The massive disruption hitting the German car industry and how it affects industry in Europe as a whole

The German weekly magazine “Wirtschaftswoche” has published a quite interesting article (understatement!) on disruptions at Volkswagen and implications on the German car industry. Full disclosure: I work at Volkswagen but not in a position with strategic insights, nor in a position of public relations. The opinions in this article are my personal ones, based on publicly available sources, own considerations, common knowledge, and no insider knowledge about VW specifics.

One major quotable part in this article was roughly as follows: VW has calculated the complete CO2 emissions the whole group is responsible for, and came up with a number of about 2% of all global CO2 emissions (which is about the same amount as the complete German economy!) As a consequence VW thus decided that the goals of the Paris Accord should also apply to the group then, which means by 2050 all VW cars must be climate neutral. From that starting point it is simple math to calculate backwards: Average life-span of cars are about 10 years, so by 2040 no more gas-powered vehicles can be sold any more. The production life-cycle of a car model from market-entry until end of production is another 10+ years, and the development of engines is finished 1-2 years before the market entry. Put these numbers together, VW apparently announced to close down its engine development department within 7 years from now! This is massive news, given the importance and also the political power within the group of the engine development department until very recently.

The engine development department used to be the most powerful department, certainly within R&D, perhaps even within the whole corporation. While most other departments like chassis or electronics rely heavily on external suppliers and mostly observe their innovation, the engine has always been deemed a core technology for all German car producers. Sure, engine parts still came from suppliers, but the engine as a whole has been produced by direct subsidiaries of the VW group. Nobody make better engines, and that is why no car is more reliable and more comfortable than ours, this has been the creed of German car makers for decades, and when the engine developers had an issue, the board of directors would listen.

I can only interpret this statement to completely close down the engine development within seven years, as a clear sign of the successful consolidation of power by the relatively new CEO Herbert Diess. Despite all lines of command, a CEO needs support from his top-management circle, and in former times the engine top-managers would have been able to erode his control of the corporation for such a direct attack on their “kingdom”. This seems to have changed, and the slowly turning super-tanker seems to bust out a quick break-dance move all of a sudden.

The effects on the German industry as a whole shouldn’t be under-estimated. VW is by far the biggest of the remaining German car makers (mainly besides the independent BMW and Daimler, and the foreign-owned Opel). When VW makes a move, most suppliers have to follow suit. And when they do, they put pressure on the other OEMs, because either the other OEMs follow VW, or their sourcing costs will increase substantially due to the decreasing economies of scale for engine-related suppliers.

Anyone with basic knowledge about car technology knows that gas-powered engines are incredibly more complicated than electric engines. While the decisive competitive technology used to be the engine in gasoline cars, it is much more likely to be the High-Voltage-Battery (and battery management system) or the electronic entertainment environment (from touch-screen, to human-machine-interface, to apps) which will define the battle for customers in the world of electric vehicles. That means, major current suppliers for engine parts cannot just develop further to supply electric engine parts, because that market is much smaller than the gasoline-engine parts market. They will either have to develop very substantial parts of the whole high-voltage system, or move into different fields or industries altogether. Of course the suppliers have known this as a distant threat for a while now. But suddenly there is a looming deadline to this threat, and 7 years is not a long time for such a shift that touches the core strategy of many a supplier.

As VW has suppliers not only in Germany, this deadline to the upcoming paradigm-shift extends to all of Europe. VW alone operates brands in Spain (SEAT), Italy (Lamborghini, Bugatti), Great Britain (Bentley), and Czech Republic (Skoda), with factories also in places like Slovakia, Belgium, Ukraine and others. The suppliers again are located in yet more countries and supply not only to one single corporation. Thus e.g. French OEMs will also feel it, when some shared suppliers who also service VW start to reduce their focus on gasoline technology.

From a Chinese perspective funny to read is the part where Wirtschaftswoche quotes Germans who call this decision of VW “high risk” or even “hazardous”. They question when and if the shift to electric cars will be coming. Anyone living in China knows, this shift is already here. China is the largest single car market in the world (and by far the biggest market for VW), and while the traditional vehicle market has stagnated last year, and before that grown around 10% per year, the electric vehicle market has grown around 70% and in the triple digits before that. Recently the Chinese government has announced that the electric car market is developing so well, the government subsidies will soon be cut down and the money saved will be used to speed up the development of a comprehensive infrastructure, namely many more public charging points. Another major figure to watch is that now more than 50% of all public charging poles are run by market-driven private companies rather than policy-ordered state owned enterprises. And perhaps even more important, several of these private charging point suppliers are now making a profit already. A virtuous cycle of higher profits, more investments, and economies of scale is about to begin.

I hear a lot the statement “the Chinese market is policy driven”, because the major growth areas are those which the Communist Party of China designates as “focus industries”. Actually, I agree with the statement, but with the caveat that these focus industries aren’t decided out of thin air or wishful thinking but rather the result of very extensive research of economic data (of both China and the historical development of now developed countries) combined with a strategic view on what the country will need to become economically stronger and comprehensively more independent. So these focus industries are a selection of industries at the brink of starting rapid development, and are deemed strategically relevant. These industries are then promoted by the Communist Party, meaning all Communist Party relation offices in all state-owned and also most large privately owned companies are strongly “encouraged” to invest in these areas, while financial incentives for fast movers are offered, and the expectation of rapid growth of the industry is more than speculation. This combination of forecast (expectation management), encouragement (tying individual careers to working towards these expectations), and direct financial incentive creates a very powerful engine for the actual growth to follow. And this engine runs towards electric vehicles. The rest of the world is bound to follow.