A Closer Look at the Volkswagen Scandal

Last month, German automobile giant Volkswagen (VLKAY) was caught bluffing the American pollution testing authorities with the help of an electronic manipulation in its cars sold between 2008 and 2015. The sophisticated software known as "defeat devices" was installed in the electronic control module of diesel vehicles issued by the company during these years. The software takes the position of the steering wheel, vehicle speed, the duration of the engine's operation and barometric pressure as input and senses when the emission test is taking place for the car.

Then it controlled the emissions well below the acceptable levels throughout the test duration. But on road, the same cars were found to release 10 to 40 times more emissions than detected during the tests.

The company admitted that the act was intentional soon after the U.S. Environmental Protection Agency’s (EPA) allegations based on doubts raised by some independent researchers about the emission levels. CEO Martin Winterkorn released a public apology and resigned while several probes are going on regarding various related issues.

The Fallout:

As per EPA, about 482,000 cars across brands like the Passat, the Jetta, the Golf and the Audi A3 in the US carry the “defeat devices” software in their electronic control module by now. As a result of the scandal, Volkswagen could face of up to $37,500 per vehicle from the EPA itself. This will amount to about $18 billion in penalty. Globally, about 11 million cars across various countries have this flaw according to the company.

Thus, the financial consequences of this scandal are going to be huge for Volkswagen. Volkswagen said it would set aside $7.3 billion to help cover the costs of the scandal. Would that be enough? Further, there are going to be serious criminal charges from several government agencies as well as the public. Volkswagen’s stock plummeted by 30% in just 5 days last week soon after the scandal came to news.

Some analysts still believe that this scandal is not going to have any major long term effects. The reasoning being that the losses due to this one is much less severe than few other scandals that have happened in the industry’s history. For example, General Motors’ ignition switch scandal claimed more than 100 lives. But it was not fined even $1 billion. Thus, Volkswagen bearing an $18 billion for this scandal which has not claimed any lives seems unlikely. More importantly the effects on the company’s performance were limited to short term. Thus they expect Volkswagen to recover from this shocker in a quarter or two.

But the fallout is not limited to only Volkswagen. It is going to affect a larger domain with its ripple effects. First thing, it has marred the reputation of the German automobile industry. The label “Made in Germany” has acted as a brand of advanced technology and promise of quality over the past century or so. German cars are known to have the cleanest diesel technology in the world.

But after this incident, doubts will be cast by Americans on German diesel carmakers and they may face tougher scrutiny and emission norms than otherwise. Further, we could see a drastic shift away from diesel cars to petrol cars. So the demand for diesel will be affected. And as diesel cars are widely sold in Europe at present, the European car makers are going to feel this pain the most.

After the scandal became known, Mr Martin Winterkorn had to resign as the CEO of Volkswagen and is now being investigated by prosecutors. And there is a management overhaul taking place in the company right now. Matthias Mueller has taken charge as the new CEO. He is pushing for a reorganisation plan that he had made earlier with the last CEO, Winterkorn. The reorganization aimed at streamlining decision-making in the company. The plan is to give more authority will be given to individual brands and regions rather than keeping it centralised. The management overhaul and reorganisation is supposed to have some positive effects by making the 12-brand group more responsive to customer needs and regain some customer trust.

Conclusion

Therefore, the emissions scandal is going to have at least a short term effect on the company and the European car industry especially German. But as the management is undergoing an overhaul, it will move ahead with a new approach. The scandal may slowdown the growth of Volkswagen for some time.

Volkswagen surpassed Toyota as the largest car manufacturer in the world in July 2015. But at the end of the year, this scandal may force Volkswagen to stay at number two. However, in the long term the company is expected to grow in terms of sales, revenue and earnings like it has kept doing. The damage is not as much as the market is reacting. So from an investor point of view, Volkswagen’s stock is down 30 % and hence an attractive opportunity.

Published on Oct 7, 2015
By Vinay Singh

Copyrighted 2016. Content published with author's permission.

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