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Why is Volkswagen thriving while Fiat and Renault crash?

What do car companies sell? If you answered "cars," you're only half right. Their other main product is customer financing.

At a time when there is little variation in car quality—the leading American, Japanese and European players seemingly pump out identikit products—price, and therefore financing, becomes the key selling point. This explains why Germany's Volkswagen is killing the competition, at least in Europe. It also explains why Europe's lesser industrial powers—France, Spain and Italy—should hightail it out of the euro zone.

To elaborate: We all know that the euro zone crisis has hit Germany with far less force than the rest of Europe. The euro's fall from about $1.60 (U.S.) just before the financial crisis took hold in 2008, to a low of about $1.20 in 2010, and the modest recovery to $1.34 recently has worked miracles for German exports, job creation and morale. It has made the bailouts of Greece, Ireland and Portugal less odious to the average German. What is only now emerging is what a godsend the crisis was to any German industrial corporation that offers customer financing.

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The borrowing costs of big companies tend to track the sovereign debt markets. A company based in a country with a top credit rating will have a huge advantage over a competing company based in a country with a lower credit rating, even if the companies sell their products in the same markets. Take Germany. Thanks to its safe-haven status, Germany could borrow 10-year money at 1.7% in January. At the same time, Italy had to pay 4.3%, Spain 5.2%, Britain 2.1% and France 2.3%.

Which brings us to VW. It wants to displace Toyota as the planet's No. 1 carmaker, and it can borrow at rock-bottom rates. The coupon on the five-year bonds that VW sold last year was about 1.875%. At about the same time, France's Peugeot Citroën was paying 5.625% and Italy's Fiat, the controlling shareholder of Chrysler, was paying 7.75% on a four-year bond.

Now, suppose you're shopping for a new set of wheels. Let's say you live in Italy and you like the little Fiat 500, Fiat's signature car. But you also like the VW Up!—not as cute as the Fiat, but a quality machine. The showroom prices of the two cars are similar. So you go for value and the VW wins. Why? Because it comes with zero-per-cent financing, depending on the size of the down payment. Financing the Fiat will set you back 3.67% (the rate in late January) over 36 months.

It's impossible to say that all of VW's surging sales and market share are the direct result of low financing costs, but there's no doubt it's a big factor in Europe, where consumers are tapped out and worried about their jobs. VW's Western European market share is 24%, up from 20% in 2009. More than a third of the cars it sells in Europe go out the door with customer financing, up from 20% three years ago.

To be sure, VW is not immune to the European crisis. Its sales in the EU declined by 1% between January and October last year. But that's a miracle compared to the 18% drop at Renault of France, 16% at Fiat and 12% to 13% at Peugeot Citroën (which recently took a bailout-lite by accepting ¤7 billion in French government loan guarantees).

No wonder Fiat-Chrysler boss Sergio Marchionne is in a panic. Fiat is even losing money and market share in the Italian market. In an interview with The New York Times last summer, he accused VW of using irresistible pricing, no doubt subsidized by ultracheap financing, to trigger a profit-margin "bloodbath" in Europe. While the French, Italians and Americans are soaking up excess capacity by closing factories, mighty VW is exploiting the fragmented borrowing market by keeping its assembly lines humming.

The yawning gap in financing costs between Germany and the rest of Europe is unlikely to disappear soon—even though it has narrowed since last summer. So, VW's competitors face painful decisions. Their efforts to replace falling European demand with exports is no easy job as the euro's value climbs. Cost-cutting is the default option, but spending less on product development ultimately hurts competitiveness.

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In the past, Spain, France and Italy simply devalued their currencies to remain competitive. For Italy, in particular, the euro has been a disaster, especially for its industrial base, which is still Europe's second largest, after Germany's. But it is now sinking fast, sending Italy's jobless rate into double digits. The downturn will worsen as the United States, Japan and other countries launch devaluation wars.

Italian industry is probably hoping that Greece will dump the euro soon. If it does, a chain reaction is virtually assured, and Italy can take back the lira and become a cheap country again. The alternative is death by a thousand cuts—a "bloodbath," to use Marchionne's words—which would put a smile on Germany's face.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More

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