Getting The Bugs Out At VW In six years, Ferdinand Piech has turned VW into one of the world's strongest car companies. Can he sustain it?
By Janet Guyon

(FORTUNE Magazine) – It was a cold, wet, windy night last November, but Volkswagen chief Ferdinand Piech was in unusually good spirits. For four days, on the vast grounds of its Wolfsburg factory in Germany, VW had been partying like it was 1969 promoting the launch of the new Beetle in Europe. The company had spent $3.6 million on entertainment, including heated tents with snake charmers and T-shirt silk-screening booths meant to provide a flashback to the flower-power era. A Beatles revival band and a Janis Joplin look-alike performed. Liquor flowed freely. One exuberant VW employee repeatedly flashed his chest to the crowd.

Okay, so it wasn't Woodstock, but the 1,200 European journalists there loved the spectacle--and more important, the car. Piech enjoyed the adulation, his normal icy stare replaced by boyish vulnerability and pride: The new Beetle, you see, is his baby, just as the original one was his grandfather's. The key to the car's success, says Piech, is its rounded shape. "Thirty-five years ago, I remember a Beetle study in which people said they felt they were inside a sphere," he says. "It gives them a sense of security in the primordial sense." When asked to explain the larger success of VW, he answers, in typically cryptic form, "It's so simple [when you have] an engineer at the top."

It may seem simple to him, but the debate over Piech has raged ever since he became chairman of Europe's biggest automaker in 1993. His turnaround of VW has been tumultuous, marked by both controversy and innovation, from the nasty fight over ex-General Motors exec Jose Ignacio Lopez to the introduction, in union-heavy Germany, of the four-day workweek. His $1 billion shopping spree for the history-laden, high-class Bentley, Bugatti, and Lamborghini brands last year earned him derision from his competitors, while early in his tenure his ruthless reduction of VW's 12-man management board to five got him a permanent clique of hometown critics. Add to that his complicated family history: One of eight grandchildren of legendary engineer Ferdinand Porsche, Piech grew up steeped in the automotive industry as well as the often tense issues of family control over the sports car company.

His management style, which he calls democratic dictatorship, has won him few friends. But he is widely admired for transforming what had become a sleepy carmaker that broke even only if its factories worked overtime into a focused giant capable of taking on GM and Ford. The year he took the helm, VW lost $1.1 billion; last year, profits rose 63%, to $3.6 billion before taxes. "The breadth of his vision and his speed in pushing it through has been rather astounding," says John Lawson, Salomon Smith Barney's auto analyst in London. Sales of more than 4.7 million vehicles last year put VW neck and neck with Toyota as the world's third-largest carmaker, while pretax profit margins of 4.7% are moving closer to VW's stated goal of 6.5% (which it is on track to reach by 2001). Surveys from J.D. Power & Associates show VW has boosted quality more than any other carmaker in the past five years, cutting defects by 60%, although it still trails Toyota, Mercedes, Nissan, and Honda in overall quality. In the U.S. the new Beetle has injected buzz into the brand, luring buyers into dealerships where they're also snapping up Passats, Jettas, and Audis. American sales last year rose to their highest level in 17 years, with a 59% increase for VW and a 39% increase for Audi. Not bad for a carmaker that almost withdrew from the U.S. market six years ago after its showroom traffic had all but disappeared.

VW warns that it may be difficult to match last year's results in 1999 because of a softening in auto sales in Europe and South America. But analysts believe that VW is also trying to understate its prospects as it goes into union negotiations this summer. Most think that on balance VW is in robust shape. Its share price climbed 36% last year, nearly double the pace of the overall German market. In the U.S., where VW ADRs trade over the counter, VW outperformed GM. "VW has been on an incredible roll," says Jay Woodworth, a former Bankers Trust auto analyst who runs his own consulting company in Summit, N.J. "Piech has turned the company around from a subpar performer that made a bunch of little Euroboxes to one that hits one home run after another."

Piech says he's only half done. "For the moment, we are happy with the bronze medal," he says, smiling. "But we want to step up the stairway" and into a permanent place as one of the world's three biggest car companies. His production strategy--building all models on only five platforms--is controversial, and he has yet to graft VW's winning ways onto his high-end acquisitions.

It is impossible to fathom VW without understanding Piech, who is by all accounts driven, intense, unpredictable, and quirky. "He thinks so far outside the box, and you always have the irritation of finding out he's right," says Richard Ide, head of VW in Britain. The first VW chairman to refuse a chauffeur, a car nut who loses track of time when fiddling with new models, the overzealous Piech has also been known to spend hourlong interviews answering only in monosyllables. He prefers not to discuss his 13 children. Recently he declined to pose for photos for VW's annual report. He neither writes nor reads company memos; his staff bursts into laughter when asked if he answers e-mail. "I am not writing, and I am not reading," says Piech. "If something goes wrong and you want to prove you're not guilty, then you write it down. This is something I don't like."

The publicity-shy Piech did grant FORTUNE two unusually candid interviews, one in dreary Wolfsburg and one in Davos, the Swiss ski resort where his former schoolmate Klaus Schwab runs the annual World Economic Forum, which Audi and VW have sponsored for 22 years. Relaxed in both settings, Piech talked about his past, his strategies, and how he has changed VW's way of doing business.

Born in Vienna in 1937, raised at the family home in Zell-am-See, Austria, and educated in Switzerland, Piech regards himself as "multicultural" and says he speaks better French than English. He can be both brutally abrupt and softly charming. "Piech is an Austrian," says Rolf Breuer, chairman of Deutsche Bank. "Austrians have a very different approach than Germans or Swiss. They are very smart businessmen, but they appear to be more easygoing."

Those close to Piech say he still regards himself as the black sheep of the family, perhaps because he is descended from Ferdinand Porsche's daughter and therefore doesn't bear the Porsche name. Yet according to Richard von Frankenberg's Porsche: The Man and His Cars, he's more like his grandfather than any other Porsche descendant. Porsche had an innate engineering talent that led him as a teenager to make the family home the first in the village with electricity. Yet his father refused to recognize Porsche's genius, pushing him instead toward the family tinsmithing business. Ultimately he left and founded Porsche as a design studio, and later created the first VW Beetle at Hitler's request.

Piech studied at Zurich's Swiss Federal Institute of Technology, then immediately began work at Porsche, where he headed research and development and created the legendary 917 racecar that won Le Mans in 1970. He quickly earned a reputation for being difficult and unrestrained; people say he wanted to run all of Porsche, but his career was cut short by his mother, Louise Porsche Piech, and his uncle, Ferry Porsche. Fed up with fights among their children over management of the company, in 1972 Ferry and Louise banned all family members from management positions, hired professional managers, and floated Porsche on the stock exchange while retaining voting control. After leaving Porsche in 1972, Piech went to VW's Audi unit, where despite his rottweiler reputation, he oversaw enough innovations to win the Audi chairmanship in 1988--although it took two votes of the supervisory board to confirm him in the post. He managed to transform Audi into a credible competitor of BMW and then moved to the top spot at VW, a job Piech says he has wanted "nearly since I was born."

With the death of Piech's uncle last year and of his mother this year (grandfather Porsche's two children), the third generation of Porsches and Piechs has taken full control of the voting shares of Porsche AG, the publicly traded car company; Piech himself holds about 10% of those shares. His Porsche stake is worth about $153 million, while his personal fortune is estimated at $300 million. While the histories of Porsche and VW are intertwined, the companies have no formal relationship beyond an agreement to jointly develop an SUV platform. (Porsche Holding, the private arm of the Porsche empire, became a major importer of VW and Porsche cars in Austria when it was run by Piech's mother, who took charge after his father's death in 1952.)

Given this background, it isn't surprising that Piech blurs the line between his family interests and those of VW. "I got from my grandfather and my mother a part of industry," he says. "I want to give it to my descendants in a bigger size, not to eat the cake. As long as I live, I don't want to see the automobile industry gone in Germany and in Europe. We have already seen electronics gone. If VW dies, Porsche in Germany is more than dead."

Using lessons he learned running Audi to focus on making great cars at low prices, Piech has rapidly overhauled VW's culture and strategy. His first move, putting his own team in place, opened wounds that still haven't healed. The animosity reached its peak when GM sued VW over the hiring of purchasing chief Lopez, alleging Lopez stole GM secrets and gave them to VW. Insiders say that many of the most damaging leaks to the press came from VW itself, where lifers hoped the Lopez mess would tumble Piech from power.

Piech hung on, settled with GM, fired his enemies, and today is surrounded by four loyalists. Jens Neumann, a lawyer who oversees North America and has worked with Piech since 1979, "would walk through fire for Piech," says another VW executive. Bruno Adelt, the finance guy, is the only top-level survivor of the Piech purge. "I kept him," says Piech, "because he had the same idea I had--no losses."

Piech recruited Robert Buchelhofer, a former BMW board member, to make sense of sales and marketing. Peter Hartz, head of human resources and a card-carrying member of Germany's IG Metall union, was brought in to solve VW's labor troubles in 1993 after Piech calculated VW had 30,000 workers too many.

The firings fueled Piech's reputation as a manager who uses fear and brutality. "Do you really think we could be successful if this would be my management method?" retorts Piech. "The culture at the time I came in was that nobody suffered if we lost money. My mother told me, 'Never borrow money and never make losses.' But my mother was quite different from me--she ran [Porsche Holding] like a woman. Women take care of the weak people. Fathers take care of the strong people. It took quite a while until I had the management I wanted."

Piech also changed the rules of behavior. All top VW managers must now attend test drives, which occur once or twice a month in secret locations around the world. Not just a forum for resolving technical issues, they form the basis for VW's culture under Piech. "The most important thing for a board member is to test the products," says Hartz. "If you have to run a company just looking at the finances, you should lead a bank." Says Adelt: "We don't play golf together. We build Golf."

When managers gather to test cars, they also swap ideas about what works best in which cars, and they compete to sell each other technologies they are developing. VW's Czech subsidiary, Skoda, for instance, plans to build four- and perhaps three-cylinder gas engines and will try to get other brands to use them. "The way we handle our culture is unique," says Piech. "In other car manufacturers, a leading brand or a leading group streamlines the others. Here, it is an open market; you put your idea out, and the other brands can accept it or not."

To focus everyone on profitability Piech requires new projects, such as Skoda's plans to build engines, to be self-financing. And Piech monitors VW's parts purchasing list for pricing that seems out of whack. Car designers have free rein on new models--as long as they buy parts off the list. "Costwise, it shows up immediately if [a component] doesn't fit into the system," says Piech.

Piech's myriad cultural changes come together in his new brand strategy. To illustrate his vision, Piech drew an organizational tree during the Wolfsburg meeting (see sketch). Although VW now owns seven different car brands, in Piech's mind he is running just two groups of brands, one for the traditional driver, the other for the performance-minded driver. The sporty stable--Spanish unit SEAT, Audi, Bentley, and Lamborghini--has more cars with gasoline engines; the staid one--Skoda, VW, Bugatti--uses more diesels (although the 18-cylinder Bugatti will have a gasoline engine). To further focus the minds of the marketers, each volume brand has a target competitor: Volvo for Skoda, Alfa-Romeo for SEAT, BMW for Audi, Mercedes for VW.

Piech says that he will raise the reputation of VW to that of Audi by further boosting quality and within two years bringing out a car code-named D1, a $100,000 machine with a 12-cylinder engine meant to compete with the Mercedes S-Class. The company is also talking about developing an Audi A10, which would bridge the price gap between the top-of-the-line Audi A8, now selling for $65,000, and a new class of lower-end Bentleys, to sell for between $120,000 and $240,000.

While Audis and top-end VWs may fall into the same price category, Piech says they will appeal to different customers. Audis are for sporty drivers who want the latest technology (see Big Ticket), while high-end VWs are for conservative customers more interested in luxurious touches such as leather and wood interiors.

Piech paid dearly last year--$790 million, to be precise--to grow VW's luxury end by acquiring the Bentley brand (BMW won the coveted Rolls-Royce moniker). He maintains it would have cost more to develop an ultra-luxury brand from scratch. Besides, says Piech, "Rolls-Royce is 25% of the volume--75% is Bentley." VW plans to spend $825 million to develop a new line of lower-priced Bentleys, bringing total production to 9,000 from the current 2,000.

VW brought Bugatti back from the grave with a swoopy blue coupe shown as a concept car at the Paris auto show last September. VW guesses it will custom-build between 100 and 200 Bugattis a year, including the coupe and a four-door sedan that was just unveiled at the Geneva auto show, both of which will sell for about $350,000. "It is a total economic irrelevance from the point of view of financial analysis," says Nick Snee, J.P. Morgan's auto analyst in London.

To keep production costs down, Piech intends to produce all of his cars, including the ultra-high-end stuff, on one of five platforms. While this is an old--and often unsuccessful--trick, the chairman maintains that VW will do it with greater attention to detail than any manufacturer has before. Because each car is designed by a different brand group, the body shapes, the position of the steering wheel, seats, engine and gearbox software, suspension systems, and anything else directly touched or felt by the driver, are different. To develop separate platforms for each car would cost at least $300 million each. VW has 47% of production on two platforms now; 90% of production will be on four platforms by the end of 2001. (Ford is implementing a similar platform strategy and hopes to build 44% of its production on just three platforms by the end of this year.) Piech wants to streamline his engine production too, making everything from three-cylinder to 18-cylinder engines with just a few basic designs.

All this sounds great in theory, but whether it will work is questionable. GM has been putting many cars on a few platforms for years, with the result that a lot of them drive and look alike, and brand identity suffers. Consultants already tell tales of SEAT parts showing up in VWs and diluting the VW brand name, and analysts say customers confuse the VW Passat with the Audi A4, with which it shares a platform. "The risk is whether a platform can be flexible enough to meet different market demands," says Chance Parker, a partner at J.D. Power.

One thing Piech hasn't overhauled is VW's backward relationship with its stockholders. Unlike rival Jurgen Schrempp at DaimlerChrysler, Piech spurns Wall Street and international accounting standards, preferring Germany's opaque accounting methods. The German state of Lower Saxony, Chancellor Gerhard Schroder's home base, still holds 20% of VW's shares, and VW views this as a built-in poison pill against takeovers. The effects of that attitude, however, are far-reaching. "It has definitely hurt their valuation and raised their cost of capital relative to Daimler's," says Greg Melich at Morgan Stanley.

The damage was most visible in the fall of 1997, when VW suddenly reversed course and said it wanted to raise $3.7 billion through a stock offering but didn't bother telling investors why. VW shares plummeted, and the company was forced to put off the offering until last year. In the end, VW raised half the original amount, belatedly saying it was for acquisitions. VW now admits it bungled its communications with investors.

Overall, however, Piech remains unrepentant. He likes German accounting methods, which give companies great flexibility to understate profits, because they keep competitors from seeing exactly how VW invests its money. They also keep suppliers, unions, and the tax collector from demanding more. "I don't say shareholders don't count for Volkswagen, but they count on the same level as our customers and our employees," says Piech. "This is very European. If I would need a lot of capital, we would have to adapt. But as long as I can build up trust through the German system for our shareholders, what I try to do doesn't show up to our competitors."

In the near future, while Ford spends $6.45 billion for Volvo's car business, Fiat looks for a buyer, and BMW struggles to revive Rover, Piech says he will spend $37 billion in the next five years, all from cash flow, to retool factories, expand his engine lineup, and make heavy trucks. Although the industry believes he will bid for Volvo's truck division and BMW, Piech claims he has finished his shopping spree for now. "My congratulations to Ford," he says. "But having seen the figures they had to pay, we understand that everything gets more expensive."

To watch him run VW, it's quite clear how much Piech values the simplicity that his grandfather built into the original Beetle. But his new Beetle, while brilliantly capturing the nostalgic hearts of boomer buyers and setting off a wave of like-minded vehicles, is a far more complex machine under its sunny exterior than its predecessor. The same may be true for VW: While Piech craves clean corporate lines, the reality of balancing growth, seven brands, and an annual production of five million cars will never be a simple affair.