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The Fall of the House of Wolfsburg

Symbolbild zur Krise bei Volkswagen und der Vielzahl an drohenden Klagen: Logo VW auf erodierender Straße Symbol image to Crisis at Volkswagen and the Variety to threat Injunctions emblem VW on erosion Road
The damage from Volkswagen's unconvincing response to its emissions-rigging scandal could be greater than the illegal pollutants from the 11 million vehicles under scrutiny.
  • Why it matters

    Why it matters

    If VW does not help in clarifying how it systematically tricked regulators and consumers of more than 11 millions customers, the automaker could face an existential threat and lasting damage to its reputation.

  • Facts

    Facts

    • VW tricked regulators into thinking emissions on 11 million of its vehicles met local environmental standards.
    • The company used software to turn on emissions controls during tests, and to turn them off when they left testing facilities.
    • The scandal caused the resignation of VW CEO Martin Winterkorn, and could lead to major job cuts and downsizing.
  • Audio

    Audio

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Arnold Schwarzenegger is “mad as hell” at Volkswagen. Writing on his Facebook page, the former California governor was furious at the automaker for taking him for a ride. Seven years ago, when Schwarzenegger toured the 2008 Los Angeles Auto Show, he listened to VW of America CEO Stefan Jacoby sing the praises of the “clean diesel” Jetta TDI, which had just pocketed the prestigious “Green Car of the Year” award. With its stellar fuel economy and sports car-like acceleration, the new Jetta even passed California’s recently introduced tailpipe emissions standards, the toughest in the world. In combining these three traits in a diesel car at reasonable cost, Volkswagen’s brilliant engineers had squared a technological circle.

 

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As all the world now knows, the engineers achieved no such thing. Volkswagen’s automotive miracle was a case of crude deception. The car’s newly-developed EA 189 diesel engine was only clean on the test stand. Out on the road, it turned into a stinker, emitting up to 35 times California’s legal limit of nitrous oxides, highly toxic pollutants that play a crucial role in creating smog. A piece of software installed by Volkswagen’s engineers detected the difference between test conditions and the open road. For the tests, the engine ran clean by sacrificing fuel economy and acceleration. For regular driving, the engineers programed the engine to run without pollution controls so drivers could enjoy the car as it was advertised, including the expected acceleration and speed.

What the German press calls “Dieselgate” is now the biggest case of fraud in automotive history. More than 11 million cars worldwide were delivered with the EA 189 engine and the deceptive software installed, requiring a massive global recall. Criminal investigations, lawsuits and regulatory probes have been launched by the U.S. Justice Department, the states of Texas and West Virginia, as well as countries around the world from Australia to Spain. At company headquarters in Wolfsburg, German police raided offices and apartments. Hundreds of class-action suits have been filed by consumers and investors. On the stock market, Volkswagen lost over one-third of its market value, or €27 billion ($29 billion), in just a few days after the scandal broke.

What boggles the mind even more than the scale of the scandal and the fallout for the company is the sheer audacity of this systematic and intentional fraud, involving all of the company’s major divisions and different types of cheat software depending on where the vehicle would be tested.

Since then, the scandal has spread far beyond just one model or a single type of engine. Different emissions scams now involve all of the company’s major brands, including Volkswagen, Audi, Seat and Škoda. Sales of various models have been halted in several countries around the world. In late October, the carmaker announced a €3.5-billion third-quarter operating loss – the company’s first in 15 years. VW has set aside €8.7 billion to cover the cost of recalls, but not the massive fines and legal settlements that are all but certain still to come.

 

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The VW CEO Martin Winterkorn appeared to be riding high after surviving a power struggle with Ferdinand Piech, a key shareholder. But VW's admission that it systematically tried to fool U.S. emissions regulators on most of its autos could stop his ascension to the German automaker's board, experts say. Source: Imago / Jan Huebner
VW CEO Martin Winterkorn resigned after the emissions-rigging scandal broke. He claimed to have no knowledge of the deception, and VW has set aside €28 million for his pension package. Source: imago / Jan Huebner

 

What boggles the mind even more than the scale of the scandal and the fallout for the company is the sheer audacity of this systematic and intentional fraud, involving all of the company’s major divisions and different types of cheat software depending on where the vehicle would be tested. Did the executives and engineers involved really think they could get away with duping the world’s regulators, lying to millions of customers and risking the wrath of the company’s investors?

The answer to that question lies buried inside Volkswagen’s corporate culture of hubris and fear – a culture once caricatured by the German magazine Der Spiegel as “North Korea without the labor camps.” Sources interviewed by Handelsblatt Global Edition describe the relentless pressure at the company to push up sales and overtake Toyota as the world’s largest carmaker – by any possible means. They describe senior executives whose principal management tool was fear. But they also describe a company without a functioning corporate governance, one so impervious to criticism that it ignored warnings by a key supplier and one of its own engineers that its trickery to evade emission standards was illegal from the start.

Investigations have so far focused on the engineers and managers directly involved in developing the EA 189 “clean diesel” engine, where the most blatant fraud was found. Yet in the background lurks the man who like no other created the corrosive corporate culture in which such a massive scandal could unfold, and who was deeply involved in the company’s technical and operational decisions for more than 20 years. Ferdinand Piëch, a former engineer and engine specialist who was CEO from 1993 to 2002 and supervisory board chairman from 2002 until April 2015, made Volkswagen into the successful global automaker it is today. But Mr. Piëch – the grandson of Ferdinand Porsche, who developed the first Volkswagen car in the 1930s – also ruled the company as a terrifying taskmaster. Legendary for his attention to the smallest technical detail and the ice-cold derision with which he’d fire managers for the slightest transgression, Mr. Piëch was ruthless in his efforts to raise quality and slash costs.

 

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Current and former Volkswagen executives say that Mr. Piëch and his protégé Martin Winterkorn, CEO from 2007 until his resignation in the wake of the scandal, created an autocratic, corrosive culture in which dissent and criticism weren’t tolerated. “Workers and managers are afraid to speak the truth,” says Utz Claassen, a former VW executive who worked closely with Mr. Piëch. “Dissenting opinions are at best ignored and at worst suppressed.” Claassen’s assessment was shared by many. Mr. Winterkorn, long groomed by Mr. Piëch as his successor, only tightened the authoritarian reins, according to sources inside the company interviewed by Handelsblatt Global Edition.

Volkswagen’s dysfunctional culture of fear was compounded by an almost complete lack of corporate governance at the carmaker. Controlled by Mr. Piëch’s own family dynasty, the Porsche-Piëchs (who hold the majority of shares), by politicians of the state of Lower Saxony (which owns a 20-percent stake) and by members of the powerful IG Metall labor union (who control half the supervisory board and executive committee), Volkswagen has long been impervious to outside influence. And so Mr. Piëch ruled it like his personal fiefdom, even promoting his fourth wife, a kindergarten teacher and the former family governess, to the supervisory board. Lower Saxony and the union, who together control a majority on the board, cared more about jobs than how the company was run, and Mr. Piëch knew how to keep them happy. Volkswagen has 600,000 employees, almost twice as many as Toyota’s 340,000 – even though both produce a similar number of cars.

 

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Mr. Piëch was also behind Volkswagen’s push to replace archrival Toyota as the world’s largest carmaker, launched in 2007 when Toyota still produced 8.5 million cars compared to Volkswagen’s 6.2 million. The strategic decision that appears to have led to the scandal was Mr. Piëch’s choice of the diesel engine as Volkswagen’s engine of growth. With their higher fuel efficiency, diesel cars are tremendously popular among European drivers, accounting for 54 percent of total auto sales last year. But in the United States, where diesel had a dirty reputation, Mr. Piëch’s plan would be a dud – unless Volkswagen’s engineers could come up with a miracle. And so the plan to build the world’s cleanest, fastest and quietest diesel engine was born. Models containing the engine – to be marketed as “clean diesel” – would also have to be so affordable that they could compete with Toyota, whose hybrid cars were enjoying rising sales. “With the TDI, we will disprove the prejudices against a diesel engine as loud, foul-smelling and dirty,” boasted Johan De Nysschen, who headed Audi’s U.S. subsidiary at the time. The launch of Audi’s new, three-ton Q7 luxury SUV with a powerful six-cylinder TDI diesel engine on the American market seemed promising. At the Q7’s unveiling at the 2007 Detroit Motor Show, the company engaged the British pop star Seal to sing his hit, “Fly like an Eagle” – but with the lyrics changed to “fly like a diesel.”

Back in Wolfsburg, the challenge for the team of engineers tasked with developing the smaller, less expensive EA 189 engine was huge. Their task had been made harder still by California’s landmark adoption of the toughest emissions standards in the world, against which Volkswagen and other carmakers had lobbied hard but lost. Falko Rudolph, who oversaw diesel engine development at the carmaker’s Wolfsburg headquarters at the time, was well aware that any effort to build a cleaner engine would either substantially raise its cost (because of expensive exhaust-cleaning equipment) or reduce its efficiency and performance (which would have to be throttled to reduce exhaust). “The biggest challenge is resolving the consumption-emissions-cost conflict,” Mr. Rudolph wrote in a technical documentation at the time.

 

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The VW patriarch, Ferdinand Piech, right, resigned from the automaker’s supervisory board after losing a public dispute with then-CEO Martin Winterkorn, right. Source: Reuters

 

Mr. Rudolph, who was suspended by VW on October 23, has emerged as a possible key figure in the scandal, along with two other mid-level engineers involved in drive train development and the development of ultra-low-emission engines. Mr. Rudolph was suspended from his job running a components plant in Kassel, while the other two are no longer working for the company. The public prosecutor in Braunschweig is investigating the three men – as well as more than a dozen other engineers and managers – but they have not been charged with any crime. As with Mr. Rudolph, Handelsblatt Global Edition attempted to contact Mr. Piëch and Mr. Winterkorn through Volkswagen but was told the men were not available for comment.

As the engineers were racing to meet Volkswagen’s ambitious schedule to introduce the Jetta “clean diesel” TDI on the American market, costs were getting out of control. The original plan was to use the same complex exhaust technology used by Daimler in its Mercedes brand luxury vehicles. Mr. Winterkorn, in a classic case of not-invented-here syndrome, axed that plan. With that option gone and time running out – the car’s launch date had already been delayed by a year, from 2007 to 2008 – the engineers faced a terrible conundrum. “They couldn’t meet the deadline, and they were too afraid to tell their superiors,” is how a lawyer involved in the company’s internal investigation analyzes the situation. “It would have been a huge disgrace for the engineers.”

The engineers may have feared another temper tantrum from their CEO as they faced another key problem: VW’s strict cost targeting. Installing additional technology to clean the exhaust, as other manufacturers do with their diesel engines, would cost an additional several hundred euros. This is where, according to sources familiar with VW’s internal investigation, another engineer at Wolfsburg headquarters, who was in charge of engine electronics at the time, came up with the shortcut of altering the engine’s emissions behavior using software in the engine control unit. Ten different software programs were installed – including the now-infamous cheat programs that changed the way the engine performed during vehicle tests; during regular driving, emissions would be up to 40 times higher. The engineer has been suspended and is under investigation by the state prosecutor.

The perpetrators at Volkswagen probably thought they were safe. For years, automakers could feel comfortable that suspicious discrepancies between stated and actual emissions would not be discovered. The only way emissions were ever measured was on test stands in laboratory-like conditions, using standardized routines that the type of cheat software deployed by Volkswagen could easily detect. Carmakers were basically operating on the honor code – which Volkswagen repeatedly ignored. As early as 2007, technicians from supplier Bosch had warned VW that the cheat software was illegal, and in 2011 one of Volkswagen’s own engineers had given a similar warning to a company executive. It seems the warnings were ignored.

But the noose around VW’s neck tightened when Japanese engineers developed mobile exhaust measuring equipment that reliably registered emissions on the open road. In 2013, researchers at the University of West Virginia, working on behalf of the International Council of Clean Transportation (ICCT), used the new technology – known as Portable Emissions Measurement System, or PEMS – to double-check the Volkswagen TDI’s suspiciously low emissions values.

 

VW Volkswagen Diesel Has Gained Popularity in the United States

 

Ironically, the ICCT had first honed in on Volkswagen’s diesel cars because they were allegedly so clean, and wanted to prove that they were even cleaner in the company’s U.S. models than those produced for the European market. At the same time, ICCT and other environmentalist groups had long complained that exhaust measurements in the laboratory had little to do with actual vehicle emissions. Now, they finally had the technology to test their claim.

What the researchers found was shocking. A BMW they tested came out clean. But the VWs they tested showed huge discrepancies between reported emissions and actual on-the-road tests. The researchers passed their findings on to the U.S. Environmental Protection Agency and the California Air Resources Board. The EPA confronted Volkswagen, which ordered a recall of some models in December 2014 and afterwards claimed that the problems were resolved. After a new set of tests showed the same high levels of toxic exhaust – and reportedly following threats by EPA chief Gina McCarthy to take VW’s 2016 models off the market – Volkswagen finally confessed to the EPA in early September that it had installed illegal cheat software to manipulate emissions testing results.

To this day, the carmaker claims it was a few rogue engineers who made all the decisions, unbeknown to upper management. And given the toxic and despotic corporate culture created by Mr. Piëch, Mr. Winterkorn and their protégés, it is entirely possible that the engineers were so afraid for their hides that they’d do anything to please the higher-ups, and that the latter didn’t want to look too closely. And the software running an engine is buried so deeply in the car’s technology that it often gets overlooked. “Millions of programs and commands control a car’s functions,” says Heike Flick, an IT specialist at Frankfurt-based auto supplier SyroCon. “A little notebook with special commands is very easy to hide in this enormous library.”

 

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Yet the rogue-engineer theory is beginning to look increasingly dubious as the scandal spreads to include other engines, car models and divisions of the company. In the EA 189 engine, different software programs were installed to detect and circumvent both U.S. and European emissions tests, which have slightly different protocols. On November 2, the EPA accused Volkswagen of installing similar cheat software on V6 engines in the Porsche Cayenne, the Volkswagen Tuareg and several models of Audis. Volkswagen has vigorously denied the claim but has stopped U.S. sales of those models. A few days later, Volkswagen came forward with its own confession that it cheated on CO2 tests involving another 800,000 diesel and gasoline vehicles – initially claiming the company had simply misreported the numbers before admitting that it manipulated the emissions tests themselves, which implies a more systematic scam involving more people than someone simply misreporting the numbers by the stroke of a pen. The company immediately set aside another €2 billion to cover potential costs. VW shares lost another 10 percent on the news.

While Mr. Winterkorn, Mr. Piëch and other C-suite executives might all have plausible deniability over the exact nature of the scams involved, they’re widely known to be experienced, detail-obsessed engineers. They might have wondered how their diesel engines had suddenly become squeaky clean at such incredibly low cost, when other automakers had to install additional hardware to clean up the exhaust. Few analysts contacted by Handelsblatt Global Edition believe the company’s claims that it was just a rogue team of lowly engineers, especially now that the scandal has spread. “VW has probably the most technically expert senior management in the industry, it’s an engineering-led culture,” says Max Warburton, industry analyst at Bernstein Research. “Investors simply don’t find it credible that these problems are due to a few rogue engineers.” At least that’s how some investors see it from afar.

As of early November – almost two months after the scandal went public, and a year and a half after the EPA first confronted VW with its findings – the company has still not explained the decision-making processes that led to emissions cheating on such a massive scale. It has suspended at least six managers, including the development chiefs at Volkswagen, Audi and Porsche. Volkswagen’s evasive statements and piecemeal admissions have not exactly helped the company regain trust — nor has VW’s refusal to let in independent investigators. “The company’s efforts to portray itself as a victim of some sort of unfortunate accident are not going to satisfy anyone,” Warburton says. As VW hems and haws, America’s EPA remains ahead of European regulators in pushing the company to come clean.

 

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Volkswagen can weather a scandal of this magnitude, analysts like Warburton say. VW sits on a €30 billion cash pile from many profitable years, and the company has already announced a cost-cutting program. The silver lining is that the scandal might finally lead the company’s owners to clean up its authoritarian culture and ineffective governance. Already, the new CEO Matthias Müller – who probably has the toughest job in the corporate world right now – promises a “new culture” at the company, including greater transparency, decentralized decision making and a less authoritarian style. In a sign of change, the company has appointed a former judge at Germany’s constitutional court as a compliance officer and given her a board position. But skeptics will remember similar promises by Mr. Winterkorn to decentralize the company, made shortly after he became CEO. And the company’s main owners – the Porsche-Piëch family and the state – have so far resisted calls to let in an outside CEO, or change the company’s exotic governance structure.

Meanwhile, the company is bracing for a year or two of costly recalls, criminal cases, regulators’ fines and legal battles. And with the various investigations still going on, no one knows what new problems will still emerge.

And so the greatest scandal in automotive history festers on.

 

Franz Rother is an editor with the German weekly magazine Wirtschaftswoche. Stefan Theil is a business journalist based in Berlin. Handelsblatt Global Edition’s John Blau contributed to this article.

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