July 15, 2014 / 1:20 PM / in 4 years

UPDATE 3-VW plans cost cuts to close profit gap with rivals

* May cease models, cut procurement costs

* VW brand trails 6 pct profit margin goal

* Analyst sees risk of brand margins slipping further

* VW declines comment on rumours of CEO contract extension

* Management must cut out its own mistakes -VW labour chief (Adds comment from VW works council chief)

By Jan Schwartz and Andreas Cremer

HAMBURG/BERLIN, Germany, July 15 (Reuters) - Volkswagen plans to cut costs at its core passenger-car brand by about 5 billion euros ($6.8 billion) per year from 2017 as it struggles to match the earnings power of global rival Toyota.

VW’s namesake brand, the carmaker’s biggest division by sales and deliveries, is lagging a profit margin target of at least 6 percent because of fixed costs that it said are high relative to Japan’s Toyota.

The brand’s 2013 profit margin was 2.9 percent, compared with auto division margins of 8.8 percent at Toyota and 9 percent at Hyundai Motor Co of Korea. Much of VW’s production is in its home market of Germany, where workers secured a significant pay increase last year.

Analysts have said VW’s profitability gains are disappointing given its steady expansion. The company looks set to hit a sales goal of 10 million autos a year in 2014, four years ahead of target.

“Let’s be honest: We have a lot of catching up to do with our core competitors,” Chief Executive Martin Winterkorn wrote in a letter to VW managers obtained by Reuters on Tuesday.

“That is why we must now take action that is clear, effective and sometimes painful,” the CEO said, pointing out that research and development costs had surged 80 percent across the multi-brand group since 2010.

To boost efficiency across its 310-model empire, Europe’s biggest automotive group is reviewing its strategy. A post-2018 plan dubbed “future tracks” will set out priorities on technology and model policy and may be outlined later this year.

“VW’s and Audi’s product momentum remains tough for 2015,” said Arndt Ellinghorst, London-based analyst at investment researchers ISI Group. “We see a real chance that margins keep slipping.”

Winterkorn said VW may decide to cease making non-profitable models, citing convertible cars at the namesake brand which accounted for over a third of the group’s 47.8 billion euros in first-quarter revenue but only about 15 percent of operating profit.

Other steps may include reducing procurement costs and improving sales channels, according to VW.

VW shares ended 0.03 percent lower on Tuesday.

The CEO’s call for greater cost discipline follows a similar plea in February, when Winterkorn urged senior managers to keep costs down to weather tough market conditions.

VW toned down its 2014 profit guidance in February, saying core earnings may only improve if economic conditions improve more than expected, especially in Europe where VW sells about 40 percent of its vehicles.

Staff representatives urged VW’s management to pay heed to workers amid the efficiency drive.

“Management must cut out its own mistakes,” Bernd Osterloh, head of VW’s works council wrote in a newsletter to be published on Thursday. “The focus needs to be shifted to whatever earns money,” Osterloh, who sits on VW’s supervisory board, said.

Separately, VW declined comment on a report by Germany’s Manager Magazin published on Tuesday saying that Winterkorn had agreed with leaders of the supervisory board to extend his contract by two years until 2018.

$1 = 0.7331 Euros Reporting by Jan Schwartz. Additional reporting by Andreas Cremer; editing by Tom Pfeiffer and Jane Merriman

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