The recent discovery that Volkswagen has been circumventing environmental standards in their diesel cars came as shocking news. Not because companies don’t try to maximize profits at every opportunity, but because the scandal seems so out of character. Volkswagen recently overtook Toyota to become the largest auto maker in the world, largely due to the company’s reputation. This reputation implicitly stems from the history of quality engineering, high performance and fuel economy. It also includes the perception that Volkswagens are environmentally friendly…at least as far as driving a car can be. This is why the Volkswagen story is so confounding. Since World War II, the German company has increasingly grown in sales and in the perception of quality and reliability. Yet, here we are, trying to wrap our brains around the unraveling of Volkswagen’s attempt to circumvent environmental standards.
What They Did
Volkswagen designed software and “defeat devices” that gave false signals in emissions tests. The purpose was to have software and defeat devices govern emissions on the car while they were subject to the treadmill pattern driving used to test emissions, but then revert to normal performance and subsequently higher emissions upon return to standard driving. This is very clever. It is also illegal. This tactic allowed their diesel cars to pollute 40 times the allowable levels and get away with it, until September 18, when the EPA’s discovery of the workaround was first reported. Then the fallout began. It has been estimated that the total economic cost to the international car company could approach $87 billion. This is difficult to comprehend, considering it is over four times the magnitude of BP’s Deepwater Horizon oil spill, which wrecked the economy of the gulf coast along with tarnishing the pristine landscape.
Valuation
Up until September 16, the stock had been in decline from a Year To Date high of $255.20. By the end of the first full trading day after the report, their stock had plummeted to $92.36, a 64% loss of the YTD value and a single-day plunge of nearly $80 a share. Volkswagen has reportedly set aside $7 billion in cash just to deal with disgruntled customers of the approximately 11 million cars affected world wide. The Justice Department is also expected to levy a potential $18 billion in fines.
Credit Impact
VW’s credit rating by Standard and Poor’s and Moody’s was lowered from A/A1 to A-/A2, which will cost them not only in borrowing, but in lending. Volkswagen offers consumer loans as a way to increase sales. They are also a lender for other, smaller European car companies. With a suffering credit rating, their ability to offer enticing loans for their car sales will put additional stress on their ability to sell cars further reducing a highly profitable revenue source. Those are the trackable economic facts. These numbers can be put into spreadsheets and calculated with ease. What is harder to determine, and what might be the bigger story in the end, is the soft numbers. How will Volkswagen’s soiled reputation cost it? It is well documented that loss of brand value is the cause for 15 percent of companies going bankrupt. VW is too large, though, to be really concerned with such an extremity. We can speculate that this will be harmful in various aspects of the company’s financial health, but it is extremely difficult to determine how consumers will respond to events with hard facts. Some consumers will boycott VW in the future out of principle. Others will determine they still like the qualities of the German car. Others will keep a side-eye on the company, watching its response. The business sector is a little easier to predict. Wall Street and the various banks are risk averse. By violating the trust of the financial world, Volkswagen will continue to see punishment until it becomes obvious that there is a clear path out of this debacle. Until then, Volkswagen provides the example of how not to operate within the economics of trust. Featured image by MootCreative, available under a morgueFile Attribution-Noncommercial license.
