Volkswagen is the most important brand of the Volkswagen Group (VAG) concern and it is the biggest manufacturer of cars in Europe and the third manufacturer worldwide, next to General Motors and Toyota. The holding company also includes other brands such as Audi, Seat, Skoda, and Porsche. Volkswagen Group is famous for their high-quality and safe cars in each segment, not only in the private cars class like Audi and Skoda, but also in the more expensive sporty class like Porsche.
The company was founded in 1937 and it was operated by the German Labour Front, a Nazi union organization. The Austrian engineer Ferdinand Porsche was hired by Adolf Hitler to make the ‘people’s car’. At the time of the World War II production couldn’t start. However, after the War, the company was rebuilt and mass production started in 1946 with well-known Volkswagen Beetle being the first car made.
Last year (2014), the company had a turnover of €202,5 billion and a net profit of €11.1 billion. This turnover and profit were some of the best they ever had. In the recent years, their stock price has seen a constant rise, valued at $100 in October 2011 and at over $220 in April 2015. However, at the moment Volkswagen Group is dealing with a scandal it never experienced before. Volkswagen is under worldwide pressure after a discovery, in the United States, that their diesel engines could only pass the environmental tests with the help of special software, changing the performance accordingly, in order to improve results. This pressure can be seen in the strong decline in the share price and also in the recent declining sales figures due to the negative news about the diesel engine scandal. The most important question is, therefore: why did the recent scandal, which is dubbed as ‘Dieselgate’, take place if you look at the amazing turnover and profit? Did they perhaps obtain these numbers in an dishonest way?
What exactly is going on?
The American environmental regulators – Environmental Protection Agency (EPA) and California Air Resources Board (CARB) – are accusing Volkswagen of fraud due to an infringement of the environmental rules regarding diesel engines’ emissions. The Volkswagen’s engines have been equipped with special software that ensures that emission output is smaller when testing in a garage compared to normal use on a public road. The process goes as follows: when a car is tested, it will be placed on a test bench, the wheels are spinning but the car is not moving and, therefore, the electronic devices like GPS are not working. Accordingly, the software detects that the car is being tested and adjusts emission to levels that meet the regulations. On the other hand, when the car is actually on the road, the so-called ‘clean’ diesel engine of Volkswagen has more emissions due to the software turning off the emission controls. As a result, released into the atmosphere is nitrogen oxide, a chemical compound that is causing smog and is harmful for our health and the environment. According to the authorities, the engines emitted nitrogen oxide pollutants up to forty times above what is allowed. The fraud is committed to circumvent the so-called Clean Air Act, a United States federal law designed to control air pollution on a national level. It is one the United States’ most influential environmental laws and also one of the most comprehensive air quality laws in the world.
Volkswagen is not denying their wrongdoing and is taking full responsibility. The Volkswagen’s top United States executive went before a congressional committee to answer questions about why his company intentionally circumvented emission regulations by installing illegal software in millions of its diesel engines. CEO of Volkswagen Group of America, Michael Horn, admitted that the illegal software was installed for the purpose of beating tests. The cars in question are being removed from sales, particularly Volkswagen and Audi models.
The question left is, why did Volkswagen do this?
It looks like it is an unwise move for Volkswagen. However, there is a reason behind it. Cars with fewer emissions – as a result of that – have less power and are more expensive in maintenance and production. Thus, Volkswagen will have more costs of producing cars, but the produced cars cannot be compared with those of other manufacturers. This is obviously not a good marketing argument and could lead to fewer sales and less profits. The market for cars running on diesel is relatively small in the United States and since Volkswagen is willing to exceed the Japanese Toyota as the biggest car manufacturer in the world, they did everything to sell their ‘fuel-efficient’ engines to gain market share.
What are the consequences now for Volkswagen?
Firstly, the Chief Executive Officer (CEO) of Volkswagen Group, Martin Winterkorn, resigned. He has the final responsibility after all. He said that his company had ‘broken the trust of our customers and the public’. Martin Winterkorn himself always rejected having knowledge about messing with illegal software systems and testing of diesel engines. There is an on-going penal investigation started against him and Volkswagen to conclude who is behind all of this. In the media, information emerges that the board had knowledge about fraudulent software systems several years ago already. Matthias Müller, the former boss of Porsche, replaced Martin Winterkorn. According to board members of Volkswagen Group, Matthias Müller is a ‘team player and does not operate on his own interest, and that is the thing Volkswagen needs’.
Secondly, Volkswagen’s bearing stock price that decreased around 45% within a month. On the 14th of September, some days before the news came out, the share price was at €167,10 and at €92,56 close price on the the 2nd of October. Volkswagen is publicly traded on the Deutsch Stock Exchange, DAX. Thereby, more than €27 billion has vanished due to the loss in equity value. This decline is, of course, very bad for the shareholders and for Volkswagen itself.
Further, the recall of approximately 482.000 cars in the US will also be very costly and damaging for their reputation. These cars will get new software systems that will be compliant with the local rules.
Lastly, Volkswagen may receive a high fine of around $37,500 per car, if the fraud is proven. Now it is just an easy calculation, 482.000 cars times $37,500 per car is $18 billion. It is questionable if the punishment will be that high, but the company will definitely be punished, because there has been a comparable situation before. In 2014, the South-Korean car manufacturers Hyundai and Kia Motors also have been fined for $350 million for tampering with fuel consumption. It is an important thing now for Volkswagen to save some money to cover the costs of this ‘Dieselgate’.
It is obviously strange that such a famous car manufacturer has to commit fraud to stimulate sales, but the usual conflicts of interests have left their mark. The shareholders want big profits and a market share as big as possible and apparently, this was either very difficult or not possible with their ‘fuel-efficient’ cars. On the other hand, shareholders do not want to invest their money in a ‘bad’ company that commits fraud. Unfortunately, it went the wrong way and that is the reason for the immense crisis at Volkswagen.
In my opinion, the scandal about the diesel engines is due to mismanagement. The top management of the company should have never taken the risk of doing this. Whether they knew about this or not, they failed in managing the company. Hopefully, Volkswagen overcomes this hardship, despite the claims of billions of dollars, possible losses and continues on doing what they are good at – making beautiful, safe and high quality cars.