It was a pivotal year for Volkswagen AG, as it faced restructuring on three continents in 2005.

The storied German group that includes VW, Audi, Bentley, SEAT, Skoda, Lamborghini and Bugatti, was dealing with troubles at home, where productivity lagged world standards, and addressing falling sales and revenue in North America and China.

Much of the drama in Wolfsburg stemmed from VW’s attempt to get at the root of its problem: its position as a high-cost producer of a limited range of vehicles for diverse international markets.

Of VW’s 343,000 workers, about 179,000 were based in Germany, including 103,000 in Wolfsburg, home to its oldest and largest plant. Unfortunately, Germany was the most expensive place to manufacture cars – and the most resistant to addressing its high cost and low productivity.

German workers were paid an average of €34 ($41) an hour in 2005, compared with about €25 ($30) in the U.S. VW’s generosity over the years had resulted in wages some 11% higher than the auto maker’s domestic peers, and about 20% higher than the competition in general.

Historically, well-paid workers were not an issue, as buyers always appeared willing to pay a premium for German engineering and technology. It was harder for VW, though, because of its heritage of affordable vehicles.

The cost situation was exacerbated by the strength of the euro against the dollar and the competitive pricing structure in North America.

“When we export vehicles to the U.S., we are losing 3-digit (hundreds of) millions (of euros),” said Wolfgang Bernhard, who took over as chairman of the VW brand group May 1. Without a solution, “there is no future for European manufacturing,” he said.

Both Bernhard and Bernd Pischetsrieder, chairman of the board of management and defacto CEO, were outspoken on the need to cut thousands of jobs and increase the efficiency of those remaining. Fewer heads, and less cost per head, became the company’s mantra.

The auto maker had been hard-pressed to rein in labor costs over the years, in part due to its governance structure where the state of Lower Saxony was the largest shareholder.

That changed in 2005, when Porsche AG became the biggest shareholder with its October purchase of an 18.53% voting stake. Lower Saxony still held a powerful 18.2% and a vested interest in maintaining a healthy, well-paid regional workforce in a country grappling with 11.4% unemployment.

Pischetsrieder and Bernhard attempted to use the current crisis to dismantle some of that national infrastructure, much like former CEO Ferdinand Piech did in 1993 when 12,500 of 130,000 overpaid, over-trained and under-productive workers were let go.

By 2005, VW had global capacity to build about 6 million vehicles annually. It sold 5.1 million in 2004.

Reports put the job-reduction target as high as 30,000. Wage cuts in the 20%-40% range were said to be necessary, and factories were targeted for more flexibility and efficiency.

As part of a quest to improve the cost structure on all vehicles over three years, Bernhard was pushing for shift changes at Wolfsburg, where staff balked at ending a 4-day work week that allowed for a lucrative night-shift bonus. Resolving this issue would save €60 million ($73 million) annually, he claimed.

To underscore the gravity, management used sourcing of a Golf-based cross/utility vehicle, known as the Marrakesh, to deliver an ultimatum. Assembly of the pending compact CUV was Wolfsburg’s to lose. The additional output was dangled in front of a plant operating at 70% capacity, but only if workers represented by the powerful trade union IG Metall agreed to concessions.

A labor model already existed. VW developed a program known as Auto 5000 GmbH in 2001 to produce the Touran compact multipurpose vehicle in Wolfsburg, in what essentially was a factory within the factory. Roughly 5,000 workers were paid about 20% less to build the Touran, and they worked overtime, for no additional pay, if a mistake was traced back to the assembly line.

VW officials said they could shave €850 ($1,000) per vehicle off the Marrakesh program by integrating it with Touran production. IG Metall was given a Sept. 26 deadline to agree to Auto 5000 or another form of lower-cost manufacturing.

Without a solution, management said it would build the Marrakesh in Portugal, where costs were projected at €1,000 ($1,222 per vehicle) less than Wolfsburg’s.

Bernhard said the development team for the CUV had trimmed €2,000 ($2,445) from the cost of the vehicle, but it still was €800-€900 ($980-$1,100) shy of being globally competitive. He said the difference had to come from manufacturing – ideally from a compromise that would allow the Marrakesh to be built in Germany.

Talks went to the wire, but the union ultimately agreed to shift from Wolfsburg’s expensive in-house wage structure to the Auto 5000 model, where lower-paid workers would build the Marrakesh alongside the Touran. The move was expected to save about 1,000 German jobs.

In return, the company committed to building two more models in Germany, likely a Passat coupe in Emden, starting in 2008, and another Golf variant for Wolfsburg. Both projects also would utilize a modified in-house wage agreement.

Pischetsrieder pronounced the Marrakesh pact a decisive start in being able to export vehicles from Europe profitably, even if the euro were to remain strong.

Efforts to preserve a manufacturing presence in Germany, as well as other weighty decisions to turn the auto maker’s fortunes around, fell on Pischetsrieder in his third year since taking over as CEO from Piech, who became chairman of the supervisory board.

The year will be remembered for management upheaval.

Pischetsrieder put his stamp on a new team, while dealing with fallout from an internal sex and corruption scandal in Germany and boardroom intrigue.

The scandal, involving allegations of bribery and embezzlement in several countries, led to the resignation of personnel chief Peter Hartz and raised speculation of a new era where management had more freedom to make decisions without undue influence from the union and government.

But the year ended with a full-scale boardroom power struggle that was far from resolved and continued to widen a rift between Piech and Pischetsrieder.

Former union leader Horst Neumann was appointed board member in charge of personnel, a move opposed by Pischestrieder and Bernhard, but supported by Piech and the 10 supervisory board members with labor backgrounds.

Porsche’s share purchase and clout raised new conflict-of-interest issues, as Piech, the grandson of Ferdinand Porsche and heir to the sports-car fortune, remained VW chairman. His loyalty to VW was questioned repeatedly, and there were suggestions Piech wanted Audi AG CEO Martin Winterkorn to replace Pischetsrieder.

A lobby formed to oust Piech, resulting in an agreement he would relinquish the board chairmanship in 2007. In exchange, Porsche would get two seats on VW’s supervisory board in 2006, including one for Winterkorn. Piech’s replacement as chairman was to be a neutral director, representing neither Porsche nor Lower Saxony.

The year ended with Pischetsrieder’s fate still uncertain, amid suggestions labor would not back a bid to renew his 5-year contract that was set to expire in 2007. In May 2006, the contract was renewed until April 2012.

Outside the boardroom, Pischetsrieder continued efforts to put his handpicked team in place.

To manage the VW brand in North America, Adrian Hallmark, who distinguished himself in sales for Bentley Motors Ltd., was chosen.

Hallmark’s appointment as executive vice president-Volkswagen of America Inc., took effect Oct. 1. He switched jobs with Len Hunt, who was reassigned to the global Bentley post, but chose instead to leave the auto maker for a job with Kia Motors America Inc. In January 2006, Bentley named a second successor to Hallmark, making Stuart McCullough a member of the board, responsible for sales and marketing.

At Audi of America Inc., 2005 was the first year in the top spot of executive vice president for Johan de Nysschen.

In June, Winfried Vahland, former head of the Skoda brand, took over as president of VW’s China operations, replacing the retired Bernd Leissner and overseeing a new sales team.

Also still relatively new to his duties was Stephan Winkelmann, who was lured from Fiat Auto SpA to head Automobili Lamborghini SpA, owned by Audi.

The VW brand group, which accounted for about 60% of sales, faced the biggest challenge. But it was not unlike the one Bernhard tackled as former chief operating officer of Chrysler Group in the U.S. There he was responsible for the cost-cutting portion of a 3-year turnaround plan that involved eliminating jobs, closing plants, reducing shifts, cutting material/purchasing costs, overseeing efficiencies in manufacturing and downsizing the product-development budget while increasing the portfolio.

The issues at VW were eerily similar, Bernhard said as he drafted a 3-year plan expected to cut investment 20% annually over the three years.

His plan called for a period of pain, followed by the introduction of five to 10 additional models, over and above the existing lineup, between 2008 and 2010. The new vehicles would take VW into new segments, such as minivans and compact SUVs.

Financially, progress was made, but Pischetsrieder said he was not satisfied with 2005’s 58.2% pre-tax profit increase of €1.7 billion ($2 billion). Volkswagen Group saw a 3.2% jump in vehicle sales and 7.1% hike in sales revenue to €95.3 billion ($113 billion).

After taxes, the auto maker earned €1.1 billion ($1.3 billion), up 61% vs 2004’s €697 million ($830 million).

Globally, Volkswagen sales were almost flat, while VW Group brand sales reached a record 5.2 million units – an increase of 3.2% over 2004.

The results were early signs of success for Pischetsrieder’s ForMotion cost-reduction initiative, approved in February 2004. It called for the cutting of 5,000 jobs through attrition and a €3.1 billion ($3.8 billion) cost reduction in 2005, on top of a contribution of more than €2 billion ($2.6 billion) to the bottom line in 2004.

VW followed up with the ForMotion Plus program, which expanded the focus beyond cost reduction, to include sales, marketing and specific product programs.

The objective, Pischetsrieder said, was to improve net pre-tax profit €4 billion ($4.9 billion) by 2008, as compared with 2004. He translated that to a pretax profit of €5.1 billion ($6.2 billion).

Bernhard’s goal was to improve VW brand group profit to €7 billion ($8.5 billion) in the same timeframe, mainly through cost cuts and his pending restructuring plan.

Pischetsrieder said achieving the overall corporate target would require deeper cost cuts to compensate for continuing deterioration in the markets and exchange rate issues. He pegged the objective at a gross savings of €7 billion.

Initiatives included bringing suppliers into product development earlier and greater re-use of parts, technologies and tooling.

Pischetsrieder remained committed to the modular strategy initiated three years earlier that encouraged component sharing across products and brands and was expected to result in another €1 billion ($1.2 billion) in savings on purchasing in 2006. It would be rolled out with each new generation of vehicle.

Pischetsrieder hoped to save another €1 billion in personnel costs over the next couple years. In 2004, the auto maker said it needed to reduce personnel costs by €2 billion ($2.4 billion) by 2011. The first €1 billion would be achieved in 2006, under terms of the contract negotiated in November 2004 that guaranteed no layoffs until 2011 in exchange for a 28-month pay freeze.

But in 2005, Pischetsrieder said VW could not wait until 2011 for the additional €1 billion in personnel cuts. “We have to bring that forward,” he said.

That included operations in China, where VW saw stiff price competition and falling sales. China was VW’s second-largest market after Germany.

The auto maker once held a commanding 50% of the Chinese market and was reporting growth of about 30% as recently as 2003. But VW saw its sales lead fall to General Motors Corp. midyear, and revenue from its two joint ventures continued to fall.

The auto maker said restructuring was under way, and expansion plans for China were on hold. Hopes of breaking even in 2005 in China were not met, as the JVs reported a combined €119 million ($150 million) loss.

In North America, VW lost €843 million ($1.1 billion), a slight improvement on 2004, even though U.S. sales declined 12.5%.

Pischetsrieder said he did not expect a profit in the region until 2007.

To help offset the negative effects of the dollar, VW targeted more U.S. content in its vehicles and consolidated global output of the Jetta/Bora at its Puebla, Mexico, plant that built the Beetle and Beetle convertible. It was slated to add a Jetta wagon in 2007. Producing within the confines of the North American Free Trade Agreement provided a natural hedge, and the auto maker looked into building a second plant in Mexico.

In addition, the parent company finally recognized the need to manufacture the right products for individual markets and tidy up its launch cadence to avoid its historic cycle of feast or famine.

To better understand the market, Pischetsrieder created Moonraker, a project named after a James Bond novel. A 23-member team – 22 of them from Germany – set up shop in California for a 13-month stint traveling the continent and studying trends, culture and buying habits to become more sensitive to regional differences.

It was hoped their input would help VW return to its roots as a high-volume, affordable brand with fun-to-drive German-engineered vehicles.

New versions of the Jetta and Passat entered the U.S. market after seven years, and the Beetle got a refresh. The new Golf was scheduled to arrive in 2006, as well as a Passat wagon.

Also on tap was the Marrakesh CUV, and the 4-seat Eos coupe/cabriolet, unveiled at the Frankfurt auto show prior to its 2006 launch.

A new large luxury coupe codenamed CC was to fill the price gap between the Passat and the Phaeton. While a second-generation Phaeton was planned for Europe, VW announced the luxury car would be dropped from the North American lineup by mid-2006.

Dealers also were excited to learn a minivan was in the works. It was to be designed by VW but based on Chrysler Group’s next-generation of minivans due in 2007, and to be built by Chrysler.

The first 7-seat vehicle, the Audi Q7 luxury CUV, went on sale in May, and by year-end, the luxury brand confirmed it would get a production version of the Le Mans Quattro supercar concept, to be called the R8, for sale in 2007.

Audi said it was no longer chasing the goal of 200,000 annual sales in the U.S. by 2008, focusing instead on margins, and it abandoned plans of having 150 exclusive dealers in the U.S., content with about 85 standalones.

VW said it planned to jump on the hybrid-electric vehicle bandwagon with hybrid versions of the Jetta and Audi Q7 in 2008, as well as VW Touran HEVs in China.

In other VW-owned brands, Bentley was managing unexpectedly high and sustained demand for its Continental GT, while ramping up the Flying Spur at its Crewe, U.K., plant with overflow output at VW’s Dresden facility that built the slow-selling Phaeton.

The luxury brand was nicely profitable with about 8,000 sales, and planned to cap deliveries at 9,000 in the future to maintain exclusivity.

The Azure, the $330,000 convertible version of the Arnage that was to become Bentley’s new flagship in spring 2006, already had orders equivalent to two years' production by fall.

At Lamborghini, the 42-year-old company saw sales grow from about 250 cars per year for the first 40 years, to about 1,600, with 2005 as its second-consecutive profitable year.

The 250 units of the Gallardo Special Edition sold out quickly, as did advance orders for the Gallardo Spyder, that was set to go on sale in spring 2006 for €145,000 ($195,000).

The number of dealers worldwide grew to 80 from 65 at the start of the year.

Lamborghini, acquired by Audi in 1998, also was studying the feasibility of a production version of the ’06 Concept S, a derivative of the Spyder that would be priced at €250,000 in Europe or $330,000 in the U.S.

And production of the 1,001-hp Bugatti Veyron finally began Sept. 11, with plans to build 300 copies of the $1.24 million supercar over five years. A second model for the line was under consideration.

apriddle@wardsauto.com