REUTERS - If Volkswagen is to achieve its goal of becoming the world's biggest automaker, it needs to conquer the only market where the German group trails major competitors: low-cost cars.
Europe's biggest carmaker plans to launch a budget brand in China with one of its local partners by about 2015, aiming to draw on more than 2,000 dealers and a market share of over 20 percent to take on similar no-frills ventures established by General Motors (GM.N), Nissan (7201.T) and Honda (7267.T).
The brand, likely to be a major talking point at the Shanghai auto show, may include a van, estate and small sedan priced about 6,000-7,000 euros, company sources have said. If successful, it could be replicated elsewhere.
But expanding into budget cars is not without its risks for a group which makes more than half its 11.5 billion euros operating profit from luxury marques like Audi and Porsche. And competitors are not standing still.
"It's difficult for any carmaker to unlearn many decades of engineering," said Deepesh Rathore, managing director of research firm IHS Automotive in India, referring to VW's traditional focus on technologically advanced vehicles.
In the face of plunging European car sales, VW has continued to prosper thanks to strong demand for its upmarket models in emerging markets, and it is determined to snatch the global sales crown from Toyota (7203.T) in the next five years.
But a group which makes everything from motorcycles and supercars to 40-ton trucks increasingly feels that to do this - and then stay ahead - it will have to address the boom in demand for no-frills cars, particularly in developing economies.
"We're having talks about this on a rolling basis," said Bernd Osterloh, deputy head of VW's supervisory board and the group's top labour representative. "We have to tap new markets like Southeast Asia or Africa more vigorously than before."
The opportunity looks huge. Global sales of cars priced up to $11,000 are forecast to surge 39 percent to 33.1 million cars by 2020, accounting for about a third of the world market, from 23.9 million last year, according to IHS Automotive.
At the same time, the two largest markets for budget vehicles, China and India, are expected to see sales in the segment increase 44 percent and over 100 percent to 7.02 million and 5.03 million respectively, IHS data show.
THE LOW-COST CAR IMPERATIVE
VW has long neglected budget cars, fearing that making money on stripped-down vehicles jars with its global pursuit of quality and profitability, a senior VW manager said on condition of anonymity because the matter is confidential.
It seems the German group is now prepared to put these concerns to one side in a bid to build a stronger presence in some of the fastest growing car markets.
In India, for example, where cars smaller than four metres account for three-quarters of sales, VW is trailing Toyota, Ford (F.N) and General Motors (GM), which in recent years have earned a foothold in the market by rolling out country-specific low-cost models.
VW's only model in those segments, the Polo, starts at around $9,100. Maruti Suzuki's (MRTI.NS) entry-level model, and India's biggest-selling car, the Alto, costs half that price, while Hyundai's (005380.KS) small-car range starts at around $5,200.
Starting in China seems logical for VW. Not only is it the world's biggest car market, but the German group has over three decades of experience there and is growing sales strongly.
To comply with local rules on manufacturing, VW's budget brand is expected to be a co-venture with one of its local partners - SAIC (600104.SS) or FAW Group.
And to keep costs low, VW would use pre-existing mechanics from models that have gone out of production or are nearing the end of production, rather than develop new costly underpinnings for the new brand from scratch, VW brand development chief Ulrich Hackenberg told Reuters.
CHEAPER AND CHEAPER
However, the German group will have a fight on its hands from the likes of GM, which has already launched its low-cost Boajun brand in tandem with SAIC and Wuling (0305.HK), and Nissan, which has the Venucia brand with partner Dongfeng.
And even if VW cracks the low-cost market in China, it is unclear how easy it will be able to apply its learnings in other markets, where it may have a weaker presence.
Meanwhile - and largely in response to Europe's plunging car market - rivals like Renault (RENA.PA) and GM's Chevrolet, as well as Hyundai and affiliate Kia, have been improving their budget offerings for years, closing the gap with mainstream brands in everything from design to fuel efficiency.
Renault's so-called Entry models, initially a flop in target markets like India, were an accidental hit back home and have become the French automaker's biggest earner, with profit margins above 6 percent. Italian rival Fiat (FIA.MI) is also mulling a low-cost brand to penetrate India.
Renault and affiliate Nissan are also devising an even cheaper crop of budget cars for India and other emerging markets, including a vehicle platform that Nissan's revived Datsun brand would also use.
The decline of Tata Motors' (TAMO.NS) $3,000 Nano, however, shows that the race to the bottom isn't without risks. With its breadth of technology, VW may well stay out of the ultra-cheap market.
"If they (Renault-Nissan) have as much success as Tata with the Nano...," VW's Osterloh chuckled. (Editing by Mark Potter)