A Pitch to the Rich

Remember Fahrvergnugen, the German tongue twister that Volkswagen adopted for ad campaigns in the early 1990s to express the thrill of driving its cheap, dependable, even lovable cars? For VW owner Ann Jones of Corona, Calif., the experience has been more like far from groovin'. Jones was lured to the Jetta by its stylish looks, elegant interior and solid road handling, which made it seem worth the $18,900 price. But a few months after bringing her new sedan home in 2000, she returned it to the dealer because of an oil leak.

Then a door lock broke. Then a spring popped out of a seat. By the time she had put 50,000 miles on her Jetta, it already felt sluggish, says Jones, 28. And what especially disturbed her were the grim faces of fellow VW owners whom she encountered at her dealership. "The majority of them weren't there for basic service" of their cars, she says, "but because of some defect."

Ordinarily, Volkswagen might be able to argue that Jones received a rare lemon. But in the latest survey of three-year depend-ability by J.D. Power & Associates, American consumers ranked VW-brand cars 34th, ahead of only Suzuki, Daewoo, Land Rover and Kia. Consumer Reports, which recommended three VW models in the late 1990s, keeps only the pricey Passat on its list of recommended cars. That's quite a tumble for the Volkswagen Group, Europe's largest automaker, which turns out 5 million units a year under brands including Audi, Bugatti, Seat and Skoda.

These quality issues are raising concerns about VW's hold on the North American market — the largest and most vibrant in the world, and a critical one for VW's profit growth. While VW is puttering along in Europe's anemic market — the firm has an 18% share in Western Europe and has sold almost 2 million cars in the first nine months of 2003--it is struggling on this continent. The VW brand's U.S. sales fell 14.6% over that same period, to 221,177, and operating profits in North America shrank to $68 million in the first six months of the year, down from $944 million during the same period in 2002. While North American sales accounted for just 20% of Volkswagen's $101 billion in global revenues in 2002, they delivered 27% of its $5.4 billion in operating profits. And VW clearly aims higher: around a third of its $1.6 billion global ad budget is spent in the U.S.

The man in charge of revving up Volkswagen is CEO Bernd Pischetsrieder, who took over from the domineering Ferdinand Piech in April 2002. A personable, goateed man who ran BMW from 1993 to 1999, Pischetsrieder, 55, is pursuing a risky sales strategy inherited from Piech: pushing his flagship brand into the U.S. luxury arena, where vehicle profit margins are higher than in the mid-priced segment in which VW typically competes. At the same time, he is wringing costs out of manufacturing through design changes and by getting relief from VW's expensive German work force. The firm recently announced that net profit was down 51% in the third quarter compared with a year earlier, and CFO Hans Dieter Potsch warned that the firm would take a charge of "a couple hundred million" euros this quarter to offset R.-and-D. costs.

The company known for the inexpensive Beetle is now launching its most expensive cars ever. Its first SUV, the Touareg, tops $42,000 with an eight-cylinder engine, putting it in league with hot models from BMW, Cadillac and Infiniti. And a loaded Phaeton, a sedan that cost more than $900 million to develop, will have a sticker price north of $85,000 when it hits U.S. dealerships in December. VW plans to launch dozens of new models over the next two years, including a new Microbus, smaller SUVs and crossover vehicles, and is considering a sexy convertible, the Concept R, which Pischetsrieder unveiled at the Frankfurt Auto Show in September. VW's new Golf, expected to hit North America in 2005, has received early positive reviews in Europe and should bolster profitability thanks to lower manufacturing costs.

Pischetsrieder insists the strategy will pay off once the new cars take hold with consumers. Investors seem to think so. VW's share price rallied 34% from the start of the year to early November, outperforming the Dow Jones auto index by 14 percentage points. The Touareg is off to a strong sales start, both here and in Europe. The Phaeton is not. Available in Europe for more than a year, it has been no threat to the Mercedes S Class and the BMW 7 Series, selling less than 8,000 units (in 2002 BMW sold 14,670 7 Series cars in Europe). Equity analysts cite the Touareg and the Touran multipurpose vehicle (MPV) as signs that VW is broadening its mix in Europe, enabling it to profit in hot segments such as SUVs and MPVs and to hedge against downturns in other segments. Some are skeptical. Christopher Will, an analyst at Lehman Brothers in London, describes the Phaeton as a "mistake" and an "irrelevancy." Says Will: "The VW brand could become muddled if the quality issues persist or if VW launches more products that don't fit its core image." Certainly it's difficult to move upmarket when the perception is that quality is heading down, so fixing that issue must be Pischetsrieder's first task. Next he has to ensure that VW's move into luxury doesn't come at the expense of sales in its higher-volume, mid-priced segments. "We know the premium segment is different from the mass market, and we need to make certain that Volkswagen lives up to its new image," he said in September.