By William Boston
WOLFSBURG, Germany--Seven years into a decadelong push to
outsell rivals Toyota Motor Corp. and General Motors Co.,
Volkswagen AG Chief Executive Martin Winterkorn appeared to be in
the passing lane.
Volkswagen, after all, is on track to sell more than 10 million
cars and trucks in 2014--four years ahead of plan. It overtook GM
last year and could soon eclipse Toyota to claim the industry's top
spot.
But on Tuesday, Mr. Winterkorn surprised investors by announcing
he would step down as CEO of the VW brand, the company's namesake
marque which has suffered dwindling sales in most markets as well
as weak overall profits. He will retain his position as group CEO.
His replacement at the VW unit, a top executive from German rival
BMW AG, Herbert Diess, will come aboard in October.
The move marks a strategic reversal for Mr. Winterkorn, a
Volkswagen lifer, who in July pledged to "take action that is
clear, effective and sometimes painful" but gave no hint of handing
off the iconic brand. Historically, the CEO of the company, which
also includes eight other marques such as Porsche, Audi and
Bentley, has always held the reins of the VW brand.
Investors had expressed concern that the CEO was too preoccupied
with the company's larger portfolio of brands to focus on the VW
unit, which accounts for more than half of group revenue but has
skidded amid high costs and falling sales in big markets including
the U.S., Russia and Brazil. Some analysts have also questioned the
CEO's stomach for profound change at VW.
In a statement Tuesday, Mr. Winterkorn said that the move "puts
the executive management of both the Group and the brand on an even
broader footing."
The decision to hand control of the VW brand to Mr. Diess may
permit faster action, analysts said.
The shift comes at a pivotal time for Volkswagen and the
industry. Global car makers are benefiting from the rise of a new
middle class in emerging markets that has spawned a generation of
first-time car buyers.
But auto makers also face rising costs to cut emissions, improve
fuel economy and connect cars to the Internet. The challenge for
Volkswagen and its peers is to stay profitable while balancing the
potential of global markets against the burden of regulation.
Mr. Winterkorn's response was to spread rising costs over an
expanding production base. But world events have been upending
those plans.
In Europe, the company is growing slowly in a weak market. In
the U.S., VW-brand sales have tumbled until recently and the marque
is struggling to break even, according to a person familiar with
the situation. Emerging market sales--especially in Russia, Brazil
and India--have been battered by political crises and sliding
currencies. Growth is slowing in China, a Volkswagen stronghold,
and VW brand sales declined for the first time ever in November.
The company has yet to penetrate other Asian markets.
Tighter regulations have added to Mr. Winterkorn's headaches.
Under current market conditions, meeting European Union limits on
carbon emissions will cost Volkswagen up to EUR5 billion ($6.2
billion) in earnings each year to 2020, or the equivalent of adding
EUR1,500 to the cost of every car it produces in Europe, according
to two people familiar with the situation.
Even before that expense, Volkswagen group's financial
performance trails that of rivals who have spent years boosting
efficiency. Toyota, for example, generates similar revenue to
Volkswagen with roughly half the workforce.
Also interfering is Volkswagen's unusual history and status as a
German national institution tightly controlled by one family. The
resulting culture complicates boosting efficiency where it is
needed most, in its massive German manufacturing operations.
Despite the stalls, Volkswagen group remains profitable. Through
September this year, net profit rose 26.7% to EUR8.5 billion and
revenue grew 1.4% to EUR147.7 billion.
Weak profits at the VW brand, though, leave the group dependent
on its high-end brands Audi and Porsche and big margins in China,
where the VW brand has expanded aggressively.
Volkswagen group's ferocious grab for growth--doubling its
revenue, vehicle sales and number of factories since 2007--took it
into new markets, but left it vulnerable to their economic swings.
Since 2012, swooning emerging-market currencies have cost the VW
brand EUR2 billion in pretax profit.
"It is not just the world outside that is putting us to the
test," Mr. Winterkorn warned his executives at a meeting in July,
according to an internal memo and people who attended the
gathering. "We are dealing with homemade problems as well."
VW's German factories are too big and complex, he said. Labor
costs significantly outpace productivity gains. Executives, steeped
in an engineer-driven culture, too often add features with little
thought to profit.
German production costs are so high, he said, that building a
new derivative of VW's Tiguan sport-utility vehicle "is not
economically feasible at a German production site." The current
version of the Tiguan is produced in Germany and exported to the
U.S. Now, VW is negotiating to build the next model in Mexico,
according to two people familiar with the situation.
In July, Mr. Winterkorn ordered his executives to cut EUR10
billion in annual costs by 2017, tasking the VW brand with covering
half the tab. That would help the brand meet its target of tripling
profit margins by 2018, to 6% of sales.
To achieve those savings, Volkswagen is moving production to
low-cost locations, like the Tiguan shift to Puebla, Mexico--its
second-largest factory after Wolfsburg. It is investing billions to
standardize its factories with a modular production system that
allow different brands and models to share up to 60% of their core
components, cutting upfront investment.
But Mr. Winterkorn has stressed that the VW brand needs a
tuneup, not an overhaul. Significantly, he has ruled out job cuts
in Germany--an edict that complicates streamlining costs in
Germany.
Volkswagen's roots date to 1937, when Adolf Hitler's Nazi party
backed Beetle inventor Ferdinand Porsche's vision of building a
Volkswagen, or "people's car." World War II interrupted the plan.
Mass production began after the war and the Beetle became a symbol
of Germany's economic recovery.
Under CEO Carl Hahn in the 1980s, it launched a successor model,
the Golf (first called the Rabbit in the U.S.) which remains the
world's best-selling car.
Mr. Hahn, who in the 1960s had made VW an American pop icon,
expanded globally and transformed VW into Europe's biggest
automotive group. He bought Spanish car maker SEAT, set up the
first Western manufacturing joint venture in China, and took
control of Czech auto maker Skoda after the Berlin Wall fell.
In 1993 Mr. Porsche's grandson, Ferdinand Piech, took over and
again transformed the company. He borrowed a page from GM creator
Alfred Sloan, who developed a multibrand strategy and pioneered
refreshing cars with annual "face-lifts." The strategy propelled GM
past Ford in the 1930s and kept GM atop the industry for
decades.
Mr. Piech positioned SEAT and Skoda at the bottom of the pricing
ladder, the VW brand in the middle and Audi, Porsche, Lamborghini,
Bentley and Bugatti at the top. His strategy, which remains in
place, was to keep prospering buyers in the Volkswagen family by
moving them up the product ladder as they become more affluent.
He also kept Volkswagen in his family after a cousin, Wolfgang
Porsche, launched a hostile takeover bid. In 2009, Mr. Piech and
his cousin agreed to a complex deal that united Porsche with
Volkswagen, giving a family-owned holding a majority of
Volkswagen's ordinary voting stock and Volkswagen management
control over Porsche's car-making business.
The state of Lower Saxony, where much of VW's workforce lives,
works and votes, holds 20% of the voting stock, enough to block
decisions that threaten jobs in the state. Volkswagen's publicly
traded preferred stock holds no voting rights. Family control
insulates Volkswagen from shareholder pressure. In 2007, Mr.
Winterkorn took charge and launched the biggest expansion in
Volkswagen's history. His growth plan, outlined in 2008 as
"Strategy 2018," was to ride surging demand in Brazil, Russia,
India and China. The goal was to make VW the biggest, best liked,
and most profitable car maker within a decade.
Success came quickly. Chinese demand soared, contributing more
than EUR4 billion to group profit last year, up from about EUR108
million in 2006. The company set up a joint venture in Russia, a
factory in India and expanded in Brazil. Such global moves helped
the company weather a six-year contraction of Europe's car markets
amid the euro crisis.
Last year, the trend slowed as currency swings, economic
weakness and political crises in emerging markets shrank car
demand. Sales growth in China, which topped 30% annually in recent
years, could skid to 6% in 2015, according to some industry
estimates.
Mr. Winterkorn has said he believes China will keep growing and
emerging markets will regain strength.
Today, VW remains the biggest foreign manufacturer in China but
Toyota is pushing hard. Elsewhere in the region, VW lacks heft. Of
the VW brand's 2.47 million cars sold in Asia-Pacific to the end of
October, just 170,000 were outside China.
The VW brand is also struggling in the U.S., reversing several
years of progress. Sales fell more than 12% in the first nine
months of this year. To eclipse Toyota, VW must get the U.S.
right.
Frustrated with slow U.S. progress, Mr. Winterkorn last December
fired the head of Volkswagen of America and appointed a Wolfsburg
insider, Michael Horn.
Mr. Horn argued for profound change to make VW more American and
give its U.S. operation more autonomy from Wolfsburg.
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"We need more U.S. products for the U.S. market and we have to
have a louder voice out of the U.S. into this company," he said in
an interview. VW, for instance, doesn't offer large and midsize
SUVs that are popular with American drivers.
With that goal in mind, Mr. Winterkorn formed a new North
America Committee. The group, consisting of U.S. executives and
about half of VW's management board, has met at least five times
since February.
In July, Mr. Winterkorn announced plans for the CrossBlue, a new
midsize SUV, and a new research and development center in
Chattanooga, Tenn. The U.S. team is now leading development of new
derivatives that could include up to six SUVs for the U.S. market
over the next three years.
VW will also update U.S. models within five years, rather than
up to seven as in Europe, and will scrap low-selling brands such as
the EOS convertible sedan. Last year, the company sold only 7,651
EOS models. More broadly, 19 of its standard models sold fewer than
100,000 cars world-wide.
Part of the problem, critics say, is that VW makes too many
components internally--even brake parts and pedals. Extreme
integration lowers productivity, drains capital and cuts profits,
said the Center for Automotive Research at the University of
Duisburg-Essen, in a recent study.
"The problem is that VW simply has far too many employees," says
research center director Ferdinand Dudenhöffer. "And the high level
of integration adds labor costs and means VW cannot generate as
much profit."
VW component-factory employees earn autoworker wages, up to 35%
higher than wages at big suppliers. VW's second-largest German
plant, in Kassel, employs 16,000 people and doesn't make cars. A
similar component plant in Braunschweig employs more than 6,000
people.
Mr. Winterkorn calls integration a strength because it keeps VW
in control of key technology.
As for the VW workforce, the CEO has avoided confrontation.
Shortly after he announced his savings plan in July, VW's top labor
representative, Bernd Osterloh, handed him a 400-page document with
savings proposals. It included no job cuts at VW's six German
factories.
"The workforce must not be made to bear the brunt of these
measures," said Mr. Osterloh. "We won't go along with that."
Mr. Winterkorn, standing next to the labor chief at a workforce
assembly in Wolfsburg in August, held the document and swore he
wouldn't cut jobs. Workers gave him a standing ovation.
"Our shared task is to create the ability to profitably produce
these vehicles in Germany," Mr. Winterkorn told executives in July.
To do that, he said, everyone needs to "pull together in one
direction."
Write to William Boston at william.boston@wsj.com
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