Audi Ponders Dilemmas of International Growth

Luxury car maker Audi is trying to perform a very delicate balancing act.

While economic pressure is forcing it to expand production to developing markets far from its German home, Audi sales benefit from customers' perception that its heritage results in well-made products. That link in part keeps Audi from moving too much of its total production out of the country.

The company has invested billions of euros to expand its production and presence globally in the past few years as sluggish demand in Europe continues to lure its manufacturers away from the continent.

"The coming year will be the first time we produce more cars outside instead of inside Germany," Audi Chief Executive Officer Rupert Stadler said in an interview.

It is not just that the European market has weakened while demand elsewhere booms that has pushed internationalization. Factors such as import duties, exchange rate fluctuations and transport costs also play a significant role.

Audi, a unit of Volkswagen AG, Europe's largest car maker by sales, will continue to shift production geographically, but intends to keep capacity in Germany constant, in absolute terms, Mr. Stadler said. Last year about 55% of the total 815,000 Audis produced came off assembly lines in Germany. Less than five years earlier it had been about 75%.

"In the long term, capacity in Germany will make up about 35% to 40% of the total," Mr. Stadler said.

"We will see the occasional opportunity to expand capacity further," Mr. Stadler said, with the Asean region and South America being possibilities.

Audi is now building new plants in Mexico and China. The next stop could be in Brazil.

"We'll make a decision on a possible production site in Brazil in the second half," said Mr. Stadler. The country is an important growth market, and Audi rival BMW AG set up assembly lines there last year.

Audi is not alone in moving production. Leading luxury car maker BMW has nearly doubled its capacity in the U.S., South Africa and China in the last two years. Daimler AG's Mercedes-Benz has also invested heavily outside Europe in the past years. But while between 70% and 75% of output remains in Germany, only about 40% of Mercedes are sold in Europe.

Speaking at a news conference on Wednesday, Daimler Chief Executive Dieter Zetsche said that by the end of the decade about half of all Mercedes will be built in Germany. Among projects outside its home country Daimler is investing $2.4 billion in its Tuscaloosa, Alabama, plant, to build the new generation C-Class there as of next year, and a new model line as of 2015.

Yet so much production moving abroad actually helps bolster production capacity in Germany, says Christoph Stuermer, an analyst at IHS Automotive.

"Home-market production is part of brand identity," Mr. Stuermer said. Top luxury models are associated with "Made in Germany," and this is a strong selling point.

Mr. Stuermer considers production abroad important for car makers in economic terms, but expects production in Germany overall to remain at least constant.

Even labor representatives realize auto manufacturers need to place some production abroad if they want to remain competitive.

"Industry growth is centered above all in Brazil, Russia, India and China—similar growth rates can't be expected in Europe anymore," said Christian Brunkhorst, auto expert at powerful German labor union IG Metall. "So we see the necessity of answering [regional] demand with [regional] output capacity," he said.

Audi itself is in the midst of the largest investment program in its history, Mr. Stadler said. At the end of 2011, the company said it would invest more than €3.5 billion per year from 2012 through 2014, or a total €11 billion in the period.

The company aims to be the top manufacturer in the premium sector by 2020, and has set a sales goal of 1.5 million units for 2015. The company could, however, reach that milestone this year, after selling 780,000 cars in the first half, thanks to strong growth in the U.S. and China. The second half also started well.

"July is developing positively, the situation is stable," Mr. Stadler said. "We are anything but disappointed with orders."

Regional developments are very uneven, Mr. Stadler admitted. "Development in the U.S. market is very stable; even China's economy continues to grow—and with it the demand for cars. In Europe, however, we feel the sovereign debt crisis is not yet over."

In Europe this year, Audi expects the auto market to decline between 5% to 6%. This will be the sixth year of decline in succession, and mark the lowest level of sales since the early 1990s.

"I see the European car market more or less stagnating for the next two to three years. It looks as though [Europe] has bottomed-out to some extent at this point," Mr. Stadler said.

But despite Europe, Mr. Stadler expects industry growth in global terms or around 2% this year, supported by China and the U.S. He is wary of overestimating indications of weaker economic growth in China, the most important market for Audi.

"One shouldn't be overly influenced by single quarterly growth reports," Mr. Stadler said. "Of course, there are fluctuations but that doesn't change the long-term trend—the Chinese car market is growing."

Audi was the first premium car manufacturer to enter China 25 years ago and is now seeing the payoff. By around 2020, it aims to sell 700,000 cars annually in China.

"In 2013, we will sell about 450,000 cars in China," said Mr. Stadler. Last year was the first time Audi topped 400,000 sales there.

Growth in the coming years should come from branching out regionally in China. Audi, like many of its competitors, is unrepresented by its own dealership in many large Chinese cities, primarily in the west.

"Every week we open a new dealership in China. At the moment we have about 300, in 2020 it will be well over 500," Mr. Stadler said.

In the U.S., business is beginning to pick up again after Audi, for a period, lagged far behind its main competitors.

"Our goal in the U.S. this year is to crack the 150,000-sales point," said Mr. Stadler. "In the U.S. we currently have the lowest level of incentives in the premium segment, because we want quality growth."

China and the U.S. are crucial to Audi's 2020 goal to be number one in the luxury car segment.

Mr. Stadler views the three-way battle with industry leader BMW and Mercedes-Benz calmly.

"We have built up a good lead on Mercedes-Benz and are close to BMW," he said.

In addition to the benefits of internationalization, a wider product range should help Audi in its bid to be top dog, with the focus on strengthening the SUV and upper-end segments.

"At the moment we offer 44 different models, and that'll move toward 60 in the coming years," Mr. Stadler said.