Why Is Germany Successful in Automotive Industry? Explain It Using the Concept of Economies of Scale.

Germany’s economic strength has been based on car production to a great extent. The automobile industry is one of the dominating sectors because many economic activities rely on and are linked to automobile production (i.e. tire industry, plastics industry, metal processing). If you include suppliers, car services, garages or retailers, a total of about 5 million employees (1 out of every 7 jobs in Germany) depend on the success of the automobile industry.

The automobile industry also involves a large number of product groups, such as the production of trucks, buses, trailers, containers, parts and spare parts. Cars are among the most well-known German products on the world market. Germany began to intensively export cars in the 1950s.

The slogan ‘Made in Germany’, initially used by the U.S. occupying forces as a sign to warn customers not to buy German products, became an international symbol for high quality, speed and technology. The Volkswagen Beetle was one of the first successful cars on the world market. Robust, compact and cheap, several million were produced. Aside from cars, such as the Volkswagen Beetle, which are produced in great numbers to meet mass demand, luxury limousines and sports cars also dominate the image of the German car industry. The German mass production of cars started in the 1920s. Most factories produced a limited number of models.

The Volkswagen plant was established in 1938 in a rural community in Lower Saxony, together with the construction of a whole town (Wolfsburg). Among the first major producers (the number of small-scale car builders reached 150 in the 1920s) were Mercedes-Benz, Opel (since 1927 part of General Motors) and BMW. At the end of World War II, the car industry was virtually destroyed. Rebuilding began in the West, with concentration processes which squeezed-out many small firms. New assembly and components plants (for example, Opel in Bochum) were erected by surviving companies and new firms like Audi, which was formed as a result of a merger of firms like DKW, NSU and Horch, were founded.

The establishment of new plants took place around major agglomerations or in adjacent rural areas with close ties to resource industries and suppliers. With the growth of the car firms, numerous suppliers opened up or shifted plants into their vicinity. Along with that, employment steadily increased. Production concepts, processes and the associated technologies have changed dramatically since the first cars were built. Some 70 years ago, car assembly was primarily manual work. Today, the

process of car assembly is almost fully automatized. In the old days, firms attached importance to the production of virtually every part in a single plant while today the car producers concentrate on only a few specific production stages (i.e. car assembly). Parts and module production, services and related activities have been shifted to other, specialized firms (outsourcing of production steps).

This gives the producer greater flexibility and lowers capacities and costs but also results in increased dependency on suppliers. Since the 1980s, it has become clear that further productivity gains to retain competitiveness could only be possible by outsourcing and securing greater flexibility. Due to this, the entire production system has changed in sectoral and spatial terms.

Currently, six German companies dominate the automotive industry in the country: Volkswagen, Audi (owned by the Volkswagen Group), BMW, Daimler AG, Porsche and Opel. Nearly six million vehicles are produced in Germany each year, and approximately 5.5 million are produced overseas by German brands.[6] Alongside the United States, China and Japan, Germany is one of the top 4 automobile manufacturers in the world. The Volkswagen Group is one of the three biggest automotive companies of the world (along with Toyota and General Motors).

As shown in graph above, Germany is the European car production leader: some 4.9 million passenger cars (and more than 245,000 trucks and buses) were manufactured in German plants in 2009; it is also Europe’s number one automotive market in terms of production and sales: accounting for over 35 percent of all passenger cars manufactured and almost 30 percent of all new registrations. There are several factors that could influence the expansion and the success of the German automotive industry and one of the most important is the exploitation of economies of scale.

Generally, economies of scales, in microeconomics, refers to the cost advantages that a business obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. "Economies of scale" is a long run concept and refers to reductions in unit cost as the size of a facility and the usage levels of other inputs increase; they are essential determinants for a cost-efficient production and they arise from the fact that an increase in input (of one or more product) does

not give rise to a proportional increase in costs. Hence, the longer the production run over a period of time, the lower the unit cost will be, until the minimum efficient scale of production for the product has been reached.

The common sources of economies of scale are purchasing (bulk buying of materials through long-term contracts), managerial (increasing the specialization of managers), financial (obtaining lower-interest charges when borrowing from banks and having access to a greater range of financial instruments), marketing (spreading the cost of advertising over a greater range of output in media markets), and technological (taking advantage of returns to scale in the production function).

Each of these factors reduces the long run average costs of production by shifting the short-run average total cost curve down and to the right. Economies of scale are also derived partially from learning by doing.

As we can see in the graph above, economies of scale arise when the cost per unit falls as output increases. At production level Q1 the average production cost will be C1. If the production were rise to Q2, then the average cost of production would fall to C2. this means that at the higher level of output, it requires less resources or costs per unit of output than it required at the smaller scale.

High national and international competition that German companies had to face implied that the companies themselves invested capital in the technological sector to meet new market’s needs reducing costs and increasing production. This produced different types of technological economies of scale. Some companies turned their efforts to the achievement of superior techniques, in order to introduce in the automotive market products non-existent before. For example, in 1992 BMW introduced for the first time in the BMW M3 the “double-VANOS” technology that varies the camshaft timing to optimize power output throughout the REV range.

This new technology provided better performance, lower pollutant emissions and improved fuel efficiency. With the introduction of this new product the company faced a high increase in the market demand and could so increase the quantity produced of that product. Meanwhile, other companies decided to enlarge their production from the mere cars up to other machines of similar type that did use the sametechnologies. This was made in order to expand their products offering. For example, Volkswagen, born in 1937, decided a couple of decades later to extend its business towards a new model of transportation able to provide a wider space than a common automobile.

Therefore the company in 1949 introduced in the market the Volkswagen Transporter, that obtained a great success and allowed the company to grow even more. Furthermore, strength in automotive German industry is due to the high specialization inside every productive sector. Specialization produces advantages, commonly called economies of specialization, in terms of reduction of time, efforts and costs; it facilitates, in addition, the quality of the economic outputs. Specialization increases when markets increase, because companies can grow and specialize among themselves; investments in R&D will be as big as the expected market dimensions.

The whole of German companies followed this specialization program that made possible a decrease in costs and an increase in productivity. The majority of German car companies has a worldwide recognized brand and, from the outset, they were successful in establish their trademarks first in Europe, then in all over the world. In the past, German companies have created strong automobile brands that consumers rank among the most prestigious brands of all.

This also finds expression in value, of course. Brand value studies place Mercedes directly after Marlboro in tenth place, with a value of US$ 21 billion. BMW ranks nineteenth at US$ 15 billion, while even lowly VW manages to place forty-second with almost US$ 7 billion in brand value. To maintain and expand this value, automobile manufacturers have set up their own brand management boards and spare neither time nor money to plan and further their brand development.

The results speak for themselves, as the example of Opel shows: thanks to its new comprehensive brand strategy based on Opel's time-honoured strengths, the company was able to swing back onto the growth path. Generally, their marketing strategy is not limited to the launching of a single product but their aim is to advertise the whole company with a single ad. And that is how most popular slogans, that come with every advertising campaign, come.

“Everyone dreams of an Audi” or “BMW, the ultimate driving experience” are just some examples. This particular strategy is aims to provide advantages to large firms: every part of marketing has a cost – particularly promotional methods such as advertising and running a sales force. Many of these marketing costs are fixed costs and so as a business gets larger, it is able to spread the cost of marketing over a wider range of products and sales – cutting the average marketing cost per unit. Furthermore, the choice to adopt a strategy of this kind implies a facilitation in the case of a launch of another product.

Every company, nowadays, has also to success in management economies: as a firm grows, there is greater potential for managers to specialise in particular tasks (e.g. marketing, human resource management, finance). Specialist managers are likely to be more efficient as they possess a high level of expertise, experience and qualifications compared to one person in a smaller firm trying to perform all of these roles. German cars companies adopted this strategy in order to gain an important place in the automotive sector. Finally, another important factor that helped German companies reaching a worldwide success are industries allied to car manufacturing.

Suppliers played and are still playing an important role in the car industry: in contrast to producers, their variety of products is broad. Today, parts are more complex and technologically advanced in order to cope with the diversified demand and the need for flexibility by car producers. Some suppliers are large and produce various goods for other industries as well. Most suppliers are, however, small and medium-sized firms.

The network of suppliers and support industries has grown in size and it is spread all over the country in order to provide goods and services to the main industries. This implied that firms have a greater chance of finding a high quality yet affordable supplier close to it. In conclusion, it is not possible to identify a unique factor that determined the success of German automotive sector, although the adoption of different kinds of economies of scale contributed predominantly; nowadays Germany continues to occupy a unique position in the international automotive industry.

German OEMs account for 17 percent of global passenger car production. And they are constantly growing, despite the financial crises of the past years: domestically, the automotive industry remains the country’s most important economic sector – and Europe’s single largest auto market. Germany also hosts the largest concentration of OEM plants in Europe. Annual EUR 21 billion commitment to automotive research and development is reflected in the creation of new environmentally friendly technologies: conventional drive technologies are being optimized and new modes of driving developed. Around ten new patents are registered each day; making Germany the most innovative auto nation in the world.