The Central and Eastern European Automotive Market - Ernst & Young

E XECUTIVE SUMMARYExecutiveSummaryThe global automotive industry todayis split between dynamic and attractivegrowth in a number of regions, driven byincreasing economic wealth and consumers’ability to afford personal mobility,and the broadly static traditional marketsof North America, Western Europe andJapan. The Central and Eastern Europeanregion is one of the dynamic growthregions, following the accession of keycountries to the European Union (EU)(with more to come), and increasing economicgrowth and stability in the region.Additionally, with its proximity to establishedWestern European markets, CEEprovides a unique opportunity for vehiclemanufacturers (VMs) and suppliers lookingfor sales growth or lower-cost productionclose to a major market region.CEE – A Saviour for WesternManufacturers?The CEE region is expected to provide amarket of around 4.5 million units withinfive years. For VMs in Western Europefighting over a static market, this offersan attractive opportunity. However,Western Europe will still dominate theEuropean market, with sales of over 16million units. The CEE sales opportunitywill not solve the problem of overcapacityin Western Europe. The attractivenessof producing in the lower-cost CEE hascaused a rush of new investments intothe region by manufacturers, creating thecapacity to produce over 5.5 million carsby 2011. This will make the region a netexporter of vehicles, adding to overcapacityacross Europe. Rather than a panacea,VMs need to look at the specificsof each of the CEE countries to identifymarket and production opportunities.4T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

CEE – A Group of Very DistinctCountriesWhile sometimes regarded as a singleregion, the countries in CEE are widelydifferent in a number of important factors.Our analysis broadly groups thesecountries into the following key types:• Global Player: Russia. With anexpected market of over 2 millionvehicles by 2011, Russia is aloneamong the CEE states in having amarket potential to match those ofsome of the larger markets in WesternEurope.• Major Production Centres: CzechRepublic, Slovakia. These countrieshave been the recipients of majorinvestments in new car plants, andwill become significant exporters ofvehicles, to the extent that over 75%of production will be exported. Thisplaces these countries in a unique positionin the global industry in respect ofthe level of their reliance on exports.There are already signs of potentialoverheating in labour markets inthese countries, and there are furthernew plants announced but not yetoperational. The two countries willbecome a major export hub feedinglocal and Western European markets,and a major centre for production bysuppliers.• Strong domestic markets, significantnet exporters: Poland, Turkey. Thesecountries have the potential to developdomestic markets of over 250,000units within five years, and are projectedto have production capacitywell in excess of this. Hence, they willbecome significant exporters. In additionto its passenger car production,Turkey is becoming a regional centrefor LCV production.• Smaller players. The remaining countriesin the region will have neither largedomestic markets nor significant exportcapability in the foreseeable future.Among these markets there is a highlyinconsistent picture of market success.Market Shares Shaped by HistorySome brands have been very successfulin particular countries because they areindigenous (such as Skoda in the CzechRepublic, with a market share of over40%). In other countries, brands havehad significant sales success because of a“pioneer advantage,” as they moved intoCEE countries early after the openingof these markets. For example, Suzukiin Hungary, with a leading market shareposition unique in Europe, undoubtedlydue to its investments dating back morethan 15 years.As a result of both factors, many CEEmarkets are more concentrated— that is,a few VMs have a large market share—than those in more mature markets. Weexpect a weakening of some of thesestrong market positions as these marketsdevelop and mature. There may also becountries where the pioneer advantage5

population far larger than any WesternEuropean state: it is entirely likely thata fully developed Russian automotivemarket could become the largest inEurope. If other CEE states also developtheir full potential, then the “Big 5”European markets of today—all of themWestern countries—may give way to aTop 8, with the centre of gravity firmlyshifted east.7

In the years to come, vehicle productionin CEE will be dominated by VMs fromoutside the region, which will establishplants mainly to take advantage of lowercosts and market presence. It remainsto be seen whether market demand andtrends in the region will generate thecreation of global brands other than thosealready in existence, such as Skoda,which are already owned by larger VMs.Whichever brands may emerge out ofthis region as true leaders, passenger carproduction will largely comprise smallervehicles from the A and B segments,mainly for the following reasons:• These products are highly cost sensitive,so VMs are looking for theproduction cost advantage of the CEEstates.• These are typically the products thatdominate the CEE markets, even incountries with higher average GDP percapita.Figure 2: Light Vehicle Sales by Region Compared (in ,000 units)2001 2005 2011*% Change2001-2011North America 18,864 18,549 19,180 1.7%Asia-Pacific 12,414 17,238 25,321 104.0%Western Europe 16,652 16,487 16,936 1.7%Central and Eastern Europe 2,574 3,964 4,860 88.8%Central and South America 4,759 5,030 6,195 30.2%Middle East and Africa 841 2,643 3,372 301.0%Total 56,104 63,911 75,864 35.2%* ProjectedLight Vehicles are passenger cars, SUVs, MPVs, medium and heavy vans, and pickups.Source: Global InsightLight Vehicle Sales in CEE Comparedto Other Major RegionsPassenger car sales in CEE are expectedto grow, in line with increasing disposableincomes and as broader economicdevelopment extends outside capitalcities. However, increased consumerspending will only stimulate productiongrowth in a limited number of countries.As a result, CEE is clearly set to remaina net exporter of vehicles and, for somecountries, exports will dominate in relationto domestic consumption. This willbring specific challenges to export economies,such as currency dependency,transport costs, and probably above all, adependency on the availability of exportmarkets in countries whose economiesand focus on vehicle production mightevolve.CEE Sales Growth vs. WesternEuropean Static SalesFor VMs with a particular strength inWestern Europe (i.e., those without significantsales outside the region), the9

CEE Area – PassengerCar Sales and ProductionOverviewProduction – Now and ForecastAcross the CEE region, the emergenceof major exporting countries is alreadytaking shape, such as the Czech Republicand Slovakia, which will become almostentirely dependent on global-brandvehicle exports when maximum productioncapacity levels are reached. Some ofthese countries are already showing signsof stress in the availability of appropriatelyskilled workers, as new foreignVMs implement production plants inclose proximity to established ones.These issues will become worse as newfacilities are built.Figure 4: Passenger Car Production by Country Compared1,600,0001,400,0001,200,0001,000,000800,000600,000400,000200,0000RussiaCzechRepublicPolandTurkey*UkraineSloveniaSlovakia* LCV production—which has a major impact in certain countries, such as Turkey—not included.Source: Global InsightRomania20052011Hungary11

CEE AUTOMOTIVE INDUSTRY OVERVIEWSales – Now and ForecastThe CEE states represent a wide rangeof domestic market sizes. Besides, themarket is not homogeneous: differentbrands have succeeded in different areas,and passenger car segments seem tohave different degrees of popularity fromregion to region.Sales growth forecasts vary. Some countriesalready have levels of car ownershipapproaching those of some WesternEuropean countries, while others havesignificant growth potential.Figure 5: Car Density per 1,000 People by Country Compared6005004003002001000552Figure 6: Passenger Car Sales by Country Compared2,000,000512GermanyUnited KingdomSource: Global Insight, Ernst & Young500 469 451388FranceSloveniaUnited StatesCzech RepublicBulgaria330 328 303261PolandHungarySlovakiaRussia180 155RomaniaUkraine109 74Turkey1,500,000200520111,000,000500,0000RussiaTurkey*UkrainePolandRomaniaHungaryCzechRepublicSloveniaSlovakiaBulgaria* LCV sales figures—which have a major impact on certain markets, such as Turkey—not included. Source: Global Insight12T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Figure 8: Key Macro-Economic Data of Selected Eastern European CountriesBulgariaCzech RepublicHungaryPolandRomaniaRussiaSlovakiaSloveniaTurkeyUkraineEU 15Population (in millions) 7.7 10.3 10.1 38.2 21.6 142.8 5.4 2.0 71.2 47.1 386.5Nominal GDP per Capita (US$ ) 3,454 11,883 10,910 7,832 4,564 5,357 8,592 17,000 5,085 1,734 37,640*Unemployment rate (%) 11.5 8.0 7.3 17.6 5.9 7.7 11.6 10.2 10.2 7.2 7.0*Inflation (%) 4.5 2.0 3.7 2.1 8.6 11.0 2.7 2.4 7.7 10.3 2.4*Car Parc (in millions) 2.6 4.0 3.0 12.6 3.3 25.5 1.4 0.9 5.3 5.2 192Vehicles / 1,000 People 330 388 303 328 155 180 261 469 74 109 464*New Passenger cars sales (‘000s) 26 125 202 236 216 1,413 57 60 439 241 14,158*AverageSource: Global Insight. Information as of 2005.Figure 9: Key Macro-Economic Data of Selected EconomiesBrazilChinaFranceGermanyIndiaUKU.S.Population (in millions) 184.2 1,308.9 60.8 82.5 1,097.1 60.2 296.9Unemployment rate 9.8 4.2 9.9 11.7 12.8 4.8 5.1Nominal GDP per Capita (US$) 4,302 1,700 34,559 33,797 724 36,591 42,058Inflation (%) 5.7 1.9 1.9 2.0 4.6 2.2 3.2Car Parc (in millions) 18.1 13.2 30.2 45.6 8.0 30.6 133.8Vehicles / 1,000 People 100 10 500 552 7 512 451New Passenger cars sales (‘000s) 1,333 3,300 2,068 3,343 921 2,440 7,620Source: Global Insight. Information as of 2005.15

C OUNTRY PROFILES — BULGARIAArkhangelskSt. PetersburgRUSSIA MoscowPermChelyabinskIzhevskUfaKazanNijzhny NovgorodUlianovskTogliattiBulgariaSaratovCZECHREPUBLICSLOVENIAGdanskPOLANDPoznanKatowicePragueKrakow LvovBrnoSLOVAKIA SolomonovoBratislavaLjubljanaLubinKalinigradBudapestHUNGARYWarsawLodzWroclaw BreslauGyorPecsLutskClujROMANIATimisoara PitestiBucharestCraiovaBULGARIASofiaBurgasKievVarnaOdessaDnepropetrovskBursaKharkovUKRAINEFrunzeZaporozhyeVoronezhAnkaraTURKEYTaganrogVolgogradKrasnodarAt present, no major vehicle manufacturer has committed to building an assemblyplant in Bulgaria, which provides an almost unique opportunity for a “pioneer”market advantage. While Bulgaria is currently a relatively small market, there isstrong market growth potential, as its GDP per capita continues to rise with itsupcoming membership in the EU. The market offers relatively low labour and othercosts, which are expected to rise more slowly than in states that have already joinedthe EU.A population of 7.3 million makes Bulgaria one of the mid-sized countries amongthe states that have joined the EU since 2004. When Bulgaria joins the EU in January2007 with an average GDP per capita of US $3,454, the country will be among theless-developed nations in the EU. GDP per capita will stand at 9.2% of EU15 average,and it can be expected that GDP levels will increase following the country’smembership.In contrast to the current level of GDP, car density in Bulgaria stands at 330 carsper 1,000 people. But the registered vehicles on the roads are rather aged—there areestimates that the average age is around 19 years, while some statistics claim that themedian age of used cars is 19 to 25 years.16T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Sales and Production OverviewProduction by BrandNeither a local nor a foreign manufacturer has established automotiveproduction facilities in Bulgaria yet. The country hasseen the first investments in the automotive supplier segment inthe last couple of years, but the sector is still lacking the speedof development found in other countries.Passenger Car Sales30.00025.00020.00015.000Saleslevel and advantageous geographical location (for instance, itsproximity to Turkey) offers significant potential. The Turkishautomotive industry, which has seen impressive growth overthe last five years, might use Bulgaria to outsource some ratherlabour-intensive manufacturing activities to stay competitiveand to sustain its own development in the future.Sales by BrandThe local passenger car market, with around 26,000 new carpurchases in 2005, is small but rapidly and consistently growing.Bulgarians have historically focused primarily on buyingimported used cars. On average, in recent years, for eachnew vehicle sold in Bulgaria, five used cars were imported.The most popular price range is quoted to fall in the €1,50010.0005.00002001 2002 2003 2004 2005Sales by BrandPeugeotFordHowever, some automotive suppliers are considering settingup operations in the country, acknowledging the very attractivelabour costs in this region. Labour-intensive manufacturingoperations are looking beyond traditional Eastern Europeanlocations for competitive advantage. Bulgaria, given its wageToyotaOpelCitroen200120050 2,500 5,00017

C OUNTRY PROFILES — BULGARIAto €2,500 range. The sales of used cars could be expected toslowly decline in the years to come, caused by a combinedeffect of the increasing purchasing power of the population andthe implementation of the Euro-4 Regulation, to be adopted in2007.The top-selling brands in Bulgaria in 2005 were Peugeot, theclear leader, followed by Ford, Toyota and Opel. Automotivefinancing and leasing arrangements have been made availableto customers and have gained popularity in the last few years.Instruments such as auto financing and car loans will definitelyhelp to grow the number of new car sales in the years to come.But before these changes are introduced tangibly, Bulgaria isstill likely to have relatively high revenues related to car maintenanceand spare parts consumption.OutlookRisksUnderdeveloped road infrastructure and business practices thatsometimes lack transparency are some of the challenges thatneed to be addressed• The network of roads and highways in the country is still wellbeneath a stage that could be characterized as fully developed.According to the statistics of the International RoadFederation, 70% of Bulgaria’s highways, 51% of its nationalroads and 28% of its secondary roads are in good condition.There is currently only one almost-complete highway, whichconnects the country’s capital, Sofia, with the Black Sea cityof Bourgas. There are 19 large highway and road constructionprojects planned which will likely get funded by the EUfunds once Bulgaria is a member state. However, it will taketime to change the conditions and the quality of the road networkto comply with standards of Western Europe.• Bulgaria is sometimes criticized for business practices thatlack transparency. Improving transparency and public procurementwill ease the way and speed up the processes to getlocal authority approvals and permissions and thus stimulateforeign investments in the sector. In preparation for the EUaccession, these practices have come more under scrutinythan in the past.18T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Opportunities and RewardsLow labour costs attract labour-intensive manufacturing operations,and the proximity to Turkey and its developing industryoffer potential• Current wage levels in Bulgaria are below the average inother Eastern European EU-accession countries. There iseven differential in labour cost between Bulgaria and itsneighbours to the south and north. The labour cost advantagewill be even more attractive to foreign investors onceBulgaria joins the EU in 2007. With harmonized customsprocedures, the import and export of components will ease sothat the country will likely attract more foreign direct investmentthan in the past.• Bulgaria’s workforce includes a large number (around3.4 million) of well-educated and skilled men and women.A high percentage of the workforce has completed someform of secondary, technical or vocational education. ManyBulgarians have strong backgrounds in engineering and sciences.The skilled workforce is a considerable incentive forforeign companies investing in Bulgaria.• Bulgaria can potentially capitalize on the unforgiving costpressure in the automotive industry to absorb some of thelabour-intensive manufacturing activities from Turkey, itsneighbour to the south. With a rapidly developing automotiveindustry, Turkey might consider Bulgaria as a “workbench,”given the labour cost differential and its proximity toexisting operations in the Bursa area.19

C OUNTRY PROFILES — CZECH REPUBLICArkhangelskSt. PetersburgRUSSIA MoscowPermChelyabinskIzhevskUfaKazanNijzhny NovgorodUlianovskTogliattiCzech RepublicSaratovCZECHREPUBLICSLOVENIAGdanskPOLANDPoznanKatowicePragueKrakow LvovBrnoSLOVAKIA SolomonovoBratislavaLjubljanaLubinKalinigradBudapestHUNGARYWarsawLodzWroclaw BreslauGyorPecsLutskClujROMANIATimisoara PitestiBucharestCraiovaBULGARIASofiaBurgasKievVarnaOdessaDnepropetrovskBursaKharkovUKRAINEFrunzeZaporozhyeVoronezhAnkaraTURKEYTaganrogVolgogradKrasnodarThe Czech Republic is almost unique among the CEE countries in having a longstandingautomaker of its own, Skoda. Skoda’s position as a local company translatesinto sales success, with over 40% of the domestic market. More recently, the countryhas attracted anumber of inbound Import vs. Exportinvestment projects,including the recent 1,000,000Toyota/Peugeot/Citroen plant and theImportupcoming Hyundaiplant. These helpcreate a projectedExportproduction capacityof around one millionunits more than anyProduction1,000,000of the other states that joined the EU in 2004 with export levels running at 80% ofproduction.SalesSales and Production ComparedThe Czech Republic, with 10.2 million inhabitants, is a mid-sized country among the10 new EU member states.New car sales, around 140,000 units, have suffered somewhat from imports of usedcars since the Czech Republic joined the EU. Used car imports represent a majorthreat to other players in the market.20T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Sales and Production Compared700,000600,000500,000400,000300,000200,000100,000SalesProductionThe company has significant international recognition as animportant brand in the VW Group portfolio.In 2005, a consortium known as TPCA, comprising Toyotaand the French PSA Group (involving the Peugeot and Citroenbrands), built a full-fledged assembly plant in Kolin, 40 kmeast of Prague. Production started in 2005. The plant producesthe Toyota Aygo, Peugeot 107 and Citroen C1.Hyundai has announced its intention to build a plant in the2001 2002 2003 2004 2005Average GDP per capita in 2005, at 32% of EU15 average,ranks the country third among the accession states. Car Densitylevel stands at 388 1 cars per 1,000 people, up from 345 in 2001.The Czech Republic is a production centre for the industry:local production currently runs at 4.8 times the sales of newcars in the country, and this will rise as planned new plantscome on stream.Sales and Production OverviewProduction by BrandAutomotive manufacturing has a long tradition in the CzechRepublic. Skoda is the biggest industrial company in the countryand a leading exporter. Skoda as a global brand produces itsfull range of cars in the country and exports to many markets.Production by BrandSkodaToyotaCitroenPeugeot200120050 40,000 250,000500,000eastern part of the country, near Ostrava. When this plant goeslive with production in 2009, the Czech Republic will have thecapacity to produce about 950,000 passenger cars annually.This represents 7.6 times the current market for new car sales21

C OUNTRY PROFILES — CZECH REPUBLICin the Czech Republic, underscoring the fact that the country ispredominantly a manufacturing base for the automotive industrywith a strong focus on export.The country has attracted a large number of automotive suppliersin recent years. Large international Tier 1 suppliers haveplants that supply Skoda, and more recently TPCA, whiledelivering to major global VMs abroad.More importantly, a number of mid-sized component suppliersand tool manufacturers now form a well-established network,laying the groundwork for a comprehensive local supply chainfor the industry. This network is mostly located in the MladaBoleslav (Skoda) and Kolin (TPCA) regions, the main automotiveclusters of the country.Sales by BrandThe Czech Republic’s market for new car sales has been and isstill dominated by the well-known Skoda brand, which reacheda 45% market share in 2005. Renault ranks second, closelyfollowed by the German brand Volkswagen. Hyundai has seensignificant growth in recent years.The Czech market, like most other Eastern European markets,is focused on the A and B segments, which account for 55%of the market. Current income levels do not allow significantspending on passenger cars, though per-capita GDP is risingand the number of registered cars in the country is growingSales by BrandSkodaRenaultVWHyundaiFordrapidly. Additionally, Czech consumers look for imported usedcars rather than new ones, which contributes to the increasingage of the cars in service.Outlook200120050 10,000 40,00080,000RisksLabour shortage and increasing wages become a more pressingissue• While the country’s overall unemployment rate stands ataround 8%, areas such as Prague and central Bohemia facea very low 2%–4.5%, which poses significant challenges forthose looking to hire new staff in this region.22T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

• TPCA experienced difficulties in staffing its new plant inKolin. The consortium recruited workers from Poland,Slovakia and Ukraine to fill the gaps.• Hyundai decided to locate its new plant in Ostrava, partly tohave better access to skilled labour (e.g., from Poland).• The tight labour market for skilled workers and engineers islikely to fuel wage and salary increases.The country’s capacity is being stretched• Some politicians have started to question whether thecountry’s dependency on the automotive industry could turninto a risk, with the industry representing 16.3% of GDP and19.7% of export in 2005. Such concerns are already startingto impact incentive packages offered to suppliers that want tofollow Hyundai.• CzechInvest (www.czechinvest.org) the country’s investmentagency, is directing attention to attract high value-added servicessuch as research and development (e.g., biotechnology)and shared service center operations.The density of heavy traffic on the Czech Republic’s motorwaysis increasing, caused to some extent by the automotivejust-in-time production logistics. As a result, the governmentplans to implement a toll system for motorway access by 2007.Opportunities and RewardsStability, good infrastructure and a large base of local suppliersattract investment in the sector• The Czech Republic has a long tradition of automotive engineeringand production. Skoda recently celebrated its 100thanniversary, and other automotive brands, such as truckmakersTatra and Avia, also have a long history.• More than any other Eastern European country, the CzechRepublic is characterized by a strong automotive suppliercapability.• CzechInvest claims that more than half of the largest globalautomotive suppliers have operations in the country. Thislarge portfolio of suppliers allows access to an almostcomplete local supply chain, providing significant costadvantages.• The country’s skilled industrial labour force, together with itsproximity to Germany and other Western European markets,secured by a stable political and economic environment, ishelping the Czech Republic become a new center for theEuropean automotive industry.23

Sales and Production ComparedWith a population of little more than 10 million, Hungary’smarket for new passenger car sales has grown steadily in recentyears, exceeding 200,000 units in 2004. The number of registeredvehicles in the country is growing continuously and thenumber of cars per 1,000 inhabitants increased to 275 in 2005.Imported used cars don’t play a significant role. The governmentrequires Euro 3 standard compatibility for cars importedinto the country, unlike in some other EU accession states.Together with higher taxes for used cars, this has reduced consumers’interest in used cars.Sales and Production OverviewProduction by BrandHungary has attracted the Japanese VM Suzuki (1991), Audi(1993) and Opel/GM (1991) to build vehicle assembly and/or engine and powertrain component manufacturing plants,respectively. Suzuki, Audi, Opel and Bosch are among the biggestindustrial companies in Hungary, followed by a significantnumber of international automotive component manufacturersthat constitute an extensive local supply base in the country.Sales and Production Compared250,000SalesProductionProduction by Brand200,000Suzuki150,000100,00050,00002001 2002 2003 2004 2005AudiSubaruFiat200120050 70,000 140,00025

C OUNTRY PROFILES — HUNGARYSales by BrandSuzukiOpelSkodaFordOutlookRisksCurrency Risks and Volatility• Hungary became a member state of the European Union in2004. Like the other new member states, it will maintain itslocal currency for a conversion period before introducing theeuro and taking part in the European Monetary Union.VW200120050 20,000 40,000• The Hungarian currency, the forint, is floating against theeuro, the U.S. dollar and the Japanese yen, and the foreignexchange rates against these currencies have been volatile inrecent years.Sales by BrandThe Hungarian market for new car sales has been dominatedfor years by Suzuki. As one of the largest employers in thecountry, Suzuki has become the country’s favourite brand fornew cars. The company’s market has been shrinking, with moreinternational brands coming to Hungary. But Suzuki’s marketshare of 20% is still considerably higher than those of Opelor Skoda. Eight other brands enjoy market shares above 5%,which shows a diverse, maturing market.• This volatility has created issues for the Hungarian economy,impacting imports and exports. In 2003, the forintstrengthened against the U.S. dollar; combined with higherwages, this resulted in a 23% increase in unit labour costs.This put significant pressures on companies producing inHungary to export to U.S.-currency markets.• The same currency swing has caused import prices to fall,improving profitability for importers such as the sales companiesof the large VMs. In 2006, however, the forint cameunder pressure against the euro, resulting in the exact oppositescenario. Going forward, budgetary imbalances and arecurring deficit in the external current account create uncertaintyand could result in a downturn in the value of the forint.26T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Opportunities and RewardsThe Hungarian economy is rather mature – its legal systemfollows Western standards, providing strong protection forinvestors• Hungary is among the most developed former Eastern Bloccountries. Its economy is more mature, becoming moresettled as the emerging markets phase runs its course.• Privatization and efforts to attract foreign direct investment,combined with Hungary’s historical and cultural links tothe old monarchy, helped the country grow quickly after theEastern Bloc countries became democratic in the 1990s.• This will change in 2007, when Romania and Bulgariabecome new member states of the European Union.• Hungary is likely to benefit from becoming more central inthe EU area, and there is optimism that the established automotiveindustry and other businesses may see growth opportunitiesstemming from these new markets.• Romania, which neighbours Hungary to the east, is muchless developed, and Hungarian businesses might have acompetitive advantage in its proximity to these emergingmarkets.• Hungary has reformed its legal system in preparation for EUmembership, so that it is compliant with Western standardsin almost all material respects.• This legal system provides a good and reliable frameworkthat helps protect the rights of investors.Hungary is geographically well-placed to benefit from EUenlargement to Romania and Bulgaria.• Geographically, Hungary has been the country farthest southeastin the EU, representing the border from EU territory tothe outside.27

C OUNTRY PROFILES — POLANDArkhangelskSt. PetersburgRUSSIA MoscowPermChelyabinskIzhevskUfaKazanNijzhny NovgorodUlianovskTogliattiPolandSaratovCZECHREPUBLICSLOVENIAGdanskPOLANDPoznanKatowicePragueKrakow LvovBrnoSLOVAKIA SolomonovoBratislavaLjubljanaLubinKalinigradBudapestHUNGARYWarsawLodzWroclaw BreslauGyorPecsLutskClujROMANIATimisoara PitestiBucharestCraiovaBULGARIASofiaBurgasKievVarnaOdessaDnepropetrovskBursaKharkovUKRAINEFrunzeZaporozhyeVoronezhAnkaraTURKEYTaganrogVolgogradKrasnodarMajor producers in Poland include Fiat, VW and Opel, which has translated directlyinto sales success for those brands in the country. Skoda and Fiat enjoy market-leadingpositions. New vehicle sales have not grown linearly; since Poland joined the EU,significant numbers of used vehicles have been imported, contributing to a drop innew car sales.Import vs. Export1,000,000ImportExportSalesProduction1,000,00028T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Sales and Production ComparedPoland ranks sixth among EU countries in population. With38 million inhabitants, it is the largest of the states that joinedthe EU in 2004. The country’s average GDP per capita in 2005was over 46% of the EU15 average, ranking the country 24thamong the EU25.New car sales in Poland dropped significantly following EUmembership, as imports of used cars rose significantly from31,873 units in 2003 to 870,777 in 2005. With the coming ofEU free trade regulations, Poland removed excise duties onimported used cars to harmonize duty schemes with existingEU standards. These duties had protected the local market inrecent years, and their elimination has once again made theSales and Production Comparedpurchase of a well-equipped, mid-sized used car competitiveagainst the purchase of a new small car.The country’s car density stands at 330 cars per 1,000 people.The long-term growth potential is estimated to more thandouble the current market size in the long run.In recent years, car production volumes in Poland were abouteven with the number of new cars sold in the country. Thedip in new car sales in 2004 and 2005 and rising productionchanged this balance.Sales and Production OverviewProduction by BrandAutomobile manufacturing in Poland in the recent past wasdominated by Western brands. Fiat, which entered the countryProduction by Brand600,000SalesProductionFiat500,000400,000Opel300,000VW200,000100,00002001 2002 2003 2004 2005DaewooSuzuki200120050 150,000 300,00029

C OUNTRY PROFILES — POLANDin 1992, acquired Polish manufacturer FSM and transformedthe old manufacturing site into a modern facility. By contrast,Opel and VW entered the market with a greenfield investment.VW produces its Caddy model in Poznan, in Western Poland,whereas Opel produces its Astra model in Gliwice, in the widerKatowice area.Fiat and VW rank among the 10 largest companies in Poland,underlining the importance of the industry sector to the country’seconomy.Economic activity is focused on areas around Warsaw,Wroclaw, Poznan and Katowice, as well as Kraków, while ruralareas are growing much more slowly.Sales by BrandThe market for new car sales in recent years has shown significantfluctuations. Skoda ranked first in the market, with nearly12% of sales market share in 2005, and its assembly operationsin the Czech Republic are only 120 km from the Polish border.Fiat is still one of the top five selling brands in Poland. Thecompany benefits from a renewed model line-up and a productrange that focus on the mini and small segments, which aregenerally popular among consumers with over 40% of totalsegment share.Sales by BrandSkodaToyotaFiatOpelFordOutlook200120050 40,000 80,000RisksRoad infrastructure is progressing only slowly• The quality of public transport infrastructure—includinghighways, roads and railways—is not yet at desired levels.• The Polish government has launched programs targetingimprovement, but implementation is slow.• Progress can be seen in fast-growing regions such asWroclaw, Poznan, Katowice and Krakow, where highwaysalready connect to Germany and Western Europe. Warsawstill lacks this facility.30T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Unemployment is high, but skilled young talent is sometimesdifficult to hire and retain.• The country-wide unemployment rate in Poland stands at arather high 17.6%.• With EU membership and the opening of Western labourmarkets, Poles—especially the young and well-skilled—areincreasingly working in Western Europe to earn higherincomes.• Engineers and skilled industrial labour is being absorbed bythe industry in the boom areas (also by quickly developingR&D centers), so mid-sized, less well-known enterprisesmay experience difficulties in finding the talent they need.Special Economic Zones offer extraordinary incentives forforeign direct investment• The Polish government has defined a large number ofSpecial Economic Zones (SEZ) outside the fast-growingareas to support economic development.• Beyond the EU funding schemes available to investors, foreigndirect investment in those areas is supported by generoustax incentives. These might reach up to 75% of capitalexpenditure for newly established manufacturing operations.• However, following EU membership, several SEZ incentiveschemes will most likely expire by 2017.Opportunities and Rewards38 million Poles represent a large local market• Poland, with a population of approximately 38 million, isthe sixth-largest country in the EU after Germany, the UK,France, Italy and Spain.• It is expected that private consumption in Poland will risewith a growing economy and living standards, making thelocal Polish market very attractive. This is likely to have animpact on the automotive market in the near future.31

C OUNTRY PROFILES — ROMANIAArkhangelskSt. PetersburgRUSSIA MoscowPermChelyabinskIzhevskUfaKazanNijzhny NovgorodUlianovskTogliattiRomaniaSaratovCZECHREPUBLICSLOVENIAGdanskPOLANDPoznanKatowicePragueKrakow LvovBrnoSLOVAKIA SolomonovoBratislavaLjubljanaLubinKalinigradBudapestHUNGARYWarsawLodzWroclaw BreslauGyorPecsLutskClujROMANIATimisoara PitestiBucharestCraiovaBULGARIASofiaBurgasKievVarnaOdessaDnepropetrovskBursaKharkovUKRAINEFrunzeZaporozhyeVoronezhAnkaraTURKEYTaganrogVolgogradKrasnodarRomania has a long tradition of car manufacturing. Dacia produced under licencefrom Renault for many years, until it was acquired in 1999 and became the low-costbrand in the Renault portfolio. Recent investments by suppliers have made the sectorone of the fastest growing in the country, as suppliers follow the Dacia investmentand take advantage of Romania’s low wage costs. Romania joins the EU in 2007, andwill then be the second-largest new state, offering market potential as GDP rises.Import vs. Export500,000ImportExportSalesProduction500,00032T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Sales and Production Compared250,000200,000SalesProductionthe efficient transport logistics necessary for the transport ofgoods from the Middle East to Europe and vice versa. Thefact that automotive manufacturing is concentrated mainly onRomania’s western border tells a story in this respect.150,000100,00050,00002001 2002 2003 2004 2005Sales and Production ComparedA population of 22 million ranks Romania as the second-largestof the new EU member states from Eastern Europe, behindPoland. Given the GDP per capita, it is not surprising that thecountry does not yet have a large number of registered vehicles.The 3.2 million cars on Romanian roads equates to about149 cars per 1,000 inhabitants. However, the car parc is growing:in 2001, it was estimated at 129 cars per 1,000 inhabitants.Between 1993 and 2003, Romania’s GDP per capita increased256%, from US$772 to US$2,741.The country’s roads are in generally poor repair, and a sizeablenumber of roads are unsurfaced. This does not supportSales and Production OverviewProduction by BrandThe clear leader in the market for new cars is Dacia, whichexpanded its market share to more than 44% in 2005 thanksto the rapidly growing number of Logans sold on the localmarket. After Dacia, the best-selling brands in Romania in2004 were Daewoo and Renault, with market shares of 20%and 7%, respectively. Romanians have a clear preference forcompact cars, which account for 60% of the market, followedby minis and small cars.Production by BrandDaciaDaewooAro200120050 80,000 160,00033

C OUNTRY PROFILES — ROMANIASales by BrandPassenger car sales increased 200% from 2001 to 2005.Imports of new cars rose 328%, to 102,043 units in 2005,although import duties increased from 20% to 25% in June2005. In compliance with WTO entry outlook (which couldtake place this year), the import ban on used cars over fiveyears old (equipped with at least a Euro 3 emission standardengines) was abolished. Boosted by increasingly affordable carcredit, passenger car sales could increase further.Sales by BrandDaciaOutlookRisksUncertain investment conditions• Frequent legislation changes have resulted in uncertainty forinvestors. A heavy and inflexible bureaucracy impedes incentiveopportunities.• Interpretation of rapidly changing tax regulations by localauthorities often results in surprise and additional tax burden.Labour costs• Romania’s low labour cost base has clearly attracted anumber of automotive component manufacturers.RenaultDaewooSkodaVW200120050 50,000 100,000• The country has a large manufacturing base and has historicallybeen less focused on agriculture compared to someother Eastern European countries. Romania employed morethan 100,000 workers in the automotive sector in the communistera, but many of those lost their jobs upon transition.• Unemployment remains steady at approximately 5.9%.Hence, investors can expect to find skilled labour that is usedto working in industrial production.34T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

General lack of infrastructure requires strong commitment fromgovernment• The current condition of the country’s roads is poor, as asizeable portion still needs to be paved. This does not supportefficient transport logistics required for just-in-timedeliveries. To counter this obstacle, export-oriented automotiveoperations are dominantly concentrated on the country’swestern border.Opportunities and RewardsLarge economy and favourable geographical location• Labour costs in Romania are considerably lower than inthe Czech Republic, Hungary, Slovakia and Poland, andare among the lowest in the Central and Eastern Europeancountries.• It will take time to raise income levels among Romaniansso that the automotive market can develop into its long-termsize. And it will probably take even longer before the countrycan take full advantage of its privileged geographicallocation.• Romania’s attractiveness as a destination for foreign directinvestment is often attributed to the size of its population andits geographical location as a connection between the Black,Caspian and Mediterranean seas.• However, although these factors will strengthen the countryin the long run, investors should not expect too much in thenear future.• When Romania joins the EU in 2007, the country will be oneof the poorest in the Community in terms of GDP per capitaand infrastructure.35

C OUNTRY PROFILES — RUSSIAArkhangelskSt. PetersburgRUSSIA MoscowPermChelyabinskIzhevskUfaKazanNijzhny NovgorodUlianovskTogliattiRussiaSaratovCZECHREPUBLICSLOVENIAGdanskPOLANDPoznanKatowicePragueKrakow LvovBrnoSLOVAKIA SolomonovoBratislavaLjubljanaLubinKalinigradBudapestHUNGARYWarsawLodzWroclaw BreslauGyorPecsLutskClujROMANIATimisoara PitestiBucharestCraiovaBULGARIASofiaBurgasKievVarnaOdessaDnepropetrovskBursaKharkovUKRAINEFrunzeZaporozhyeVoronezhAnkaraTURKEYTaganrogVolgogradKrasnodarWith an annual market of over 1.4 million units in 2005, Russia is the largest of theCEE markets and offers significant further market growth. AvtoVAZ still dominatessales—with production at over 720,000 units in 2005, the company owns half thecountry’s market for cars.The industry became very active in 2004-2005. Toyota, GM, VW, Nissan and someothers have announced the construction of plants, to add to existing internationalinvestments from global VMs that date back to the late 1990s. The indigenous industryalso shows signs of developing onto the international stage. Forecasts suggest thatby 2011 Russia will be a significant manufacturer of foreign brand cars, at around900,000 units in 2011.Import vs. Export2,000,000ImportExportSalesProduction2,000,00036T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Sales and Production ComparedRussia’s economic growth has surpassed most expectationssince the country’s financial crisis in the summer of 1998.GDP grew from US$274 billion in 1998 to US$743.3 billion in2005. The country not only enjoys increasing global demandfor raw materials, but also strong inland consumption growth.GDP per capita in Russia increased 280% between 1998 and2005, from US$1,850 to US$5,200.Sales and Production Compared1,600,0001,400,0001,200,0001,000,000800,000600,000400,000200,000SalesProductionSales and Production OverviewProduction by BrandSince the 1960s, Russia launched its own mass car productionfacilities, which were the only source of vehicles during theentire communist era. Hence, the Russian car fleet remainslargely occupied by Russian brands such as VAZ and GAZ,which in 2005 owned 67% and 5% of market share, respectively.In addition to passenger cars, Russia also produces a significantnumber of LCVs, largely for domestic consumption.Foreign passenger car assembly projects began in 1997 withAvtotor (Kia and BMW) and Daewoo. Since then, many otherforeign VMs have entered the country. According to currentplans and announcements, about 20 foreign car makers areProduction by BrandLada02001 2002 2003 2004 2005ChevroletGAZWith a car density still below 180 per 1,000 people, and morethan 50% of the car fleet aged 10 years and over, the countryoffers outstanding consumer growth potential.HyundaiFord200120050 100,000 830,00037

C OUNTRY PROFILES — RUSSIAexpected to have manufacturing activities in Russia by the endof 2008.Sales by BrandRussia’s sales of new foreign passenger cars reached 560,000units in 2005, a 60% increase over the previous year and 187%increase over 2003. Used car imports as a share of the total passengercar market declined by 16.6% in 2005, to 305,000 units,following the implementation of unattractive customs dutieson vehicles over three years old. Russian car makers are losingmarket share as they do not manage to fulfil consumer qualityand reliability expectations.Sales by BrandLadaHyundaiChevroletToyotaFord200120050 100,000 800,000OutlookRisksHeavy bureaucracy can significantly slow down productionstart-up• Heavy regulations hinder quick response to market needs andmay delay smooth entry for foreign investors.• Russia’s tax, legal and financial systems are much morecompatible to foreign investors’ needs than ever before, butmany discrepancies still impede the way to rapid and efficientproduction start-up.• Too many licences and permissions are required for timelylaunch. This obstacle has often resulted in surprises thatadded additional costs and slowed down the process formany companies.Higher-than-expected production costs may quickly alter thereturn on investment of a tenuous business plan• Companies seeking the lowest possible labour costs increasinglyhave to search for facilities far from Russia’s capital,often to regions where foreign investment is not yetsignificant.38T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

• Although the country has abundant raw materials essential tothe industry, prices are not significantly lower than resourcesfrom developed economies.• Energy, transportation and warehousing costs are constantlyon the rise. Hence, time and attention given to the preparationof a business plan should be made carefully in order toensure successful market entry.Consumer trends create a new type of demand as Russian consumersincreasingly look for quality and reliability• A closer look at foreign car sales and overall consumptionattitudes reveals that since 2003, passenger car consumersare increasingly purchasing higher-than-average specificationvehicles.Opportunities and RewardsUnparalleled prospective market conditions in Russia nowcreate the highest consumer growth potential in Europe• Russia’s passenger car manufacturing activities do not fulfilvehicle demand in the country. Most domestic plants operateat nearly full capacity.• Russia’s domestic car manufacturing industry remains highlyvertically integrated. This creates merger, acquisition andjoint venture opportunities for foreign suppliers as well assales opportunities to Russian domestic VMs reaching outfor higher parts quality and reliability.39

C OUNTRY PROFILES — SLOVAKIAArkhangelskSt. PetersburgRUSSIA MoscowPermChelyabinskIzhevskUfaKazanNijzhny NovgorodUlianovskTogliattiSlovakiaSaratovCZECHREPUBLICSLOVENIAGdanskPOLANDPoznanKatowicePragueKrakow LvovBrnoSLOVAKIA SolomonovoBratislavaLjubljanaLubinKalinigradBudapestHUNGARYWarsawLodzWroclaw BreslauGyorPecsLutskClujROMANIATimisoara PitestiBucharestCraiovaBULGARIASofiaBurgasKievVarnaOdessaDnepropetrovskBursaKharkovUKRAINEFrunzeZaporozhyeVoronezhAnkaraTURKEYTaganrogVolgogradKrasnodarAlthough a relatively small market, Slovakia is becoming one of the major automotiveproduction hubs in the CEE. Investment in car plants started with VW in the1990s, and more recently PSA and Kia have built plants in the country. Together,these companies are projected to produce 800,000 units by 2008 and to export 90%of them. This level of export dependency is without parallel in the industry globally.These new plants have yet to make a significant impact on local sales, with Skodastill enjoying the largest market share.Import vs. Export500,000ImportExportSalesProduction500,00040T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Sales and Production ComparedSlovakia, with a population of 5.4 million, is about half thesize of the Czech Republic, from which it separated in 1993. In2005, Slovakia’s GDP per capita was 23% of the EU15 average,ranking the country fifth among Eastern European countries.(See page 15 for further comparisons.)Sales and Production Compared300,000250,000200,000150,000100,00050,000SalesProductionFollowing recent developments and announcements, Slovakiais becoming a production hub for the automotive industry.Upon completion of announced investments by Kia (expected2007) and the launch of the PSA plant in 2006, the country’sproduction capacity for passenger cars will exceed 12 times itsnew car sales volume.Sales and Production OverviewProduction by BrandUntil recently, automobile manufacturing in Slovakia was dominatedby Volkswagen, with its plant in Bratislava. Over theyears, the Volkswagen Group has expanded its production basefrom Golf to a number of other models: Polo, Touareg, and theAudi Q7. In 2004, Slovakia attracted the French PSA Groupto Trnava, where production began earlier this year, and Kia toZilina, expected to launch production in 2007.02001 2002 2003 2004 2005Production by BrandSlovakia shows a diverse profile with a comparably welldeveloped,Western-influenced territory around its capital,Bratislava, and a relatively less-developed Eastern-orientedpart with deep roots in agriculture.The country’s car density, at 261 cars per 1,000 people, willclimb further with rising GDP per capita.VWSeatAudi200120050 100,000 200,00041

C OUNTRY PROFILES — SLOVAKIASales by BrandThe market for new car sales in Slovakia is rather small, withsales of around 70,000 units per year. Skoda, the Czech brandthat was the “own” brand for Slovakians for many years priorto separation of the two countries, enjoys the top rank in thesales charts, claiming over 30% of market share. Volkswagenand Renault follow with approximately 6.5%. With over 55%of total car sales, the Slovakian passenger car market is clearlycharacterized by segment B consumption.Sales by BrandOutlookRisksThe sector activity is currently highly concentrated in theBratislava area – hiring and retaining skilled labour is becomingincreasingly challenging• Volkswagen’s entry in the Bratislava region was followed bya number of suppliers, which boosted the capital’s regionaleconomy.• Volkswagen on its own employs about 10,000 people at thisfacility. High demand for workers to staff manufacturingoperations at the plant and surrounding centres created adaily workforce migration from up to 100 km away.SkodaPeugeotVWRenaultSuzuki20012005• Operations of PSA in Trnava (50 km north of Bratislava)and Kia in Zilina (200 km north of Bratislava) are likely totighten the labour availability conditions, which will result inhigher wages and more difficult conditions for smaller componentmanufacturers establishing new operations.0 20,000 40,00042T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Opportunities and RewardsFavourable environment for automotive manufacturing andinvestment• The Slovak government has been very proactive towardslarge investors like PSA and Kia in offering tailored infrastructuresolutions and attractive incentives.• This approach, linked with persuasive reforms such as aflat and user-friendly corporate tax system, helped to securethese prestigious projects.• The country’s economy shows a clear focus on developingindustrial manufacturing activities.The country’s dependence on the manufacturing sector and theautomotive industry in particular provide a reasonable basis toassume that operations in Slovakia will see a favourable environmentfor many years to come.43

C OUNTRY PROFILES — SLOVENIAArkhangelskSt. PetersburgRUSSIA MoscowPermChelyabinskIzhevskUfaKazanNijzhny NovgorodUlianovskTogliattiSloveniaSaratovCZECHREPUBLICSLOVENIAGdanskPOLANDPoznanKatowicePragueKrakow LvovBrnoSLOVAKIA SolomonovoBratislavaLjubljanaLubinKalinigradBudapestHUNGARYWarsawLodzWroclaw BreslauGyorPecsLutskClujROMANIATimisoara PitestiBucharestCraiovaBULGARIASofiaBurgasKievVarnaOdessaDnepropetrovskBursaKharkovUKRAINEFrunzeZaporozhyeVoronezhAnkaraTURKEYTaganrogVolgogradKrasnodarSlovenia is the smallest but wealthiest of the new EU member countries, with a wellestablishedautomotive industry. Renault has had an investment in a Slovenian plantfor over 30 years, which now produces approximately 170,000 passenger cars peryear, well surrounded by various suppliers’ plants. However, there are no firm plansfor any other major car plants, and the country’s FDI in the sector has declined.Sales and Production ComparedSlovenia, with a population of approximately 2 million, is sometimes described as “amini Switzerland.” It is one of the most highly developed of all the new EU memberstates—the GDP per capita stands at approximately €13,800, which is already similarto the level of Portugal.Car density stands at an impressive 465 cars per 1,000 people, indicating that thecountry’s automotive market is mature; car density in Slovenia is already close to thatof many Western European countries.Import vs. Export500,000ImportExportSalesProduction500,00044T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Sales and Production Compared200,000180,000160,000140,000120,000100,00080,00060,00040,00020,0000SalesSales and Production OverviewProduction2001 2002 2003 2004 2005Production by BrandAutomotive manufacturing has a certain degree of tradition inSlovenia. Revoz, the Slovenian company owned by Renault,is one of the largest industrial companies in the country and aleading exporter. Revoz was developing and producing passengercars in Novo Mesto before Renault acquired a controllingstake in the company in 1991. With Renault becoming a shareholder,the operations at Revoz underwent substantial renewaland started to produce Renault vehicles. In recent years, theRevoz plant has produced about 150,000 units of the Cliomodel. In 2004, Renault decided to invest another €400 millionin Slovenia to increase production capacity and prepare for theproduction of a new model to be positioned between the Clioand the Twingo (X 44). So far, Renault is the only manufacturerthat produces cars in the country.Production by BrandRenault200120050 90,000 180,000Automotive suppliers have chosen Slovenia as a location, aswell. This industry segment represents a production volumeof approx. €1.2 billion, of which the majority is designatedfor export into Western Europe. Suppliers are predominantlylocated around Revoz, in Nove Mesto, and in the Maribor area,close to the Austrian border.Sales by BrandThe local passenger car market, with around 60,000 new carregistrations per year, is small but rather stable and predictable.With the harmonization of VAT and duty schemes for EUaccession, some of the local market’s growth potential movedto imported used cars in 2004 and 2005. In 2005, the numberof imported used cars reached 17,288 units, compared to 8,102in 2004. However, it is expected that new car sales will grow in45

C OUNTRY PROFILES — SLOVENIAthe mid-term. The market may reach 70,000 units for new carsales in the next five years.The top-selling brands in Slovenia in 2005 were Renault, theclear leader, followed by VW and Opel, and then Citroen somedistance behind. By type of car sold, the Slovenian market isdominated by B, C and MPV segments, with the Renault Cliobeing the bestseller in the market.Sales by BrandRenaultVWOpelPeugeotCitroen200120050 7,500 15,000OutlookRisksEstablished business practices, combined with prevailingsocialist traditions, may create challenges for foreign investors• Slovenia has a longstanding tradition in socialist politicalculture. This can be seen by a rather restrictive privatizationprocess for some former state-owned enterprises in the banking,telecom and other sectors, aiming to protect the “crownjewels” of the country. Where privatization has taken place,the government has retained a substantial stake in many ofthe businesses.• For companies considering a greenfield investment, the legalsystem allows a fully owned investment, but companiesentering the Slovenian market find it beneficial to involvelocal authorities in the overall investment strategy.• Although the tax system has been aligned with WesternEuropean pre-accession standards, taxes are an area thatbears some level of uncertainty for investors. This uncertaintystems from an inconsistent application of rules andinterpretations among the various regional tax authorities inthe country.46T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

• Slovenia has therefore concentrated on attracting business inthe service arena that requires more highly skilled employees,as opposed to relying on cheaper labour for more traditionalmanufacturing operations.Slovenia is about to catch up with Western Europe economically,and labour costs are following this trend closelyWith Slovenian GDP per capita approaching the level ofPortugal, labour costs are well above the average of the EU’sother new member states, with high personal income tax ratesand social security costs. However, it is likely that tax rates willbe significantly reduced in 2007.Opportunities and RewardsA solid road infrastructure, proximity to Western Europeanmarkets, and the relationship to former Yugoslav neighboursconstitute some of the country’s attractiveness• The road and highway infrastructure is well developed inSlovenia and the conditions of these roads are better thanin many other Eastern European countries. This infrastructure,together with the geographical proximity to Westerncountries, provides logistical advantage. The port of Koperis also used extensively, particularly by Asian automotivemanufacturers.• Traditionally, due primarily to its location, Slovenia hasrepresented the trading hub for the former Yugoslavia,whereas Serbia, Croatia and Montenegro have been areaswhere manufacturing took place. This makes Sloveniaan attractive gateway for business into the other formerYugoslav countries.47

C OUNTRY PROFILES — TURKEYArkhangelskSt. PetersburgRUSSIA MoscowPermChelyabinskIzhevskUfaKazanNijzhny NovgorodUlianovskTogliattiTurkeySaratovCZECHREPUBLICSLOVENIAGdanskPOLANDPoznanKatowicePragueKrakow LvovBrnoSLOVAKIA SolomonovoBratislavaLjubljanaLubinKalinigradBudapestHUNGARYWarsawLodzWroclaw BreslauGyorPecsLutskClujROMANIATimisoara PitestiBucharestCraiovaBULGARIASofiaBurgasKievVarnaOdessaDnepropetrovskBursaKharkovUKRAINEFrunzeZaporozhyeVoronezhAnkaraTURKEYTaganrogVolgogradKrasnodarTurkey has a longstanding automotive industry, going back to the 1920s, and thecountry’s associate status with the EU gives it free market access. In addition to itscapacity for passenger car assembly, Turkey has become a centre for the productionof LCVs, largely for export. Overall, including these LCVs, Ford is the largest producerin the country, followed by Fiat, PSA and Hyundai. Turkey is a large market;currently around 700,000 units are sold, and the country’s large population offers significantpotential market growth.Import vs. Export1,000,000ImportExportSalesProduction1,000,00048T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Sales and Production ComparedThe automotive industry, centralized in the Bursa region,nearly 200 km southwest of Istanbul, is a key contributor to thecountry’s GDP growth.Turkey’s economic turnaround since the financial crisis of2001 has reduced structural inflation, tamed previously out-ofcontrolbudget deficits, and reduced the public debt. However,difficulties in meeting expectations of an IMF agreementsigned in 2005 might cause sudden change in overall investorsentiments.Turkey’s GDP per capita increased 14.5% between 1993 and2003, from US$ 2,981 to US$ 3,412.Sales and Production Compared500,000450,000400,000350,000300,000250,000200,000150,000100,00050,0000SalesProduction2001 2002 2003 2004 2005Production by BrandRenaultToyotaFiatHyundaiHonda200120050 90,000 180,000With over 70 million inhabitants, Turkey is the third-largestcountry in Europe, after Russia and Germany. With a car fleetestimated at 112 per 1,000 people in 2004, the country has thecontinent’s highest growth potential in terms of overall marketvolume growth.Turkey enjoys the reputation of a low-cost and high-qualityproduction base. The country’s free trade agreement with theEU has attracted several projects intended both to satisfy localdemand and, particularly, to produce vehicles for export.The Turkish automotive industry began in 1929 when the firstauto assembly plant was set up. Currently, the country counts17 car plants, of which 13 manufacture LCVs. More than 700foreign suppliers have production activities in the country, both49

C OUNTRY PROFILES — TURKEYto supply assembly plants in Turkey and for export to WesternEuropean customers.Sales by BrandRenaultFordOutlookRisksChallenging macro-economic expectations• From a macro-economic standpoint, Turkey faces seriouschallenges ahead and could have difficulty meeting targetsfrom the IMF.HyundaiOpelFiat200120050 40,000 80,000• While long-term interest rates (over 60% in 2001) are stillover 20% in 2006, the current account balance remains negative,which should be an additional obstacle to diminish foreigndebts, currently at over 47.3% of GDP.The country’s geographical position might put exports to somecountries at stake• Higher energy prices have led to increasing transport pricesaround the globe. This has had a direct influence on vehicletransportation costs.• Most exports go to Western Europe; direct neighbours importfew of Turkey’s vehicle output.50T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

• As other CEE countries closer to Western European marketsincrease their production, Turkey could face fierce competitiondue to its greater distance from these markets. On theother hand, Turkey offers unprecedented proximity to MiddleEastern and Northern African countries.Opportunities and RewardsLow car density combined with strong population growth• Turkey’s comparatively small car fleet (5.3 million passengercars) and large population, combined with more accessiblecredit offerings, present a strong combination of factors forsignificant prospective growth.A well-established foreign automotive industry and structuralreforms ease market entry of foreign VMs and productionexpansion• With over 20 foreign VM projects and more than 700 foreignsuppliers involved, it can be considered a mature industrysector that gives easy access to implement new facilities.• A newly implemented corporate tax code (introducing a flattax rate at 16%) will even out business in this region.51

C OUNTRY PROFILES — UKRAINEArkhangelskSt. PetersburgRUSSIA MoscowPermChelyabinskIzhevskUfaKazanNijzhny NovgorodUlianovskTogliattiUkraineSaratovCZECHREPUBLICSLOVENIAGdanskPOLANDPoznanKatowicePragueKrakow LvovBrnoSLOVAKIA SolomonovoBratislavaLjubljanaLubinKalinigradBudapestHUNGARYWarsawLodzWroclaw BreslauGyorPecsLutskClujROMANIATimisoara PitestiBucharestCraiovaBULGARIASofiaBurgasKievVarnaOdessaDnepropetrovskBursaKharkovUKRAINEFrunzeZaporozhyeVoronezhAnkaraTURKEYTaganrogVolgogradKrasnodarUkraine’s economic turnaround since 2002 has led to significant development in theautomotive sector. Russian AvtoVAZ continues to be the leading producer and hasthe largest market share. Total production grew significantly in 2005, to over 250,000units. The government has committed its support to develop the sector further, toaround 500,000 units by 2010, by attracting further investment and expanding existingplants. 1Import vs. Export500,000ImportExportSalesProduction500,0001Statistics Committee of Ukraine52T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Sales and Production ComparedUkraine’s automotive manufacturing industry does not meetlocal car demand. Hence, the country relies on imports to satisfyincreasingly demanding consumers.Sales and Production Compared300,000250,000200,000150,000100,00050,000SalesProductionat 120 per 1,000 people in 2005, the country has hight growthpotential in terms of car ownership rates.Sales and Production OverviewProduction by BrandPassenger car production reached 188,500 units in 2005, upfrom 147,600 the previous year. 3 AvtoZAZ, the country’s onlyindigenous car maker, which produces the Tavria and Slavutamodels, has increased production tenfold to 148,163 units since2001. It also assembles foreign models from different makessuch as AvtoVAZ (from Russia), GM, DaimlerChrysler, Cheryand Tata. Eurocar, located in the Uzhgorod district, westernUkraine, is licensed to assemble models from Skoda andVolkswagen.2001 2002 2003 2004 2005Production by BrandHaving been successful in addressing structural inflation,budget deficits and reducing public debt, Ukraine is nowposting convincing consumption results, supported by risingincome per capita. GDP per capita in Ukraine increased by8.2% between 1998 and 2003. However, its growth for the followingyears and forecast until 2008 is estimated at 6.3%. 2Ukraine, with approximately 47 million inhabitants, is theseventh-largest country in Europe. With a car fleet estimated2Datamonitor3EuromonitorLadaChevroletZAZDaewooSkoda200120050 40,000 80,00053

C OUNTRY PROFILES — UKRAINEIn order to become more competitive and eventually exportoriented, local production requires more presence from foreignsuppliers in the country.Sales by BrandPassenger car sales increased 260%, from 70,000 units in 2001to 250,000 in 2005. Imports of new cars rose to 100,600 unitsin 2005, although import duties increased from 20% to 25% inJune 2005. In compliance with WTO entry outlook, the importban on used cars over five years (equipped with at least a Euro3 emission standard engine) was abolished. Boosted by increasinglyaffordable car credit, passenger car sales could reach350,000 units in 2006, well over most forecasts.Sales by BrandOutlookRisksVolatile macro-economic conditions• The country’s current account balance is increasingly negative,which may make it difficult to keep inflation at a levelthat would support stable, long-term economic growth.• Ukraine is highly dependent on energy imports from Russia.• Ukraine’s high current account deficit may lead to furthertightening of public finances.General lack of stabilityThe country’s frequently changing political and economic climateputs efficient use of available incentives at stake.LadaGM-DATZAZSkodaMitsubishi200120050 35,000 70,00054T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Opportunities and RewardsGovernment reforms open new industry and marketperspectives• In August 2006, the Ukrainian government released TheConcept for Developing the Ukrainian Automobile Industryand Regulating the Automotive Market Until 2015, which isaimed at promoting further foreign investment into the countryand supporting local manufacturers.• Based on the government concept, passenger car productionshould reach 500,000 units by 2010.• A new incentive, which will be effective soon, should allowcompanies reaching local component supplier levels of over50% to import the remaining components tax free.• The recent implementation of a special economic zonenear Uzhgorod will ease the entry of further componentmanufacturers.55

C OMPARING THE CEE COUNTRIESComparing theCEE CountriesAutomotive Diversity in theCEE AreaThe CEE area is not a homogeneousblock, but a rather diversified economy.With the exception of Turkey, thecountries analyzed in this report have acommon historical background as satellitecountries of the former Soviet Union.Since the opening of the CEE economiesin the early 1990s, the paths thesecountries have taken to modernize theireconomies have varied significantly. Thecountries differ widely:• Geographic breadth – CEE spans fromthe German border to the Iranian frontier,and from the Mediterranean to theArctic Circle.• GDP per capita development variesby a factor of nearly 10 between thelowest and the highest.• Population sizes vary by a factor ofover 70.• Recent automotive inward investmentranges from the highest in Europe toalmost none.• There are diverse attitudes towardforeign investment from incentivefriendly to protectionist.• The countries’ relationship with theEuropean Union varies from full membershipto simply trading.• The importance of the sector to thecountry’s economy differs widelyfrom exporting over 75% of productionto complete import.• Car ownership levels vary by a factorof five between the least and the mostdeveloped.Additionally, the tradition of the automotiveindustry varies from longstandingindigenous brands to no tradition at all.56T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Diverse Histories of VehicleManufacturingCentral and Eastern European automotiveproduction is not just based onrecent investments by overseas VMs.Notable automotive traditions exist in theform of:• Skoda, designing and making cars forover 100 years in the Czech Republic• Dacia, producing Renaults underlicence since the 1950s• AvtoVAZ, producing Ladas (initially aFiat model) in large numbers since the1960s• Turkey, with a strong engineering traditionand a car production history ofover 50 years.So, prior to the more recent inflow offoreign VMs, some Eastern Europeancountries had their own complete carcompanies, brands, manufacturing operationsand R&D centres. The challengesfor governments and companies copingwith this heritage can be considerable,in facing international competitivenessand rapidly developing consumerexpectations.Figure 10: Former Automotive Brands Produced in Central and Eastern EuropeCzechRepublicHungary Poland Romania Russia Slovakia Slovenia Turkey UkraineCars Skoda FSO DaciaBusesTrucksKarosaAviaTatraIkarusRàbaIberiaSource: Ernst & Young. Please note: this list is not exhaustiveAvtoVAZGAZIzhmashUAZGAZRuspromAvtoAMO ZILKamAZRuspromAvtoBAZ Revos DuratTAZTMVTMVTemsaAvtoZAZLuAZBAZCherkazkyAvtobusLAZAvtokrAZLuAZ57

C OMPARING THE CEE COUNTRIESSome of the domestic VMs of EasternEuropean countries, notably those thatdo not have strategic partnerships withinternational VMs, are still highly verticallyintegrated, producing many of theirown components at the plant, and usuallyhave a much higher labour content perunit produced. In addition, some VMsmay still own non-core activities such askindergartens, schools or medical centresas relics from the pre-1990s era. Othersmay be forced to invest in or rent housingto accommodate new staff who comefrom too far away to allow for dailycommuting.In such a context, the task for governmentscan be challenging. On one hand,they face the need to provide incentivesdesigned to attract foreign VMs as ameans of improving the product andproduction. On the other hand, the incentivesmust protect the domestic industryto allow a transition period during whichlocal VMs and suppliers may adapt to thenew market needs. It remains to be seenwhether the CEE region will developindigenous, stand-alone brands able tocompete locally and in global markets, orwhether local companies will only surviveunder the ownership of VMs fromoutside the region.CEE Countries – DifferentPositions in the AutomotiveLandscapeA closer look at the countries investigatedin this report reveals that CEEcountries can be classified in one offour distinct positions in the globalautomotive landscape. While somecountries have deployed an industrialstrategy leading to a strong presence ofthe automotive industry in the domesticeconomy, others are currently positioningthemselves in the sector.Each of the clusters raises its own set ofissues.Global Player – While the region willbecome a net exporter of vehicles, willthe largest market, Russia, buck the forecastand avoid being a net importer?Major Production Centres – Howwill the local labour markets cope withthe demand for the wide range of skillsneeded to run the plants? Will this pushlabour costs up, thus negating one of thekey reasons for producing in the region?Strong Market, Significant NetExporters – Will these countries balancelocal demand with export potential?Smaller Players – Do some of thesemarkets have growth potential, and areany still open to a pioneer advantage fora VM willing to invest in production?58T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Figure 11: Cluster TypesCluster TypeCountryNumber ofpassengercar plantsGlobal Player Russia 15*Major ProductionCentresStrong Market,Significant NetExportersSmaller PlayersDescriptionRussia is the only CEE country with a market large enough to appear in the top 10 globally, and hasproduction capacity of over 1.5 million units. With its strong automotive background—not only in thepassenger car but also in the bus and truck segments—the country has a real potential to be a globalplayer.Czech Republic 4 These countries’ production is approaching 1 million units, and their exports account for approximatelySlovakia 3 80% of total production.PolandTurkey48** Including announced production plants to be launched by 2007Source: Ernst & Young.These countries have domestic market potential of over 500,000 units and strong local productioncapabilities. They also export significant proportions of their output.Bulgaria None These countries have local markets and/or local production at levels below 250,000 units. Some ofHungary 2 these countries are small and will always have a minor role in the industry, either for production orRomania 2 sales. It is not yet clear how some other countries will position themselves in the industry—as strongSlovenia 1 exporters, strong importers or simply suppliers of local demand. The strategy of these markets is to beUkraine 3 supported by additional local government measures.59

C OMPARING THE CEE COUNTRIESFigure 12: Passenger Car Production vs. Sales Compared2011 data2,000,000Global PlayerRu1,800,000 1,800,0001,600,0001,600,0001,400,000Global Player- Russia1,400,0001,200,0001,200,000 1,000,000sales 800,0001,000,000Sales800,000600,000400,000600,000200,000400,0000Smaller playersStrong market,significantnet exporterTNet ImportersNet exportersStrong market, significant netexporter – Turkey, PolandRussiaMajor production centres –Czech R, SlovakiaSlovakia-200,000 0 200,000 400,000 600,000 800,000 1,000,000 1,200,000 1,400,000Smaller players-200,000H200,0000,000RoMajorproduction productioncentres CZBSn0Bulgaria 0 Hungary 200,000 Romania 400,000 Slovakia Turkey 600,000 Czech 800,000 Republic 0 000 Poland 1,000,000 Russia 1,200,000 Slovenia 1,400,000 Ukraine* LCV production—which has a major impact on certain markets, such as Turkey—not included.Source: Ernst & Young (Based on 2011 forecast from Global Insight)UPSkProductionNet ImportersNet ExportersBCZHPRoRuSkSnTUBulgariaCzech RepublicHungaryPolandRomaniaSloveniaTurkeyUkraine60T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Main Risks and RewardsAcross the RegionIn addition to presenting widely differentopportunities, each of the CEE countriesprovides variable business environmentswith a different emphasis on the keyrisks to be considered.Figure 13 shows a summary ofmain risks and rewards identified byErnst & Young’s local automotive colleaguesas current issues of attentionamong our clients and the businesscommunity.Labour Force (Cost, Cost Trend,Labour Laws, Labour Supply)Among the criteria most influencing VMsand suppliers to select a specific countryto invest in, labour issues commonly havethe largest impact. Labour availabilityis not simply measurable throughunemployment rates or the average ageof the available workforce. Both areimportant indicators but don’t sufficientlyreflect the maturity of a market towelcome manufacturing industries.• Skilled-labour shortages in automotiveclusters are presenting a significantchallenge in many emerging markets.Skilled-labour shortages put significantpressure on wages.• Competition in the market for skilledlabour is a threat competitors recruitingskilled staff add substantial extracosts.• Published wage comparisons are oftennot meaningful, and are often missingkey information, such as the widerange of costs per qualification leveland the large spread of costs betweenvarious regions.At first glance, many of the CEE countriesoffer significant wage-cost advantagesover Western European countries.However, to be useful, any analysis hasto consider the cost for a given qualificationlevel and skillset, regional costs, andthe availability of the required staff.Market GrowthVMs choosing to invest in a countrymay have to make decisions about a factorythat will not produce for perhapstwo years, and which they expect to beworking at reasonable levels of capacityutilization for many years to come.Yet within that time horizon, the marketdemand, at the overall and product level,is likely to be volatile, due to a numberof factors:• Erratic economic growth in thecountry.• Sales growth depending on complexfactors, including the growth of anaffluent middle class, and the triggeringof sales in specific cities.• Actions by competitors, in bringingproducts to market, establishing theirown plants, or adding products toexisting plants.61

C OMPARING THE CEE COUNTRIESFigure 13: Risk and Reward Overview by Country Compared*Risk Country RewardBusiness practices lack transparencyUnderdeveloped infrastructureLabour shortages: increasing wagesReaching production and sales capacity limitsLabour shortages, increasing wagesHeavy bureaucracySlowly progressing infrastructureUnemployment: talent leaves to Western EuropeIncreasing labour costs due to surchargesHeavy bureaucracyHeavy bureaucracyFast-growing production costsImplemented incentives are difficult to obtainLabour availabilityTax inconsistenciesHigh labour costsVolatile marketGeographical location – exportsDependency on RussiaVolatile market* Please note: this list is not exhaustive.Source: Ernst & YoungBulgariaCzech RepublicHungaryPolandRomaniaRussiaSlovakiaSloveniaTurkeyUkraineAttractive labour costsProduction base to supply componentsInvestment climate: stability and predictabilityLarge supplier baseAdvantageous export position to Romania and BulgariaWell-developed investment climateLarge local marketSpecial Economic Zones offer attractive incentivesLarge local marketAdvantageous geographical location as EU expands eastwardOutstanding growth potential: large marketTangible demand for quality and reliable carsProactive government is implementing attractive investment conditionsStrong industrial focus on automotive manufacturing issuesExcellent infrastructureAdvantageous geographic locationOutstanding growth potential – large marketWell-established automotive industrySuccessful reformsGrowth potential: significant market62T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

• Legislation: for example some EUaccessionstates have had to open theirborders to freer importation of usedcars, which has caused volatility in thenew-car market.As a result, sales development in theregion is rarely linear and stable. Quitethe opposite, it has proved difficult toforecast future sales with reasonablelevels of accuracy.Analysis and Outlook: KeyIssues for ConsiderationFrom our research and analysis, thereare a number of significant emergingthemes companies investing or furtherdeveloping their business in CEE shouldconsider.The Czech-Slovak Production HubThe new automotive hub centred inthe Czech Republic and Slovakia willbecome a major production centre forthe industry, with an output of close to 2million units—an almost unique concentrationfor the industry across the wholeof Europe. These will be mainly newplants, deploying the best practices withthe most modern equipment, and can beexpected to be among the most productivein Europe.Production in the region will be a mixtureof vehicles largely engineeredlocally, such as Skoda, and those largelyengineered elsewhere, such as PSA, Kiaand Hyundai.In addition, the region has drawn in awide range of new suppliers in additionto those already present. This trend isexpected to continue as new assemblyplants, announced but not yet built, willattract more suppliers to the region forreasons of proximity.The concerns for the region centre primarilyaround labour availability, thepossible cost pressures caused by shortagesof appropriately skilled people, andthe ability of infrastructure to keep pacewith the industry as it grows rapidly.Pioneering a Market Helps EstablishSignificant Market ShareTo be the first, or among the first, tolaunch vehicle production in a new countryhas a direct and long-term impact onconsumer awareness and market position,not only for the selected modelto be manufactured but for the entirebrand. Hence, localizing production in aspecific country has been proven to be amost effective marketing tool itself. Thisphenomenon, which can be called thepioneer effect, is particularly valid for anumber of Eastern European countries,such as Suzuki in Hungary and Ford inRussia.The pioneer effect results from the perceptionof consumers that the first manufacturersto move into a country faceand sucessfully resolve many challengesrelated to producing in a new region.Very few VMs take real advantage ofthis situation by linking production andsales strategies more closely in developingeconomies.63

C OMPARING THE CEE COUNTRIESHowever, as the CEE markets develop,there are fewer and fewer opportunitiesfor VMs to take advantage of the pioneereffect in the local market.The Supplier’s Key Questions –Whether, When and How to MoveEast?Many suppliers decide to invest in aspecific region following the announcementof a customer VM that it is going tolocalize production in a new country. Insome cases, the suppliers wait until theVM has reached convincing productionfigures before they make their move.For suppliers producing modules andcomplex units, the investments in largescaleproduction are significant; hencethe delay in following a VM is easilyunderstood. Others use supply to the newplant to absorb excess capacity in existingfacilities.However, many Tier 1 and 2 supplierscan be more flexible and act more rapidlythan VMs, and move into the regionfirst. Establishing plants in new locationscan lead to attractive businesses in theregion, and result in relationships withnew VMs. In some cases, this can createa stonger negotiation base at the headquartersand lead to supply from the CEEsupplier plant into Western Europeanvehicle assembly plants.Many suppliers fail to take advantage ofthese opportunities. A key issue is findingthe best, most risk-friendly solutionwhen entering a new region. Supplierscan move into a region in a number ofways (see figure 14).Many suppliers from the CEE region(notably those in the new EU memberstates and Turkey) that were once independenthave now formed joint ventureswith or been acquired by existing Tier1 suppliers, restricting the opportunitiesfor further suppliers to pursue this route.New suppliers, therefore, have to establishgreenfield operations, which can bewith higher risk.CEE Government Policies on Excise,Import Duties and EU AccessionThe recent accession to the EU by thenew member states had an importantimpact on those markets in a number ofways:• Excise duties in place before accessionwere eliminated. This had a strongimpact on used car imports in Polandand other markets, with a consequenteffect on new car sales and on thesupply side.• Harmonized customs procedures easeshipping of components and products.• Incentive schemes available in Europeare harmonized, limiting the newmember states’ flexibility to offerextraordinary incentive packages toinvestors.With Bulgaria and Romania scheduledto join the EU in January 2007, many ofthese factors will affect those countriestoo. In addition, Turkey has associate64T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Figure 14: Selected Supplier Entry Options – OverviewStrategy Pros Cons BalanceGreenfieldJoint VentureMergers and AcquisitionsSales NetworkSource: Ernst & Young- Control- New plant, with new equipment andbest practices- Financial risk sharing- Local partner handles administrative/licence issues- Market knowledge/penetration- Time saved- Local M&A market may presentattractive opportunities, particularly ifhighly vertically integrated VMs haveprevailed since the early 1990s- Control- Increased profit margin- Initial investment could be quite low- Time required for licences/utilities- Need to handle government relations/administrative issues- Financial and operational risks- Corporate governance risk- Technology and brand transfer issues- Control may be lacking- Difficult to agree on production costoverheads- Difficult to negotiate transfer of control- “Skeletons in the closet”- Post-integration difficulties unless localtarget was built and operates accordingto Western standards- Corporate governance and counterpartyrisk- Substantial knowledge of the localmarket required- Customs duties may be regularlychanging- Demand may be hard to predict- Major entry strategy for VMs- Control is a difficult issue- Expectation on return on equity likely tovary strongly between parties- In some regions, increasingly used entrystrategy since 2002-2003- A lot of due diligence needed, nothingshould be taken for granted- Detailed market study should beimplemented to determine locationsand demand for the product65

C OMPARING THE CEE COUNTRIESstatus with the EU, with the benefit of freetrade. In the interests of EU accession,Turkey is also harmonizing its incentiveofferings to align with those of the EU.Moving East – The Decision is Drivenby Company StrategyWhile virtually all VMs have a salespresence in all the CEE markets, byno means have all VMs or suppliersmoved, or plan to move production intothe region. In general, CEE capacity hasbeen installed for value and mass brands,rather than premium product manufacture.Each VM and supplier has adoptedand will continue to develop its ownstrategy, based on:• The company’s need to increase capacityin Europe• The role a CEE plant could have in thecompany’s global supply network• The company’s need to take advantageof the lower costs offered by producingin CEE countries• The market opportunity created bymanufacturing in key CEE markets.Rather than developing their productionbase in CEE countries, some VMs preferto invest in capacity in other growth markets,such as China and India.Figure 15: Market Evolution Forecast of Selected Countries 2006-2008GDP/Capita (US$)30,00025,00020,00015,00010,0005,0000ChinaIndiaTurkeyBrazilSource: Global Insight, Ernst & YoungUkraineRomaniaSlovakiaRussiaGDP per Capita – A Tipping Point forthe Market?The automotive market develops in agiven country in line with a numberof factors, one of the principle onesbeing GDP per capita. As GDP grows,HungaryPolandBulgariaSloveniaCzech Republic0 100 200 300 400 500 600Passenger Cars/1,000 People66T HE CENTRAL AND EASTERN EUROPEAN AUTOMOTIVE MARKET

Figure 16: Potential Market Size for New Car Sales of Most Rapidly Evolving EconomiesProspective Developments:Underestimated Market Outlook?Forecasts show that each national marketin the CEE region will develop along adifferent path, with only broad correlationbetween GDP per capita and cars per1,000 people.4,000,0003,500,0003,000,0002,500,0002,000,0001,500,0001,000,000500,000Source: Global Insight, Ernst & Young0TU Pan emerging proportion of the populationhas sufficient disposable income toafford a car. It is a fairly simple measure,but a closer look at the evolutionof car consumption and GDP per capitagrowth in specific countries shows theimportance of the latter as an indicator ofmarket development. Other factors comeinto play as well, including disposableRactual marketRPTUpotential marketPolandRussiaTurkeyUkraineincome levels, demographics, urbanization,and the size of the emerging middleclass, availability of credit, and the country’spolicy on imports of used cars.PRTUGiven the difficulty in forecasting likelyfuture sales in the region—and the factthat most forecasts look no further thanfive years ahead—we have taken a viewon the longer-term market potential forthe CEE countries. This view is useful,as investments by VMs tends to be forthe long term. Based on some realisticassumptions about future car densityrates, and projected economic development,we could see future positions asshown in Figure 16.This would mean that Russia, with itsdomestic population far larger than anyWestern European country, could at leastmatch Germany as the largest market forpassenger cars in Europe. Poland wouldtake its place among the larger markets,roughly equivalent to Italy or Spain fornew car sales. If these predictions proveaccurate, we will truly be able to say thatthe centre of gravity of the industry inEurope has moved east.67

The Ernst & Young ApproachWhich market should we most seriouslyconsider?Ernst & Young Approach :• Feasibility study• International Location Advisory ServicesIn which region should we open an officeand production facilities?How do we choose location and proceedwith the construction?Ernst & Young Approach :• International Location Advisory Services• Real Estate appraisal and feasibility studies• Partner search• Development of a business plan• Business and real estate valuation• Analysis of business environment in specificregionsHow can we best take advantage of thelocal tax system?Ernst & Young Approach :• Tax-optimized planning for selecting thelegal form of the business• Tax-efficient planning for shareholder contributions,financing and transfer pricing ofthe new business• Tax, customs and VAT review planningWhat are the current incentives favourableto foreign investments in the CEE area?Ernst & Young Approach :• Tax incentive planning• Incentive application support• Strategic analysis of key competitive advantagesand weaknessesIs the company we would like to acquire orpartner with the right choice for us?Do they have the right permits and licencesfor our business?Ernst & Young Approach :• Background check• Financial and commercial due diligence• IFRS and/or U.S. GAAP audit• Partner fit criteria• Partner screening and selectionHow do we value our investment?Ernst & Young Approach :• Business strategic valuation and real estatevaluation• Financial modelling• Scenario analysisHow do we start up the business?Ernst & Young Approach :• Assistance in applying for relevantpermissions• Assistance getting connected to localauthorities• Outsource back-office infrastructureHow can we get a “head start” in integratingcompanies, people, processes andtechnologies?Ernst & Young Approach :• Roll-out to local market• Human Capital• Business process alignment• System localization to the key competenceareas• IT due diligence• Advisory on corporate information systemHow can we be confident in theconstruction of our facility?Ernst & Young Approach :• Real Estate Project Management (pre-constructionand construction)• Project monitoringOnce established in a new environment,how can we best assess and monitor operationsand other risks?Ernst & Young Approach :• Enterprise Risk Management services

Global Automotive CenterMichael S. HanleyGlobal Automotive LeaderDetroit, Michigan, U.S.Tel. +1 248 457 3914michael.hanley02@ey.comGermanyPeter FußAutomotive LeaderCentral and Eastern EuropeFrankfurtTel. +49 6196 996 27412peter.fuss@de.ey.comBulgariaDiana NikolaevaSofiaTel. +359 2 81 77 100diana.nikolaeva@bg.ey.comCzech RepublicPetr KnapPragueTel. +420 225 335 582petr.knap@cz.ey.comHungaryIstvan HavasBudapestTel. +36 1 451 8701istvan.havas@hu.ey.comPolandLeszek LerchKatowiceTel. +48 32 760 77 42leszek.lerch@pl.ey.comRomaniaAnca IonescuBucharestTel. +40 21 410 70 52anca.ionescu@ro.ey.comRussiaIvan BonchevMoscowTel. +7 495 755 9700ivan.bonchev@ru.ey.comSlovakiaPeter ChrenkoBratislavaTel. +421 2 59229 600peter.chrenko@sk.ey.comSloveniaStephen FishLjubljanaTel. +386 1 568 0422stephen.fish@si.ey.comTurkeyMustafa CamlicaIstanbulTel. +90 212 368 5233mustafa.camlica@tr.ey.comUkraineOleg SvetleuschyiKyivTel. + 380 (44) 490 3000oleg.svetleuschyi@ua.ey.com

E RNST & YOUNGey.com© 2006 E RNST & YOUNGAll Rights Reserved15995