Monday, October 5, 2015

Volkswagen’s Emission Crisis

The recent allegations that VW engaged in corporate fraud to deliberately manipulate emissions data and deceive environmental regulators has been met with global shock.

The ire of the US and German Governments in particular, as well as the United Nations, was quickly forthcoming; Barack Obama and Angela Merkel weighed in to demand answers and swift resolution. Then, the dismay of its loyal customers and workforce who have been faithful to the brand became overwhelming.

The level of scrutiny and outrage that the world’s largest auto manufacturer is now subjected to is enormous.

What has been witnessed since the scandal broke is sure to fit anyone’s definition of crisis; a black swan event with company destroying potential. It is simply one of the largest corporate crises this decade and, in the annals of history, will likely sit alongside Enron, Tesco, Barings Bank and News Corp’s similarly shocking scandals.

The Immediate Effects

From a strategically focused corporate crisis management perspective, an almost irreparable amount of damage has been done, which, at a glance, is immense:
  • The Global CEO, Marin Winterkorn, delivered an unreserved apology prior to resigning.
  • The President and CEO of VW Group America, Michael Horn offered a blunt apology acknowledging “we totally screwed up”.
  • Senior Research and Development staff have been stood down pending investigations.
  • VW faces financial liabilities of up to US$18B, based on 11 million cars worldwide that may be affected. Already, VW has set aside US$7.3B from the third quarter; an indication of how serious they suspect this could be.
  • VW’s value has shed approximately 30% in the immediate days after the scandal broke.
  • The crisis contributed to the European market slumping 3% immediately after the announcement.
  • Many rival auto manufacturers saw sympathetic price drops as wary investors avoided the auto sector for fear of how the crisis could deepen and spread. Even Nissan, who do not manufacture diesel cars for the US market, saw a price hit.
  • The United States Department of Justice has launched a criminal investigation into VW. The Environmental Protection Agency has also launched investigations as have similar branches within governments from countries including Germany, France, Italy, United Kingdom and South Korea.
  • In addition to criminal investigations by the US and German Governments, there are, at the time of writing, 34 class action law suits filed in the US alone. Canada has also filed a handful of law suits as have Investors and Superannuation funds. Understanding how far the legal liabilities extend will be a gargantuan task requiring nothing short of a small army of lawyers.

  The cost of lost reputation

The costs of VW’s goodwill is where one of the biggest hits will likely be felt. Goodwill, the value of the brand which also includes intellectual property and patents, measures the company’s value beyond the assets it owns. It can also include future growth, brand value and human capital.

Interestingly, VW’s goodwill was estimated at around US$67B (before the crisis), or 16% of its total assets. Compared to Daimler (4%) and BMW (3%), some may conclude that VW’s ‘goodwill’ is overvalued.  Already, some estimates put VW’s loss of brand value at around $US10B.

What is certain though is that their brand has taken a seismic hit. If their goodwill is potentially overvalued (by comparison of other major auto makers) there may still be massive write downs of their valuation to come. If their brand value was brought into alignment with their competitors then the quantitative drop could be huge.

The Broader Strategic Issues

The effects of VW’s crisis are severely threatening the auto manufacturer’s long term viability. Given that it employs over 600,000 people worldwide, 270,000 of whom work in Germany alone, this is very concerning. The German Government has a vested interest in keeping the wheels of the beleaguered auto company turning, from both a financial and social stand point.

At a time when Germany is baring the large brunt of the humanitarian crisis affecting Europe, it needs  VW to remain a viable integral cog in German industry. While the crisis has a course to run, German Government involvement to keep VW alive is likely and we can expect to see continued diplomatic efforts and involvement by Angela Merkel to ensure transparency and complicity with US Authorities.

From a reputational perspective, VW has suffered a near knockout blow. Similarly, the overarching reputation of any item that has earned “Made in Germany” status has been affected. The global psyche has always associated German engineering as being amongst the best on the world; it is a shame to have seen that engineering prowess focused into deception over innovation in their attempts to break the back of the key US auto market.

Beyond Germany’s interplay within this burgeoning crisis, the global automotive industry has been reshaped, particularly the philosophy of diesel powered cars. Certainly, in the US, VW has likely delivered a significant set-back for diesel technology take-up compared with its gasoline competition. VW’s future revenues associated with the US market are likely to have suffered greatly as a result.

When the United Nations weighed in on the issue in the days following, it did so in the knowledge that it needs the automotive sector on-side to meet its own agenda related to climate change. The mere notion of diesel possibly not being as green as they were led to believe, may have consequences for other industries related to how the UN advocates for meeting climate change objectives.

In some respects, VW’s future being so intertwined with Germany’s strategic direction is in the auto manufacturer’s favour. It would be catastrophic for Germany if VW went under and, bemusement and anger aside, it would be a global travesty too.

Where to from here for VW?

VW have replaced outgoing CEO, Martin Winterkorn, with Matthias MΓΌller the former head of its subsidiary, Porsche. This move has generally been received well in terms of providing clear leadership focused on resolution and recovery.

Apologies by the former CEO, Winterkorn, and President and CEO of VW Group America, Michael Horn, have been delivered. There has been no ambiguity in taking responsibility for the scandal and both pledged the transparency demanded by global stakeholders.

As a company, VW is complying with authorities, Governments and clients, which bodes well for repairing many of the bridges that have been broken. The test for VW is maintaining this solidarity in the face of mounting conflict; particularly with increasing lawsuits.

Broadly there need to be displays of strong leadership, rapid action to control the event, effective two-way communication and sensitivity to stakeholder concerns. So far these attributes have been displayed, signposting how the company intends to continue responding.

VW’s stakeholder concerns have been given strong attention and there is likely to be an acute awareness of the social impact this crisis has had on its customers, workforce, suppliers and contractors, government and global audiences. All these stakeholders are key to VW succeeding at rebuilding its reputation and re-earning trust on the back of undoing much of the 55 years it has spent building its image.

In parallel, VW must demonstrate a drastic departure from the behaviours which landed it in this scandal. Their culture, transparency and risk-management processes must be robust to ensure this type of crisis can never occur again.

Indeed, holding those responsible or involved to account will deliver a twofold outcome: It will satisfy the insatiable desire of the public for those responsible to be dealt with appropriately but also demonstrate that VW intends to abolish the seeds of the toxic culture which caused this scandal. 

This all needs to be done carefully to confirm to employees that it is not a witch-hunt but a lesson in accountability and ensuring a new culture founded on moral integrity is formed. There is a need to protect those hardworking, honest and intelligent employees who are the life blood of the world’s largest auto manufacturer. VW will likely be focused on retaining as much of its workforce as it can. It simply cannot afford to lose the good people who remain in the company. If it does it will be that much harder to rebrand itself as an innovative car manufacturer making high quality products.

In an ironic way, it is usually these high impact, low frequency events which drive the most notable change-for-good in companies and industries. Whilst the current saga for VW is undeniably damaging, the company has a real opportunity to rebuild, rebrand and reshape itself.

Many of the processes that have contributed to this crisis will be exposed and eradicated. Internal structures that were difficult to change prior to the crisis will be modified; from moving, removing and elevating individuals through to the removal of inefficient corporate systems that create slow-burn issues. All of this change will be scrutinised under the microscope of public, Government and regulatory attention.  And, importantly, if investors like what they see in the future direction of VW, they will re-invest their capital.

The Lessons

In the same way that Nick Leeson brought down Barings Bank, a group of high powered individuals operating with a lack of oversight has inflicted major strategic damage to VW. The actions and inactions of a relative few have threatened one of the world’s largest companies, tarnished the reputation of diesel technology and the hard won reputation of German industry, threatened the careers and livelihoods of a largely innocent workforce and added risk to the financial and social stability of a nation. Certainly, white collar crime must remain high on the corporate threat agenda.

Disproportionate power divisions are always going to be present. It therefore underpins the critical role that Boards must play in the Governance of companies and ensuring they remain objectively aware of strategic corporate risk. The independence of Boards is one key element that makes them strong and gives them the positioning to take a helicopter view of the company so that they can ensure the company remains appropriately led, managed and governed.

More practically, the VW crisis underscores the need for all companies to have robust procedures in place to quickly respond, manage and recover from high impact low probability events. Processes must be endorsed and championed from the top, be implemented with a strategic focus and regularly rehearsed.

Crisis Management Teams must be able to interface with the board, understand each group’s role and control the strategic threats emanating from any major event. It should not matter whether the event is physical, non-physical, acute or slow-burn in nature. What needs to be continually assessed is how bad a situation could get and understanding the worst case scenario.

Companies that establish high level frameworks of corporate crisis management, with defined links between the Board and the executive crisis management team, respond quicker and more thoroughly to events with company destroying potential. Their response is governed by an understanding of how to rapidly control the strategic exposures occurring across communications, human-resources, legal, financial, risk, operations and recovery.

VW has responded effectively so far but a long path to recovery remains. There are many strategic threats that still need to be addressed. But it is not beyond them and there are opportunities to prosper and recover strongly through strategically focused crisis management and recovery.