Diesel Gate: Is VW ready to take on yet another emission challenge?
With a damaged reputation from its Diesel emission scandal, can Volkswagen achieve its aspirations in electric car production?
Background: VW Diesel as an alternative to petrol to reduce greenhouse gases
Diesel vehicles are thought to have a smaller carbon footprint than their gasoline-powered counterparts and were thus heavily subsidized by European regulators in their effort to mitigate global warming. In fact, nearly 50% of new cars sold in Germany in 2015 ran on Diesel engines [1]. Although Diesel cars contribute less to global climate change, the European governments soon realized that the local pollution effects of Diesel engines are far worse than those of gasoline due to increased emissions of particulate matter – the main contributor to smog. In recognition of this fact European governments imposed stricter emission targets for Diesel cars. Heavily relying on the production of Diesel cars European car manufactures were under unprecedented pressure to fulfill the new emission targets while ensuring a steady profitable growth.
Volkswagen, the largest car manufacturer worldwide, made global headlines in 2015, when it admitted to having installed “defeat devices” into 11 million Diesel cars worldwide [2]. Those devices would sense if the car was being tested by an official agency and activate equipment that reduced emission. The actual emission on the road could be as much as 40 times as high [3]. Experts estimated that the long-term effects of the increased emissions could lead to more than 1,200 premature deaths in Europe [4]. The total estimated financial impact of the scandal on VW is estimated to amount over 30 billion USD [5] up to date, although the long-term effects are yet to be assessed. Due to a significant demand decay for Diesel cars (Figure 1) over 500 suppliers of VW were forced to stop the production line and build up inventories [6].
Figure 1: Demand decay of Diesel cars in the German market
Short and long term steps VW has taken
In the short term, VW tried to transfer some of the production risks (unpredictable and declining demand) to its suppliers. It leveraged its strong purchasing power to enter relentless negotiations with most of its suppliers. Among other terms, VW demanded more flexibility of supply, e.g., possibility of unnoticed and uncompensated production stops. Although most of the suppliers were able to accommodate the changes, there were some exceptions. One of VW’s major suppliers, Prevent, has caused a production freeze for VW, because it demanded 58 million EUR for factory investments it had made for VW as part of a contract that VW cancelled [7]. As a response to increasing supplier dissatisfaction VW established the F.A.S.T program to intensify collaboration with its suppliers. In this program VW’s key suppliers are able to gain full transparency of the VW innovation cycle at an early stage, co-create products, and fully align production schedules [8].
In the long term, VW intends to establish itself as an electrical car manufacturer in order to live up to its promise of lowering its carbon footprint and adhere to emission standards. VW has announced to spend 80 billion EUR to bring 300 electric vehicle models to market by 2030.
Other recommended short and long term steps
Besides VW’s efforts to re-establish financial performance by making its supply chain more efficient VW should also focus on re-gaining trust from the automotive industry. For this purpose it is critical that VW creates greater transparency. Until today VW has not made significant efforts to increase transparency into its Diesel car emissions. Also, VW has failed to come up with a mitigation plan for the millions of diesel cars still on the road. VW needs to proactively publish their emission test results for new cars and offer a compensation plan to owners of Diesel cars already on the road to regain customer trust.
Re-installing VW’s strong position in the automotive industry will also help VW in the long-term. Shifting the production to electric cars will need significant changes in the supply chain, since the effectiveness and costs of electric cars depend mainly on batteries. First, it needs to establish tight bonds with other car manufacturers to speed up research and development, especially because the German EV industry is falling behind the American and Asian competition. More importantly, the increased purchasing power gained through co-operations with other German car manufacturers will help lower the costs of critical raw materials used in battery production.
Remaining questions
VW has lost credibility in the automotive industry by not being able to comply with emission targets. Although it has slowly started its recovery by strengthening its supply chain, the question remains whether it has enough credibility to lead the upcoming electrification of the German automotive industry.
(759 words)
[1] “Jahresbilanz der Neuzulassungen”, Kraftfahrtbundesamt (German equivalence to the U.S. Department of Motor Vehicles), https://www.kba.de/DE/Statistik/Fahrzeuge/Neuzulassungen/neuzulassungen_node.html, March 2017
[2] “Volkswagen Says 11 Million Cars Worldwide Are Affected in Diesel Deception”, New York Times, https://www.nytimes.com/2015/09/23/business/international/volkswagen-diesel-car-scandal.html, September 2015
[3] “How Volkswagen’s ‘Defeat Devices’ Worked”, New York Times, https://www.nytimes.com/2015/09/23/business/international/volkswagen-diesel-car-scandal.html, September 2015
[4] “Volkswagen’s excess emissions will lead to 1,200 premature deaths in Europe”, MIT News Office, http://news.mit.edu/2017/volkswagen-emissions-premature-deaths-europe-0303, March 2017
[5] “Volkswagen’s diesel scandal costs hit $30 billion”, CNN Money, http://money.cnn.com/2017/09/29/investing/volkswagen-diesel-cost-30-billion/index.html, September 2017
[6] “VW and suppliers settle their dispute after marathon talks”, Fortune, http://fortune.com/2016/08/23/vw-and-suppliers-settle-their-dispute-after-marathon-talks/, August 2016
[7] “VW plays chicken with supply chain and loses”, Forbes, https://www.forbes.com/sites/kevinomarah/2016/08/25/vw-plays-chicken-with-supply-chain-and-loses/#67ad95bc1d89, August 2016
[8] Volkswagen, http://www.vwgroupsupply.com/one-kbp-pub/en/kbp_public/homepage/homepage.html, November 2017
Great essay on VW and how they are thinking about the future of the automotive industry and the environment. Supplier relationships will be key as VW tries to recover from the emissions scandal that was uncovered in 2015. Consumers will have a shorter memory than the suppliers that were left holding the bag after demand for diesel cars plummeted. The F.A.S.T. program is a great way for VW to get their traditional suppliers back on the same page making decisions that collectively benefit both parties. This approach reminds me of how Dell partners with their suppliers (and customers) to reduce friction along the supply chain. Aside from the traditional suppliers, electric car production will require VW to build relationships with new suppliers, and F.A.S.T. could help VW earn trust among these unfamiliar parts suppliers as well.
Very interesting to read the follow on actions taking place at VW after the emissions scandal. Addressing the credibility issue, I don’t think this is as big a deal as it might seem. Several other automakers have encountered public scandals, e.g. Ford Pinto, and have come back just fine. I think the question moving forward for the company is whether they will produce automobiles that (1) customers want to buy and (2) the government will permit them to make. Addressing the electrification issue, if we suppose the company is already a late mover into the space, what’s the way for them to play? My suspicion is that they need to find ways to differentiate VW’s electrification efforts from those of the American and Japanese companies.
VW seems to be on a good path of restoring its credibility and underlying business performance. The company’s latest financial results showed a strong recovery across all regions (9M‘17 revenues up 6.8% vs. prior year, 9M’17 operating profit up 23% vs. prior year), primarily driven by an increased number of delivered vehicles, indicating the company’s ability to regain trust among its customer base on a global basis.
However, in order to lead the electrification of the German automotive industry (and the industry as a whole), credibility will not be the limiting factor in the long run. In my view, it ultimately comes down to VW’s organizational ability to successfully capture the shift towards electric mobility, driven by continuous innovation and high strategic focus. A positive signal in that context is Management’s guidance to offer up to 80 electric models by 2025 of which 50 vehicles will be purely electric and 30 will be hybrid models. This translates into c.10 new models or model variations p.a. which seems somehow ambitious on a timeline perspective. As stated in the essay, battery development represents a core competency that drives competitive edge in the near-term. So far, German car manufacturers (incl. VW) heavily rely on Asian manufacturers. VW will need to carefully reconsider its long-term strategic approach to battery manufacturing. For example, BMW recently announced to invest EUR 200 million in a new in-house R&D center to develop prototypes of new battery cells in order to increase battery performance and reduce production costs. Finally, the corresponding infrastructure, i.e. the availability of a dense network of charging stations remains a limiting factor in most countries. In order to lead the further electrification of the sector, VW should therefore investigate partnership opportunities with leading infrastructure players (e.g. Siemens, RWE, etc.) to enable the successful implementation of its ambitious plans.
It’s very interesting to read, as this Diesel-gate was huge in my country too. 126,000 cars from VW and Audi sold in Korea had same issue of installing defeat devices. In addition to this, in 2016, Korea government found out that they manipulated their documents of emission and noise for another 83,000 cars sold in Korea. Consequentially, they were suspended from selling cars in Korea, leaving 20,000 new cars at Pyoung-tak port in Korea. After 14 months suspension, they are trying to reinstate their certification from Korea government. However, most of their new cars are still on the waitlist of approval and nobody knows when it will be done. During the suspension period, they used their showroom as art galleries and stages and a lot of sales employees left for other car companies. They would struggle for several months more to reinstate their organization and sales activities, however, as Toyota recovered before, they will take the market share again. After the Diesel-gate, VW announced to shift their strategy to electric mobility, which is lagging far behind. I want to see how VW overtakes other competitors in electric mobility industry.
Great essay! It’s extremely important that VW invest in electric vehicle production, as many countries around the world are getting closer to enacting bans on all fossil-fuel powered vehicles. VW will need to have a stable share of the electric vehicle market when that happens. As you stated in your essay, a lot of the success of a given electric vehicle program will depend upon the price of batteries. However, I believe that VW is already in a strong position as far as purchasing power goes, since it’s one of the largest automakers in the world (https://www.forbes.com/sites/bertelschmitt/2017/06/29/worlds-largest-automakers-toyota-renault-nissan-volkswagen-neck-and-neck/#47762be572fe) However, a technical partnership with a well-regarded OEM might help the public regain confidence in their ability to deliver an environmentally-friendly vehicle.
A very interesting essay on the impact of VW’s cover up of its emissions output, great job Lige!
The irony of this situation is VW’s ultimate dependence on transparency and trust – two qualities VW failed to establish – to remedy its current predicament. The cover up of its actual emissions test results diametrically opposed the tests’ objective of transparency, and, in so doing, VW lost any trust that its customers had in the brand. As we witnessed in the Beer Game, the supply chain overall benefits from transparency by reducing inventory holding costs and costs of back-orders. The F.A.S.T. program is commendable as VW has reversed its stance on transparency following the cover up, however, trust in VW is not so easily won back from supply chain partners and consumers. This lack of trust could very well prevent VW from becoming the industry leader in electric cars since few consumers, suppliers, and car manufacturers will likely want their names associated with VW’s as an unethical company that is more interested in making profits than helping the environment, and, as mentioned in the essay, collaboration among these stakeholders is needed in order to move the market towards electric vehicles.
Very great points you put forward. It’s interesting to note how the current share price (178.10 euros) is still struggling to reach it’s previous maximum (253.20 euros on Apr 2015) contrasting the overall direction of the market during this same time period.
I wonder what else Volkswagen could possible try doing in this situation to re-gain consumer trust given their elastic product? Their long-term plans to move their product mix to electric would work, but that doesn’t address the overwhelmingly negative sentiment they are currently facing in the day-to-day. In the short-term, it seems most of the work has been to disperse risks through the supply-side, and I agree that they should have doubled-down on renouncing their former actions to a higher degree and increasing transparency on the consumer side of things.
Really interesting read about a very important and impactful topic, great job! Regarding VW regaining trust, I think its clear they are on their way, especially as regards other market players, but I wonder how they can do about the general public perception (short of just letting time work its magic).
As regards electric cars, I wonder how their past actions will affect them going forward. Obviously they need supplier trust in order to re-make the electric car supply chain, and the development of electric cars aren’t without emissions and environmental risks themselves (higher production costs / battery production etc.). There is a risk here that VW is being seen as too shady of a company to be trust to follow into this new market, and they have permanently impacted their brand value and ability to capitalize on this entirely new phase of the automobile market.
Thanks for a great read Lige!
It is very encouraging to see the lack of climate sensitivity impacting consumer demand for the product even for such a well established and well admired company like Volkswagen and moreover for all similar products. In an industry already known for the variability in demand, effects of climate change have added tremendously to this variability. The skeptical side of me feels that one of the reasons why this had such a direct impact on consumer reaction and demand could be because of immediate and noticeable nature of its effect on the consumer – having experienced it, smog is quick to form and can be seen, smelt and felt. If this is true, it makes me wonder whether we can artificially replicate the effect of other such climate impact issues so as to drive home its reality and importance!