Special Report

2008 Year in Review

Even with continued intrigue at the auto maker’s very top and markets sinking quickly under pressure from the tightening grip of the global economic meltdown, there’s been no turning back for Volkswagen AG in 2008.

Set on a course in 2007 to place itself on a par worldwide with sales leaders General Motors Corp. and Toyota Motor Corp. and finally make a more permanent dent in the U.S. market, VW management appears undeterred by the rapidly deteriorating economic conditions that first staggered the U.S. and now have Europe and Asia stumbling as well.

With the year drawing to a close, VW is pushing forward with its planned return to manufacturing in the U.S., as it prepares for the official groundbreaking of its new Tennessee assembly plant, now slated for January.

Its critical sixth-generation Golf launching this year kicks off the auto maker’s new design philosophy, and its rollout of diesel engines in the U.S. marks a big step in a strategy to proliferate fuel-saving powertrain technology across its lineup and throughout the world.

The bearish economic conditions have caused VW to stick its hand out to the German government, however, as it became the nation’s first vehicle manufacturer to seek a share of the country’s €500 billion ($685 billion) aid package aimed at rescuing the financial markets. VW’s affiliates, Volkswagen Bank and Volkswagen Financial Services, applied for the state guarantees. Netherlands-based car-lease group Leaseplan, 50% owned by VW, made a bid for €1.5 billion ($2 billion) in loan guarantees from the Dutch government in late November.

The weakening economy also is slowing Porsche AG’s move to acquire a majority stake in the auto maker.

While the goal remains to raise its voting stake in VW to more than 50%, “we are under no time pressure” to do so, Porsche CEO Wendelin Wiedeking said in late November.

Porsche already controls 42.6% of VW and had targeted a 75% holding by 2009.

Ironically, it was the Stuttgart-based auto maker’s efforts to corner rights to VW shares that pushed the price of the stock to just below €1,000 ($1,337), an astounding valuation that made VW the No.1 company in the world based on a stratospheric market capitalization of nearly E150 billion ($201 billion).

Porsche disclosed in October it had secured 74.1% of VW directly and indirectly through options, an amount that puts it within reach of the three-quarters holding it needs to control the auto maker and fully consolidate its operations.

Still blocking Porsche from asserting full control, though, is a German law that gives VW’s home state of Lower Saxony veto rights in policy making as part of its 20% stake in the auto maker.

However, a squabble between Porsche and VW management appears to be settled for now. In late October, Porsche Automobile Holding SE declared resolved the rift that had pitted the families of VW Chairman Ferdinand Piech and Porsche Chairman Wolfgang Porsche, Piech’s cousin.

Piech had been trying to thwart the takeover, abstaining from a critical September vote that allowed labor representatives on the VW board to push through a measure that would have hindered Porsche’s game plan.

Under the new provision, Porsche would need to get VW supervisory board approval for any collaboration between the two companies, even if Porsche held a controlling interest in VW. One of Porsche’s objectives in the takeover is to expand platform sharing and product coordination between the two groups, with the auto maker reportedly targeting a cut in its development costs to 10% of sales from about 15% today.

The two already share a platform for their cross/utility vehicles, the Porsche Cayenne and VW Touareg, a next-generation version of which is expected by 2010. VW also will supply the bodies for Porsche’s upcoming Panamera 4-door coupe to hit the market next year, and there was concern the labor-backed rift would sabotage the project, with sub-par bodies being delivered.

“I am horrified by the behavior of the chairman,” Wolfgang Porsche told Germany’s Focus magazine in calling out Piech following the board vote.

The new measure to limit Porsche’s authority is expected to be rescinded now that a truce between the two sides has been reached.

“It wasn’t in the interest of Ferdinand Piech” to continue the family fight over Porsche’s stake in VW, Wolfgang Porsche noted in a Wall Street Journal article in October.

For its part, Porsche is promising to install a new management model once its takeover is completed, allowing VW executives to sit on the management board of Porsche Automobil Holding, the company that controls the two car makers.

“I am working right now on a joint paper on the future management model together with my finance colleague at VW,” Porsche’s Chief Financial Officer Holger Haerter told German daily Handelsblatt in October.

Earlier this week, VW labor leader Bernd Osterloh gave VW workers a bigger voice in the tie-up, winning a unanimous vote to head the works council at Porsche Automobil Holding SE.

While VW appears to have escaped a showdown with Porsche, it has not been able to completely dodge the effects of a suddenly contracting West European market.

VW’s Spanish subsidiary, SEAT SA, moved quickly to curb production late in the year, after five straight months of industry-wide sales declines culminated in September’s record 32.2% plunge in Spain’s new-vehicle market.

SEAT took 22,000 vehicles out of its 2008 build plan, cutting 15 days’ worth of output for its Altea, Leon and Toledo models and five days’ production for the Ibiza. The moves affected more than 4,000 workers, including 750 slated to be idled through July 2009.

As other countries began to feel the pinch from Western Europe’s economic downturn, VW planned additional production cuts via extended holiday shutdowns at its main operations in Wolfsburg and key Audi AG and Skoda Auto a.s. plants.

Audi also has shut its Gyor, Hungary, facility for four weeks in December to curb supply of its TT coupe and roadster. Some engine production at the plant is being reduced this month, as well, and Audi has eliminated jobs for some of Gyor’s temporary workers.

Czech subsidiary Skoda reportedly took 31,000 vehicles out of its fourth-quarter production plan and is said to be eying a 3% cut in its workforce in 2009, potentially eliminating 870 jobs.

Earlier in the year, VW output in Mexico came under threat, as workers were demanding concessions from the auto maker. Originally demanding a 13.03% wage increase, labor settled for a 5.4% hike – in line with inflation in Mexico, an additional paid holiday and $1,227 annually in food coupons. Production at the Puebla plant continued uninterrupted and through October output was up 14.8% on like-2007’s pace.

Despite the economic meltdown that is taking its toll on automotive demand worldwide, VW Group sales appear to be holding up relatively well, although indications began to emerge in early December the auto maker may be ready to back off its growth targets for the next year or two.

In August, VW Group declared itself the world’s third largest auto maker in terms of sales, saying its 3.31 million-unit tally enabled it to leapfrog Ford Motor Co. in the rankings.

“We are delighted that the Volkswagen Group has made it to the global automobile industry’s top three for the first time,” Winterkorn said. “This shows that we are on the right track with our ever-stronger international presence and, above all, our product program.”

Although deliveries declined 5.1% in October, sales for 2008 through the first 10 months rose 2.8% to 5.29 million units, outpacing the global market overall, which VW says was off 2.9% in the same period. The performance enabled a 0.6-point rise in passenger-car market share, the auto maker says, taking its penetration to 10.2%.

The gains came in part from traction in China and Brazil, where January-October sales increased 12.6% and 16.7%, respectively. Also remaining hot was Russia, where VW delivered 107,900 vehicles, a gain of 64.4%, and India, where demand jumped 66.0% to 16,700 units.

As the fourth quarter got under way, VW still expected to finish the year ahead of 2007 results.

“Our target of selling more vehicles in 2008 than in 2007 remains valid,” stated Detlef Wittig, executive vice president group sales and marketing.

And CFO Hans Dieter Potsch was predicting VW’s gains in a slumping industry overall would allow the auto maker to continue to siphon away market share from its rivals in 2009.

Luxury-vehicle arm Audi has been a solid contributor to VW’s positive results, with sales through 11 months up 3% worldwide, in spite of drops in November in such key markets as the U.S., China and the U.K.

“Despite the currently difficult overall economic environment, we will reach our sales target of 1 million vehicles for 2008,” Audi marketing chief Peter Schwarzenbauer told Reuters last month.

Still, the economy is forcing some belt-tightening, with Audi announcing in December it would withdraw from the American Le Mans Series racing circuit after eight years on the grid, choosing to focus its resources on European racing.

VW’s Winterkorn also was taking a cautious stance as the fourth quarter got under way.

“The financial crisis has hit everyone,” he told reporters in October. “We don’t know the full impact yet. We see consumer confidence going down, but VW is doing better than the competition (so far this year).”

Even so, 2009 “will be extremely difficult for the entire industry,” Winterkorn warned.

VW’s new design strategy under Walter de Silva, named group design chief in February 2007, was kicked off in October with the release of the Golf VI in Europe. The new model features a cleaner exterior design, with an emphasis on horizontal, crisp lines and an elegance that carries through into the interior, where the focus is on higher-grade materials and a quiet ride.

“In the recent past, the design was over-styled and over-decorated,” de Silva told Reuters at the car’s rollout in Reykjavik. “It had little to do with the VW brand’s simplicity and character, and the approach was wrong for Volkswagen.”

De Silva later tells reporters in Wolfsburg VW’s new design philosophy would communicate “quality, solidity and simplicity.

“We have to recognize what VW DNA is – that’s what we have to communicate,” he says. “We must look at our past, and (our design) must be unique and responsible.

“We don’t want a VW to be fashionable or trendy in any way,” de Silva adds. “We want a good balance of vehicle lines.”

The Golf’s front end now is distinguished by a horizontal character line across the grille, a trait that will be used in every model, de Silva says, “from the smallest to the largest.” All VWs will share some rear styling, as well.

“But despite the similarity, there will be a different personality for each vehicle,” he promises. “The Golf is (just) the first concrete example of (the new design) theory.”

The new Golf carries over its predecessor’s platform, which is expected to help VW maximize economies of scale and speed the production ramp-up so the car reaches profitability much faster than the model it replaces.

It reportedly took over a year for the Golf V to begin earning a profit for VW.

Also rolling out this year was a new pickup for the VW brand.

“We are the first European volume manufacturer to enter the globally growing segment of 1-ton pickups,” VW Commercial Vehicle head Stephan Schaller told reporters at the IAA truck show in Hanover in September.

The new model, developed from scratch, is expected to enter production at VW’s Pacheco, Argentina, plant in second-half 2009, with sales projected at 100,000 units per year. The vehicle is seen as an important cog in VW’s plans to lift CV sales to 800,000 units annually by 2018.

To focus more on the light-duty side of the sector, VW this week revealed it would sell its Brazilian CV arm, Volkswagen Caminhoes e Onibus Industria e Comercio de Veiculos Comerciais Ltda., to Munich-based MAN AG. The deal, valued at €1.175 billion ($1.614 billion), is expected to close in first-quarter 2009. VW owns 29.9% of MAN and also controls a 69% stake in Swedish CV maker Scania AB.

In the U.S., VW launched a diesel in its ’09 Jetta compact car, with the engine forecast to account for a quarter of Jetta sedan sales and up to a third of wagon demand.

Joining the diesel Jettas on the U.S. market in 2008 was the Routan, a minivan based on the Chrysler Town & Country. The Routan is being built for VW at Chrysler LLC’s Windsor, ON, Canada, assembly plant, and at launch VW was targeting the new model to add 40,000 units in sales in 2009.

VW also is moving forward on a powertrain strategy bent on improving both fuel economy and performance and rife with small-displacement turbocharged and supercharged engines and dual-clutch transmissions. In the new Golf, for instance, VW offers nearly identical horsepower to the same car of two generations ago, but has improved fuel economy and lowered carbon-dioxide emissions 35%.

But VW’s biggest product rollout for the U.S. is still to come with the return to U.S. production after a 20-year absence. Site preparation already is well along on the $1 billion, 150,000-unit-per-year Chattanooga, TN, plant, and VW said this week it was set to begin construction on the paint shop.

In addition to the paint shop, the complex will include body and final assembly operations, plus a modest onsite supplier park. Some of the powertrain components will be supplied by VW’s Mexican operations.

In first-quarter 2011, the auto maker expects to throw the switch on the assembly line and launch an all-new sedan slotted between the Jetta and Passat in size.

VW remains mum on details surrounding the new model, saying only that it will be derived from an existing platform and be priced in the U.S. market’s sweet spot – below $20,000.

Still undecided is whether Audi will share capacity at the Chattanooga facility. Audi believes it ultimately will need a North American plant to meet its U.S. sales goal of 200,000 vehicles per year by 2018.

VW ultimately wants to add powertrain capacity to supply the new assembly plant, but it remains unclear whether Chattanooga will win that investment or the auto maker ultimately will scout for another North American site.

One thing is certain, the Chattanooga facility and its midsize sedan will be critical if the target of selling 800,000 VW-brand vehicles in the U.S. by 2018 is to be realized.

“The U.S. is crucial,” Winterkorn says. “It is the biggest, most-demanding car market in the world,” and VW wants to “take (its) place as a leading auto maker” there. “There are great challenges ahead, (but) we expect to be a leader in the U.S. once again.”