(Bloomberg Businessweek) -- As the world’s largest automaker, Volkswagen in some ways better resembles an army or a country than a mere corporation. Its flagship factory in Wolfsburg, Germany—a city built from scratch by the Nazis for the express purpose of manufacturing vast numbers of automobiles—spreads over an expanse the size of Monaco and produces more than 3,000 vehicles every day. It is electrified by not one but two Volkswagen coal plants. It is fed by a 3,400-person Volkswagen catering brigade and a sausage-making operation so comprehensive it sells to supermarkets. Here and at more than 100 other factories worldwide, the company’s 12 brands make 355 models in millions of color and trim combinations, employing more than 600,000 people who generate $284 billion in annual revenue.
It’s hard to imagine that such a robust corporate edifice could ever be at risk of collapse, as it was less than three years ago, when Volkswagen AG was consumed by one of the largest scandals in automotive history. The revelation of a systematic effort to cheat on emissions tests—employees wrote software that made diesel cars appear cleaner than they were—brought the company to its knees, ended the career of its long-standing chief executive officer, and shattered a 70-year reputation for engineering-led competence. For a time it looked like Volkswagen might not survive, at least not recognizably, a prospect so alarming in Germany that Chancellor Angela Merkel stepped in to do damage control for what is arguably the country’s most important industrial giant.
And yet today—$30 billion in compensation and repair costs and 11 million affected vehicles later—Volkswagen is, improbably, back on the offensive. Last year the Volkswagen portfolio of brands—including Audi, Porsche, and Bentley—comfortably defended its global sales crown from a challenge by archrival Toyota, in large part because revenue is soaring in China. Volkswagen’s profits, and shares, have largely recovered to pre-catastrophe levels. It’s even growing again in the U.S., a market its namesake brand considered abandoning. Consumers’ willingness to forgive Volkswagen is remarkable, given the enormity of its wrongdoing: Scientists at the Massachusetts Institute of Technology estimated the extra pollution generated by its rigged cars will eventually contribute to more than 1,200 premature deaths.
Emboldened by this unexpectedly rapid rehabilitation, CEO Matthias Müller, 64—a Volkswagen lifer who received a battlefield promotion from running Porsche when the crisis claimed his predecessor—is attempting to reimagine the company for the electric vehicle age. Volkswagen late last year embarked on by far the largest program of electrification in the global car industry, pledging to spend €20 billion ($25 billion) to develop battery-powered or hybrid variants of every one of its models by 2030. Müller’s goal is to make EVs, currently concentrated at the high end of the market, cheap and commonplace, inspired by Volkswagen’s own 1960s Beetle, which was instrumental in bringing mass-market driving to postwar Europe.
Transformation won’t come easily to Volkswagen. It’s fighting thousands of investor and customer lawsuits that will keep it in court well into the 2020s, and criminal probes into some aspects of the diesel fiasco are still active. Its powerful unions have a de facto veto over any major strategic change and have long resisted efforts to reform a sprawling, costly corporate structure. And as the entire automotive world faces an unprecedented threat—the rapid shift of a car from something consumers buy to a service they order on demand, probably with no driver involved—Volkswagen’s insular culture will make adapting to new ways of selling mobility a huge challenge.
The company is nonetheless in a much better position than was imaginable not long ago. Its leaders are even daring to suggest that the diesel crisis may ultimately prove to have been a good thing, at least from their perspective: a trauma that forced Volkswagen to ask hard questions about its operations and strategy and what a carmaker will need to look like to survive the 21st century.
The crisis was “an unmistakable wake-up call—a warning that things couldn’t stay the way they were,” Müller said in Berlin in March. “It told us there was a need for radical change,” he continued, “change that would have previously been unthinkable or, at the very least, impossible to implement.”
On Sept. 20, 2015—just after the U.S. Environmental Protection Agency accused Volkswagen of rigging software to make cars that generated 10 to 40 times the legal levels of smog-causing nitrogen oxide appear compliant with the rules—its top executives gathered for an emergency meeting in Wolfsburg. Virtually everyone present was male and German, most of them engineers or scientists by training—not an ideal team to handle a dramatic public-relations crisis playing out primarily across the Atlantic.
As one of its first decisions, the group dispatched then-CEO Martin Winterkorn to record a two-minute apology video. It was a disaster. Standing in front of a white background in a Wolfsburg studio and speaking in stiff, staccato German, an ashen Winterkorn said he still didn’t know the full extent of what had happened, but described the cheating as a result of “terrible mistakes made by only a few.” The strained tone and clunky production brought to mind a kidnapping victim’s forced appearance in a ransom video, rather than a commanding corporate leader demonstrating control of the situation.
Things only got worse. The U.S. Department of Justice began laying the groundwork for criminal charges against some staff, and authorities in France, Canada, Germany, and South Korea began their own inquiries. Within a few days of the EPA going public, Volkswagen shares lost a third of their value. Winterkorn’s attempts to blame the cheating on a few bad apples were widely ridiculed. A 30-year Volkswagen veteran with a doctorate in metallurgy, he was notorious for scrutinizing the tiniest production details—chastising underlings when he deemed chrome parts inconsistently shiny or gaps between metal panels too large. After Winterkorn bowed to investor pressure and resigned in late September, Volkswagen’s board emerged from a seven-hour meeting to name Müller as his successor. (It later appointed a new chairman, Hans Dieter Pötsch.)
For Müller, it was a move from perhaps the best job in autos to the worst. He’d spent the previous five years as CEO of Porsche, delivering considerable profits and cultivating a reputation for cheerful informality—at least by the standards of German automotive executives—with stunts such as joining the Porsche pit crew at Le Mans, ditching his usual suit for a mechanic’s outfit. In his new job, he adopted a graver tone: “This crisis,” he told a tense gathering of workers in a hangar-size Wolfsburg production hall shortly after taking charge, “is about the very core of our company and our identity.” Volkswagen, he said later, was in for “a painful process.”
The beginning of Müller’s tenure easily lived up to that warning. He didn’t seem prepared for scrutiny; the German press lambasted him for turning up at a black-tie ball in Leipzig and an auto race in Bahrain as the crisis deepened. Meanwhile, the list of models alleged to have used rigged software kept expanding, eventually including Porsches—undermining Müller’s untainted image. In January 2016 he told an incredulous U.S. radio interviewer that the software spoofing was a “technical problem” and that Volkswagen hadn’t lied about its cars—hardly indicative of a grasp of the gravity of the situation. Not long afterward, the company took the extraordinary step of delaying its scheduled earnings release, an ominous sign that it didn’t have a handle on the damage. Industry analysts’ estimates of the final bill to recall rigged cars, compensate buyers, and pay fines ranged as high as $80 billion, significantly more than Volkswagen’s market capitalization. Some predicted that a breakup of the group, with units put on the block in a fire sale to pay that bill, was a probable outcome.
“You would have wondered a year ago to what extent Volkswagen was going to follow through on their headlines, but it’s really happening, and they’re serious”
Volkswagen, however, caught some very lucky breaks. In the U.S. it had the good fortune to be in trouble after previous megascandals, including BP Plc’s 2010 oil spill, had helped create an infrastructure for consolidating the claims of state and federal regulators, along with the bulk of customer lawsuits, into a single legal proceeding. That process, which was partly overseen by former FBI Director Robert Mueller—then working in private practice as a sort of unimpeachable referee for hire—allowed its U.S. outlay, while enormous, to become something of a fixed quantity relatively quickly. That meant executives could begin to plan for their ultimate exposure. (The main settlement cost Volkswagen $14.7 billion.) The company also benefited from a judge—Charles Breyer, of the U.S. District Court in Northern California—who guided the legal proceedings in an uncommonly efficient manner. Another advantage: the media spotlight rapidly shifted to a more sensational story than sneaky firmware, namely the presidential campaign of Donald Trump.
Volkswagen was also fortunate that the vast majority of the affected cars were sold in Europe, where rules on nitrogen oxide emissions, unlike those for carbon, are less stringent than in the U.S. European Union rules stipulate that the decisions of an automaker’s home-country regulator typically prevail across the 28-nation bloc, and in Germany, Merkel’s administration ruled that Volkswagen could simply modify the vehicles, instead of forcing it to offer the buybacks and compensation that were required in the U.S. As a result, Volkswagen is now coming to the end of a process to repair about 8 million European cars, mainly with inexpensive software upgrades that brought their emissions into compliance with the rules.
The scale of the crisis at Volkswagen nonetheless provided an opportunity for Müller and his team to eliminate some costly sacred cows. One of the first was the Phaeton, an ungainly luxury sedan beloved by former Chairman Ferdinand Piëch and seemingly no one else. Priced at almost €90,000 and assembled by hand in a factory with hardwood floors and glassed-in viewing stations for the public, the Phaeton represented a bizarre bet that high-end buyers would prefer an over-engineered Volkswagen to a BMW, Mercedes, or, for that matter, an Audi. Just 4,000 were made in the year before the model was killed off.
Müller handed over the Wolfsburg building that housed the Phaeton’s engineering team to a new unit charged with rapidly developing EVs. He also began work on a new deal with Volkswagen’s unions. Previously, they’d helped ensure that Volkswagen employed two-thirds more staff than Toyota Motor Corp. to produce roughly the same number of cars. Volkswagen’s vehicles have far more components produced in-house than competitors’ cars do: Items from seats to transmission parts are made internally, largely by well-paid German workers. The unions and Müller ultimately agreed to a 30,000-person reduction in Volkswagen’s workforce. Out also went an events budget lavish even by the standards of the publicity-focused auto industry. Before the crisis, Volkswagen had routinely booked the likes of Justin Timberlake to appear at product launches; nowadays the music pumped in is recorded.
Moving Volkswagen into the future, rather than just past the immediate effects of the emissions scandal, would require more dramatic change. Diesel was at the core of Winterkorn’s strategy, billed as sportier and better for the environment than gasoline. With “diesel” suddenly synonymous with “fraud” for many customers, Müller needed a different approach. He unveiled it at an event in Paris in September 2016: the I.D., a battery-powered hatchback with a range considerably longer than Tesla Inc.’s lowest-priced vehicle and intended to bring electric propulsion to the masses. The car, Müller said, was a symbol of “a new Volkswagen”—one that might still be apologizing, repeatedly, but was ready to move forward, too.
While every automaker is pushing into EVs, levels of ambition vary widely. The Asian giants—Toyota and Hyundai Motor Co.—are betting on exotic technologies such as fuel cells while also investing in hybrids. U.S. automakers, on the whole, are moving slowly because of their home market’s reluctance to reckon with climate change. None is committing nearly as much capital as Müller’s Volkswagen. The company’s goal is for EVs to account for as much as 25 percent of global sales by 2025—when they will still represent just a small fraction of worldwide demand. The Paris event kicked off 18 months of increasingly ambitious pronouncements on Volkswagen’s EV plans, from a €10 billion pledge to develop new models in China to a €20 billion deal announced in March to secure battery deliveries through the early 2020s, part of a total of €50 billion earmarked for battery purchases. Such big spending is made possible, in part, by Volkswagen’s unusual shareholding structure. The state of Lower Saxony, where Wolfsburg is located, owns 20 percent of the voting rights, and can almost always be counted on to support job-preserving expansion.
Volkswagen is “absolutely more ambitious on EVs than the other global giants,” says Max Warburton, an automotive analyst at Bernstein Research in London. “You would have wondered a year ago to what extent Volkswagen was going to follow through on their headlines, but it’s really happening, and they’re serious.”
Early on a Tuesday morning in February, a team of investigators from the Munich prosecutor’s office arrived unannounced at Audi’s headquarters in Ingolstadt, just outside the Bavarian capital—a hulking, glassy office block inscribed with the luxury brand’s slogan, “Vorsprung durch Technik,” or “Progress through technology.”
Employees stood aside as the investigators fanned out, boxing up documents and pulling hard drives. The Audi staffers knew the drill: The raid was the second at the HQ in less than a year and followed searches of a half-dozen executives’ homes a week earlier, part of an ongoing German inquiry into the unit’s role in the diesel scandal. The investigation is distinct from probes into Volkswagen as a whole and is focused on whether Audi had its own software-based diesel-rigging program and could lead to criminal fraud charges.
Audi, which contributes more to Volkswagen’s profit than any other brand, has been roiled by the investigation. One senior manager, who asked not to be identified discussing the internal mood, said workers are exhausted by the one-thing-after-another drumbeat of bad news. A certain gallows humor prevails across the Volkswagen group; some employees have taken to joking, when praised for doing a good job, “Yeah, well, I just modified my software.”
For Müller and his team, the Ingolstadt raid was an unpleasant reminder that the diesel scandal will have quite a long tail. BP provides a cautionary example. The oil producer is still paying for the Deepwater Horizon spill almost eight years on, and in January it announced a further $1.7 billion hit, bringing the total bill to about $65 billion. More than €9 billion in legal claims are outstanding against Volkswagen, including suits from investors who argue it disclosed the rigging program too late.
As it tries to limit the pain from those cases, Volkswagen must navigate another major challenge: persuading consumers to buy diesel cars again. Even with aggressive development, it will take another half-decade or more for EVs to be consistently profitable, especially at the lower end of the market—batteries are still simply too expensive. One example: An electric Volkswagen Golf starts at more than $30,000 in the U.S., compared with $21,000 for the conventional model.
Until prices come down, Volkswagen and other German carmakers need to keep selling diesels, which produce less carbon than comparable gasoline cars, to meet EU emissions requirements while still making money. With billions in capital investments sunk into diesel, “they don’t want to have the transition happen too quickly and disruptively,” says Stefano Aversa, a managing director at corporate advisory firm AlixPartners LLP.
For Volkswagen, this means trying to pull off a tricky two-step. It must sell consumers and investors on a shimmering electric future, while also restoring their faith in old-fashioned diesel—a technology that Müller, with exquisite Teutonic awkwardness, praises as “a very comfortable drive concept”—in the here and now. Current evidence suggests it’s not working. Diesel cars currently account for about a third of sales in Germany, down from half before the cheating crisis. Many German cities have considered barring from their downtowns some older diesel engines, which can contribute far more to smog than gasoline counterparts. In Germany the issue has great political import; Merkel convened two “diesel summits” last year with car-industry bosses and municipal leaders, at which she tried to come up with compromises to head off urban bans that would devastate German automakers.
Volkswagen in the meantime is trying to prepare for the future as best it can. At the Geneva International Motor Show in early March, Müller took the stage to unveil the I.D. Vizzion, an electric sedan that will be on sale from 2022. (It will follow the release of an SUV called the I.D. Crozz; apparently, nonstandard orthography will be another defining feature of 21st century cars.) From next year, the company plans to release a new EV or hybrid model every month. It’s also investing in so-called mobility services through Moia, a new unit that will begin offering ride-sharing in Germany this year with a fleet of Volkswagen-built electric shuttles.
Yet as impressive as Volkswagen’s recent performance may be, its ultimate success is uncertain and fragile. Until recently, access to natural light at its offices was determined by seniority; a company that hierarchical is an unlikely candidate to out-innovate Silicon Valley in data science and mobility services.
And its leaders still live in fear of the catastrophic damage that could result from another scandal, whether from fresh malfeasance or skeletons from its precision-machined closets. They had a taste in January, when reports surfaced of a series of tests, funded by Volkswagen and other German carmakers, measuring the effects of diesel exhaust on monkeys sealed in an airtight chamber. The experiments would have provoked outrage anywhere, but were especially horrifying in Germany, for obvious historical reasons. (Volkswagen condemned the testing and suspended an executive who had been aware of it.)
Müller, who’s become noticeably less relaxed and approachable since leaving his job at Porsche, sometimes appears haunted by the responsibility of keeping Germany’s industrial crown jewel clear of another disaster. At an all-hands meeting of managers in mid-March, he showed colleagues a bracelet he wears every day as a symbol of his stated priorities, a leather band engraved with the phrase “trust and honesty.” Words to live by, certainly—and a reminder that despite its unexpected success, Volkswagen still has a long way to go to rebuild. —With Elisabeth Behrmann and Dimitra Kessenides
https://soundcloud.com/bloomberg-business/how-volkswagen-survived-dieselgate-read-aloud
To contact the authors of this story: Matthew Campbell in London at mcampbell39@bloomberg.net, Christoph Rauwald in Frankfurt at crauwald@bloomberg.net, Chris Reiter in Berlin at creiter2@bloomberg.net.
To contact the editor responsible for this story: Nick Summers at nsummers1@bloomberg.net.
©2018 Bloomberg L.P.
