Vw Is Back, But For How Long?

No time for a breather now: Three years of stress and sacrifice will count for little if the costs of a bloated workforce undermine ambitious plans

Steely-eyed and intense, Ferdinand Piech looked out at the crowd of journalists assembled at Volkswagen's World War II-era Wolfsburg plant. It was March, 1993, his first public appearance since he had become chairman of the ailing German auto maker three months before. Declaring an "emergency" at the company his grandfather had founded, he vowed a shakeup to get it back on course by yearend.

Fast-forward three years. Piech's reign at the head of Europe's biggest car company has been among the most turbulent in its history. He has cleared out top management ranks through a string of firings. In a move that rocked the industry, he brought in remorseless cost-cutter Jose Ignacio Lopez de Arriotura from General Motors Corp. to drive down prices at VW's suppliers. Although losses totaled $1.35 billion in 1993, Piech and Lopez have pulled VW back from crisis. When Piech addresses this year's annual press conference in March, he's expected to report that 1995 profits have at least tripled, to $320 million on sales of about $61 billion. In the past year, VW's share price has risen 57%, to $364.

But the turnaround Piech has so determinedly fought for is far from assured. VW remains one of the world's least efficient carmakers (chart, page 31). Margins are razor-thin as aggressive rivals such as Fiat and Ford undercut VW's prices. The European auto market, which contributes 75% of VW's sales, is stalling, with growth expected to be no higher than 3% this year. Even more trouble looms as upstarts such as South Korea's Daewoo Corp. pour billions into plants in Central Europe.

Piech, shy about granting interviews, declined to talk to BUSINESS WEEK about his company's turnaround. But in a written response, he made clear that he is counting heavily on an ambitious plan to shrink VW's dizzying array of 16 platforms down to four by 1998 to solidify the company's recovery. "We are heading in the right direction, but we have not yet turned the corner," Piech wrote BUSINESS WEEK. "We still need to make considerable improvements if Volkswagen is to rank among the best automobile manufacturers in the world." Indeed, analysts and former VW executives warn that the success of the platform plan is not guaranteed and that the company could slide back into losses if European economies take a nosedive.

To ensure VW's prosperity, Piech must above all confront its expensive German workforce. Some 101,000 strong, it accounts for 42% of the group's 242,000 worldwide payroll and 58% of total wage costs. But VW's structure is a giant obstacle to change. Launched by Adolf Hitler in the 1930s to make a "people's car" designed by Piech's grandfather Ferdinand Porsche, VW is still 20% owned by the German state of Lower Saxony. Unions wield tremendous influence from the factory floor to the supervisory board--greater sway than at other labor-friendly German companies. Fiercely resistant to layoffs, the unions have made VW something of a laboratory for generous job-saving schemes. That has prevented the kind of restructuring now under way at Daimler Benz and other German blue-chip groups. Quips a prominent German banker: "VW is the last communist company in Europe."

SKODA SKIDDING. Even manufacturing ace Lopez' moves to reorder VW's supply lines are being undermined as the company brings parts production back in-house to keep workers occupied. Meanwhile, VW's efforts to grow in foreign markets such as Spain, China, South America, and Central Europe are having mixed results. While business is surging in Brazil and China, VW's SEAT subsidiary in Spain is a disaster, and sales in Mexico have collapsed. And VW's tiny Skoda unit is losing market share in the Czech Republic, its home market.

This labyrinth may be too difficult for Piech, 58, to negotiate. Scion of one of Europe's wealthiest families, the Austrian-born Piech has an estimated net worth of about $3.5 billion. His family owns a controlling stake in Porsche, the sports-car maker, as well as interests in Austrian auto dealerships, banks, insurance companies, and hotels. Harsh and demanding, Piech has built a reputation as one of Germany's toughest managers. His reign at VW has marked a huge change from the tenure of his urbane predecessor, Carl H. Hahn.

The Vienna native began his career in 1963 as an engineer at Porsche and rose quickly to become head of research and development. But when it became clear he would not make CEO, Piech quit to form his own engineering company. In 1972, he joined Audi, climbing the ranks to become engineering director three years later and chairman in 1988. In his five years at the helm, he boosted quality and oversaw the design of models such as the current hot-selling A4 sedan. He became the front-runner to follow Hahn.

PENDING CASE. Piech created an uproar at VW from the start. When he hired Lopez away from GM, the company accused the former purchasing chief of stealing confidential product plans. Late last year, German prosecutors finished a probe into the corporate espionage charges but won't decide on whether to indict Lopez until midyear.

Piech also wasted no time slashing layers of VW management. In his first 13 months on the job, Piech cut VW's nine-member management board, which is responsible for day-to-day decision-making, down to six. He fired Juan Antonio Diaz Alvarez, longtime head of VW's SEAT unit, while Audi chief Franz-Josef Kortum quit to work for a parts supplier. Daniel Goeudevert, management board vice-chairman, and Werner P. Schmidt, managing director for finance, also left. Dozens of other managers have subsequently been let go.

While many analysts applaud the shakeup, others see problems. Some consultants and former executives say the layoffs created a climate of fear that has led managers to delay key decisions rather than cross the boss. "If you don't do anything, you can't make mistakes," says a former executive.

Piech continues to centralize decision-making, in contrast to auto makers such as Chrysler Corp. and BMW that are giving midlevel managers more responsibility. In December, he ousted Ulrich Seiffert, VW's research and development chief, and took over stewardship of all product engineering. "Even a genius can't do all that," says Wolfgang Lincke, a former VW R&D chief who worked with Piech off and on for 20 years. Piech disagrees. "I have spent most of my life developing, building, and driving cars," he says. "[This] new assignment did not impose an extra burden on me. In fact, quite the opposite; I enjoy this task."

Whether or not Piech is taking on more than he can handle, he has consolidated support on VW's 20-member supervisory board. Placating labor early on, he turned to the board's 12 union and government directors when he wished to fire managers or slash capital spending. But that leaves him with limited clout for cutting the workforce. The same board majority that backed management layoffs opposes any quick or radical measures to furlough workers.

SO, VW has little room to maneuver. Cost-cutting is crucial as car prices drop in Europe and companies scramble for market share. VW's 2% price hike at the end of 1995 failed to keep pace with inflation. Moreover, the company is pouring on incentives, raising marketing costs. Buyers of diesel-fueled models, for example, get a $700 rebate.

Even so, VW models are often more expensive than competitors'. In Britain, the sticker price on a Ford Mondeo GLX sedan is $22,000, about $1,650 less than a similarly equipped Passat GL. And the jazzy Fiat Bravo, which starts at about $15,000, costs $2,000 less than a comparable Golf.

For years, VW could get away with such premium pricing. Customers were willing to pay an average of about 6% extra for what they believed was superior VW engineering. But that gap is disappearing. In a recent British survey, researcher J.D. Power & Associates Inc. found VW models just average in terms of mechanical problems in the first two years of ownership, well behind the performance of Japanese brands.

So Piech is hunkering down and implementing his platform consolidation plan. His aim is to have similar-size models from all VW brands--VW, Audi, SEAT, and Skoda--share thousands of common parts, from steel floor pans to windshield-wiper motors. In place of 46 horns, VW will offer only 2. Explains Piech: By using only four platforms, "we will be able to offer a much greater number of models than before while keeping their designs highly distinctive." Once in place, the strategy could add up to $455 million in pretax profits, or about $150 a car, says Schroder Munchmeyer Hengst & Co., a Frankfurt investment company.

But the success of the plan can't really be determined until more models based on shared platforms hit the showrooms. The VW Passat, a $24,000 four-door sedan that will share platforms with the Audi A4, for example, isn't due until late this year. And the crucial test won't come until 1997, with the arrival of the redesigned Golf, a model that accounts for half of VW's total European sales.

BMW BAIT. Piech's one-size-fits-all strategy has risks, too. It could tarnish the sporty, high-tech image Audi has worked so hard to create. A small Audi due in European showrooms later this year, the A3, is based on the same platform as the upcoming Golf. To squeeze out an additional $200 per car, VW engineers carried over a 20-year-old Golf rear-axle design. Audi competitors such as BMW's 3-series line, with more sophisticated suspension, will run circles around the A3 in ride and handling, say former VW engineers.

For VW's bargain-basement models, the uniform platform strategy poses the opposite problem. VW engineers are designing new SEAT and Skoda models based on the same Golf platform as the Audi A3. The steel structure that makes Audi and VW handle well on bumpy roads at Autobahn speeds will probably add unwanted cost to the cut-rate cars, say former VW engineers. That could force the brands to raise prices and compete against VW models such as the Polo and make it more difficult to compete against Korean and other rivals.

Beyond that, the strategy runs headlong into VW's social contract. By Piech's estimate, VW has 30,000 more workers than it needs. As new models arrive and consolidation kicks in, productivity gains will free up even more labor. The new Polo, for instance, takes 16 hours of assembly labor, vs. 25 or so for the old model.

Already, VW is under political pressure to protect its workers. So far, Piech has only been been able reduce the workforce through attrition, by about 6,000 a year. Two years ago, in a move praised by unions across Europe, VW shortened its 36-hour workweek by 20%, to 28.5 hours, cutting wages 16%. But the extra manpower costs VW roughly $1.5 billion annually.

Lopez' supplier strategy faces roadblocks, too. Using tactics honed at GM's European and U.S. operations, he broke long-term contracts and put nearly every part up for bid. Some components shifted from German suppliers to lower-cost rivals in such places as Spain. Many suppliers matched lower bids and scrambled to slash costs.

But such savings can only go so far. To keep extra workers busy, the company is being forced to make more parts in-house. For example, VW workers will make half the new Golf's plastic door trim. An outside supplier could make trim using labor costing 10% less than VW's, before the extra expenditure of VW's short workweek. VW will also continue to make virtually all its own seats--labor-intensive components that almost no carmaker handles any more. Management "is under pressure to do more [parts] in-sourcing," says Bernd Sudholt, vice-chairman of VW's worker council and a supervisory board member.

CURRENCY MISCHIEF. While Piech tangles with problems in Germany, he's also trying to clean up the pieces from Hahn's pell-mell overseas expansion. Operations from China to the Czech Republic compete for VW's scarce capital and overtaxed management resources. The Brazilian subsidiary, which split from a joint venture with Ford in 1995 and earned an estimated $675 million in net income last year, is purring along smoothly, but other regions demand closer attention.

The most pressing case remains SEAT, VW's Spanish subsidiary. The company lost $1.1 billion in 1993, when Piech booted its president, Alvarez. Losses shrank to $150 million last year, partly thanks to an accounting shuffle, analysts say. But the unit is saddled with huge interest payments on its new $1.9 billion plant in Martorell. The factory was financed with a loan in marks and other Western European currencies. It is being repaid largely with pesetas devalued nearly 30% against the mark since early 1992.

At Czech carmaker Skoda, Piech slashed by 50% Hahn's plans to inject $5 billion to upgrade plants, expand capacity, and freshen the model lineup. Skoda has struggled to break into Poland, Hungary, and the Western European market. Over the long haul, though, platform consolidation will likely make Skoda models increasingly similar to those at SEAT and VW. At that point, Piech must decide whether it makes sense to keep such a small brand alive.

Meanwhile, the peso devaluation, stumbling economy, and scarce credit in Mexico spooked customers in 1995. Sales plunged 79%, and losses totaled an estimated $140 million. The outlook isn't much better this year. VW's low-income niche is being eroded by Nissan Motor Co.'s Tsuru and GM's Chevrolet, which are competing with VW's venerable Beetle. A new Beetle, code-named Concept One, starts production in 1997. Although it will resemble the old Beetle, it will be based on the new Golf platform, with a front engine like other VW models. But its $12,000 sticker price will be high for Mexico, and most of the cars will be exported to the U.S. and Europe.

Even in China, where VW is the market leader with a 55% share, new competitors are gearing up. In 1998, GM plans to begin selling Buicks that will rival VW's somewhat stale $18,000 Santana and $25,000 Santana 2000. VW aims to defend its early lead. After sales surged 49% last year, to 221,000, the company decided to expand its main plant in Shanghai and launch a joint-venture in Changchun in the north.

Taken together, VW's challenges abroad and at home illustrate the fragility of Piech's turnaround. Even if all goes well, he needs a few more years of steady sales to carry out his rebound plan. By then, the company reasons, attrition will have pared VW's workforce by an additional 20,000 or so and engineers will have had time to work the kinks out of the platform-consolidation strategy.

The biggest danger for Piech is that some force beyond his control will upset VW's recovery. He knows that if Europe's economy slows down and consumers close their wallets, VW could once again veer off course. And as competition in the global auto market grows fiercer, he will come under pressure to speed up his deliberate strategy. With his professional reputation and his grandfather's company on the line, Piech's tough strategy and style aren't likely to mellow any time soon.

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