Is the Volkswagen Scandal Surprising? How Profitability Pressures Drive Corporate Misconduct

By Stephan Manning.

The Volkswagen diesel scandal has been dominating recent news headlines. The U.S. Environmental Protection Agency (EPA) is accusing the German automaker of using a ‘defeat device’ that manipulates results of health-threatening nitrogen oxides emissions tests by switching the engine to a low-emissions mode when detecting a test. Following the accusations two weeks ago, VW’s stock price has dropped by 40%; Martin Winterkorn has lost his job as CEO; VW will be removed from the Dow Jones Sustainability Index; and the German multinational is facing a lasting damage to its long-built reputation. On top of that, the automaker will need to refit up to 11 Million diesel cars and vans running with the ‘defeat device’ worldwide, incurring costs of $7.3 Billion or more. Current investigations focus on various top executives responsible for letting the fraud happen, including research and development (R&D) managers Ulrich Hackenberg and Wolfgang Hatz. But is the scandal just the result of the ‘criminal energy’ of individuals, or is it a more systemic problem? Do rising pressures in a competitive global economy – meeting customer needs and shareholder expectations, driving down costs, adhering to norms and standards – perhaps promote individual cheating and corporate misconduct?

The global economy and competitive landscape have changed dramatically in recent decades. In the 1980s, strategy scholar Michael Porter famously proposed that firms can be profitable either by differentiating based on quality and product features, by being the lowest cost competitor, or by going after niche markets. But not least the leading auto manufacturers Toyota and Volkswagen have shown that in mature industries increasingly both high quality standards and cost-efficiency are needed to succeed. Today, most firms cannot survive in a highly competitive global economy without meeting several, often conflicting demands: revenue expectations of shareholders, quality demands of customers, cost pressures from low-cost competitors, increasing labor, social and environmental standards and regulations – all of which have raised the bar for firms to stay competitive and profitable, especially in advanced economies. I argue that such pressures may drive cheating and misconduct – which does not make decision-makers less responsible, but which makes the VW scandal less surprising. Let’s take a closer look.

Several articles suggest that the ‘defeat device’ – a software tool – was installed by VW engineers back in 2008 because the EA 189 Diesel engine, which was developed by VW in 2005, could not have complied with pollution regulations and cost objectives without deception. At that time, VW was facing increasingly stringent emissions regulations, and it seemed almost impossible to meet various performance targets with the new engine, such as fuel economy and cost efficiency, without a ‘software trick’. The fact that the software in question had already been used for ‘test purposes’ since 2007 made the next step – of installing it in cars for sale – relatively easy. But was the actual decision to install it driven by the ‘criminal energy’ of VW engineers? Did they perhaps act upon specific incentives or orders given by superiors?

Results of investigations suggest a more complex story. Rather than acting upon individual opportunities or directives from the top, observers agree that VW engineers acted under time pressure in a ‘climate of fear’* – embedded in a rather complex power structure where orders were typically not clear, but where engineers were managed by conflicting cost, quality and regulatory constraints with very little room for maneuver. In fact, reports suggest that, rather than giving orders, the VW system would reward those who “don’t need to be told what to do“, but instead act upon the interest of VW leadership in sustaining corporate success, no matter how. In other words, installing the ‘defeat software’ may have come handy as a shortcut to satisfy various expectations at once. In addition, it is quite likely that VW engineers acted in line with a growing industry practice at that time: Even if concrete cases of misconduct are yet to be revealed, the environmental campaign group Transport & Environment (T&E) reported recently that new Mercedes, BMW and Peugeot cars use 50 percent more fuel on the road than laboratory tests indicate. As a result, there is a noticeable gap between test and real-world CO2 emissions across the industry. According to Greg Archer, clean vehicles manager at T&E, “the Volkswagen scandal was just the tip of the iceberg.”

All this suggests that the VW scandal is part of a larger issue. With rising quality, cost and regulatory pressures threatening sustained profitability, along with ever shorter product life cycles and expectations to reduce time-to-market, the room for generating margins in legitimate ways has become smaller. Also, as argued by sociologist Colin Crouch**, the profitability imperative is undermining the integrity of firm behavior. According to Crouch, firm decision-makers are more and more willing to drive short-term profitability at the risk of damaging long-term reputation. In addition, however, I would argue that even in the absence of concrete decisions from the top, like in the case of VW, profitability demands along with conflicting expectations may create a culture of anxiety and pragmatism that favors cheating and misconduct – not for individual gain but simply to ‘get things done’.

I therefore disagree with Angela Merkel’s optimistic statement that the VW scandal will leave Germany’s reputation for high-quality products untouched. On the contrary, due to global profitability demands and competitive pressures, the behaviors – and misbehaviors – of multinationals like VW will become rather indistinguishable, no matter where they are headquartered. And whether cars are ‘Made in Germany’ or ‘Made in China’ – their likelihood of passing emission tests will not depend on where they originate but how well their makers can deal with global demands and pressures – without getting caught!

References:

*Wenzel, F.-T. “Manipuliert in Germany” (“Manipulated in Germany”) (Berliner Zeitung, 9/29/2015)

**Interview with Colin Crouch in German newspaper Freitag (10/1/2015)

Picture taken from: “Volkswagen Reels from ‘Dieselgate’ Emissions Scandal” (by Dale Buss, September 22, www.brandchannel.com)