Exclusive Interview: David Herman on GM’s Strategy for Russia

GM, the world’s biggest
automaker, is on the verge of announcing its largest project in Eastern Europe:
a complex and innovative venture of $500 million-$600 million to build cars in
Russia with AO AvtoVAZ, producer of Lada vehicles. By mid-October, the US manufacturer
is expected to decide whether to approve the deal, which would be based at AvtoVAZ’s
headquarters in Togliatti, nearly 1,000 kilometers southeast of Moscow.

In a two-hour interview
at his office in Moscow recently, Herman detailed the substance of the plans
as well as their context and logic, speaking with fresh insight about an array
of automotive issues in Russia and the world. He talked to Ryan James Tutak,
associate editor of just-auto.com for Eastern Europe and former Soviet Union.
An edited transcript of the conversation follows.

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just-auto.com:
Since agreeing in 1990 to supply fuel-management systems to AvtoVAZ, GM has
talked with the Lada producer about building cars in Russia. Plans have floundered
for different reasons at different times. Once again, a deal seems imminent.
But do negotiations now hinge on external factors?

Example: Daewoo Motor
Co Ltd. It has roles in car plants across the ex-USSR – in Russia plus Ukraine
and Uzbekistan. GM is the automaker closest to Daewoo, and it tried to buy the
Korean producer last year. GM showed interest in mounting another bid, after
Ford Motor Co said on September 15 that it had broken off talks to acquire Daewoo.
Strategically, in Russia, GM may not need AvtoVAZ with the Koreans in hand.
So will GM want to determine any future it might have with Daewoo, before deciding
on a venture with AvtoVAZ?

Herman:

No. Daewoo may offer
a range of vehicles in price segments that GM may not reach with Opel, and this
could be useful. But that would not be enough for us to develop a meaningful
presence in the former Soviet Union. This is a distinct region with nearly 300
million people in 15 countries. Twelve of the markets, minus the tiny triad
of Baltic states, may never join a trade zone, besides the Commonwealth of Independent
States (CIS). So GM never will enjoy high sales volumes here by producing only
Korean vehicles. Even if we buy Daewoo, we will want to make a core brand of
GM in Russia, and we want to do that with AvtoVAZ.

David J Herman Vice President of General Motors Corp for the former Soviet Union

just-auto.com:
Daewoo aside, GM still may be over-represented in Russia. It now owns 20% of
Fiat Auto SpA, the foreign manufacturer most experienced in the ex-USSR. The
Italian group built cars near St Petersburg before the 1917 Revolution, and
it was effectively father and mother to AvtoVAZ, which launched operations in
1970 with Fiat-based vehicles. Iveco NV, sibling to Fiat Auto as the bus-and-truck
subsidiary of Fiat SpA, has industrial ventures in Russia and Ukraine. So the
Italians are unrivaled veterans here. Plus they already plan to start making
cars in Russia in a venture named ZAO Nizhegorod Motors (NM), involving local
producer OAO Gorkovsky Avtomobilny Zavod (GAZ). As GM could own 100% of Fiat
Auto within five years, why would the companies continue to invest separately
in major manufacturing projects in Russia?

Herman:
Fiat Auto and GM may grow closer in the future, but they have agreed to remain
competitors in selling vehicles. In terms of producing vehicles, if the Russian
ventures of Fiat and GM could have been combined creatively or elegantly, we
might have considered it. But Russia is a big place, and the projects are fundamentally
different. Besides, AvtoVAZ and GAZ make different types of cars, and it is
hard to imagine either building models of the other. Anyway, the schedules for
Fiat and GM to launch operations in Russia may diverge.

just-auto.com:
Capitalism has been replacing communism here since the USSR dissolved in 1991,
and Russia has the biggest population of any country in Europe with 147.2 million
people. Yet, in the past decade, no output in Russia of any foreign vehicle
has topped even 10,000 units a year. The country may be recovering from the
economic crisis of August 1998, but opportunities still seem unpromising. Nevertheless,
GM wants to produce close to 100,000 vehicles a year with AvtoVAZ. What are
your chances for success?

Herman:
We always assumed it would be too risky in Russia to build cars that would
be designed principally in Western Europe – and supported principally by engineering
in Western Europe. Whether the venture would be on a brownfield or a greenfield,
it would be hard to keep costs down, and costs are critical, since sales of
models priced over $12,000 will remain very small in Russia through 2005.

To justify a factory
financially in Russia, we must ensure output is high enough for economies of
scale, while keeping the price of vehicles from the plant low enough to attract
customers in Russia – and 97% of new models sold there in 1999 cost below $10,000.

If a plant would make
only 5,000-to-10,000 units in 2005 and maybe 35,000 units later, it would not
work. Among other problems, you could not recover the costs for the body shop
and paint shop within an acceptable period of time.

So we have to be creative,
and we will utilize two unique assets from AvtoVAZ to boost the feasibility
of our project. First: AvtoVAZ’s engineering staff, nearly 10,000 people including
technicians. Their work is competitive and creditable. We know because Opel
has used it. This will be important in reducing costs in one of the two vehicles
that our venture would make: a Russified model based on the T3000 platform underpinning
the current Opel Astra… Second: a new vehicle ready to be made: the Lada Niva
2123. We have evaluated it, and we like it. Plus it can be sold well below $10,000…
These elements give us a much better chance of success. We can open a plant
for 75,000-to-90,000 units, and we can feel pretty sure we can sell the volume.

Lada Niva 2123

just-auto.com:
I understand both models would be badged Chevrolet.

Herman:
That is one possibility.

just-auto.com:
Would the names Astra and Niva stay?

Herman:
Not Astra. Maybe Niva.

just-auto.com:
Vladimir Kadannikov, chair of AvtoVAZ’s board of directors, said the venture
would invest $575 million.

Herman:
I would not say that is incorrect. It is over $500 million, but the exact
sum depends whether certain items are included, like working capital. I cannot
say much more now, except AvtoVAZ would finance its share with the worldwide
rights to the 2123, and this is special.

Normally, a carmaker
opens a factory to build a model that it owns, and this is true with other ventures
in Russia: Fiat will make its Palio, Ford its Focus, Renault its Mégane. Here
the cost is mainly the plant, tools and vendors. But, in our project, the value
increases significantly because AvtoVAZ is contributing the global rights to
a vehicle and everything related to it – intellectual property, technology,
trademark, etc.

Our venture in Russia
would be the exclusive manufacturer of the new Niva with rights to sell it domestically
and internationally. This is something of great value, so it is AvtoVAZ’s biggest
contribution to the project.

just-auto.com:
AvtoVAZ will contribute no capital or cash?

Herman:
It does not have the cash, so it will contribute something else: the vehicle
plus some tools. This is unusual, but it is interesting – and something we want.

just-auto.com:
Who would control
the rights to sell the vehicle?

Herman:
The joint venture. GM – or a GM-designated channel – would sell the 2123
outside the CIS. We felt the AvtoVAZ network would not offer the best chance
for the price we would want. The price depends on a lot – parts and service
plus the image of the retailers. GM outlets could sell the new Niva at higher
prices than Lada dealers could.

just-auto.com:
Who would sell the vehicle inside the former Soviet Union?

Herman:
The venture would identify sites from GM and Lada dealers.

just-auto.com:
What will be the ownership structure of the venture?

Herman:
I cannot comment on the stake each party would hold. GM would have management
control, and that is not an issue of contention. AvtoVAZ wants us as a strategic
partner, so it can learn modern approaches to the auto business that we have
cultivated over decades of global competition. Manufacturing, marketing and
sales now involve sophisticated systems that automakers like GM possess. AvtoVAZ
needs to access this knowledge and technology, and we would not object to sharing
it in a natural way through our cooperation. AvtoVAZ would contribute managers
and workers to the venture – some may remain employees of the joint project,
but others likely would return to AvtoVAZ over different periods of time to
disseminate their experience. As this would happen, AvtoVAZ would replenish
the venture with others in its ranks. Over the years, this rotation of staff
would enable AvtoVAZ to glean much about our approach to the auto industry.

just-auto.com:
But the venture is still not finalized. What is the status?

Herman:
It has taken a long time, but this has been positive. We have refined the
project to cut costs, and production targets have been carefully evaluated.
As an example, over time, Opel has reduced the sums allocated for technical
assistance, as confidence has grown that AvtoVAZ can handle an increasing portion
of this responsibility in the venture.

But the time has come
for GM to decide whether to do it. We know AvtoVAZ wants to get ready to produce
the new Niva, and it needs to know whether we will be a partner. If we will
not, AvtoVAZ will try to build the model alone. It would buy new welding equipment,
but it would assemble and paint the vehicles on its existing lines.

So GM must decide the
amount of money it is willing to put into Russia now – and the amount of exposure
it is willing to accept.

just-auto.com:
When will a decision come?

Herman:
We should know around mid-October. GM’s top executives already believe the
substance of the project is solid, and they like it from four important viewpoints.

One: They want the new
Niva, an all-wheel-drive off-road vehicle with a steel frame that can be sold
for $7,000 before value-added tax ($7,500 after VAT). No one in the world besides
AvtoVAZ can offer this. Some econo-boxes purport to be off-roaders, but they
are not four-wheel drive, and they cannot compete with the 2123, once they leave
the Tarmac. Opel engineers say this. This is a really good vehicle off road.
On road, it needs work because it is not quiet enough or refined enough, but
it is perfect for Russia. You see them all over here – people love them.

Two: The new Niva has
promise in export. It could be sold in Western Europe plus established markets
for the old Niva in Africa, Asia, Latin America and Middle East.

Three: Access to human
resources is attractive. If the venture happens, GM will increase its use of
AvtoVAZ’s technical staff for work outside Russia. AvtoVAZ has lots of people
with great qualifications, and lead engineers only cost $240 a month. This talent
is impressive.

Four: In the big picture,
GM realizes eight high-growth markets will be crucial to maintaining its global
leadership. One is Russia, alongside China and India. As Russia is the country
selling the most new vehicles under $8,000, the 2123 could be a key to our success
here.

But the commercial environment
in Russia is difficult, and GM must feel it can conduct business here the way
it would like. If we would make a big investment here, we would be part of the
economy, and we must believe we could succeed. This takes time to analyze and
understand.

just-auto.com:
Still GM seems slow in deciding.

Herman:
GM is taking an intelligent reasoned approach. I am leading this project,
and I feel good about it, so I want it to happen. But, in a time of global competition,
decisions about our allocation of capital and resources never have been more
important than now, especially for long-term projects like this one. We cannot
have a ‘plant-the-flag’ strategy around the world, where we decide to be present
at any cost in China, India, Russia, etc. We cannot afford simply to be here.
The investments are too big. We must be sure a project will perform well. A
lot of questions must be asked, and I am not at all dismayed by the time it
has taken to answer them – and to convince our people. It is difficult, but
it is the responsible way to proceed.

just-auto.com:
Does GM have any doubts or questions lingering about the venture?

Herman:
I believe not. But Russia is special. I have spent almost all of my career
overseas. I have seen all sorts of governments and markets. I worked in Chile
when Augusto Pinochet came to power. But I cannot remember anything like Russia.
There never has been anything quite like it. Russia really is unique, but that
is good and bad. There are Russia issues that we must work out.

Unfortunately, automotive
history casts a shadow over our efforts in Russia too. Consider all of the car
factories that have opened around the world: the record is pretty spotty, especially
in Asia, where companies have lost lots of money. No one wants to repeat those
experiences. The pressure is greater than ever to check every fact – to do a
project right. No one can afford to shell out a couple hundred million dollars
with a glib justification that, “we needed to be in Russia, so we did the best
thing available”.

We have a rule in our
office. We never recommend anything simply because it happens to be the best
thing we can do. We only recommend things that we think are really good. This
is a big burden, and it is tough to follow because we are in a market that does
not offer a lot of economic opportunity now, especially for manufacturers of
foreign vehicles.

just-auto.com:
How quickly could production at the venture grow?

Herman:
We could hit capacity in 2006 of 75,000 cars: about 60,000 of 2123; 15,000
of T3000.

just-auto.com:
Mainly for Russia?

Herman:
It depends. We plan to export substantially – maybe 50% of output at capacity.

just-auto.com:
What changes in Russia generally could facilitate the venture?

Herman:
The biggest changes will be organic, not changes in government, laws or policy.
Ten years ago, how many people here knew Generally Accepted Accounting Principles?
Maybe 100. Ten years ago, how many companies here asked their senior executives
to sign conflict-of-interest questionnaires? Perhaps none. US companies typically
require their top managers to complete these questionnaires every year.

But the final generation
of Soviet-era managers is retiring. An increasing number of people never have
worked under the USSR. Soon, all middle managers here will have been educated
in a post-Soviet system. Universities now teach modern business practices. When
you talk to young bankers here, you understand them. So the biggest changes
will emerge naturally.

just-auto.com:
If GM approves the venture this year, when could production begin?

Herman:
It takes two years to start, especially to get the dies and paint shop. We
would aim for the end of 2002.

just-auto.com:
You would launch operations with full manufacturing?

Herman:
With Niva. With T3000, we would need a little time.

just-auto.com:
Both vehicles would be made on one assembly line?

Herman:
Yes.

just-auto.com:
What would be the workforce?

Herman:
Roughly 1,200 at capacity.

just-auto.com:
GM already opened one plant in Russia in December 1996 – to make Chevrolet
Blazer in Elabuga in Tartarstan. It planned to manufacture 50,000 units a year,
but operations never advanced beyond simple assembly, and work stopped in late
1998, due to poor demand. Under 3,600 units were made. Basic assembly of Opel
Vectra began there in mid-1999, but that stalled, following output of only a
few hundred kits. What is the future for GM in Elabuga?

Herman:
We agreed with our partners there to study options for the site in the coming
months. We will not proceed with the original plan because an operation of that
size for a big vehicle costing over $20,000 would not have a chance to succeed
in the market today.

just-auto.com:
Was that not clear from the start?

Herman:
Apparently not. In planning the project in 1994 and 1995, GM was overwhelmed
by auspicious economic developments and opportunities in Russia. Did anyone
foresee the crash in August 1998?

just-auto.com:
We first discussed GM’s plans for Russia in May 1994 at the Poznan motor
show in Poland. Then you explained GM wanted to build Opel Corsa with AvtoVAZ.
Given the price sensitivity of the current market in Russia, why does GM now
want to produce a bigger vehicle there – one based on Astra?

Herman:
Then I was not responsible for Russia at GM, though I have been a student
of Russia all my life. I was a Ford Foundation Fellow in the Russian Research
Center at Harvard, when I was completing a law degree there in 1971. Incidentally,
three years after joining GM in 1973, I was given a mandate to develop business
in the USSR. I proposed we build a vehicle in Moscow with AZLK (Avtomobilny
Zavod Leninskovo Komsomola, a company re-named AO Moskvich. Renault now assembles
cars there.) That model became the Opel Ascona in 1980, and my plan was to export
half the volume to Western Europe. GM decided against it because it did not
want to sell technology to a company owned by the Soviet state, and GM anticipated
difficulty in sending quality control inspectors there to develop relations
with workers who were being indoctrinated. Plus GM was concerned the quality
of production there would not reach a level that would be adequate for Western
Europe. Remember: in the mid-1970s, Germans were averse to buying vehicles from
Belgium – let alone Spain. The world is quite different now. Corsa is made in
Spain, and it is enormously successful.

Since I returned to Russia
in June 1998, we have concluded the compact segment (T3000 class) is and will
remain the largest part of the market. Minis and small cars have not enjoyed
strong demand in Russia, due to their limited interior space and torque. But
these vehicles have improved significantly, and versions with 1.0-liter-to-1.4-liter
engines eventually could comprise 10%-15% of the market in Russia. This is hardly
trivial. If we would launch a venture here, if it would prosper, we eventually
could consider making a car smaller than T3000. But the old Corsa would not
work, especially since its piece costs are not much cheaper than Astra’s.

just-auto.com:
In an interview at the Moscow motor show on August 23, Kadannikov said the
European Bank for Reconstruction and Development is keen to support the AvtoVAZ-GM
project. The bank, others added, would play two roles in the venture: lend nearly
$175 million to it; and take 14% of its equity for $50 million. AvtoVAZ and
GM each would hold 43% of the shares.

Herman:
I cannot comment on any aspects of the financing and ownership of the venture,
partly because the details still must be finalized.

just-auto.com:
What is GM’s biggest concern in deciding whether to approve the venture?

Herman:
Russia is subjected to intense media scrutiny, but many reports are confusing
and inaccurate, so we need to evaluate the facts carefully, and that takes time.
This is true for any investment in an unfamiliar market. Since the economic
crashes around the world in 1997 and 1998, we look at projects with greater
care. We cannot simply rely on macro-forecasts that everything will be great
in Russia, then rush here to invest hundreds of millions of dollars to build
vehicles. We cannot set a fleet of ships to sail, accepting some will float,
while others will not. Now, if we do one project, it means we will not do another.
We cannot do everything. That is an issue here.

just-auto.com:
Would the venture eventually build engines?

Herman:
Ultimately. AvtoVAZ is interested in Opel’s engine technology. If the venture
would be successful, we would hope to expand it to engine production, and the
motors could be fit to AvtoVAZ vehicles besides Niva.

just-auto.com:
Will the powertrain for T3000 be imported?

Herman:
Yes. Later, we would try to put Opel engines in the 2123. Eventually, we
would try to make engines in Russia.

just-auto.com:
Will any parts be common to Astra and Niva?

Herman:
We will try to modify Niva in ways that benefit from Astra, and we will work
on this with component suppliers. As an example, we may put Astra seats into
Niva.

Also the foreign automakers
looking to produce in Russia (GM plus Fiat, Ford and Renault) have formed a
committee to standardize parts that can be used in the models that each would
produce, such as glass and tires. Hopefully, this will help to persuade a few
major suppliers to invest in Russia to support all the foreign ventures. A lot
of progress already has been made here.

just-auto.com:
I hear a big obstacle to attracting foreign parts makers to your project
in Russia is that AvtoVAZ’s suppliers often insist on control or majority stakes
in ventures with international partners.

Herman:
I am not aware that is an issue, but we would have time to work it out. Anyway,
60% of the parts for the new Niva are from the old Niva.

just-auto.com:
How will T3000 be Russified?

Herman:
We are encouraging AvtoVAZ engineers to find ways to cut costs. Some things
are immediately possible, like localizing mud flaps and visors. We would press
sheet metal in Russia, and some dies already are available here. The integration
of Russian suppliers may be slow. But, eventually, we want most of the final
product made here.

just-auto.com: How
will the market develop in Russia?

Herman:
Sales will grow steadily. Prices for foreign models will recover gradually
in dollar terms, but prices for domestic marks will not return to pre-crisis
levels because the vehicles are the same as they always have been.

Here is an important
question for us: The current Niva sells for $3,300. If we would introduce a
new version at a higher price, could we sell it in the same volume as the existing
one? (About 50,000-to-60,000 units a year in Russia.) I believe the answer is
“Yes”. Consumers would be happy to buy something new at an intermediate price.

Russians will not pay
more for old domestic stuff, and few can afford new imported stuff for $14,000
to $18,000. Still, if we would offer interesting new vehicles for $12,000, we
may not get lots of customers. To attract a big number of buyers, we may need
to offer interesting new vehicles for $7,000 to $10,000. This could be good,
especially since no vehicle is sold here in this price range besides Daewoo
Nexia from Uzbekistan. Not much of a choice.

just-auto.com:
What would a Russian-made T3000 cost?

Herman:
We could not make an interesting volume with a base price above $10,000.
Such a vehicle would feature fair specifications – ABS and airbags plus a 1.6-liter
16-valve engine. But, if the car costs $12,000, it is only $2,000 cheaper than
certain foreign imports, and this gap may be too small to generate enough sales
to justify a factory. We always knew we could make a vehicle cheaper with AvtoVAZ,
but we need to ensure the price advantage of T3000 against imports of competitive
models is closer to $7,000 than $2,000.

Only 27% of bank assets
are lent in Russia, an extraordinarily low percent for a developing market.
The reason is simple: a lack of opportunity. A lot of people want to borrow
money, but few can repay it. So if GM does this deal, the capital available
to support domestic parts makers would be great, and that would help us localize
faster – to take costs out of T3000. This could lead to a resurgence in the
supplier industry here.

just-auto.com:
How many Russian suppliers would be ready to support the venture now?

Herman:
Few meet international quality standards with ISO certifications. There is
a long way to go. Russia needs foreign investment to spur improvements. In Spain
in 1979, the minister of industry told me that his main interest in attracting
GM to build cars there was to create opportunities for local parts makers to
supply our plants outside Spain. This has happened, and Russia should think
the same way. It may lack the resources to induce foreign investment like Spain
did, but support in Russia exists in other ways. Few people actually understand
the elaborate economic system here, but the net result is workers earn $150
a month, and material costs are low. These facts will not change for a long
time, and they should be promoted as good reasons for suppliers to come to Russia.

just-auto.com:
When could Opel start to source significant volumes of parts from Russia?

Herman:
That is my dream. If parts makers here can improve enough to support our
venture with AvtoVAZ, later they can support GM in Western Europe. This will
be easier, once the technology is here – once GM and others attract more of
their suppliers here.

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