Volkswagen: how to destroy 30 billion dollars in a week

On the evening of Monday the 21^st of September, Michael Horn – Volkswagen’s head of U.S. operations stood at an event in New York and confessed to audience members that the company had “totally screwed up”¹. Less than a week earlier the company had been trading with a value of US$90 billion but at the time of Horn’s address almost US$20 billion in value had been wiped away and another US$12 billion would be lost in the following day’s trade². Interestingly, Horn noted that the behaviour that had been uncovered was “totally inconsistent with the company’s qualities” – an acknowledgement of the misalignment between the firm’s business and operating models that had occurred.

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Volkswagen’s business model relied on four key value creating pillars:

1. A diverse portfolio of autonomous brands: structured to enable each brand the independence to create a distinct value proposition in its segment of the market; ranging from economy through to ultra-premium³.
2. A focus on sustainability: investment into green technology as a key enabler of sales growth in the 21^st century as consumers become increasingly environmentally conscious.
3. Vertically integrated economies of scale: ownership of a much of the value chain prior to dealerships with many specialised component factories.
4. An employer of choice: with over 500,000 employees the firm considers its ability to attract talent as a key value driver.

Within Volkswagen Group’s operating model there are five core process, with all (excluding distribution) being completed independently by each of the Volkswagen brands.

1. Vehicle design
2. Component manufacturing
3. Vehicle assembly
4. Distribution through Volkswagen Transport (global shipping and freight)
5. Sales

Brand independence across the operating model is vital to ensure that each of the manufacturers is able to implement processes that best suit the value proposition desired by the target customer segment. To illustrate the important differences across the group the following image contrasts the production of Volkswagens at the company’s massive Wolfsburg factory (take a tour) with the production of Bugattis in France^4,5.

The sharing of distribution services across the group is facilitated through a dedicated logistics arm “Volkswagen Transport” that enables some of the smaller manufacturers (Porsche, Lamborghini etc.) to leverage the scale of the other businesses in the portfolio – improving access to ports and shipping routes and lowering costs.

In an effort to extract manufacturing efficiencies and share “green” technology across the portfolio Volkswagen has more recently implemented what it refers to as the “modular toolkit strategy”, a design group outside of the normal manufacturing process intended to reduce platform material costs up to 60% by reducing engineering hours per vehicle and lowering one-off expenses⁶. As with the Group-wide distribution process, the modular toolkit strategy is shared across the mass-market brands with initiatives typically implemented across the core Volkswagen, Skoda and SEAT.

On the face of it, Volkswagen’s business model had been highly effective – supporting a decade of impressive growth and expansion between 2005 and 2015.

 So what went wrong?

The following illustration sets out Volkswagen’s business and operating models, highlighting in red the problem area.

While this is a story that is clearly still developing, it seems that at its very root the introduction of the “modular toolkit strategy” across multiple brands was inconsistent with the group’s business model, which relies on autonomy between brands. The breakdown in alignment can be considered in the following stages:

1. Aggressive sales growth and productivity targets at a group level combined with an increased focus on green technology lead to the creation of the “modular toolkit strategy”
2. The strategy sits outside of the normal production process within brands and is not integrated into the governance process that exists at a brand level (each portfolio company has its own governing board) to control quality and regulatory compliance
3. Once issues were discovered, the extent of the impact was exacerbated by the multi-brand nature of the toolkit strategy. As such, more than 1.2 million vehicles are affected across the three mass-market brands: Volkswagen, Skoda and SEAT
4. The issue is expected to drive further misalignment by jeopardizing Volkswagen’s capacity to continue to be an employer of choice and attract talent

In almost every way the operating and business models at Volkswagen are aligned but this post demonstrates that it only takes one source of misalignment for significant and lasting consequences to be felt. In the long term, Volkswagen will be able to fix this issue and management has already implemented changes to the structure of the modular toolkit strategy, to ensure greater oversight from senior group executives and input from portfolio brands wherever standardization is concerned⁷.

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Sources:

(1) Mark Clothier, “VW’s U.S. Chief Apologizes for Diesel Dupe: ‘We Screwed Up’”, Bloomberg Business, September 21, 2015, http://www.bloomberg.com/news/articles/2015-09-22/vw-s-u-s-chief-apologizes-for-diesel-cheating-we-screwed-up-, accessed November 2015

(2) Capital IQ data, accessed November 2015

(3) VW Factory tours, http://europeforvisitors.com/germany/cars/vw-autostadt-factory-tours.htm accessed December 2015

(4) Travis Okulski, “Inside Bugatti’s Factory, Where The World’s Fastest Cars Are Built”, April 19 2012, http://www.businessinsider.com/how-the-bugatti-veyron-is-made-2012-4# accessed December 2015

(5) “Brands and products”, http://www.volkswagenag.com/content/vwcorp/content/en/brands_and_products.html, accessed December 2015

(6) Frank Witter, “Volkswagen Group: Volkswagen Group – Regaining trust”, Volkswagen Aktiengesellschaft Investor Roadshow with J.P. Morgan, London, 29 October 2015 Slide 35 http://www.volkswagenag.com/content/vwcorp/info_center/en/talks_and_presentations/2015/10/London_RS.bin.html/binarystorageitem/file/07_Handout_Presentation.pdf accessed December 2015

(7) VW Group restructuring in response to emissions testing scandal; greater focus on the modular toolkits; Klinger out, Horn stays, Green Car Congress, 25 September 2015, http://www.greencarcongress.com/2015/09/20150925-vwag.html accessed December 2015