VW takes action to stem sales slide; aging product line blamed By RALPH KISIEL | Automotive News (08:30 March 24, 2004) DETROIT -- Volkswagen's U.S. strategy of maintaining high residual values while avoiding generous incentives is coming unglued. The German automaker this month sharply increased incentives to $2,000 per vehicle after suffering a disastrous 25.9 percent U.S. sales decline in January. VW had sharply reduced incentives that month to what Edmunds.com estimates was $420 per vehicle - down from about $1,100 in 2003 - to stem sliding profits. But the automaker reversed course after dealers demanded action last month and Volkswagen of America Inc. President Gerd Klauss lobbied corporate parent Volkswagen AG for help. "The programs in January and February were absolutely 100 percent uncompetitive," says Al Gossett of Gossett Motor Cars, a multibrand dealer in Memphis, Tenn. "We had nothing to talk about with customers. We didn't have anything to advertise." VW on March 2 began offering: >>> Lower lease payments on Jettas and Passats >>> 0.9 percent financing for a broader range of models >>> 1.9 percent financing for certified used cars >>> $500 loyalty coupons to current owners and lessees >>> Cash bonuses for dealers who meet sales goals. The program runs through April. Volkswagen of America is pouring on the incentives even as Volkswagen AG struggles to cut $2.5 billion in costs. The automaker is reducing capital spending and will eliminate 5,000 jobs by 2005. The company announced the cost-cutting plan after disclosing that its first-quarter earnings would be miserable. Even with the new incentives, dealers and company executives concede that 2004 will be a tough year. Volkswagen of America hopes to sell 300,000 units, down from 302,686 last year and 355,648 in 2001. The problem is product. High-volume products such as the Jetta, Golf and Passat are almost 7 years old. VW won't introduce redesigned versions until 2005. So Volkswagen of America has launched its most costly incentives package since it began rebuilding its brand image a decade ago. VW's U.S. sales began to drop in mid-2002 after reaching a 28-year high in 2001. But this year's plunge horrified dealers, and they demanded action at last month's National Automobile Dealers Association convention in Las Vegas. The automaker responded. Leases account for about 40 percent of VW dealer sales, and VW has sweetened lease deals to promote the Jetta and Passat. Consumers can obtain a 39-month lease for a Passat GL for $219 a month. A Jetta GL is available for $179 a month. Dealers say the new incentives already are helping sales. "This past weekend we had our best weekend probably in the last six months," says Eddie Lee of Lewisville Volkswagen, north of Dallas. "I can't imagine a dealer not being satisfied with what they put out there right now." Lee likes the lower finance rate for certified used cars. "VW gave us nearly new-car rates on pre-owned cars, which makes a huge difference," he says. "Our used-car business has increased dramatically over last year." Lee added that he is examining his operation with an eye to cutting costs, and is counting on other profit centers such as parts and service to weather the sales slump. "That's how we're surviving," Lee said. But dealers didn't get everything they wanted. VW refused to accelerate the U.S. introductions of the redesigned Jetta and Passat, scheduled for 2005. VW plans to launch the Passat in Germany this year. Some dealers accept VW's decision. Gene Langan, chairman of the VW national dealer council, says the slower launch will ensure vehicle quality. "I think it's paramount that we launch these new products right," Langan says. "I would rather us do it right than bring them ahead three or four months and not be ready. Let's make sure we're ready - the quality's there, we have an adequate parts supply and we have a good mix of cars at launch." Dealers say sales appear to be stabilizing. But VW's new incentives carry risks. Previously, the automaker had avoided the unrestrained price wars triggered by the Big 3. Last year VW's incentives averaged $1,103 per vehicle, according to Edmunds.com, a consumer information service in Santa Monica, Calif. That was lower than the average of $1,648 for European automakers and substantially lower than the industry average of $2,426 per vehicle. By sacrificing some sales, VW maintained some of the industry's highest residual values. Among high-volume brands, VW's residual values are second only to Honda and Toyota. Residual values are calculated by subtracting the estimated resale value of a vehicle at the end of its lease from its original list price. Automakers and banks use this calculation when they set lease rates for new vehicles. Residual values are affected immediately when an automaker offers big cash rebates, says Jeremy Anwyl, Edmunds.com president. While VW has not resorted to big cash rebates, the company is starting to compete on price. Says Anwyl: "If you throw a thousand dollars on a car you will see an impact on residual values - particularly on 2-, 3- and 4-year-old vehicles - almost immediately." VW's troubles are beginning to soften the market value of its dealerships. Overall, blue-sky values for VW stores are declining at a time when other franchises are enjoying increases. Blue sky is the price of a dealership beyond the value of physical assets. Typically it is the value of intangible assets such as location, franchise strength, reputation, customer base and profit potential. Sheldon Sandler, founder of Bel Air Partners, an investment firm servicing dealerships in Princeton, N.J., says blue-sky values of VW dealerships have slipped to three times pre-tax earnings, down from four times earnings before sales started to slide. Even if sales recover, a VW dealership is not likely to command the blue-sky valuations of a Toyota, Honda, or BMW franchise, Sandler says. "But I'd still like to be a Volkswagen dealer," he adds. "They still make money."