Tuesday, July 29, 2014

The Double Edged Sword of Profit

Raking in the profit for an automaker seems like the ultimate accomplishment, and when you sell millions of cars around the world the final tally can reach satisfying levels. For example, the Volkswagen Group recorded an after tax profit of 11.7 billion, Euros, last year. However, even such healthy profits are often times not enough in the eyes of investors as Volkswagen has recently targeted 5 billion Euro a year of cuts that it sees necessary to shore up its margins. Certainly some of the cuts will come from the usual places that make the most sense, smarter purchasing, cutting factory costs and even eliminating some of the least profitable models. Yet, cuts will be done to R&D as well as VW has seen its R&D spending surge by 80% in the last four years. In general R&D spending should lead to better products and the latest Passat is a good example, a family sedan (at least in Europe) will come with up to 240 horsepower from a 2.0 TDI diesel or 280 from a 2.0 gas turbo. Numbers never before seen from diesels and only on high strung gas turbos are now mainstream. Certainly these engine developments don't come cheaply and future improvements could be stymied with the cuts.

The cost-benefit analysis of additional R&D certainly creates some interesting questions about what a car company could do if given the chance to focus on its product and let the finances sort themselves out. Say if  your stock was closer related to your product, its public perception and future potential of the brand. In other words the life of start up gone public. This model has certainly worked well for years in Silicon Valley in tech and web. Would cars built with this mindset tend to maximize their performance or broaden their design? All the evidence so far points to a yes as the answer in the auto industry as well. How much, if any, of an effect will this have on the rest of the industry is something interesting to track over the next few years.

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