A VULNERABLE GIANT

Volkswagen's soaring growth under Piech masks troubles

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During his two-decade reign, Volkswagen Group Chairman Ferdinand Piech has created an automotive giant with broad geographic reach, a diverse product portfolio and a huge pile of cash it can tap to finance further growth.

Piech's right-hand man, CEO Martin Winterkorn, pledged to shareholders that nothing would stop VW on its steady climb to the summit of the automotive industry. "We have the necessary financial solidity and strength -- and a convincing strategy for the future," he told investors at the automaker's annual meeting in May.

But industry analysts looking ahead to Piech's departure take a far more nuanced view of VW's prospects. The No. 3 global automaker -- with its 12 brands spanning everything from heavy trucks to motorcycles -- may be too vast and fractured to stay cohesive in Piech's absence, they warn, and yet not globally diversified enough to take full advantage of the industry's biggest growth markets.

They note, for example, that VW depends heavily on China, while it has failed to gain traction in the United States and India. It faces higher-than-expected costs from introducing its new MQB architecture, and it has a delicate balance of power among core shareholders that risks splitting the group and its 12 brands apart once the 77-year-old Piech is no longer there to unite the separate factions.

Without Piech in charge, UBS auto analyst Philippe Houchois warns, VW Group's complicated ownership structure could lead to infighting among its main shareholders: Porsche Automobil Holding, the German state of Lower Saxony and Qatar Holding, which together control almost 90 percent of the votes.

"Piech is clearly the 'glue' at VW, the person who can make decisions in a shareholding structure where nobody really has control," Houchois says. "Succession is therefore a meaningful challenge."

Ferdinand Piech: a gifted engineer and a lightning rod for controversy

Photo credit: REUTERS

Porsches and putsches


VW's boardroom has been the stage for intrigue worthy of "Game of Thrones." A sex scandal centered around union leaders rocked the company in 2005, leading to the resignation of Piech's boardroom ally, Klaus Volkert. Hoping to clean house, former VW board member and ex-Lower Saxony head Christian Wulff attempted a coup against Piech but failed.

In the years that followed, former VW board member and Porsche CEO Wendelin Wiedeking tried to acquire VW Group and use its cash reserves to pay for the hostile takeover. That sparked a feud between the Porsche and Piech families over control of VW that lasted until Wolfgang Porsche capitulated to Ferdinand Piech, his cousin, in 2009.

Both a gifted engineer and lightning rod for controversy, Piech has devoted his life to VW in a bid to emulate the success of his grandfather, Ferdinand Porsche -- the intellectual father of the company and creator of the Beetle. But the chairman seems to fear his legacy may not be safe. His chief lieutenant, Winterkorn, has remained VW Group CEO even though he turned 67 in May (most CEOs in Germany serve until their early 60s). Piech also used his influence to install his wife, a kindergarten teacher, on the VW supervisory board.

Managing a smooth succession could be tricky given the shifting alliances and feuding interests of the past, says John Wormald, managing partner of automotive consultancy firm Autopolis. "It may be somewhat of an exaggeration but it's reminiscent of Yugoslavia under Marshal [Josip] Tito, where all the various factions battling it out internally for control created these centrifugal forces that eventually tore the country apart," he said. "Who's there that could really take charge? Is Winterkorn really strong enough?"

Winterkorn: Has led rapid growth

Winterkorn, for his part, has put VW in an enviable position among European automakers. Volkswagen has grown rapidly since he took over as CEO at the start of 2007, adding four brands and nearly doubling its annual revenue to 197 billion euros. ($268 billion). Its global manufacturing footprint has more than doubled to 106 plants, including the one in Chattanooga, its first U.S. plant since it closed its Westmoreland, Pa., plant in 1988. And its model lineup has grown threefold to about 315 vehicles.

The company plans to invest more than $100 billion in product development and production capacity, including $7 billion in North America, from now through 2018, by which time it aims to overtake Toyota Motor Corp. as the world's sales leader. Meanwhile, many of its cash-strapped competitors in Europe are still busy cutting jobs and production in response to a six-year slump in new-car sales.

By the end of 2018, despite commitments of cash to pay for plants, products and technology, VW expects to have about $43 billion in surplus cash that it can add to the roughly $24 billion already on its books at the end of the first quarter.

As a result, VW can afford to look beyond 2018 to prepare itself for coming challenges as the industry moves toward self-driving cars and new personal mobility models. With the Future Tracks strategic plan expected to be detailed this year, Winterkorn aims to accomplish nothing less than answer the challenges that he calls "one of the greatest upheavals since the invention of the automobile."

Decision on Chattanooga


But for all its might, VW is struggling already with more mundane challenges -- not the least of which is its decline in the United States, where sales of the core VW brand are shrinking at a double-digit rate this year. Sales of the Passat mid-sized sedan, produced in Chattanooga since 2011, have tailed off, and VW is not a factor in the booming market for small crossovers.

With sales of just 407,700 Volkswagen vehicles in 2013 -- the brand peaked at just under 569,200 cars in 1970 -- VW replaced the head of its U.S. operations at the start of this year in an effort to quell a dealer revolt and get back on track to reach its target of 1 million VW and Audi vehicles sold by 2018.

The longer-term solution -- a better lineup of products to answer American consumers' tastes for SUVs and crossovers, and more competitively priced cars -- is well understood among VW's U.S. and German executives.

Those plans were slowed by a long-pending decision on where to build the new crossover, a decision that ultimately went in favor of the Chattanooga plant, where VW had already laid the groundwork for an expansion. But even with Winterkorn’s announcement today on the future of the crossover — along with plans for a 200-employee development center at the same site — it will still be late 2016 before the crossover shows up on dealer lots.

That represents one of several holes in VW's global presence. "In the strictest sense, Volkswagen is not a global player," said Helmut Becker, head of the Munich-based think tank IWK and author of several books on the industry. He feels the company is becoming too dependent on China, which accounted for a third of VW Group's sales last year.

"They are strong in China, Europe and Brazil, but they continue to struggle in the U.S. market, are a latecomer to Russia, and they are not at all present in India," Becker said.

Even Brazil is starting to cause problems, with sales dropping 16 percent last year and falling 18 percent in the first quarter. The automaker's 2013 deliveries in India declined 19 percent, almost three times the rate of decline of the overall market, which dipped 7 percent. And after repeated attempts at establishing a foothold in Southeast Asia -- initially with Malaysia's Proton -- it still has failed to gain traction there.

Some analysts see this pattern as the result of a corporate structure that's too massive and unwieldy to manage effectively. Debt-rating firm Fitch also complained in May about conflicts of interest as well as a "lack of independence and diversity" in the board as a key weakness in VW's corporate governance.

Meanwhile minority investors are powerless, since most public stock doesn't confer the right to vote at annual meetings. In other companies, activist shareholders often play a valuable role by challenging boardroom decisions, pushing for change and putting pressure on management to unlock value by focusing their strategy and selling noncore assets.

VW, for example, still owns a 19.9 percent stake in Suzuki Motor Corp. that is strategically questionable given that the Japanese company wants out. Suzuki filed for international arbitration in November 2011 after Volkswagen refused to sell back its stake. VW also operates companies that produce steam turbines and container ship engines, which are left over from its acquisition of MAN, and even owns 8.3 percent of German soccer club Bayern Munich through its Audi brand.

For the moment, VW seems to have steered clear of the recall problems that befell Toyota after its growth spurt under former CEO Katsuaki Watanabe, and the German carmaker's current success goes a long way toward masking some of the underlying problems at the company.

"No other carmaker in the world has been able to increase its production by 4 million cars during the time since Winterkorn took over," said IWK's Becker. "Achieving that kind of growth while safeguarding quality is a real accomplishment. You can't do everything at the same time."

You can reach Christiaan Hetzner at christiaan.hetzner@gmail.com.


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