Volkswagen's Long Road to Recovery Pt. 1

My first car was a 1989 Passat station wagon. The Passat fully embodied the literal translation of the company’s name: the people’s car. It was reasonably priced, cheap to maintain and mechanically robust. The interior was roomy and practical. Compare it to today’s expensive, unreliable and over-plush Passat and you’ll know why the German automaker is in trouble. Volkswagen has lost their natural place in the market, a spot originally staked-out by Adolph Hitler.

In January 1933, twelve days after Hitler became German Chancellor, Austria’s native son announced that the German people would get a car that could travel at 60mph, fit four people and cost less than 1000 Reichsmarks. The next year, Ferdinand Porsche designed a prototype.

Production of the KdF-Wagen (KdF for “Kraft durch Freude” or “Strength through Joy”) began in 1939, the same year Germany invaded Poland. Germany’s pressing and ongoing need for military vehicles brought manufacture of the “people’s car” to an abrupt halt.

After the war, occupying British forces initially moved to sell the Wolfsburg factory. (Ford and Humber were amongst the potential buyers.) Then the Brits decided to restart production of the Beetle (as the KdF-Wagen had been rechristened). When the key players bailed, the government of the federal state of Lower Saxony stepped in.

The Beetle turned out to be the most successful car design in human history, with over 21 million examples sold. VW began exporting the Beetle around the globe, from Thailand to Sri Lanka to Nigeria to the United States of America. By 1970, the car Henry Ford II called "a little shitbox" racked-up enough sales (569,696) to become America’s top selling foreign car.

Even at the height of its success, Volkswagen was in trouble. It had put most of its eggs in a Beetle shaped basket, which was rapidly losing ground to Japanese and American-financed competition. Facing floundering finances, Volkswagen flirted with a Daimler-Benz merger. Instead, in 1964, VW bought Auto Union (later renamed Audi) from Daimler-Benz, and saved itself from ruin.

Auto Union possessed mission critical state-of-the-art technology for new models, including front wheel-drive and water-cooled engines. Initially, VW found a measure of success by lightly re-engineering Audi vehicles. In 1974, the company broke the mold with the Golf, a stunning worldwide success. Despite the innovation, the company continued to see inter-brand platform and parts sharing as the key to corporate success.

VW Chairman Carl Hahn put the theory to the test. In the late 80’s, Volkswagen bought controlling interest in Spain’s SEAT and Eastern Europe’s Skoda brands, and began slipping Volkswagen Audi Group platforms underneath new sheetmetal. Unfortunately, at the same time, VW became a victim of sister Audi’s success. As Ingolstadt’s finest took on BMW and Mercedes, VW moved into Audi’s traditional middle market, leaving lower cost SEAT and Skoda to fight it out at the budget end of the business.

Although it’s easy to see how German labor unions’ stranglehold on Wolfsburg left VW management little choice, mid-market was the worst possible place to position “the people’s car.” VW faced threats from Asian economy brands reaching upwards and German luxury brands (including Audi) reaching downwards– not to mention American and other brands fighting for its [new] target demographic.

At the same time, over-expansion and bad management were destroying the brand’s core value: bulletproof build quality. As VW's market share evaporated, rigid labor agreements forced the company’s German operations to crank out cars that couldn’t generate life sustaining margins. In a desperate move to cut the glut, Volkswagen agreed to a 28-hour work week– without significant wage reductions.

All these decisions culminated in a single vehicle: The Golf Mk V. Although it’s a fine automobile, the Golf’s latest incarnation is simply too expensive– both in terms of labor costs and manufacturing complexity– to rescue the brand’s declining fortunes. Volkswagen sells plenty of the new, German-made Golfs, but it doesn’t make a single Euro on any of them.

On the positive side, VW’s management has finally realized that it can’t change its image OR charge more money than the competition (which includes Audi). Which still leaves Volkswagen tied-up in a Gordian knot.

If Volkswagen wants to resurrect its reputation for engineering excellence and driving satisfaction– at a price point below Audi– it must do so outside of Germany (i.e. The People’s Republic of China) or find a way to dramatically reduce its labor costs inside Germany. The unions’ political power makes both options largely untenable.

The company’s only hope: Porsche’s move to overthrow the local government’s lock on majority ownership of VW. But even if the unions’ stranglehold can be broken, it still looks like the future of the brand started by a fascist dictator lies outside Europe, in a country run by a military dictatorship.