To Topple Toyota, Volkswagen Must Accelerate in the U.S.

Volkswagen has a hefty goal: to displace Toyota as the world's No. 1 car company. Once fondly known to a generation of Americans for the quirky air-cooled Beetle that it sold in the U.S. until the mid-1970s, VW's (VLKAY) current batch of products are far more substantial but not nearly so popular.

Today, the German automaker has just 2.5% of the U.S. market and lags well behind Toyota Motor (TM). In the first nine months of the year, Volkswagen sold slightly less than 200,000 cars and sport-utility vehicles in the U.S., compared to Toyota's more than 1.3 million.

Europe's largest car company, VW set out three years ago to eclipse Toyota's worldwide sales by selling about 10 million vehicles annually by 2018. Given the current recession, neither automaker is anywhere near selling that many cars this year, but while Toyota's sales have fallen, thanks to both the economy and its recall woes, VW sales are on the rise -- and so are its profits.

Although it hasn't cited a specific number, Volkswagen Group, which includes Volkswagen, Audi, Bentley, Bugatti, Lamborghini and Europe-only Skoda and Seat, expects 2010 sales to exceed last year's record of 6.29 million cars and light trucks. Compare that to Toyota's full-year forecast of 7.38 million vehicles, and it becomes apparent that VW could eventually surpass Toyota.

Winning the Race to the Bank

On a profit basis, Wolfsburg-based VW is already on its way giving Toyota a run for the money. On Oct. 22, Volkswagen reported it earned €4.03 billion ($5.6 billion) in profit during the first nine months of the year, easily outpacing Toyota's anticipated full-year profit of $4.2 billion. (Toyota is expected to soon revise its profit assumptions after the yen's recent run-up against the dollar.)

Volkswagen's momentum has been helped by strong sales in China, where it commands about 18% of the market. "In China, VW is decades ahead of Toyota," says Christoph Stuermer, research director at IHS Automotive in Frankfurt. The Japanese automaker, despite its considerable efforts, has had trouble gaining traction in China.

In the three months ending September, VW sold about 1.5 million vehicles in China -- seven times that of Toyota. And clearly VW aims to sell many more. It announced plans earlier this year to build two new factories, raising its total in China to 11, in a bid to double Chinese production to 3 million units within four years, Bloomberg News reported.

In North America, however, VW faces an uphill climb. And to become the world's dominant automaker, VW needs to make big gains in the U.S. market. The company has committed to significantly increasing U.S. sales, seeking to sell about 1 million vehicles by 2018. "We're working hard to grow in the United States," says VW spokesman Kerry Christopher.

To that end, VW is investing $1 billion to build a new assembly plant in Chattanooga, Tenn., where a new, yet-unnamed midsize car will be built. VW also has several more new models just introduced or on the way. They include the revised Jetta, geared specifically for American tastes and aimed squarely against the likes of the Toyota Corolla and Honda Motor's (HMC) Civic.

'Unimpressive' Effort

Though VW has poured much engineering and market-research expertise into making the Jetta more appealing to U.S. consumers, analyst Stuermer says, VW's "reading of the American market is still very much with a German accent." The result is that the new Jetta hasn't been a smash hit with some automotive critics.

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For example, in initial tests of the compact sedan, Consumer Reports noted that the Jetta's current batch of engine choices -- a 2-liter four-cylinder and a 2.5-liter five-cylinder -- were "unimpressive." Further, while the previous-generation Jetta offered a nicer interior than typical of cars in its class, the new model's cabin more resembles "five-year-old Fords" than recent VWs, the magazine said. Overall, Consumer Reports said its first impressions of the 2011 Jetta were "mixed."

VW counters by saying the Jetta has received as many, if not more, positive reviews by the automotive press. Ultimately, VW's Christopher says, "sales will tell the story." He didn't stipulate the company's U.S. sales goals for the new Jetta, but he did say VW expects to sell more copies than the previous-generation Jetta, which topped 108,000 units last year.

Despite its efforts, VW faces a tough slog in the U.S. market, says Jesse Toprak, an industry analyst at TrueCar.com. A few years ago, before Hyundai and Kia began making better cars and selling them more cheaply than comparable U.S. and Japanese makes, there was a hole in the market.

Questions About Quality

But Hyundai and Kia, both part of Hyundai Kia Automotive Group, have made significant strides in quality. In its most recent survey of initial new-car quality, J.D. Power and Associates said Hyundai scored seventh overall, better than the industry average and ahead of luxury nameplates such as Volvo and Ford Motor's (F) Lincoln brand.

In the same J.D. Power survey, VW placed near the bottom among all manufacturers, outscoring only Mitsubishi Motors and Land Rover. Quality improvement is a must for any major automaker that wants to sell lots more cars, Toprak says. "It isn't just volume and global presence and coming up with desirable models."

One advantage VW now enjoys is having witnessed the beating Toyota's reputation for quality has taken after its recent spate of recalls, Toprak says. VW has seen Toyota's misery, he says. "You can always learn from others' mistakes if you pay enough attention."