How VW stumbled so badly and what it needs to do to recover

This should never have happened at Volkswagen. The automaker says it has a well-known, frequently used internal system that encourages employees to “prevent damage to the finances and reputation of the entire Volkswagen Group” by reporting problems.

Last year more than 50 reports by whistleblowers were forwarded to VW through its two independent ombudsmen. Separately, nearly 90 cases were brought to the group’s anti-corruption officer. During local internal audits, an average of one report of suspected fraud was submitted per day. Despite all of this internal policing, VW Group’s deliberate and systematic manipulation of emissions tests for 11 million diesels sold around the world was missed.

The scandal hit the carmaker like an enormous tsunami in September, revealing a criminal deception that remains difficult to comprehend because of its massive scale and its recklessness. Insiders and experts agree that the heart of the problem is the lasting influence of VW’s long-revered – and much-feared – leadership duo of former CEO Martin Winterkorn and ex-Chairman Ferdinand Piech. For more than two decades VW was a hierarchically managed company dominated by those two perfectionists.

Open instead of insular

Although both men have left the company, they left behind an atmosphere of pervasive fear mixed with obedience. VW’s insular and authoritarian corporate culture led in extreme cases to mistakes being hidden, problems compartmentalized and accountability viewed as a swear word. Only by tackling this legacy and breaking with the past can VW move forward, its new CEO, Matthias Mueller, believes.

“Structures only are of value when they ‘live and breathe’ so I can only repeat (…) we need to reform our culture and leadership philosophy,” said Mueller during a meeting of 400 high-ranking managers in Leipzig, Germany, last month. “Personally I would wish for a new culture of openness and cooperation but I cannot make this an order.”

As if to underscore the carmaker’s lack of transparency, a key director on Volkswagen’s supervisory board, Lower Saxony Premier Stephan Weil, expressed his frustration and astonishment to the state’s parliament about first learning of the scandal in the news. Moreover, the scandal is expected to cost Volkswagen tens of billions of euros in part because the company also chose not to inform investors of the deceit until after it was already made public by the U.S. government.

By the time it officially acknowledged the problem on Sept. 20, roughly two days had passed since the Environmental Protection Agency published its notice of violation and nearly three weeks had come and gone since VW admitted its guilt behind closed doors to the EPA on Sept. 3.

Mixed messages

In the 17 days between those two events, the company celebrated its “reinvention” at the Frankfurt auto show as an industry leader for digital connectivity and electromobility. It even bragged about being named the world’s most sustainable auto group by Dow Jones and RobecoSAM, saying it received top marks in compliance and anti-corruption among other categories. (VW has since been stripped of the honor).

When investors finally learned that millions of VW Group diesels included so-called “defeat devices” to cheat emissions tests, a quarter of its market value was vaporized within two days.

If VW needs to raise additional capital to pay for expected penalties and class action lawsuits related to the scandal, the original deception combined with the carmaker’s slow reaction have undermined the group’s credibility and could even change its controlling shareholder structure.

Nordea Asset Management, the Nordic region’s largest retail fund provider with 174 billion euros in assets under management, has put its VW holdings under quarantine and refuses to invest more in the company’s stocks or bonds. In the meantime, state prosecutors in Germany, France and Italy have raided offices and homes of VW employees.

Few answers

The list of unanswered questions related to the scandal is long. Mueller has said only a few people in Wolfsburg knew about the scheme, although even his own U.S. chief, Michael Horn, admitted he had difficulty believing that. Currently, no culprits had been named and VW has asked for patience because it expects the investigation to take “several months.”

“It’s not as if they strike upon a goldmine every day,” said one person close to the investigation. “They have to sift through a decade worth of emails and documents, and in some cases wait until the public prosecutors releases some of them back into the hands of the company.” State prosecutors in Germany took some documents during raids of VW’s offices last month.

Despite the mounting problems, so far there is little evidence that the emissions scandal will result in lasting damage to the company, either in terms of sales or profit margins, according to investment bank Bernstein. “We believe VW’s long-run earnings power will not be impacted significantly,” wrote Bernstein’s Max Warburton after his team interviewed more than 40 dealers, senior retail executives and fleet buyers in major European markets. “Fears about a big and sustained hit to VW volumes and profitability are overdone.”

Rebuilding trust

Corporate governance and oversight expert Christian Strenger, who sits on the boards of German corporations Tui, Fraport and Evonik, feels three things need to be done before VW can salvage some of its credibility. First, a comprehensive investigation of the scandal in which the findings are confirmed by neutral experts. Second, top executives must serve as role models within a new corporate culture. The third recommendation is the trickiest. VW needs “a considerable change in the supervisory board to serve as a convincing counterweight to the large shareholders and unions that so far have proved hapless in this issue,” Stenger told Automotive News Europe in an email reply to questions.

VW’s 20 person supervisory board currently has only one external member, Annika Falkengren, the CEO of Swedish lender SEB. All others are either Porsche or Piech family members sent by Porsche SE, politicians from Lower Saxony or emissaries of Qatar. Like all German boards, half of all directors are appointed by labor and unions.

VW appears to be making some headway. Last month it announced that former German federal judge Christine Hohmann-Dennhardt will become its first management board member for integrity and legal affairs. She starts on Jan. 1 Hohmann-Dennhardt will join VW from Daimler, which agreed to release her from he contract a year early.

Additionally, VW stakeholders are becoming more involved. Rather than report to the management board, Jones Day, which VW hired to conduct an independent investigation, is accountable only to a subcommittee of the supervisory board headed by Wolfgang Porsche, who is a key director.

Evercore ISI auto analyst Arndt Ellinghorst sees a silver lining for VW. He argues that Mueller should use the crisis to increase diversity and hire external talent: “VW has a huge opportunity to fix the diesel issues, tackle its morbid culture, cut costs and return revitalized.”

Lower Saxony’s Weil, who acts as a trustee for his state’s 20 percent voting stake in its biggest employer, urged VW find a place for people that in the past might have been viewed as troublemakers: “Responsible workers that internalize corporate principles are not disruptive -- they are welcome.”

To be fair, the company was tackling some of the problems when the scandal hit. Winterkorn was finishing a comprehensive management reshuffle prior to his resignation. “You can think of the crisis as a kind of accelerant,” said one company source. “The cultural change already had begun, but it’s now being sped up enormously.”

‘Future at stake’

Other German automakers such as Mercedes-Benz and BMW and key suppliers such as Robert Bosch are sure to be watching the developments closely after VW damaged the reputation of clean diesel technology in the U.S. market. All three insist that diesels are absolutely vital for reaching strict CO2 emission targets in 2020 and beyond.

“The Volkswagen crisis could have far-reaching implications,” said Frost & Sullivan Automotive Senior Research Analyst Arun Chandranath, citing the very real possibility of the scandal speeding up the adoption of even more stringent emissions regulations, which would hit all automakers. “Volkswagen may be standing trial, but everyone’s future is at stake.”