In May 2014, Bernd Gottweis, a quality control at Volkswagen AG executive warned the company’s top management about an upcoming investigation by U.S. environmental authorities. The grounds? Volkswagen AG was suspected of using “test recognition devices” on some of its diesel engines. The whistle-blower was a group of researchers at West Virginia University; they had discovered that certain diesel-powered VW models emitted 30 times the allowable levels of nitrogen oxide during normal driving – models that all had passed laboratory tests.
On September 3rd, 2015, VW technicians informed the company’s management that modification of the engine control software “constituted a prohibited defeat device under U.S. law”. VW claimed to have been unaware of the situation’s true dimensions and believed that the issue could be resolved by agreeing with U.S. authorities on the necessary measures. In addition to making the vehicles compliant with the regulations, VW estimated a fine of $91 per vehicle. These calculations were based on past cases. Two weeks later, U.S. environmental authorities issued a notice of violation stating: (1) potential fines of $37,000 per vehicle; (2) The usage of the defeat device extend to 11 million vehicles worldwide. It turns out Volkswagen had been employing this emission-cheating software, the so-called defeat devices, in diesel models since 2008.
The Defeat Device
Apparently, by using a range of measurements the defeat device can determine if a car is driving on a road or in a laboratory and then automatically adjust the performances to legal levels, thus deceiving the inspectors. VW has stated that this illegal action was a necessary manoeuvre to meet the tightening emission standards as well as to boost sales in the U.S., a market where it was losing ground to rivals and faced intense cost pressure.
Make it Right
In January 2016, VW started recalling its cars in Europe, in what was estimated to be the biggest recall operation in automobile history. The fix for each model has to be approved by German authorities – an ongoing process. Once a fix is approved, however, it applies to all vehicles across the European Union. Whereas the recalling process has picked up good pace in the EU, the situation in the U.S. is very different because: (1) The U.S. operates with tougher restrictions on nitrogen oxides than Europe; (2) The U.S. vehicles are equipped with older technology that cannot be fixed so easily; this results in a more complicated fix – U.S. authorities have yet to approve any of VW’s plans. Subsequently, VW has offered its U.S. customers monetary compensations as a sign of good will. This last attempt of making things right in the U.S. has made European victims grumble, as they never received monetary compensations for the inconvenience. This certainly paints a good picture of the turmoil VW has gotten itself into.
The Reality Hits Hard
In 2015, VW worldwide sales dropped by 2% – a first in 13 years. Status thus far in 2016 is interesting: while it is true that sales of all VW diesel models in the U.S. have ceased, February sales grew, interestingly enough, by 6.5% in Europe. VW blames the fast dropping sales in Brazil and Russia on the countries’ economic woes, while a more moderate drop in China has been due to this year’s late Chinese New Year holiday.
Troubled finance ahead
After making an initial estimation, VW set aside about $7.5 billion to cover the costs related to car recalls – not accounting for litigations. By multiplying car numbers by the maximum fee, the U.S. government has lodged a suit indicating maximum damages of roughly $45 billion. However, it is worth mentioning that similar fines ultimately never came close the sum calculated by this method.
As if that was not enough, class action lawsuits are being filed against Volkswagen from multiple groups of interest in America, alleging that VW has “perpetrated a massive fraud upon consumers” and “profited greatly from its misconduct”. These statements are not made up, since Volkswagen did actually advertise hard on its “clean diesel” technology (ultimately giving them 70% of the diesel engine market in the U.S.) during the very same period that they were cheating on the emission tests.
The entire rumble around their brand name has lead to €26 billion drop (note that the Euro Stock Index itself has dropped 14%) in VW’s market value since the beginning of the scandal, or to put it into context, 1/3. This makes for a difficult future for a company that as late as in 2014 raised concerns about the fixed costs spinning out of control. The latest reports confirm that uncertainty about the cost of the emission scandal has lead to VW delay reporting its annual earnings and move back the date of its annual shareholder’s meeting. According to a MIT professor, it is not unusual for companies to delay earnings. But it is often a harbinger for bad news.
The Future of VW
Not only will VW have to fix over half a million cars, it may be forced to take environmental action to clean up the air it has polluted. Some environmental groups have even suggested that VW should fund the infrastructure required to promote the research and development of electric cars.
Diesel engines are typically 25% more efficient than petrol versions. However, in light of the VW scandal there is significant consumer sentiment that better is not good enough. Many are looking for an electric future. This scandal is expected to result in a steep drop in demand for diesel cars.
A road to change
Volkswagen’s reputation has taken many blows during this affair, and significant management changes have already taken place. Michael Horn recently stepped down as the CEO of VW Group of America, while the company CEO Martin Winterkorn resigned already late September last year, and was then replaced by Matthias Müller. The top management can always dispute whether Gottweis’ first report on the emission problems ever reached them or not, the answer to this may never come for a day. What they cannot argue, however, is that as leaders of this business it was their responsibility to know. That they cannot argue. It may therefore be to the best that the men at the top steps down, despite the uncertainty on whom to blame. A change in leadership may spur on renewed hope in the giant.
With a significant push to promote the use of electric cars by the German car giant, Tesla may even see new competitors entering the market as a result of the increase in public demand for cleaner cars. A number of new electric cars were rolled out at this year’s Geneva motor show in March. Of the new competitors Citroen and Fiat boasted stunning new electric cars that may well give tesla a run for its money.
By the same token, the once trusted brand in the motor vehicle industry may have an opportunity to recover only if they can beat Tesla. Whilst Tesla may have a head start in the race, one should not disregard that VW is among the world’s two largest auto manufacturer.
VW has a lot going for it in a fight against Tesla. For one, it has money to burn, with about $30 billion in cash, and the scale of its operations really sets it apart from Tesla, which is hoping to sell only 200,000 units in 2020, nothing against VW’s 9.9 million cars sold in 2015. Remarkably enough, Volkswagen brands and models not directly involved in the scandal can show for impressive sales numbers lately. This may indicate that VW could be better off distancing themselves from the diesel options from now on, and truly start exploring the opportunities of newer technology. The only way forward for VW is far forward, well into the future of electric cars.
The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.