms compete on quality they also compete on brand: "Glashtte watches are not competing with Timex," he notes. Brand and quality are arguably greater issues than ever before for German companies. As other firms around the world improve in competitiveness and quality, at what point are customers no longer going to be willing to pay a premium for higher-quality goods? The quality differential will also probably shrink over time in other product areas as Japanese luxury car makers have famously shown. That's an issue Fear thinks a lot of German firms justifiably worry about. "Which are the companies that are going to survive? How are they going to be able to survive? And how much are German companies as a whole going to be able to retain that brand premium either through the name, quality, or particular excellence in its price?"

Location world

in

globalized

As Fear and Knoop looked more closely into the Leipzig decision, they realized that the Leipzig plant only employs around 400 workers. BMW made a similar sort of decision to locate in Leipzig rather than go abroad, but for very different reasons, says Fear. BMW has built a plant that employs thousands of people and is a major manufacturing site, while the Leipzig plant for Porsche is much smaller.

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Reinvention
German companies have also had to reinvent themselves, as Porsche accomplished between '93 and the present, he continues. In a sense Porsche is applying Japanese production processes of lean production while still producing German-made cars and maintaining the German reputation for quality automobiles. And since 2000 or so, German workers have in general been moderating their wage demands, allowing German firms to become more competitive vis--vis other European countries. Improved productivity helps unit labor costs in Germany decline over time. While these are positive adjustments, "the problem is that these super-successful export machines are not necessarily creating new jobs in Germany," Fear says. "Labor is also more moderate in its demands and flexible about working hours, conditions, and downsizing, but they are saving existing positions or slowing the process of shrinking them. The process does turn into kind of a second-best solution for creating new jobs."

two, you're not seeing how fast wages are rising relative to increases in productivity. It's an issue on the border for Mexico as well. . . . So that is an issue for any firm moving abroad. You shouldn't be looking at a static number, but you really should be thinking about it more dynamically over time."

Then, it's about brand

The first case stops at the point of the 1998 decision: Should you enter the SUV market? "We try to put the students back into Wiedeking's shoes at that moment in time. While students already know that the Cayenne turned the company around, we ask the students to weigh the risks and rewards of entering the SUV market and where to locate the new plant. Students also grapple with present-day controversies about SUVs and rising gas prices. Although in the luxury SUV market, drivers are not likely to fret about paying ten cents more per gallon. But we really ask if by moving into the SUV market did Porsche remain 'true to brand,' and what does that mean anyway?" How much is the Porsche brand dependent on its German roots? Is Porsche one of those products or brands dependent on being made in a particular place, or not? In terms of teaching the cases, he says, "What's really remarkable is that, at least for non-German students, for the most part they do not really care whether the Cayenne is made in Germany or not. Customers are buying the Porsche name. For the most part, the controversy in Germany is a non-controversy in the classroom. Yet there does appear to be some limit to where Porsche could locate because of its image." "The Cayenne is clearly German-designed and inspired. Only when you think of it in terms of a pure manufacturing product does its content become problematic for deciding just how 'German' it is. We do not try to figure that out. It's near impossible because of the long supply chains among parts suppliers. But, I think, in many ways, Porsche has unconsciously gone back to its roots. After leaving Mercedes, Ferdinand Porsche founded his own design firm in 1931 with his son and his son-in-law, Anton Pichyes, the father of Ferdinand Pich of

"We try to put the students back into CEO Wendelin Wiedeking's shoes at that moment in time."
In terms of wage relations, going to Central Europe is very much like going to Mexico, he says. Yet as Central Europe is integrated into the European Union, it is still important for managers to keep in mind that wage rates also tend to rise very quickly there, particularly for skilled laborers, ironically because a lot of German companies in particular are moving into these countries. German firms were always highly present in central and southeastern Europe in the early part of the 20th century. What we are seeing today is a way of returning to the past. "When you just look at that wage difference, it's too static. One, you're not looking at relative productivity at a given moment in time or the relative unit cost levers, for instance, of managerial expertise. And then

VW, making the original Ferdinand Porsche his grandfather. That 1931-founded firm was mostly a design and engineering firm, which helped to create the Volkswagen Beetle. So the alliance and cooperation with VW is reproduced." "In addition, as the founder of Porsche, Ferdinand Porsche also had Central European roots, since he was born in Maffersdorf, Bohemia (now Vratislavice in the Czech Republic). If you think of Europe more broadly than just Germany or other national states, it's really a Central European story here." In this respect, Porsche's Cayenne manufacturing also brings the company full circle, observes Fear. Asked if he has driven a Porsche himself or considers himself a car fan, Fear laughs and admits, "I like cars, and actually doing these cases has made me appreciate cars. But I don't naturally gravitate toward cars as one of the main gadgets in my life. Never driven a Porsche. But I like convertiblesI love convertibles. I also have a daughter now, so my car requires four seats at least." His current projects include histories of German management thought and German capitalism, but working on the Porsche cases has given him a new appreciation for automobiles. "These are some of the most technologically sophisticated things that we've got going right now. They need to be reliable and safe. You're in them all the time. Some cars, particularly German cars, will be on the road for twenty to twenty-five years. And yet these are mass production goods." "Our whole society is unimaginable without automobiles. They really are part of our physical culture as well as almost our mental culture. And automobiles are such an emotional product. People put their personalities into their cars. It's not true for everyone, but people's personalities come through in terms of the car they choose, especially for people who get to base their decision on choice rather than just price."

About the author

Martha Lagace is senior editor of HBS Working Knowledge.

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