Two of my colleagues – Tom Osegowitsch and Susan Trenholm (who recently moved to Kings College London) – just published an analysis of the Volkswagen scandal over at The Conversation. Below is a longer, more detailed, version of their analysis for your reading pleasure:
Volkswagen Group and the Device Defeating Trust
Volkswagen Group’s reputation is in tatters after it was recently caught using “defeat devices” to deceive environmental regulators and the general public regarding its vehicles’ pollution emissions. The device, a piece of software, ensures that a diesel engine’s emissions of nitrogen oxides (NOx) are minimised during pollution testing in the laboratory. When the device is disabled during normal operations, the engine yields maximum fuel economy and acceleration although emissions could be up to 40 times higher than in the laboratory. Effectively, the software allowed Volkswagen to have its cake and eat it too.
It is not the first time that technology has been used by car manufacturers to defeat pollution testing standards, but according to the Center for Auto Safety’s Clarence Ditlow, Volkswagen “took it to another level of sophisticated deception.” As a company that traded on its green credentials, Volkswagen’s transgression is particularly egregious. The scandal has already claimed the company’s CEO and the company faces a torrent of law suits and class actions, as well as a worldwide product recall.
At this stage, the individuals responsible for the deployment of the defeat devices remain unknown, or at least unnamed. The company initially blamed the “moral and political disaster“ on “the unlawful behavior of engineers and technicians involved in engine development”. But blaming a band of rogue engineers was an implausible explanation, especially since German newspapers reported that the company had been warned by both employees and key supplier Robert Bosch GmbH.
When CEO Martin Winterkorn was terminated, the supervisory board issued a press release explicitly stating that “Dr. Winterkorn had no knowledge of the manipulation of emissions data.” More recently the company suspended two R&D heads without further explanation.
While we do not yet know the culprits behind the scandal, the damage done is becoming clearer. In the US, the EPA is weighing fines that could be as high as US$18b and the Department of Justice is contemplating criminal charges. Governments around the world have announced enquiries into the affair. Vehicle owners impacted by lower resale values will want to see compensation, as will angry investors. Dozens of class action lawsuits against Volkswagen have already been lodged in the US. The resulting fines and compensation payments will be substantial, to be litigated and negotiated over many years. In addition there is the cost of a worldwide product recall of at least 5m cars. As a worst case scenario, the total costs could top €100b Investors reacted to the news with panic, wiping more than 40% off the company’s share price since the scandal broke..
The effect on future sales may be even greater. According to one survey, 90% of consumers would boycott a product or service if they learned of irresponsible business practices; and more than 55% of consumers claim to have done so in the last year.
The severity of the backlash and corresponding financial damage result from Volkswagen’s marketing approach, and consumers’ perceived breach of trust. Increasingly, companies market their products and services on the basis of an overarching set of values. They no longer emphasise the narrow benefits of their offerings, but the broader set of values, or purpose, underpinning them. One of the key benefits of such value-driven brands is the ease of expansion. This approach allows companies to enter multiple, loosely related markets. Take Nike, for instance. Its expansion beyond running shoes into numerous categories of sports and fashion apparel as well as equipment was achieved by appealing to the lifestyle values of an “athletic subculture”.
Volkswagen Group holds a varied collection of automotive brands, including Volkswagen, Audi, Porsche, Lamborghini, Bugatti, Bentley, Skoda and Seat. The common values underpinning this diverse portfolio of brands (or marques as they are frequently referred to in the auto industry) are the Group’s technical prowess and environmental sustainability. As argued in an earlier article, individual brands have their own, distinct brand identities but also benefit from the parent’s reputation, thereby realising powerful corporate synergies. But in times of crisis, these corporate benefits can quickly turn into liabilities. As Volkswagen is discovering, hell hath no fury like a consumer or regulator duped. The company’s carefully honed image of technical excellence and environmental responsibility has become a double-edged sword.
When organisations espousing ethical leadership violate their own stated standards the backlash is often particularly fierce. Consider BP and the Deepwater Horizon incident of 2010. The massive disaster killed 11 employees and released nearly 5 million barrels of oil into the Gulf of Mexico, damaging more than 1,000 miles of shoreline and a large section of the Gulf seafloor. Prior to the incident, BP had frequently and loudly extolled its green and safety credentials. By playing out in public over many years (BP settled legal claims only in June 2015), the incident wreaked havoc on the company’s reputation, not to mention its balance sheet. The ultimate payout was estimated at US$44b. The fallout for BP was significantly amplified when it was revealed that the company had cut corners in setting up the well and had inadequate processes in place to prevent or mitigate a disastrous event.. Communities, regulators and politicians felt tricked by BP and made it pay dearly for its hypocrisy. Espousing an admirable set of values, and then flagrantly ignoring them is courting disaster.
Sustainability is at the centre of Volkswagen Group’s avowed purpose – “to offer attractive, safe and environmentally sound vehicles.” The company heavily promoted the green credentials of its diesel engine, even during the US Super Bowl. In another, now cringe-worthy commercial, Volkswagen highlighted its virtuousness by portraying its engineers as angels. Unsurprisingly, these messages are now seen as cynical marketing ploys. Following the scandal, market research showed that 64% of US vehicle owners no longer trusted Volkswagen, and only 25% held a positive view of the company. Compounding all of this for Volkswagen is the role of social media, where the company has been subjected to relentless criticism.
Today’s consumers are empowered to voice their anger and, in an era of choice, will ultimately vote with their feet.
Regulators and politicians will feel similarly deceived, and likely foolish for allowing Volkswagen and other car manufacturers to largely self-regulate. Volkswagen can expect their reaction to be commensurately harsh, and tougher emission standards are likely. The same is true for the investment community. As of October 6, Volkswagen Group has been removed from Dow Jones’s Sustainability indices for social and ethical failings.
All parts of the Volkswagen Group will feel the wrath of those whose trust has been betrayed. Brands that used the defeat device in their diesel engines, such as Audi, will suffer the most. A recent survey revealed that only 29% of US vehicle owners had a positive opinion of Audi, compared to 69% prior to the scandal. But even units that do not use the diesel engines in their models will sustain some reputational damage, simply for being part of the Volkswagen portfolio.
The fallout will not be contained to the issue at hand. Following a breach of trust, the offender’s other practices will suddenly come under the spotlight, possibly on account of a negative halo effect. For instance, questions have very recently been raised about Volkswagen’s tax payments in Australia.
THE LOCAL PICTURE
Speaking of Australia, the country’s Volkswagen subsidiary has come in for criticism for its handling of the crisis. Mirroring a product recall debacle in 2013, where the Australian subsidiary was widely perceived as slow and ineffective Volkswagen Australia has once again proved unresponsive to local concerns.
Because of Volkswagen Group’s centralised management structure national subsidiaries are hamstrung in their communication with local customers, regulators and other stakeholders. Ten days ago Volkswagen Group announced it would set up national websites to update customers but Australians waited until yesterday (October 7) to learn that more than 91,000 Australian vehicles were affected, including Volkswagen, Skoda and Audi models. Prior to that, Volkswagen Australia’s only message to its customers was that “we have approached head office for clarification and we’re awaiting feedback”.
Australian regulators were equally frustrated with the local unit’s lack of cooperation. The Australian Competition and Consumer Commission (ACCC) launched an inquiry into whether consumers had been misled and vented its frustrations over Volkswagen Australia’s failure to notify the Australian market about the use of defeat devices. The ACCC warned Volkswagen about potential fines in the millions of dollars if the carmaker was found to have deployed the devices in Australia. Australian emission standards are lax by international comparison, but given that emissions under normal operating conditions (when defeat devices are disabled) are 35 – 40 times higher than in the laboratory, it is likely that Australian standards have been breached.
Even in the era of globalisation, country differences remain important and multinational firms need to be attuned to the different contexts in which they find themselves in. Reducing national subsidiaries to the role of neutered sales platforms is likely to deprive the multinational firm of valuable information and resources, as well as sales. In times of crisis, subsidiaries unable to meaningfully and promptly respond to local stakeholders reflect poorly on the group as a whole.
Overall, the direct and collateral damage arising from this scandal will be staggering: decimated shareholder value, damage to the environment and human health, and plundered public trust. For a while, Volkswagen’s oh-so-clever devices helped the company to defeat emissions tests around the world; in the end, however, their use proved self-defeating.
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