Volkswagen and U.S. flag.

Photographer: Ulrich Baumgarten via Getty Images

Hubris Made Volkswagen Settle With the U.S.

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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Volkswagen is apparently setting aside $10 billion to settle all U.S. claims against it for cheating on emission tests. The settlement, according to some reports, could include offering American VW owners $5,000 each or a buyback of their cars. If a deal with U.S. regulators and plaintiffs has indeed been reached on these terms, it's a high price to pay to maintain a presence in a relatively unimportant market, especially since paying it will result in losses to its reputation in bigger markets.

The U.S. is not huge for VW, which has struggled and failed to break into the big leagues there. In 2014, the last full year before the emissions scandal, it made $36.7 billion in revenue in North America. Applying the company's 5.2 percent net income margin would mean a profit of about $1.9 billion, less than 13 percent of the global total. Even assuming that VW's sales in the region don't drop following the emissions scandal, $10 billion is more than five years' worth of American profits for the company. Essentially, it's agreeing to operate at cost, or at a loss, for half a decade just to lay the scandal to rest.

Apart from the direct outlay and the opportunity cost of not being able to use those resources in more receptive markets -- for example, in Asia and Latin America -- there's collateral damage that is hard to quantify. In Europe, VW is not offering car owners buybacks or bonuses. There's a technological reason for that: Less stringent European regulations didn't require cars to be fitted with nitrogen oxide (NOx) traps or selective catalytic reduction systems, as in the U.S., so a software fix or a cheap mechanical one makes the cars regulation-compliant on VW's home continent.

In the U.S., compliance requires a more expensive fix that is tricky from an engineering point of view: It involves fitting the cars with an extra liquid tank for urea, a NOx-reducing chemical. Still, European consumers are reluctant to go into these details: They have been cheated just as much by VW's "clean diesel" marketing as the U.S. buyers, and they'd like equal compensation. 

Elzbieta Benkovska, the European commissioner responsible for regulating the auto industry, has promised to pressure the German carmaker to provide equal compensation for its customers in Europe. The company's position is probably defensible -- it shouldn't be forced to apply U.S. rules elsewhere -- but the consumers have a point, too. The U.S. is the largest CO2 emitter in the world in per capita terms, but somehow its environmental regulations are tighter than in Europe. Though the rules don't make the air much cleaner, they make sure Americans get preferential treatment in a case like Volkswagen's. That's hardly fair.

One has to wonder whether remaining in the U.S. market and paying out enormous amounts of money to American car owners and regulators is worth opening that can of worms. Perhaps placing its U.S. subsidiary under bankruptcy protection and pulling out of the U.S. altogether would be a less costly option. It's not clear if the U.S. government and courts could succeed in holding the parent company liable for the subsidiary's wrongdoing under U.S. rules. If nothing else, such a move would teach the U.S. authorities a lesson: Instead of throwing the book at foreign companies, as it has repeatedly done, they might have to consider the implications for the country's investment climate

The VW factory in Chattanooga, Tennessee, provides 3,200 jobs directly and 9,500 indirectly, by generating business for supplier firms. What does the U.S. need more, these jobs or a better deal for its car owners than any other country is getting?

VW, however, didn't go down this confrontational path. One could attribute that to the conservative, conformist culture of Germany's big business, which treats transgressions like the emissions cheating with painful disbelief: This couldn't have happened here!

There could be another explanation, though: hubris, built into the VW culture by Ferdinand Piech, the corporate patriarch who left the company a year ago. 

Because of the scandal, VW ceased to be the world's biggest car company. Analysts at Bloomberg Intelligence recently put out a primer on VW, arguing that the continued fallout from the cheating would make it hard for the company even to remain in second place behind Toyota. Pulling out of the U.S. would constitute surrender and relegation to the second tier of global automakers. It might save some money and teach overzealous regulators a lesson, but it would be cowardly behavior that would put a blemish on the company's name for years to come.

 As it is, VW is winning back in market capitalization whatever it stands to lose in cash terms from the settlement. Its shares rose as much as 7.5 percent Thursday after news of the settlement. The markets appear to believe the car maker is getting off cheaply: Some estimates of potential U.S. damages have exceeded $40 billion.

A decision to leave the U.S., by contrast, probably would have pushed the company's stock down: It would have been depressing news.

Volkswagen management could be accused of a lot of things, including sluggishness in investigating the scandal, slowness in offering fixes, poor negotiation tactics in talks with regulators, unfairness to customers. Yet no one can fault it for a lack of stubbornness in continuing to pursue a vision of VW as a global leader.

Though the scandal will extract further costs, both in lost sales and in customer disappointment, that stubbornness is a prerequisite for VW to emerge from its troubles with its head held high.

 

(Updated to better reflect the preliminary nature of potential settlement terms.)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor responsible for this story:
Susan Warren at susanwarren@bloomberg.net