How auto giant Volkswagen steered off the road

The German auto giant, Volkwagen, is famous more for its pre-World War II iconic Beetle car and its role in the Dieselgate scandal of 2015. Most people are not aware of its plan to become an all-electric auto company by 2030, or that it owns luxury brands like Lamborghini, Bugatti, Porsche and Bentley. The company made 9.3 million vehicles in 2023. It is majority owned by three key shareholders, the Pietsch family, German state of Lower Saxony and the Sovereign Wealth Fund of Qatar.

More recently it is in the news for the precipitous decline in its stock price from a high of €245 during April 2021 to €85 in November 2024. That has wiped out almost €100 billion off its market capitalization.

Graph I: VW revenues and operating profit

It’s a story of wrong strategic bets (China), bad execution of its strategy (electric vehicle transition) and is symptomatic of the malaise impacting most of the traditional auto industry giants since the arrival of the electric car upstart, Tesla in the late-2010s, which has quickened the pace of change. VW has gone through four CEOs in the past 16 years. This combined with its unusual ownership structure, which makes change difficult, has made investors wary of its stock.

Table I: Change in market capitalization of major auto industry players

As is evident, VW is not the only legacy auto company that has suffered in the past few years as the market is banking on manufacturer's making the transition to survive and not many Internal Combustion Engine (ICE) makers are good at that transition.

How VW makes its money

Most of VW's earnings are from the Core and Sport Luxury brands.

The Core group brands include Volkswagen, Skoda, SEAT. The Progressive brands include Lamborghini, Bugatti and Bentley. The Sports Luxury brand is Porsche and the Traton commercial vehicle brands are MAN, Scania.

Adolf Hitler actually founded Volkswagen

Adolf Hitler, the Chancellor of Germany, between 1933 – 45 was responsible for the founding of Volkswagen. As the leader of the German labour party, Nationalsozialistische Deutsche Arbeiterpartei (NSDAP or Nazi Party), Hitler wanted to offer Germans a cheap vehicle as the motor car was starting to become the expression of technological advancement, freedom of movement and he had been building the new highways in Germany, the Autobahns.

He commissioned the Reichsverband der Deutschen Automobilindustrie (Reich Automotive Industry Association), or RDA, to develop a vehicle that could carry four adults and reach speeds of 100 kilometers per hour (recall that this is the 1930s!) and costing under 1,000 marks (about US$140 at that time). He asked famed Austrian automotive designer, Dr. Ferdinand Porsche, the founder of Porsche, to design the car.

The German government established Gesellschaft zur Vorbereitung des Deutschen Volkswagens mbH (later renamed to Volkswagenwerk, or "The People's Car Company"), on May 28, 1937. The company was originally operated by the Nazi organization, the German Labor Front. In May 1938, Hitler inaugurated the new factory purpose-built to manufacture the car which was known as the Stadt de KdF (Kraft-durch-Freude)-Wagen (City of Strength-Through-Joy car) in present city of Wolfsburg.

The air-cooled engine was intentionally designed to keep the weight/power ratio high, and avoid any coolant freezing in Germany's winters but that resulted in a lower power engine, and the aerodynamic design (it was one of the first cars designed in a wind tunnel in 1930s) was to allow it to be powered by that smaller engine.

Post-WWII

The Wolfsburg factory began making vehicles for the Wehrmacht during World War II and was bombed heavily. Due to efforts of the British military it restarted production of the Beetle in 1948 and by 1955 had produced over one million units. By 1972, it had sold over 15 million units making it the world’s most mass-produced vehicle surpassing the Ford Model T.

In 1964, Volkswagen acquired Auto Union, which owned the Audi car brand as it realised the era of air-cooled engines may come to an end and needed a luxury vehicle brand. The influence of this resulted in development of iconic VW models like the Passat, Scirocco, Golf and the Polo in 1970s. This resulted in growing sales volumes across various models, as VW also expanded globally, until 2015.

Graph I: Production of VW vehicles (2014-2023)

Unusual ownership structure

VW's management is controlled by a 20-seat supervisory board where unions control half the votes and two politicians from the state of Lower Saxony who often vote with them. This type of management structure makes restructurings very difficult as the union representatives are reluctant to agree to plant closures, which maybe necessary as VW transitions its production from gasoline powered to electric powered vehicles.

Dieselgate scandal

During 2015, the US Environmental Protection Agency accused VW of intentionally programming its vehicles to detect test by the agency allowing those vehicles to pass emissions tests despite polluting at almost 40x the permitted levels during normal driving. VW had installed this software in almost 11 million cars between 2009-15. The stock fell by a third after this announcement and the CEO, Martin Winterkorn, resigned. By 2017 VW pleaded guilty to criminal charges and was fined US$2.8 billion for rigging diesel-powered vehicles to cheat on government emissions tests.

This scandal severely damaged the VW brand and is estimated to have cost it almost €33 billion in litigation costs, fines, recall of vehicles and damages to customers who had bought those vehicles.

Electric era: 2017 onwards

To counter the impact of Dieselgate, the new CEO Mathias Müller announced a bold plan during 2017 to have all electric versions of its various models by 2030 at a cost of €20 billion. During 2019 it announced the discontinuation of production of the iconic Beetle model.

It invested in electric car startups like US manufacturer, Rivian, and Chinese firm, Xpeng.

However, over the cost of converting its model line-up to electric have spiralled out of control and the resulting models have not been embraced by customers thus impacting VW’s profitability. Dr. Müller left VW in 2023 and was replaced by Oliver Blume.

COVID pandemic

The pandemic hit VW’s supply chain very hard, and it exposed its vulnerabilities. That combined with reduced customer demand because of stay-at-home orders in many countries led to depressed production and sales numbers.

In addition, the global semiconductor chip shortage that was caused by the pandemic further depressed VW’s production as it struggled to obtain the vital electronic components.

The China market slowdown

One of VW’s growth areas was Asia, particularly China, where it has been operating through the 1980s initially selling its frugal cars and then the higher end Porsches and Bentleys as the Chinese consumer grew wealthy. Through its own business there and via a whole bunch of subsidiaries (like SAIC Motors), VW became the number one western car manufacturers there.

However, in late-2010s local Chinese electric car manufacturers (like BYD), whose investors included state-owned banks and local governments keen to support a political mandate to move China to a green economy, started offering low-cost electric vehicles to Chinese consumers. As a result, by 2023 almost half the Chinese automobile market is dominated by electric or hybrid vehicles, neither of which are VW’s forte, especially at price points that are being sold by Chinese auto manufacturers. VW’s distraction with the DieselGate scandal probably distracted its entry into electric vehicles and/or hybrid vehicles and so it lost its pole position in China.

In the first nine months of 2024, VW’s sales of automobiles in China dropped almost 12% compared to last year negating all the sales growth in the rest of the world and resulting in an overall 4% loss of volume. As a result, VW had to shut down three manufacturing facilities in Germany that were driving exports into China.

Until VW stabilises its China strategy (or finds alternative markets) and its EV strategy, it is likely to face headwinds to improve its valuation.

Sources:

1. Volkswagen AG Annual Reports

2. Bradsher, Keith. “How Volkswagen Lost Its Way in China”, New York Times, November 10, 2024