General Motors And Avto Vaz

General Motors and AVTO VAZ of Russia

To: GM Board of Directors

From: David Herman, President General Motors-Russia

Date: February 6, 2001

Subject: Business Plan for General Motors- Joint venture with AVTO Vaz in Russia

Goals -GM Russia Joint venture with Avto VAZ:

To make and sell cars in the former Soviet Union and eventually export a considerable percentage of them. This can be successfully achieved through a Joint Venture with AvtoVaz to penetrate the Russian market and produce and sell Chevrolets.

Be of the first auto makers to strongly penetrate the Russian market and gain first come benefits: Having the chance to get a network and get started with suppliers and other partners in Russia in a way that will put GM among the leaders. (Avto Vaz dealers across the country make up the only truly national distribution network for cars in Russia. And the existence of this dealer network is very positive for GM because building a dealer network from scratch is enormously difficult. )

To increase GM Global Market Share above its 13.6% mark by entering emerging markets: Due to GM shrinking global market share in 2000, Emerging markets like Russia represent the so called white-territories which are still unclaimed and uncertain markets for the traditional Western automakers and therefore provide a huge opportunity.

Situational Analysis:

Political Environment

Recent economic reforms and the perceived stability of President Putin's government indicate that the conditions are right for investment at this point. The European Bank for reconstruction and Development seconds this assumption..

Economic Environment

The Russian economy, although recovering from the 1998 collapse is still weak, uncertain and subject to confusing tax laws and government rules. The Russian car industry seems to reel from one crisis to another.

Domestic car production was on the growth again after the re imposition of import duties in 1994, but the 1998 financial crisis tremendously hurt the Russian economy and auto industry.

Exceptions and concessions have been made before: The Russian government has already given the blessing to the joint venture between Ford Motor Company and Russian manufacturers by allowing the elimination of import duties on imported inputs as long as the local content of the car reaches 50% within five years of the startup.

Legal and regulatory structure

The relatively lax legal and regulatory structure for corporate governance has been one of the primary deterrents to foreign investment in Russia. Identifying the owners of most major Russian companies is extremely difficult. Actual ownership of Avto Vaz is unclear and this may present problems like the hostile takeover bid of GAZ. Two main groups control Avto Vaz: AVVA 32.35%and AFC 19.19%. AVVA itself has been at some point influenced, controlled or owned in part by one of the most high profile oligarchs in Russia, Boris Berozowsky. By 2000 AVVA changed its status to a holding company and many speculate it was positioning itself to run AvtoVaz which had reorganized into divisions (car production, marketing and sales, research and development).

Recent warnings from the Kremlin that the new administration of President Vladimir Putin would not tolerate continued industry profiteering and manipulation by the country's oligarchs have put company's with dubious under reporting of automobile production on the spot, like Avto Vaz, who was accused off falsifying vehicle identification numbers, the basis for the states assessment of taxes. The case has been dismissed.

Automobile Industry Environment

Lags far behind that of Western Europe, North America and Japanese industries. Inadequate capital, poor infrastructure and deep seated mismanagement and corruption have resulted in outdated, unreliable and unsafe automobiles.

The industry is promising because of the gap between Russian market demand and supply and because of expected future growth in demand. Auto sales in Russia as a whole fell 8% after the Economic financial crisis of 1998 but the industry experienced a strong resurgence in 1999 and 2000.

Purchases of cars in Russia grew dramatically in 1993 due to the reduction of import duties and therefore at the expense of domestic producers, but imports came back from 49% to 10% with the re imposition of import duties in 1994.

Crime and organized Crime was prevalent in the factory floor with mobsters entering the factory and taking card directly from the production liens at gun point. By 1997 the intrusion of organized crime was so rampant that Russian troops were used to clear the plant of thugs.

Supplier market

Auto Vaz is not vertically integrated and depends on a variety of suppliers for components and subassemblies and an assortment of retail distributors.

Auto Vaz was prohibited by law of retail distribution, and in recent years the supplier base has been continually consolidated with the three biggest suppliers being DAAZ, Plastik, and Avtopribor. All are owned by SOK.

Auto Vaz, short on cash frequently paid taxes, suppliers and management in cars.

Dealership and Distribution

Most trading companies that were formed around Avto Vaz would exchange parts and inputs for cars at prices 20% or 30% below market value. These trading companies then sold the cars themselves capturing significant profit meanwhile Avto Vaz waited months for payment of any kind from them. This was possible because most of the trading companies were owned and operated by AvtoVaz managers and Russian law did not prevent management from pursuing interests related to their own enterprises.

Avto Vaz dealers across the country make up the only truly national distribution network for cars in Russia. The existence of this network is very positive for GM because building a dealer network from scratch is enormously difficult.

International Players

There are a number of foreign automobile producers in various stages of entry into the Russian marketplace. Daewoo of Korea has quickly reached a sales level in Russia of 15,000 units

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