Shifting Focus: Emerging Trends in Eastern European Vehicle Manufacturing
Key Takeaways:
Geopolitical shocks have caused energy prices to spike, leading manufacturers to question Germany’s efficacy as a host for their operations.
The German regulatory environment exacerbates the effects of geopolitical shock, reducing the opportunity for development in competitive EV technology.
The Central and Eastern Europe (CEE) region has a unique opportunity to recalibrate its position in Germany’s productive model and emerge as a highly valuable manufacturer and innovator.
Car manufacturers in Czechia should leverage their existing software development talent pool and integrate it into the automotive manufacturing value chain.
There is significant market entry opportunity in Slovakia through R&D and innovative tech, as well as a talented engineering and IT labour market.
The Hungarian market is optimised for larger investments in EV development in specialised areas like battery production.
In spite of the rising cost of living and a looming recession, the European Union is pursuing an aggressive policy of carbon reduction through mass vehicle electrification and reduction of fossil fuel consumption across the continent. The core of this policy requires shifting from conventional Internal Combustion Engines (ICEs) to Electric Vehicles (EVs) to decarbonise the automobile industry. This transition, however, raises numerous operational and logistical concerns for the major European car manufacturers. The automation of EV manufacturing poses significant risks for job security on the continent, whilst competition from US and Asian EV manufacturers threatens Germany’s reputation for premium car production. With the prospective EU 'Fit for 55' package aiming to ban the production of ICE vehicles beyond 2035, German manufacturers have been forced to reorient their entire supply chain and operational structure towards EVs to ensure their future in the car industry. This report explores the potential impact of this transition, with particular focus on Eastern European manufacturing and trends in the German automobile industry.
The German Manufacturing Model
For decades, the German car industry has enjoyed global recognition, employing millions whilst promoting German political and economic influence in the EU. In the early 2000s, the German car industry began collaborating with manufacturers in Central and Eastern Europe (CEE), benefitting from looser market regulations, cheaper labour, and more affordable access to materials. In 2004, Opel became one of the first German automakers to open a production plant in the CEE region. Although Opel's headquarters in Germany had the capacity to meet production demand, it shifted a sizeable portion of its Zafira model production to Poland to optimise operational cost-efficiency. By designating labour-intensive tasks like parts production and vehicle component assembly to facilities in the CEE region, German manufacturing plants could focus on the complex, skill-dependent operations required for development and innovation.
This separated strategy became known as the 'German Productive Model'. The model was mirrored by auto parts suppliers like Bosch, who have relocated over 800 roles to Czechia. Despite the CEE region boasting historic car manufacturers like Raba in Hungary, the dominance of German capital in the market compelled many of these companies to restructure their operations as low-cost parts suppliers, while others like Skoda were absorbed by more competitive Western companies like the Volkswagen Group. The revenue accrued from producing cutting-edge premium vehicles at a lower cost allowed German manufacturers to offset the domestic impact of initial workforce relocation. The model has helped Germany maintain its position as a leader in the European automotive market and has contributed to the global "Made in Germany" reputation which denotes quality and productivity.
Current Trends in the German Market
Germany built the foundations of its production-based economy on the back of cheap and secure access to raw materials and energy. Germany’s controversial policy to phase out its nuclear power plants throughout the 2000s resulted in agreements with foreign gas suppliers, such as Russia’s Gazprom, to meet energy demand. Materials like Palladium for catalytic converters and Nickel for spark plugs, for instance, are imported from Ukraine and Russia. By reducing their energy and materials independence, Germany has been overwhelmed by supply issues resulting from Russia’s invasion of Ukraine and the sabotage of the Nord Stream pipeline. This has caused energy prices and subsequent production costs to soar, contributing to deindustrialisation in Germany. The prospect of stringent EURO 7 engine requirements and a shifting global economy have dampened current investment opportunities. This was manifest in an exodus of German small and medium-sized parts suppliers in 2023, with 22% expressing a desire to invest abroad, and 53% postponing or cancelling investments.
The infamous VW emissions scandal and the supply chain impacts of the COVID-19 pandemic were pivotal moments which highlighted flaws in the German automotive industry. As a result, the German government reconsidered its relaxed treatment of the industry, which was typically lenient on regulation and oversight in favour of profit and tradition. The introduction of stringent EV regulations also poses challenges, making German companies less competitive than major EV players like Tesla in the United States. The US recently introduced the Inflation Reduction Act, which stimulates green technology investments through subsidies, grants, loans, and tax credits. Instead, German companies like VW, BMW, and Mercedes have been forced to reorient €220 billion of their own R&D budgets over the next 3 years towards the production of EVs. Germany’s lack of incentives and infrastructure strategy is at odds with its goal of having 15 million EVs on the road by 2030. Germany has also been slow to digitalise its economy, a result of its stubborn reluctance to collaborate with external tech innovators like Nvidia and Qualcomm, who are of growing importance in the car computer industry. Microchip shortages, decreasing access to skilled labour and increasing demand for reliable software in the production of EVs have forced German companies to recognise the importance of tech and automation in their production process.
Continued high prices for raw materials and energy in Europe are squeezing profit margins, impacting suppliers like Bosch, Continental, and ZF Friedrichshafen. The situation is compounded by a recessionary environment, with a 20% decrease in orders for both ICEs and EVs in June 2023. Further to these market conditions, EV sales are restrained by the effects of high battery costs, labour strikes, and limited government support. To achieve cost parity with ICE vehicles, maintaining financial incentives for EV sales is crucial. Benefits from digitisation and electrification mean Asian companies are outpacing Germany, which is still dealing with a backlog of orders due to component and semiconductor chip shortages in 2022. Chinese competitors like SAIC Motor and BYD are benefitting from much lower materials and production costs due to the resource and energy endowed market environment in China. A potential measure to overcome this burgeoning gap would be for German companies to refine the productive model, allowing their CEE counterparts to combine high and low value manufacturing processes, reducing costs and increasing productive output. By concentrating further investment in the CEE region, focused on education and training for the evolving EV labour market, German capital could help facilitate efficient and cost-effective EV manufacturing.
The pace of EV transition, however, is disrupting the conventional operations of the German automotive sector as providers of long-lasting and fuel-efficient ICEs. EV companies in the US and China are already challenging the dominance of German ICEs in the European market. This shift has driven German car brands, largely dependent on their premium pricing model, into a price war to maintain their position as industry leaders. A clear indication of this aggressive pricing strategy is VW’s electric ID3, which costs approximately €30,000 in Europe with the help of rebates and incentives. However, in China, the same vehicle is available for approximately €17,000. China is not just a competitor for production but also a significant market, accounting for approximately one-third German car exports. This market, which demands EVs at affordable consumer prices, is forcing Germany to rethink its entire status as a premium vehicle producer.
The recent announcement of EURO 7 engine requirements has caused yet further concern among German manufacturers over the pace and necessity of EV development. EURO 7, part of the EU’s European Green Deal, will feature low-emission ICE vehicles with no distinction between petrol and diesel engine emissions. This requirement has raised concerns about unrealistic implementation timelines, set for 2025 and 2027 for cars and trucks respectively, given the innovation required to meet the emissions standards. This contradictory policy messaging from the EU also puts strategic pressure on European manufacturers. With decreasing diesel sales, EURO 7 is seen as a backward step for German car manufacturers, many of which have already reoriented their operations to exclusively produce EVs in coming decades. As a result, it is anticipated that the German market may take two to four car generations to catch up with US and Asian EV manufacturers’ technological competency and development.
Challenges and Opportunities for CEE Countries
Czechia
Car production is the most important Czech industry, accounting for 35% of GDP. Car companies directly employ approximately 180,000 people (3% of the Czech workforce) and 1.5 million people indirectly within the broader car manufacturing sector. There are 4 assembly factories and 2 engine factories, with Skoda, Hyundai and Toyota conducting the majority of manufacturing.
Czech vehicle manufacturers, such as Skoda, are currently outcompeting regional manufacturers while operating at the limits of their productive capacity. Therefore, any potential decline in German demand would not have as catastrophic an effect on them as it would on lower-output manufacturers. The VW Group allows Skoda to exercise a notable degree of autonomy, which Skoda uses to balance its focus on both ICEs and EVs. Like most manufacturers, the war in Ukraine has disrupted the parts supply chain for popular Skoda models like the Fabia and Superb, as well as the supply of components for further ICE and EV models. Whilst these supply chain disruptions were unexpected and have contributed to significant economic strain, they have shed light on the vulnerabilities of dispersed operations, emphasising the importance of employing both short-term and long-term scenario planning for critical supply chains.
The EV transition presents an opportunity for Czechia to expand its horizontal production, particularly in intermediate goods like EV car frames. This approach would help address both employment concerns and EV production costs by making minor adjustments to existing ICE-oriented operations. To increase Czechia’s appeal as an investment location, vehicle manufacturers should look to collaborate with growing sectors, such as energy for EVs and IT for car computing, as well as engage with government to encourage opportunities and incentives for productive collaboration. Skoda aims to meet half of its European sales through EV production by 2030, which will require converting all three of its Czech plants into EV production centres before the end of the decade. Achieving this goal is highly dependent on partnerships with companies like the CEZ Group (a major Czech electricity distributor). Due to their reliance on external investment and limited autonomy, other Czech-based subsidiaries are restricted in their ability to collaborate and innovate, with their only option being to convince their international headquarters that they can handle the complexity of EV projects.
The Czech government has made some effort to invest in EV development with programs like ‘TRANSPORT 2020+’, which is allocating €20.2 million to support sustainable transport innovation with the aim of increasing the share of EVs in the domestic market. These incentives, whilst still relatively limited, provide market entry opportunities for smaller businesses in a variety of critical EV applications, like batteries and software, by allowing them to join the car manufacturing supply chain without the need for seed funding from within the car industry.
Slovakia
Slovakia is the leading global producer of vehicles per capita, producing more cars than Italy and the UK. It also employs approximately 177,000 people in the sector, with the main manufacturers being Volkswagen, Kia, PSA Peugeot Citroen and Jaguar Land Rover. It is Slovakia’s strongest sector in terms of GDP share and job creation.
Premium Swedish car producer Volvo has recently chosen Slovakia for its new cutting-edge production facility, capable of manufacturing 250,000 EVs per annum as part of a €1.2 billion investment. This initiative is part of Volvo’s strategy to consolidate its European market dominance but is also indicative of its confidence in the CEE region to help optimise its EV development. Slovakia has shifted its labour market from one of low productivity at the fall of the Soviet Union to a skilled, flexible, and highly productive workforce. Volkswagen's investments in Slovakia are primarily focused on traditional ICE vehicles. In early 2023, VW expanded its Bratislava factory to make up for supply chain disruptions for the Passat and Superb models, doubling down on Slovakia’s ICE vehicle output. Unlike Volvo, the generation of new ideas and innovative processes typically occurs at the parent companies' headquarters outside of Slovakia, meaning the development of EVs is heavily influenced by German brands. While Slovakia has a skilled domestic market that could potentially lower the cost of parts, its ability to independently initiate EV development is hindered by German multinational corporations retaining control of EV innovation.
Currently, all four major factories are still focused on passenger vehicle production, with only one producing engines. Slovakia would benefit significantly from further investment in companies capable of conducting R&D to diversify the country’s heavy production base. Some recent government incentives have made steps to assist the growth of EV component manufacturers in Slovakia. However, R&D for EV markets is largely spearheaded by Slovak universities. These universities work with research centres to create a labour market more oriented toward EV innovation and production. German car brands would benefit from following Volvo's example and engaging with the Slovak labour market which is eager to embrace EV transition. This could involve vocational programs and collaboration with the Slovak government, which has a history of offering incentives in return for access to its substantial supplier network. Slovakian companies could also appeal to VW to cooperate in R&D, particularly those operating in the development of EV batteries, a market that Slovakia is steadily breaking into.
Hungary
Hungary is host to 6 factories, all of which are operated by German manufacturers: VW Group, Mercedes-Benz, Audi, and soon BMW, with a strong focus on luxury cars. It exports around 90% of manufactured vehicles and employs 4% of the country’s workforce.
The country relies heavily on assembly work, lacking any substantial R&D or marketing activities. Dependence on German manufacturers has created concern over market diversification, particularly following the 2016 Volkswagen diesel scandal, as a significant number of affected vehicles were produced in Hungary. The country has historically maintained weak labour union and regulation laws to attract luxury manufacturers. This strong relationship with German brands made it easier for BMW to successfully establish a battery facility in Debrecen, with the goal of becoming the leading EV battery producer in Europe by 2030. This unique project has already garnered substantial investment, with BMW's initial €2 billion investment encouraging further interest from numerous suppliers and small investors, amassing approximately €10 billion for the city. This initiative sets Hungary apart from other CEE countries given its proclivity to offer German brand generous incentives, something not echoed as strongly in Slovakia or Czechia.
Despite this, Hungary still suffers from its reputation for low-cost parts and assembly line manufacturing. Investment in the Hungarian EV manufacturing industry would likely involve a reorientation of current ICE operations to EV parts and assembly lines. There is, however, an opportunity for investors, in the short-term, to utilise franchising and agency arrangements to establish EV assembly plants swiftly. Similarly, BMW's investments in Debrecen signify a shift towards part-specific manufacturing, moving away from traditional assembly lines and presenting opportunity for specialised manufacturers. Commitments to EV-focused production activities can boost higher value-added sectors in the country in the long term and decrease Hungary’s reliance on parts imports. Unlike Slovakia, where more collaboration is required between software developers and manufacturers, opportunity in Hungary lies in the development of existing manufacturing processes and skills to meet growing EV demand. This would benefit businesses specialising in automation-heavy production, but also those with skilled workers in welding, mechatronics and metalwork.