Volkswagen’s Smog-filled Scandal

Smog is a hot topic in this week’s U.S. news. President Obama’s administration just tightened the limits on smog-related pollution, which is suspected to cause heart disease, asthma and premature death. Ground-level ozone, as it’s called, forms when emissions from power plants, industrial facilities, vehicles and landfills react with sunlight. At least one company that has been much in the news in the past few weeks will be taking note of these stricter standards as it moves forward with a much-needed recall and recovery. 

Here’s the story of Volkswagen’s emissions fraud.

When Arvind Thiruvengadam, a young professor at West Virginia University, took a road trip in a Volkswagen Passat to test diesel emissions, he didn’t realize his findings would reveal a shocking hidden truth involving one of the biggest carmakers in the world. “Our happiness was, ‘Wow, we are going to be the first guys to test diesel cars on the road,'” he told NPR’s Morning Edition. “And then after that, when we were getting the data we were like ‘OK, we’re going to write a lot of journal papers, and we’ll be happy if three people read these journal papers.’”

Little did Thiruvengadam know that what he found would uncover dangerous threats to public health and expose Volkswagen, one of the most recognized car brands, in a global scandal. He and his colleagues discovered that Volkswagen diesel cars were releasing a lot more pollution into the air than they claimed. However, it wasn’t even as simple as that. Volkswagen was exposed as a liar and a cheater.

Volkswagen used a software trick to pretend it was complying with the Environmental Protection Agency’s standards for emissions. The German carmaker admitted it used a “defeat device” to rig the results when the diesel exhaust was being inspected.

When the diesel-powered vehicles were out on the road during everyday driving, the cars would switch into another mode to let out more nitrous dioxides, or NOx, into the air. The level of pollutants that the cars released into the environment was up to 40 times higher than permitted by law. Volkswagen drivers were unknowingly releasing excessive gasses into the atmosphere that could cause smog and health problems related to breathing.

Marketshare in America

Volkswagen admitted that 500,000 cars in the U.S. violated regulations, and then the car giant confessed that it had used the same illegal software in 11 million cars around the world.

Volkswagen intentionally violated the Clean Air Act because it wanted to sell more of its “clean diesel” cars in the U.S., which environmentally conscious consumers saw as getting more gas mileage and emitting less pollution. Only one out of 100 cars sold in the U.S. is powered by diesel, and about half of those are Volkswagens. America has one of the softest diesel markets in the world, meaning consumers don’t buy a lot of cars with those types of engines.

Investigations are continuing, but it looks like some Volkswagen insiders may have known that the company’s cars wouldn’t pass the strict American emission-testing procedures, so the company intentionally altered the software algorithm to allow cars to pass – and thus to sell more cars and secure more marketshare in America. In Europe, half of the Volkswagen cars sold are diesel-powered and even one out of three automobiles run on diesel. In Europe, NOx testing is more relaxed, but countries want cars to achieve good fuel economy, which also benefits the environment.

Here are the three biggest fallouts from the Volkswagen scandal:

1. The Department of Justice could fine Volkswagen as much as $37,500 per car, costing the company up to $18 billion. Last year, the car company made $12.5 billion in profits. The company has set aside $7 billion to pay for fines. Undoubtedly, this controversy will guzzle up its earnings.
2. The U.S. Environmental Protection Agency, called the EPA, ordered Volkswagen to recall nearly 500,000 cars in the U.S. to fix the problem. The carmaker has promised to refit all the cars worldwide that originally used the illegal software.
3. Shares in Volkswagen’s stock plummeted by one-third of its value before the news became public, wiping $26 billion from the company’s value. CEO Martin Winterkorn resigned on Sept. 21 and is under investigation for fraud. He has blamed the scandal on the “terrible mistakes of a few people.”

In spite of these repercussions, Wharton management professor John Paul MacDuffie says, “I can’t see it taking down the company in any sense.” Volkswagen only recently overtook Toyota as the king of the automakers. “They have many brands and strong brand portfolios from Audi to SEAT in Spain. … They have been clever about platform engineering and get a lot of different models to fill these many different segments from a small number of platforms” very efficiently. “None of these competitive strengths [competitive advantage] are going to disappear,” adds MacDuffie.

Volkswagen was striving hard to gain a bigger share of the American car market and maintain its tenuous foothold as the No. 1 carmaker. And certainly, this controversy will damage its reputation.

Cary Coglianese, Penn law professor and director of the school’s Penn Program on Regulation, notes that Volkswagen has been marketing the vehicles as environmentally sensitive. “Although Europe has a less stringent in-use emissions testing regime than in the U.S., the consumer marketplace [in Europe] values the environmental performance of vehicles – even greater than the American market does.”

Related Links

• The Washington Post: Obama Administration to Tighten Smog Limits
• K@W: There’s No Quick Fix for Volkswagen’s Emissions Crisis
• NPR.org: How a Little Lab in West Virginia Caught Volkswagen’s Big Cheat
• The Washington Post: Volkswagen Will Recall All 11 Million Diesel Cars
• CNN Money: German Prosecutors Probe Former Volkswagen CEO for Fraud

Conversation Starters

Does Arvind Thiruvengadam’s unexpected discovery make you question the ethics of big corporations? Why or why not?

Name three business concepts mentioned in this story that might motivate a company to lie or cheat.

Wharton professor John Paul MacDuffie says he can’t see the Volkswagen scandal “taking down the company in any sense.” Why wouldn’t such large-scale fraud hurt a company like Volkswagen? How does brand influence the way consumers think about a company? Can you think of other brands that have been damaged by scandal?