September 25, 2015 — The Volkswagen diesel scandal has quickly become one of the year’s biggest stories since it erupted a week ago. The fallout has been brutal, with a 38% decline in stock price knocking nearly $30 billion off of the automaker’s market cap in just two days while forcing out CEO Martin Winterkorn.
The events of this past week raise numerous questions about Volkswagen and its future as an automaker. Below, we’ve addressed some of those questions and possible answers.
Who is responsible?
Unknown at this time. The real question is whether the scandal reaches the highest levels of management or is the work of a few engineers who recognized the diesel technology didn’t work as promised, and subsequently, wrote software to hide that fact. The software recognized when the 2.0 liter diesel TDI engine systems were being tested and was able to reduce the amount of nitrogen oxide (NOx) pollutants released while the test was going on.
Nevertheless, the scandal forced CEO Martin Winterkorn to resign on Wednesday while claiming ignorance. The board announced today that Porsche CEO Matthias Müller as Winterkorn’s replacement.
Also leaving the company is sales and marketing chief Christian Klingler due to differences in strategy and not necessarily directly related to the scandal.
Michael Horn, Volkswagen Group of America’s top executive, is staying with the company, despite earlier reports that he was going to be fired. VW dealers in the U.S. lobbied hard for the automaker to retain Horn. Keeping the popular executive is a big and necessary step for VW in regaining the trust of its dealers.
Meanwhile, as part of VW’s internal investigation, several unnamed employees were suspended today.
Also reportedly to be fired are Wolfgang Hatz, head of R&D for Porsche and Ulrich Hackenberg, who ran Audi’s R&D.
Effect on sales
VW dealers thought sales were bad before September but the real pain will be felt over the next several months.
Nearly 25% of VW’s sales in the U.S. are vehicles with the TDI engines. Since 2008, approximately 482,000 vehicles in the U.S. (11 million worldwide) have been sold with the software designed to deceive emissions tests. Vehicles affected the 2009 – 2015 Jetta; 2012 – 2015 Beetle; 2012 – 2015 Passat; 2010 – 2015 Golf; 2010 – 2015 Audi A3.
The automaker issued a stop-sale order on all of the affected vehicles sitting on dealer lots — including certified used vehicles. Even 2016 models are affected as the EPA has said it will withhold certification of all vehicles with 2.0 liter TDI engines.
TrueCar estimates Volkswagen will see sales drop 5.2% in September while the rest of the industry gains 13%.
One of the problems is that there is no timetable or real answer yet to what a fix may entail. So these cars could be sitting on dealer lots and in the ports for months.
From an objective metric, we can estimate Volkswagen will lose at least 25% of its sales in the U.S. over the next several months. And that’s not taking into account any fallout from the overall damage VW is suffering to its reputation.
How will Volkswagen fix the problem?
Contrary to earlier media reports, there have been no recalls issued yet. The challenge is that a recall might not fix the problem. The ugly fact is that the diesel technology does not perform as marketed.
Volkswagen has to figure out how to get its TDI 2.0 liter engines to meet EPA certification without causing a decline in engine performance. There are no easy fixes for this one which is why the scandal happened.
It’s not out of the question that Volkswagen will be forced to buy back all of the affected vehicles at sticker price. A more likely scenario, though, will have VW making up for any drop in residual value of the vehicles along with significant cash payments to customers.
In addition to naming Müller as the new CEO, VW also named Skoda head Winfried Vahland as the chief of a newly organized business unit comprised of U.S., Canadian and Mexican operations. The automaker also says it will give geographic regions and brands greater operational independence.
Effect on Dealers
Make no mistake, this is going to hit VW’s 650 dealers hard. They already were dealing with declining sales along with severe hits to their profitability.
Volkswagen jumped quickly this week telling its dealers it will reimburse them for floor plan financing costs generated by vehicles still on their lots affected by the stop-sale order, including certified vehicles.
To offset lost sales, VW will pay 1% of the MSRP of each vehicle sold in the third and fourth quarters of this year, along with another $300 per vehicle sold in September (Passat sales will get $600 each for dealers).
But attorney Leonard Bellavia notes that the assistance is nothing more than another sales incentive program and doesn’t take into account the fact that dealers won’t be selling many vehicles for the foreseeable future.
Meanwhile, at least 18 different Volkswagen dealerships changed ownership through August of this year, according to data compiled by The Banks Report. It’s not a stretch to think the dealers buying those stores will have significant legal recourse as the automaker clearly misrepresented their product.
Dealership values were already at near zero according to several people who are engaged in the dealership buy-sell market, with some stores values in negative territory. Good luck trying to give away a VW store today, let alone sell one.
Adding to the pain, dealers are getting caught up in lawsuits against VW. Earlier this week, a Volkswagen customer in Florida included AutoNation in a lawsuit against VW because of the scandal.
AutoNation Chairman and CEO Mike Jackson responded quickly distancing the nation’s top dealer group from VW’s actions, telling CNBC’s Squawk Box that, “This is not a rogue employee. This is not a bad apple. This is not poor judgment. This is not a lapse. This is not negligence. This is a deliberate scheme to deceive customers and regulators.”
Approximately 30 lawsuits have been filed already by Volkswagen owners. And there are more to come.
At the moment, other than a lawsuit filed by group of independent used car dealers in California, dealers have refrained from suing the automaker, but dealers may have no choice if dealers find their businesses are at risk.
So far, there have not been any criminal charges, but as the dust begins to clear and the facts come to light, it’s probable the Department of Justice will come down hard on those responsible.
General Motors and Toyota both have three-year deferred prosecution agreements from their recent scandals provided they fulfill certain requirements stipulated by the DOJ. No one from those companies is going to jail or will be criminally charged.
Don’t expect a similar agreement for Volkswagen. Although people have not lost their lives (although, studies have estimated at least 58,000 Americans may die each year from pollutants caused by vehicles), there undoubtedly was a willful attempt to mislead federal regulators.
U.S. prosecutors likely will use this case to send a loud and harsh message to company executives who attempt to circumvent the law. As a result, we’ll likely see responsible parties convicted of criminal charges.
Volkswagen, for a few months at least, has been the number one automaker in the world this year. It will be a short reign. The long term damage to the brand globally will be felt for years.
Even if sales rebound like they have for GM and Toyota, the long term legal costs alone will hurt VW’s product development.
Meanwhile, its grand clean diesel strategy, on which VW was staking its comeback in the U.S., is in shreds now. This scandal has set the brand back in the U.S. at least five to 10 years.
Not only for Volkswagen, but the diesel market overall in the U.S. may be dead as the result of the scandal. It’s comeback already was slow, but now, say the words “clean diesel” and watch people roll their eyes.
Volkswagen has set aside $7.3 billion to cover the costs resulting from the scandal. The automaker could be forced to pay $18 billion in fines ($37,500 per vehicle) but that probably won’t happen. Nevertheless, overall costs will likely exceed $10 billion once all of the lawsuits are settled and fines are paid.
It’s probably too soon, but is it out of the question that Sergio Marchionne sees Volkswagen as a potential target in its weakened state? Don’t be surprised when analysts start speculating about a possible FCA-Volkswagen merger/takeover.