Revving Up Volkswagen

Remember when Volkswagen was known for making cheap, dependable and, above all, lovable cars? So does Ann Jones, a Jetta owner from Corona, California. Jones was lured to the Jetta (known as the Bora in Europe) by its stylish looks and solid road handling — easily worth the $18,900 sticker price. But a few months after bringing her new sedan home in 2000, she returned it to the dealership because of a fluid leak. Then a door lock broke. Then a spring popped out of the driver's seat. With 80,000 km on it, her Jetta started to feel sluggish, says Jones, 28. But what especially disturbed her were the grim faces of other VW owners that she encountered at her dealership: "The majority of them weren't there for basic service," she says, "but because of some defect."

Ordinarily Volkswagen might say that Jones simply got a lemon — or a "Monday car" assembled by hungover workers. But that's a tough case to make these days. In the latest survey of three-year dependability by J.D. Power and Associates, an automotive consulting firm, American consumers ranked VW-brand cars fifth from last (of 37 nameplates), ahead of only Suzuki, Daewoo, Land Rover and Kia. The influential independent magazine Consumer Reports, which recommended three VW models in the late 1990s, now only keeps the Passat on its list of recommended cars. That's quite a tumble for Europe's largest automaker, which employs 332,800 people worldwide and manufactures some 5 million units a year, including the brands Audi, Bugatti, Seat and Skoda.

Those quality issues are also raising concerns about VW's hold over the North American market — the largest and most vibrant in the world and one critical for VW's profit growth. While VW is holding its own in Europe's anemic market — the VW group has an 18% market share in Western Europe, and sold almost 2 million cars in that region in the first nine months of 2003 — the company is struggling in the U.S. The VW brand's U.S. sales plummeted 14.6% over that same period and operating profits in North America shrank from $944 million to $68 million in the first six months of the year. While North American sales accounted for just 20% of Volkswagen's $101 billion in global revenues in 2002, they delivered an outsized 27% of its $5.4 billion operating profits. And VW clearly aims higher: around one-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 domineering Ferdinand Piech in April 2002. A personable, goateed man who ran BMW from 1993 to 1999, Pischetsrieder, 55, knows he must do something to shake up the company's North American sales. But he is pursuing a risky 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 where VW typically competes. Thus, the firm is launching its most expensive cars ever: its first SUV, the Touareg, hits $42,000 fully loaded, putting it in league with hot models from BMW, Cadillac and Lexus. And its Phaeton — a sedan that cost over $900 million to develop, with an optional 12-cylinder engine and a sticker price expected to top $85,000 — hits American dealerships in December with a modest sales target. (The Touareg, which is seeing growing demand in the States and was named Motor Trend magazine's SUV of the year, was introduced in Germany last November and sold 9,200 units in Europe in the first half of 2003; the Phaeton, available in Europe for more than a year, has been no threat to the Mercedes S Class and BMW 7 Series, selling less than 8,000 units.) The strategy is taking its toll: last week, the company announced that net profit was down 51% in the third quarter compared to a year earlier, and Chief Financial Officer Hans Dieter Pötsch warned that the company would take a charge of "a couple hundred million" euros this quarter to offset R&D costs. Pischetsrieder insists the high-end strategy will pay off once the cars take hold with consumers.