Risks and opportunities
In this section, we outline the risks and opportunities that arise in the course of our business activities. We have grouped them into categories. Unless explicitly mentioned, there were no material changes to the specific risks and opportunities compared with the previous year.
The diesel issue gives rise to its own risks for the Volkswagen Group and also has an impact on existing risks. These are described under the respective risk category.
We use competitive and environmental analyses and market studies to identify not only risks but also opportunities with a positive impact on the design of our products, the efficiency with which they are produced, their success in the market and our cost structure. Where they can be assessed, risks and opportunities that we expect to occur are already reflected in our medium-term planning and our forecast. The following therefore reports on internal and external developments as risks and opportunities that may result in a negative or positive deviation from our forecast.
Risks from the diesel issue
The Volkswagen Group has recognized provisions arising from the diesel issue, in particular for the upcoming service campaigns, recalls and customer-related measures as well as for legal risks, but also for residual value risks.
Due to existing estimation risks particularly from legal risks, criminal and administrative proceedings, higher expenses for technical solutions, lower market prices, repurchase obligations and customer-related measures, further significant financial liabilities may emerge.
Demand may decrease – possibly exacerbated by a loss of reputation or insufficient communication. Other potential consequences include lower margins in the new and used car businesses and a temporary increase in funds tied up in working capital.
The funding needed to cover the risks may lead to assets having to be sold due to the situation and equivalent proceeds for them not being achieved as a result.
As a result of the diesel issue the ability to use refinancing instruments may possibly be restricted or precluded for the Volkswagen Group. A downgrade of the Company’s rating could adversely affect the terms associated with the Volkswagen Group’s borrowings.
We are cooperating with all the responsible authorities to clarify these matters completely and transparently.
Macroeconomic risks and opportunities
We believe that the risks to continued global economic growth arise primarily from turbulence in the financial markets, protectionist tendencies and structural deficits, which pose a threat to the performance of individual industrialized nations and emerging economies. In the southern part of the eurozone, a sustained economic recovery is being hindered by the situation of some financial institutions whose ability to withstand a crisis is still not assured. Risks are also associated with the effects of the UK’s planned withdrawal from the EU. Persistently high private- and public-sector debt in many places is also clouding the outlook for growth and may cause markets to respond negatively. Declines in growth in key countries and regions often have an immediate impact on the state of the global economy and therefore pose a central risk.
The economic development of some emerging economies is being hampered primarily by dependence on energy and commodity prices, capital inflows and socio-political tensions. Corruption, inadequate government structures and a lack of legal certainty also pose risks.
Geopolitical tensions and conflicts are a further major risk to the performance of individual economies and regions. As the global economy becomes increasingly interconnected, it is also vulnerable to local developments. Any escalation of the conflicts in Eastern Europe, the Middle East, or Africa, for example, could cause upheaval on the global energy and commodity markets and exacerbate migration trends. The same applies to armed conflicts, terrorist activities, or the spread of infectious diseases, which may prompt unexpected, short-term responses from the markets.
Overall, we consider the probability of a global recession to be low. Due to the risk factors mentioned, however, the possibility of a decline in global economic growth or a period of below-average growth rates cannot be ruled out.
The macroeconomic environment may also give rise to opportunities for the Volkswagen Group if actual developments differ in a positive way from expected developments.
Sector-specific risk and market opportunities
The growth markets of Asia, South America, and Central and Eastern Europe are particularly important to the Volkswagen Group in terms of the global trend in demand for passenger cars and commercial vehicles. Although these markets harbor considerable potential, the underlying conditions in some countries in these regions make it difficult to increase unit sales figures there. Some have high customs barriers or minimum local content requirements for production, for example. The political crisis and its economic consequences again inhibited market development in Russia in fiscal year 2016. In South America, structural deficits continued to have a negative impact. Restrictions on vehicle registrations could enter into force in further Chinese metropolitan areas in the future. Additionally, a global economic slowdown could negatively impact consumer confidence. Furthermore, we cannot entirely rule out the possibility of freight deliveries being shifted from trucks to other means of transport, and of demand for the Group’s commercial vehicles falling as a result.
At the same time, wherever the economic and regulatory situation permits, there are opportunities above and beyond current projections resulting from faster growth in the emerging markets where vehicle densities are still low. The demand that built up in individual established markets during the crisis could also bring a more marked recovery in these markets if the economic environment eases more quickly than expected. Price pressure in established automotive markets due to high market saturation is a particular challenge for the Volkswagen Group as a supplier of volume and premium models. As the global economy is still under strain, competitive pressures are likely to remain high in the future. Some manufacturers may respond by offering incentives in order to meet their sales targets, putting the entire sector under additional pressure, particularly in Western Europe, the USA and China.
Western Europe is one of our main sales markets. A drop in prices due to the economic climate triggered by falling demand in this region would have a particularly strong impact on the Company’s earnings. We counter this risk with a clear, customer-oriented and innovative product and pricing policy. Outside Western Europe, delivery volumes are widely spread worldwide, with the Chinese market accounting for a large share. In numerous existing and developing markets, we either already have a strong presence or are working hard to build one. Moreover, strategic partnerships are helping us to increase our presence in these countries and regions and cater to requirements there.
Economic performance varied from region to region in fiscal year 2016. While the situation in Western Europe stabilized further, China remained on its growth trajectory and the US economy continued to expand, market conditions in Eastern Europe and South America remained under strain. The resulting challenges for our trading and sales companies, such as efficient inventory management and a profitable dealer network, are considerable and are being met by appropriate measures on their part. However, financing business activities through bank loans remains difficult. Our financial services companies offer dealers financing on attractive terms with the aim of strengthening their business models and reducing operational risk. We have installed a comprehensive liquidity risk management system so that we can promptly counteract any liquidity bottlenecks at the dealers’ end that could hinder smooth business operations.
We continue to approve loans for vehicle finance on the basis of the same cautious principles applied in the past, taking into account the regulatory requirements of section 25a(1) of the Kreditwesengesetz (KWG – German Banking Act).
Volkswagen may be exposed to increased competition in aftermarkets for two reasons in particular: firstly, because of the provisions of the block exemption regulations, which have applied to after-sales services since June 2010, and, secondly, because of the amendments included in EU Regulation 566/2011 of June 8, 2011 regarding access by independent market participants to technical information.
In addition, the European Commission is currently evaluating the market with regard to existing design protection. If the proposed abolition of design protection for visible replacement parts were to be approved, this could adversely affect the Volkswagen Group’s genuine parts business.
The automotive industry faces a process of transformation with far-reaching changes. Electric drives, connected vehicles and autonomous driving are associated with both opportunities and risks for our sales. In particular, more rapidly evolving customer requirements, swift implementation of legislative initiatives and the market entry of new competitors from outside the industry will require changed products, a faster pace of innovation and adjustments to business models.
Below, we outline the market opportunities for the Volkswagen Group. We see the greatest potential for growth in the markets of the Asia-Pacific region and in North America.
China, the largest market in the Asia-Pacific region, continued to grow in the reporting period. The Chinese demand for vehicles will continue to rise in the coming years, albeit at a slower pace than in the past, due to the need for individual mobility. Demand will also shift from the large coastal cities to the interior of the country. In order to leverage the considerable opportunities offered by the Chinese market – also with regard to e-mobility – and to defend our strong market position in China over the long term, we are continuously expanding our product range to include models that have been specially developed for this market. We are further extending our production capacity in this growing market through additional production facilities.
The political and economic situation in India further stabilized in 2016. The vehicle markets continued their recovery. We expect this trend to continue. Against this backdrop, the Group is currently consolidating its activities, as India remains an important strategic future market for the Group.
The volume of the US vehicle market in 2016 marginally exceeded that of the strong previous year. For 2017, we expect the market to fall slightly below the 2016 level. In the USA, Volkswagen Group of America is systematically pursuing our strategy of becoming a full-fledged volume supplier. An engine plant and the development of additional production capacity in the North America region will allow the Group to better serve the market in the future. We are also pressing forward with additional products tailored specifically to the US market. Our success here will largely depend on how transparently, thoroughly and quickly we deal with the diesel issue and restore customer confidence.
The economic environment remained weak in the reporting period and the volume of demand on the vehicle market fell once again. The ongoing recession, coupled with high unemployment, falling real incomes and restrictive lending policies, prevented the hoped-for recovery. In 2017, we expect the vehicle market to stabilize slightly above its 2016 level. The growing number of automobile manufacturers with local production has resulted in a sharp increase in price pressure and competition. The Brazilian market plays a key role for the Volkswagen Group. To strengthen our competitive position here, we offer vehicles that have been specially developed for this market and are locally produced, such as the Gol and the Fox.
Russia has the potential to grow into one of the largest automotive markets in the world. However, the heavy reliance on oil revenues that are lower than in the past, a substantial fall in real incomes, and high vehicle prices as a result of the weak currency led to a decline in the market as a whole in 2016. Demand for vehicles also continued to be impacted by the political crisis and the related sanctions imposed by the EU and the USA. The market remains strategically important to the Volkswagen Group, which is why we are working intensively there.
The Middle East
Despite economic and political instability, the Middle East region offers growth opportunities. We are leveraging the potential for growth with a range of vehicles that has been specifically tailored to this market, but do not have our own production facilities.
The underlying trends in the global economy such as sustained growth and a greater international division of labor are set to continue, as are the resulting increase in global transport routes and volumes, a growing demand for energy and the required forces for innovation in relation to global climate policy.
We are working systematically to leverage these market opportunities across the world. In the medium term, significant potential can be leveraged by enhancing the after-sales business through the introduction of new products and the expansion of our service network. Going forward, stricter requirements with respect to reliability, the availability of the plants that are already in operation, the increase in environmental compatibility and efficient operation, together with the large number of engines and plants, will provide the basis for growth.
As part of the capital goods industry, the Power Engineering Business Area is affected by fluctuations in the investment climate. Even minor changes in growth rates or growth forecasts, resulting from geopolitical uncertainties or volatile commodities and foreign exchange markets, for example, can lead to significant changes in demand or the cancellation of existing orders. The measures we use to counter the considerable economic risks include flexible production concepts and cost flexibility by means of temporary employment, working time accounts and short-time work, and – where necessary – structural adjustments.