“The Chinese use two brush strokes to write the word ‘crisis.’ One brush stroke stands for danger; the other for opportunity. In a crisis, be aware of the danger – but recognize the opportunity.”
~ John F. Kennedy ~
Europe’s biggest carmaker Volkswagen is facing its worst crisis in its 78 year history after admitting to cheating diesel emissions tests in the United States, with eleven million vehicles affected worldwide.
The crisis erupted after U.S. environmental authorities said that Volkswagen intentionally installed software in some of their diesel powered cars that made them perform better in emissions tests than they do on the road. The scandal not only toppled the CEO but also resulted in the suspension of several engineers, including Heinz-Jakob Neusser, head of Research and Development for Volkswagen brand passenger cars.
In response to the scandal, Volkswagen did what Volkswagen does: promote from within. Even now, in the midst of an historical crisis that has wiped out roughly 40% of Volkswagen’s market capitalization, they have installed CFO Hans Dieter Poetsch as their new CEO. Mr. Poetsch has in turn been replaced as VW CFO by Frank Witter, who since 2008 has served as Chairman of the Board of Management of Volkswagen Financial Services.
Volkswagen’s decision to nominate a long-serving executive as Chairman highlights the carmaker’s corporate governance and culture, one which some experts argue were a root cause of the diesel-emissions scandal. The well-known phrase “German Engineering” has long inferred a sense of quality and integrity in the things that are made and the way they went about making them. But with Volkwagen’s culture of hubris currently on full display, they have proven that they had plenty of pride but not enough enforcement of their own corporate values in the way they managed the company. The Financial Times even writes that Volkswagen has long behaved as if it were “the last principality on German soil” and functions fundamentally as a clan where above anything else loyalty and devotion are rewarded.
Hans-Christoph Hirt, a director of Hermes Equity Ownership Services, an adviser to pension fund investors in companies including VW, points out that the appointment also creates a “serious conflict of interest”. “Mr. Poetsch was a key VW executive for more than a decade and under German law the management board has a collective responsibility . . . The lawyers will surely demand that he recuse himself from any supervisory board meetings when management’s role is discussed,” Mr. Hirt said.
VW’s response stands in stark contrast to the way Siemens dealt with a huge bribery scandal in 2006. For the first time in its 150 year history, the German engineering conglomerate appointed both an outside Chairman and Chief Executive. Together they transformed Siemens’ culture and took legal action against former Siemens executives for not stopping the bribery. “How is Mr. Poetsch supposed to do that?” said Mr Hirt.
With the help of a US law firm, VW has launched its own internal investigation and is reporting their wrongdoing to prosecutors. However, governance experts argue the cheating was predictable because of VW’s lax boardroom controls and peculiar corporate culture. “The scandal clearly also has to do with structural issues at VW . . . There have been warnings about VW’s corporate governance for years, but they didn’t take it to heart and now you see the result,” says Alexander Juschus, director at IVOX, the German proxy adviser.
As Volkswagen seeks to address the scandal, the first big issue they face is the cost. VW must recall and repair all the affected cars, pay steep fines, and are likely to take a big hit on sales. Credit Suisse estimates the scandal could end up costing anywhere between €23 billion and €78 billion.
Secondly, capital market analysts are expressing big concerns regarding Volkswagen’s Financial Services (VWFS) business which provides car financing and insurance to customers. Credit Suisse believes VWFS is going to face a sharp increase in the cost of financing itself which in turn means pressure on its capital ratio. As a result, they will need to pull more and more money out of the car manufacturing business.
Credit Suisse says, “We see risk to VW’s balance sheet, as industrial net cash position of circa €25bn is unlikely to be sufficient to cover potential recall costs/fines or subsidy clawbacks. Even in a more optimistic outcome, we see meaningful risk of a capital increase.”
Plain and simple, VW is going to need more money. And a lot of it.
Credit Suisse goes on to predict that the result over time will be a further fall in the share price of an additional 20%. In a note sent to clients, the investment bank says “the market does not appear to be discounting negative knock-on effects” from the scandal and concludes “there is more downside despite the €32bn drop in market cap.”
The Volkswagen crisis is also sure to have a substantial impact on their 600,000 employees, and poses a larger threat to the overall German economy as one of the country’s largest employers.
Whatever happens, this scandal is clearly nowhere near its end. Seven Investment Management’s Justin Urquhart-Stewart told BBC Radio 5: “In a few years’ time, you’ll be going to those business school exams, and there’ll be an entire question just on VW – how to make sure you can recover your brand from what is a disaster.”
There are of course many companies which have traveled down this road before. Some believed they were invincible, before going down in flames. Example: Enron. Others managed to weather the blows but remain a shadow of their former selves. Example: Toyota. The reality is only time will tell if VW really understands the monumental challenge they are facing. And whether or not they will seize the opportunity to secure their future which at this stage is only possibly if they take the necessary steps to fundamentally change their ways from deep within.
