The Transformer: Why VW Is the Car Giant to Watch

Editor's note: The original version of this story said Volkswagen sold 35,000 Passats in 2009. The company sold 11,000.

When Volkswagen (VOW:GR) CEO Martin Winterkorn said two years ago that he was determined to zoom past Toyota (TM) to become the world's biggest automaker, the notion seemed laughable. At the time, the German automaker sold 3 million fewer vehicles than Toyota, was losing ground in the U.S., and had a reputation for iffy quality. Toyota, then set to pass General Motors as the best-selling carmaker on the planet, seemed unassailable.

Today Toyota is vulnerable, and Winterkorn's ambitions seem a lot less outlandish. In November, for the first time, VW built more cars than its Japanese rival. Toyota still sells more each year, but VW has closed the gap to less than 1.5 million cars. Quality continues to be an issue for VW in the U.S., but Toyota is the one suffering negative headlines after a series of embarrassing recalls. Toyota's CEO—in an act of extreme self-flagellation—has even said his company's best days may be behind it.

Winterkorn sees an historic opportunity. And with the backing of his formidable boss and mentor, VW Chairman Ferdinand Piëch, he's seizing it. By 2018, Winterkorn vows, VW will pass Toyota. "VW saw a chink in Toyota's armor and realized they could act on their ambitions," says Stephen Pope, who follows the industry for Cantor Fitzgerald in London. "They went for it straightaway."

All over the globe, Winterkorn, 62, is punching the accelerator. VW has agreed to buy a 20% stake in Suzuki Motors (7269:JP) to gear up for an assault on the rapidly growing markets of Southeast Asia and India. Winterkorn is going after BMW (BMW:GR) and Mercedes (DAI), committing $11 billion over the next three years to Audi, VW's luxury brand. Peter Schwarzenbauer, a board member who oversees Audi's sales and marketing, says the brand plans 10 new models, including the A1, the world's first "premium subcompact."

Aiming Downmarket

Winterkorn's most ambitious plans are in the U.S., where he aims to double sales by 2012. It was only five years ago that VW tried and failed to move upmarket in the U.S. Remember the Phaeton, the VW with a sticker price of $85,000? Now Winterkorn is reversing course. He's betting that Volkswagen can steal customers from Toyota, Honda (HMC), Ford (F), and others by selling Americans on German engineering and style at affordable prices. This year, VW will introduce a compact priced to compete with cars like the $16,000 Toyota Corolla. "We have to bring the masses to VW," says Mark Barnes, VW's U.S. chief operating officer.

Beating Toyota won't be easy. For starters, VW sells fewer vehicles in the U.S. than Subaru (7270:JP) or Kia and still has a reputation for making unreliable, overpriced cars. In Southeast Asia—a Toyota stronghold—the VW brand is practically unknown. Ditto for India. Winterkorn's plan to double Audi's sales in the U.S. by 2018, meanwhile, isn't exactly scaring BMW. "They have been saying that for years," says Jim O'Donnell, president of BMW of North America.

Still, VW is a formidable competitor; it earned $975 million in the first three quarters of 2009, despite the global collapse of car sales, and it has $33.3 billion in cash. "We want to make [VW] the economic, ecological, and technological leader by 2018," Winterkorn wrote in an e-mail. "Our goal is not just about size—we are aiming for quality-driven growth."

Piëch has long wanted to move beyond VW's bases in Europe, China, and Brazil. In the 1990s, as Audi chairman and later VW CEO, Piëch acquired lower-end brands, including Spain's SEAT and the Czech Republic's Skoda. Later he added ritzy names like Bentley, Lamborghini, and Bugatti. "He used to privately talk about selling a car for every purse and purpose like Alfred Sloan did at GM," says Garel Rhys, president of the Center for Auto Industry Studies at Cardiff University in Wales.

Fixing VW's America Problem

By the end of 2006 it was clear that VW's move upmarket wasn't working, and in January 2007 Piëch installed Winterkorn as CEO. Before his elevation, Winterkorn ran Audi, where he boosted quality and supercharged growth with new models that rivaled BMW's cars. Winterkorn rewarded employees for speaking their minds and bringing ideas to his attention.

In the summer of 2007, Winterkorn and the board met to brainstorm ways to become the world's biggest automaker, says VW's U.S. chief, Stefan Jacoby. High on the agenda was fixing VW's America problem. That year, VW expected to sell 200,000 cars in the U.S., a 40% drop from 2000 and a third of what VW sold in 1970 when the Bug and Bus were Hippie icons. Jacoby says executives at the meeting saw three choices: They could continue to lose buckets of money selling cars that were too small and too expensive; they could wave the white flag; or they could go on the offensive. They chose Door No. 3.

Jacoby says he persuaded the board to build VW's first U.S. plant since closing a Pennsylvania factory in 1988. He recalls arguing that doing so would help VW overcome resistance in the American heartland to imported vehicles. If VW built the plant, Jacoby recalls saying, he would sell 150,000 cars from that factory alone each year. The board approved the plan and allocated $1 billion for the facility, which is scheduled to open next year in Chattanooga, Tenn. VW's decision to build cars in the U.S. has not gone unnoticed by its main rival. "The fact that they are producing in the U.S. gives them a leg up," says Donald V. Esmond, senior vice-president for automotive operations at Toyota Motor Sales USA. "But we'll just keep focusing on our customers."

Jacoby's most pressing challenge is devising a roomy family sedan at a price Americans will pay. Today's Passat, despite being smaller than most mid-size sedans, sells for $28,000, or $8,000 more than a Toyota Camry. That's largely why VW sold only 11,000 Passats in the U.S. last year, compared with some 350,000 Camrys. VW plans to stretch the Passat's successor four inches, add three inches of legroom, and sell it for a starting price of about $20,000. Timothy Ellis, VW's U.S. marketing chief, says he expects to move more than 135,000 mid-size sedans a year starting in 2011. James N. Hall, principal of the auto consulting firm 2953 Analytics, is skeptical. Typically, Hall says, it takes two generations for a new mid-size sedan to get traction in the U.S. "The first-generation car is going to have to hit it out of the park," he says.

Expansion Plans for U.S. Lineup

Industry analysts say Winterkorn's mass market approach could work in the U.S. VW will be the only company offering affordable European cars. BMW and Mercedes sell German engineering, but their cheapest models start at $30,000.

According to a source briefed on VW's plans for the U.S., the company plans to expand its lineup from 10 cars today to 14 in five years. VW will have new compact and mid-size sedans priced for the American market, plus a small SUV. VW also may introduce its Polo compact—now available in Europe, China, and other markets—to the U.S.

VW will have to convince Americans its cars are worth buying. In J.D. Power & Associates' (MHP) Initial Quality Study, which ranks cars in the first three months of ownership, VW came in 15th out of 37 last year. The company's ranking improved from 24th in 2008. But VW still trails Toyota, Honda, and Nissan (NSANY), as well as the Chevrolet and Ford brands. What's more, though 78% of Americans know the VW brand, only 2% buy the cars. Most Americans recognize the Beetle and Jetta, says Ellis, but draw a blank on VW's other eight U.S. models. "Volkswagen has a bigger brand than it deserves," he says. "But we have a low sense of awareness for our products."

Turning around those perceptions will take a sustained marketing push. VW's new American commercials will debut during the Super Bowl on Feb. 7 in a campaign called "Punch Dub," (as in Vee Dub). It's a reference to a game kids used to play back in the original Beetle's heyday: The first kid to see a Beetle would yell, "punch Bug," and slug their friend. In the ads, people will say, "punch Dub," when a Jetta, Passat, or any other Volkswagen model drives by. The idea: Show millions of Americans that VW sells something besides the Beetle.

Asia Push

If VW is playing catch-up in the U.S., it is many laps behind its rivals in India and Southeast Asia. Indians now buy about 2 million cars a year; Southeast Asians about 1 million. VW is lucky to sell 20,000 cars a year in each region. It will have to steal customers from Honda and Toyota, which have dominated Southeast Asia for many years. That's where Suzuki comes in. By buying a stake in the Japanese company, VW gets access to Suzuki's small-car technology. Suzuki's Indian joint venture already does well with its Alto and Swift subcompacts. "India has a massive road-building program," says Cantor Fitzgerald's Pope. "With Suzuki, VW will be able to put out very efficient vehicles."

VW has tapped Weiming Soh to oversee its Asia push. A U.S.-educated Singaporean, Soh most recently helped orchestrate a turnaround of VW's operations in China. Soh says VW Group, which includes VW, Audi, and Skoda, will add or freshen 20 models in China by late 2011. His goal is to double VW's Chinese retail network to 1,600 dealers in five years and sell 2�million cars. As part of his Southeast Asia strategy, Soh plans beachheads in Hong Kong and Singapore. Those markets are tiny, selling 30,000 and 100,000 cars a year, respectively. But Soh says Singapore sets trends for Southeast Asia, and Hong Kong is influential in southern China. "My aim is to make these two markets VW states," Soh says.

Winterkorn and Piëch have put in place the pieces of their global strategy. Now that VW's two main rivals, Toyota and GM, are retrenching, they're speeding up their plans. The big question is whether size for size's sake generates real benefits for a car company. Automakers like to get big so they can spread the huge costs of developing new models over mass volumes. Of course, car companies have a tendency to get so big that they become unmanageable. That's what happened to GM. Bolting together various acquisitions also can be problematic. Exhibit A: the unhappy Daimler-Chrysler marriage. Winterkorn and his executives argue that they can retain management control of their sprawling enterprise because VW is more decentralized than many automakers. "The critical factor is that each brand has its independence, a clear positioning, and autonomous management," Winterkorn wrote in his e-mail to Bloomberg BusinessWeek.

Eric Noble, president of auto consultant The CarLab, says that Winterkorn's tactical moves make sense. But, he adds, "VW had best be making these acquisitions for reasons other than size alone." Looming over the debate is Toyota. A few years ago, its management decided Toyota needed to be bigger than GM. Look what happened.

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Evolution of an Emblem

A photo- and illustration-packed post on the blog Neatorama traces the evolution of the VW logo from its inception in 1939, when it resembled an iron cross (once the symbol of the German armed forces), to today's more pared-down look. The logos of Audi, Porsche, and a host of other carmakers get similar treatment.

To view the post, go to

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