Ferdinand Piëch has powered Volkswagen to the top slot in Europe. Now he is stepping down, and troubles are building. What's next?

Volkswagen CEO Ferdinand Piëch has every reason to feel satisfied. The Austrian engineer and scion of one of Europe's most noted automotive dynasties is less than a year from retirement as chief of the German carmaker. As he looks back, Piëch can boast of one of the great turnarounds in automotive history. Since taking the top job at the Wolfsburg headquarters in 1993, his engineering brilliance has helped resurrect Volkswagen quality and turn models such as the Golf and Passat into all-time best-sellers. Piëch's relaunch of the Beetle has cemented VW's hold in the U.S. market. Only VW has successfully revived a communist-era carmaker, Skoda of the Czech Republic. Even now, as the global car industry lurches through a stressful year, VW expects profits to grow: In 2000, they more than doubled, to $1.8 billion, on sales of $76 billion. And before Piëch steps down, VW will launch his pet project, the powerful D1 sedan, the company's first foray into the luxury market under the VW name. He even seems to have settled on his heir apparent--Bernd Pischetsrieder, the former boss of BMW and a supremely able executive in his own right.

Looks like a job well done. Piëch has already rewarded himself by buying a 102-foot yacht to sail around the world with his family. The boat is the talk of nautical circles. The gossip is that the $15 million yacht, being built by the top-notch Dutch shipyard Jongert, will be one of the most powerful, best designed private vessels ever launched, a fitting tribute to Piëch, who is passionate about superbly crafted objects.

RAIDERS? And so another corporate chieftain prepares to sail off into the sunset. End of story? Hardly. In recent weeks, Piëch, 64, has not acted like an exec who's winding down, a boss whose company is going from strength to strength. If anything, he's behaving like a CEO in the midst of a full-blown crisis, a corporate hero surrounded by dim-witted underlings and hostile outside forces. Piëch has publicly lambasted the management of VW's Audi luxury car division for timid product choices. He has discussed the potential value of spinning off Audi, a potentially huge transaction in the global auto industry. He has mused aloud that VW needs a major management realignment. Most amazing, he frets that VW could be a takeover candidate, "a tempting worm" to other companies on the prowl. VW officials have even named Ford Motor Co. (F ) as a potential suitor. Execs at beleaguered Ford, meanwhile, wonder what the Germans are smoking. "There's another agenda here," says a senior Ford of Europe manager.

If there is another agenda, it's Piëch's. Discussing the likelihood of takeovers and restructurings is a classic way to talk up a company's stock price. Yet many investors are mystified by the idea of Piëch as the shareholder's friend. Historically, Piëch--who will not even reveal how much VW stock he owns, although it's believed to be negligible--has shown scant regard for boosting shareholder value. So wary investors and auto execs wonder whether his talk is a drive to bid up the price and leave in a blaze of glory, which in turn would allow Piëch to exert power after retirement.

How? After he steps down as boss, Piëch wants to be named chairman of VW's supervisory board, a position that must be approved by a majority of shareholders. If he can goose the stock, Piëch should be a shoo-in for chairman, a seat that gives him power to influence management and executive appointments. That could create complications for his successor. "The new CEO will have a big handful of challenges," says one former board member. "But the one [challenge] that's make-or-break will be managing Piëch."

SQUELCH. Piëch, by the way, is not talking for this story. Most outsiders don't want to talk on the record about Piëch, either. But the question remains: Would the continued presence of Piëch be good for VW? Piëch the engineer has always excelled. "He is completely focused on the product. He lives, breathes, loves cars," says a former manager of VW's vast Wolfsburg assembly plant in Lower Saxony. The VW he has revived is in many ways the legacy of the best of the old Europe. It makes products that are the envy of rivals, employs thousands of workers for life, and enjoys the protection of the government: The state of Lower Saxony owns 18.6% of VW. Piëch is close to German Chancellor Gerhard Schröder, who as Prime Minister of Lower Saxony sat on VW's supervisory board. (The Chancellor's office now employs Audis in its fleet.)

But Piëch the executive will bequeath quite a number of problems to the company's next boss. VW, Europe's largest carmaker and the fourth-largest globally in terms of vehicle sales, has long struggled to improve profitability and productivity. The company's ambitious push to drive the brand upmarket risks hurting its existing premium marque, Audi. VW has far too many highly paid workers at its German plants. Yet politics prevents a radical restructuring. Many outside shareholders, who have seen the stock stagger back down to 1997 levels, distrust the numbers they're given by the company. Finally, some former execs say Piëch cows subordinates, squelching debate at VW's top levels.

All these issues loom just as uncertainty is mounting about what will happen next. The supervisory board, which oversees the management board in German companies, is not expected to announce a successor--probably Pischetsrieder--until November. Meanwhile, the industry picture is darkening. Sales are soft in the U.S., Europe, and South America. The last thing VW needs is a messy transfer of power at the moment it should be building on Piëch's gains.

Without question, those achievements have been considerable. Volkswagen's four main brands--VW (VLKAY ), Audi, Seat, and Skoda--have taken 19% of the European auto market, a gain of some three points in eight years, mostly at the expense of General Motors Corp. (GM ) and Ford. Not bad for a company that eight years ago suffered from quality problems and a paucity of hit models. In South America, VW vehicles account for one-quarter of car sales, and in China, one-half.

Piëch had a dynastic interest in seeing VW revive. His grandfather Ferdinand Porsche, founder of the sports-car maker, designed the first Beetle in the 1930s, and his father, Anton Piëch, ran the factories during the Third Reich. Anton's son, after working for Porsche, switched to Audi, which he eventually headed, and then moved on to VW itself. Ferdinand Piëch certainly doesn't need to work. His clan is worth about $4 billion, thanks to its Porsche businesses.

But Piëch is driven. Unlike many other auto chiefs, he calls the shots on product design and engineering. And if you work for Dr. Piëch, you had better get it right. In Wolfsburg, executives joke that PEP, the acronym for the product development process (Produktentwicklungsprozess) really stands for Piëch entscheidet persönlich--Piëch decides himself. And he can do it fast. He is said to have sketched out the Audi's all-wheel-drive system on the back of an envelope.

When Piëch isn't drawing up the plans, he's examining them with a gimlet eye. No screaming, of course: That's not the way for Piëch, an Austrian blueblood. One former transmission-plant manager said Piëch would tour the factory quietly, reviewing production data sheets and zeroing in instantly on any numbers suggesting something was amiss in the manufacturing process. "He's the only person whose very presence on the floor would make my stomach begin to hurt," says this manager.

Terrifying, yet inspiring. Under Piëch's tutelage, VW sweats the small stuff. Check this out, says one rival exec: On VW models, the gap between body panels--say between the front fender and wheel panel--has been cut to 1 millimeter. That puts them in a league with the industry's best.

Obsession with detail is one reason VW has succeeded so brilliantly in reviving its fortunes in the U.S., where the VW brand was road kill a decade ago. Last year, VW and Audi sales in the U.S. jumped 14%, to 437,000 units, for a combined 2.5% market share. That's up from a microscopic 0.5% in 1993. Although VW trails its Japanese rivals, it's the only European mass-market carmaker in the U.S.

The top VW brands in the U.S. are the Jetta, Passat, and the new Beetle, a remake of the humble bug so beloved of '60s youth. Part of VW success lies in its quirky features. At night, the dashboard instruments the driver looks at, such as the speedometer and clock, light up in red, while those the driver touches, such as the radio, are backlit in blue. "It gives the vehicle some soul, which many of VW's competitors lack horribly," says Wes Brown, a consultant at Nextrend Inc., a Thousand Oaks (Calif.) auto-research firm.

Delivering the soul stuff is good for prices. A well-equipped Passat can top $29,000 in the U.S., making it one of the most expensive cars in its segment. In Europe, meanwhile, the $15,300 Golf compact commands a premium of some 20% over other cars in its class. "Very wealthy people will buy a Golf. You never rub people the wrong way with a Golf," says Joachim Rebmann, the owner of Autohaus Rebmann, a VW and Audi dealership in Stuttgart.

PET PROJECT. Piëch wants to extend the VW magic--in several directions. On the drawing board is a 21st century remake of the old VW bus, the chariot of hippiedom in the 1960s. And in the power category, a $35,000 super Passat will soon be on the autobahn, equipped with an eight-cylinder, W-shaped engine that delivers super acceleration. "They've fit a huge engine into a medium-size bay," says Goldman, Sachs & Co. analyst Max Warburton.

Dear to Piëch's heart is the D1, which launches in Europe next spring. This is the first Volkswagen luxury car and the cornerstone of Piëch's efforts to move upmarket. Positioned to compete with the stately Mercedes S-Class in the $50,000-plus segment, the sleek D1 recalls the swooping lines of BMW sedans, while the interior is a rich mix of walnut and leather. Piëch took an obsessive interest in the D1's top engine, a direct-injection diesel-fueled V-10 monster. And the D1 is not the only new model for the ruling classes. Piëch, who bought the Bentley and Bugatti brands, is preparing a $700,000, 800-horsepower Bugatti able to go from 0 to 60 mph in four seconds.

This is impressive stuff. So why do many investors have such uneasy feelings about VW? "Shareholders are second-class citizens in this company," says Simon Waxley, a fund manager at Liverpool Ltd. Partnership, which owns just under 2% of VW's preferred shares. Strong language--and this from a guy who sees some value in VW.

To the frustration of Waxley and other investors, VW has shown little interest in giving them the data they hunger for. The company does not disclose operating profits, for example, and it's hard to figure out how VW calculates earnings. "It looks like their market dominance is paying off, but I see some investors who are still mistrustful as to whether these are real or pumped-up earnings because of Dr. Piëch's desire to depart on a high note," says John Lawson, chief car analyst at Schröder Salomon Smith Barney (C ). He estimates VW's profit margin was 1.9% in 1999, rising to 3.6% in 2000. Other analysts think it's even thinner. Investors, meanwhile, are frustrated that VW is not able even to reach its own announced target of a 6.5% return on sales. Last year, its return on sales was 4.1%.

Investors have long harbored the suspicion that Piëch and his top managers care little for the margins. As a result, VW stock has one of the lowest price-earnings ratios in the European auto sector: Based on projected 2002 earnings, it's between 7 and 8, compared with industry averages of 13 to 14, according to Merrill Lynch (MER ). Even poor old DaimlerChrysler (DCX ) has a p-e of 16. VW's market capitalization of $17.6 billion is a fifth less than BMW's, even though Volkswagen generates more than twice as much revenue. In the second half of 2000, VW's shares rose about 40%, thanks to a $2 billion share buyback, but they have mostly drifted sideways this year. At $45, VW stock is about where it was in the spring of 1997. Rolf Drees, a financial analyst at Germany's third-largest fund, Union Investment, which owns a 1% stake in VW, says the return on VW stock in the three years to the end of 2000 was an average annual 5.2%, using dividends plus the change in the stock price. That's just a third of the 15.3% return on the blue-chip DAX index over the same period.

HARD SLOG. A swift boost to the stock is a hard feat to pull off. The government of Lower Saxony, the biggest investor, worries more about jobs than shareholder value. Five of VW's seven German factories are located in Lower Saxony, and they're among the least productive in Europe. According to World Markets Research Center in London, production at the Wolfsburg plant runs at 46 cars per worker per year, compared with 101 at Nissan Motor Co.'s (NSANY ) British factory in Sunderland.

Piëch would love to change that. In 1993, to buy labor peace, he cut the workweek at VW's German plants from 35 hours to 28.8. That saved 30,000 jobs. But now VW workers can make upwards of $34 an hour. Piëch is trying to push through a plan to lower the base wages of new German workers and link them to output instead of hours. If this doesn't succeed, VW threatens to put new projects in places such as the Czech Republic, where wages are less than one-third German levels. Cutting such a deal is turning into a hard slog. The unions concede they need to be more flexible. But they are resisting management's demands to increase the workweek to more than 40 hours during peak production without paying overtime.

Profitability has remained an issue even though Piëch has worked hard to cut costs in other ways. Soon after he arrived, he decided to build all Skoda, Seat, VW, and Audi cars on four shared platforms, or chassis components. The Golf, Skoda Octavia, Beetle, and even the Audi TT roadster share platforms. The strategy has helped save up to $1.5 billion a year. Now, VW plans to share brakes, transmission, and other systems. "We can save billions of marks with these strategies," says Martin Winterkorn, VW's research and development chief.

Sharing the ingredients, however, may have harmed some of VW's own marques, as some consumers conclude that cars sharing platforms are sisters under the skin. Although hard to prove, it seems that some potential VW and Audi customers in Europe end up going for lower-priced Skodas and Seats. Since 1996, Skoda's share of the European market has more than doubled, to 1.5%, while the VW brand's share dipped slightly. "Skoda's image of `value for money' is too close to VW's brand image, which hasn't been moved upmarket fast enough," says a German auto consultant.

VW also has gaps in its product lineup. It has nothing to offer in the category of compact minivans--the scaled-down versions of minivans that are popular in Europe. A sport-utility vehicle will not come out until 2002. "We're [also] missing some niche models--sports car, roadster, another convertible," says Jürgen Lehmann, manager of the Autohaus Moltke dealership in Stuttgart. VW has to sort out these issues while the competition gets tougher. According to market researchers J.D. Power & Associates, Renault, Peugeot (PEUGY ), and Ford of Europe have closed the quality gap with VW. What's more, luxury auto makers are venturing downmarket. Mercedes is expanding the $18,000 A-Class, while BMW has rolled out a $14,000 Mini and has a compact in the works.

With the markets weakening, VW's next CEO will find it hard to keep boosting profits, especially if VW produces too many cars this year. According to Merrill Lynch & Co. VW's factory sales to dealers rose by 4.6%, whereas dealers' sales to customers nudged up only 0.7% in the first quarter. And production jumped 13.4%, Merrill Lynch reports. "There's a big disparity between what they're producing and what they're selling," says analyst Zee Tull. Higher sales to dealers boost short-term profits, and the first-quarter results were impressive, surging 57%, to $330 million. But "payback can be brutal" if production must be slashed later, according to the Merrill report. VW says the gap between production and sales narrowed in April and May, and the company predicts its half-year results will show production and sales in closer alignment.

Piëch has vowed to cut costs by about $1 billion this year. He has not specified how. A less-than-premium stock performance is not an immediate threat to the company. But if VW ever wants to use its stock to acquire another carmaker or expand further into the truck business, it needs a high share price. Also, the European Union is scrutinizing a German law that specifically bars any VW shareholder from voting more than 20% of the stock. If the law is repealed, VW could be vulnerable to outside pressure. For the time being, Lower Saxony's clout and the voting limits shield VW's management. "If you look at the supervisory board, you see all the union and local state's not sufficiently profit-oriented," says Union Investment's Drees.

It all spells a big headache for Piëch's successor. While speculation lingers that Pischetsrieder might be upstaged at the last minute, the bigger issue is whether he or any new CEO will be able to set his own strategy and unleash more of VW's earnings potential. At the least, Piëch's presence in the background will complicate the succession.

Pischetsrieder has sterling qualifications. He played an important role in revamping BMW's factories into models of flexibility and efficiency. Piëch hired him last July and named him head of Seat, VW's Spanish brand, and put him in charge of group quality. That was after Pischetsrieder lost his job at BMW, taking the fall for the acquisition of Rover, the floundering British carmaker.

Critics say Pischetsrieder was dominated by BMW's supervisory board chairman, Eberhard von Kuenheim, who had been CEO for 23 years and fully backed the Rover acquisition. As the deal soured, detractors dubbed Pischetsrieder "der Zauderer"--the ditherer. Former colleagues say Pischetsrieder is very much his own man, but there's some doubt whether he will be able to stand up to Piëch. In a long year as heir apparent, Pischetsrieder has discreetly withstood the glare of publicity. That's probably smart. But the uncertainty about VW's next boss adds to the doubts surrounding the future of one of Europe's great companies.

By Christine Tierney, with Andrea Zammert in Frankfurt, Joann Muller and Katie Kerwin in Detroit, and bureau reports

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