Volkswagen’s Diesel DeceptionBetween 2009 and 2015, Volkswagen manufactured and marketed clean diesel automobiles that were designed to provide high performance without the polluting emissions commonly associated with diesel engines. These turbocharged direct injection (TDI) clean diesel vehicles were very popular in Western Europe, where environmentally conscious or “green” consumers found they could have fast, responsive cars that seemed to sip diesel. On September 18, 2015, the U.S. Environmental Protection Agency announced that it was suing the Volkswagen Group for selling over 482,000 diesel Volkswagens and Audis with software “defeat devices” that caused the vehicles to be far more polluting than expected during normal driving. The vehicles would be recalled for repairs.In the following weeks, the U.S. and German investigators swarmed into Volkswagen offices, including the company’s international headquarters in Wolfsburg, Germany, and the corporate offices of the company’s U.S. subsidiary, Volkswagen Group of America (VWoA). The Volkswagen group manufactures and markets automobiles, vans, and trucks around the world in a variety of brands. The Volkswagen marque is the company’s most popular brand. Prestige brands such as Audi, Porsche, and Bentley have significantly lower sales volumes, but much higher margins. In May 2016, VW reported a quarterly profit on Volkswagen-branded cars of only €73 million for the first quarter of 2016, a significant decrease from the €514 million profit it posted in the first quarter of 2015. Much of the profits were erased by dealer incentives and consumer rebates that supported sales of gasoline-powered Volkswagen-branded vehicles. As a whole, Volkswagen Group posted a quarterly profit of €2.4 billion; Audi and Porsche accounted for two-thirds of that profit.Volkswagen’s History and CultureFounded in 1937, Volkswagen was intended to produce a “people’s car,” designed by Ferdinand Porsche, for the citizens of the Third Reich. The town of Wolfsburg was established in 1938 for VW employees.U.S. distribution of the VW Beetle, a modified version of the original “people’s car” design, began in 1949. The company founded Volkswagen Group of America (VWoA) in 1955, and created the Audi marque in 1969. VW’s international success helped spur the recovery of West Germany. VW opened a U.S.$1 billion manufacturing facility in Chattanooga, Tennessee, in 2008. To secure Volkswagen’s commitment, the state of Tennessee offered Volkswagen a package of tax incentives that grew to almost $U.S.1 billion by 2015. Porsche took over VW in 2009 after decades of cooperation and conflict between the Porsche family and Volkswagen management.In 2015, Volkswagen was tightly controlled by the billionaire descendants of Ferdinand Porsche, who own 50 percent. Independent shareholders own about 12 percent of the stock. The north German state government of Lower Saxony, where Wolfsburg is located, and Qatar’s sovereign wealth fund own the rest. A network of powerful German labor unions participate in management decisions, as compensation for funds that were confiscated after World War II. Volkswagen had a fleet of corporate jets, including an Airbus A319; VW owned over 100 factories in 31 countries across 12 different brands (see Figure 1), and the Volkswagen air services subsidiary that flew company executives as needed.Figure 1Volkswagen Automotive BrandsVolkswagenAudiBentleyBugattiLamborghiniDucatiMANPorscheScaniaSEATŠKODASources: Volkswagen, “Brands and products,” http://www.volkswagenag.com/content/vwcorp/content/en/brands_and_products.html. Accessed June 8, 2016.“Be aggressive at all times” was how one Volkswagen executive described the company’s confident approach to global competition. Volkswagen chief executives including Ferdinand Piëch, a grandson of Ferdinand Porsche, and Piëch’s successor, Martin Winterkorn, heavily promoted clean diesel technology as part of the company’s environmental commitment. He had promised that Volkswagen would surpass Toyota to become the world’s largest automobile manufacturer, and that clean diesel vehicles, not hybrids, were the key to global domination.Soon after the EPA recall announcement in September 2015, Winterkorn resigned. In December 2015, the new CEO, Mathias Müller, and the chairman of Volkswagen’s supervisory board announced in a press conference that Volkswagen employees had created the emissions test scheme in 2005, after realizing the company’s diesel technology could not pass U.S. environmental standards. CEO Müller, announced that the company might have to sell the corporate Airbus A319 corporate jet, among other major changes. The company set aside €6.7 billion to cover the costs of repairing faulty diesel cars, including the option of repurchasing some diesel vehicles from consumers. While Volkswagen planned to keep its 12 different brands, plans for a €100 million corporate design center intended for Wolfsburg were scrapped.In January 2016, members of the Porsche and Piëch families, who owned half of Volkswagen, made public statements endorsing Müller after his controversial visit to the United States. In an NPR interview recorded during a visit to Detroit, Müller apologized for the scandal, and promised to “deliver appropriate solutions to [VWoA] customers.” Earlier in the interview, Müller claimed that Volkswagen did not lie to the American public:Frankly spoken, it was a technical problem. We made a default, we had a … not the right interpretation of the American law. And we had some targets for our technical engineers, and they solved this problem and reached targets with some software solutions which haven’t been compatible to the American law. That is the thing. And the other question you mentionedu2005—u2005it was an ethical problem? I cannot understand why you say that. NPR interviewed Müller the next day, and the CEO attempted to mitigate the damage of his previous statements:We have to accept that the problem was not created three months ago. It was created, let me say, 10 years ago. … We had the wrong reaction when we got information year by year from the EPA and from the [California Air Resources Board]…. We have to apologize for that, and we’ll do our utmost to do things right for the future.In April 2016, Volkswagen agreed to repurchase almost all the affected 2 L diesel vehicles in the United States, and further agreed to provide owners with additional compensation. This buyback program was estimated to cost U.S.$7 billion, but it did not include 3-liter diesel vehicles from Audi and Porsche. Later in April, Müller personally apologized to President Barack Obama for the emissions scandal. The following month, Volkswagen challenged the U.S. Department of Justice’s authority in the matter, claiming that the affected cars were sold not by the European parent companies, but by local businesses in the United States. While Volkswagen’s European operations designed the automobiles and their emissions systems, many of the affected diesel automobiles were manufactured in Volkswagen’s Chattanooga facility.Cheating the SystemThe emissions control systems used in the affected Volkswagen, Audi, and Porsche cars included software designed by Volkswagen engineers to deceive or cheat emissions tests. Automakers often use common body frames, engines, components, and software across multiple brands to reduce duplication and costs. Emissions tests usually involve running at several different speeds while the driving wheels of the vehicle rest on a treadmill. When testing a front wheel drive model, the back wheels remain stationary. To test an all-wheel or four-wheel drive vehicle, treadmills are placed under both axles. The vehicle is connected to a dynamometer, a device that measures the torque or power of an engine. Sensors attached to the vehicle’s exhaust pipe measure the vehicle’s emissions.The test or “dyno” mode used in the engine control unit (ECU) of VW diesel vehicles was activated only when the following conditions were met:the steering wheel was not being moved;the vehicle was operating at a constant speed; andthe atmospheric barometric pressure was steady. In April 2016, German newspapers and television broadcasts revealed that an early version of this “dyno” mode plan was found in a 2006 PowerPoint presentation that had been prepared by a German Volkswagen executive. Under normal driving conditions, the vehicle’s braking and stability control systems might take over the vehicle because a lack of steering column movement; this is one indication of a loss of vehicular control, such as a skid. Therefore, the test or “dyno” mode performed a useful function by allowing the vehicle to be driven normally on a dynamometer.The ECU, braking, and stability control modules for VW diesel vehicles were manufactured by Bosch, a major manufacturer of automotive components. These components were programmed by VW engineers, using proprietary code developed within the company. The U.S. Environmental Protection Agency (EPA) performs emission testing on only about 10 to 15 percent of new cars each year, and relies on automobile manufacturers to certify the emissions performance of its vehicles. According to Columbia University law professor Eben Moglen, “[s]oftware is in everything … proprietary software is an unsafe building material. You can’t inspect it.” In the summer of 2015, the EPA announced that it opposed inspection of proprietary automobile software, supporting automobile manufacturers who claimed that people might try to reprogram their vehicles systems to increase performance in unsafe ways.Volkswagen engineers took advantage of “dyno” mode by programming the ECU to shift the vehicle’s emissions control systems into a full power mode that significantly reduced emissions, but used significantly more fuel to operate. Diesel engines produce emissions that include nitrogen oxides and ozone. These are chemical compounds that, according to the EPA, can cause “adverse respiratory effects including airway inflammation in healthy people and increased respiratory symptoms in people with asthma,” especially inside vehicles and near roads. Emissions control systems are installed in vehicles to reduce the production and/or emissions of compounds. Volkswagen started selling diesel cars in the United States in 1977, taking advantage of increased consumer interest in diesel fuel economy.One form of Volkswagen’s diesel emissions control systems used a technology called selective catalytic reduction (SCR). This method used a solution of 70 percent water and 30 percent urea to convert emissions to nitrogen, oxygen, water, and carbon dioxide . A computerized controller sprayed an optimal amount of liquid as the emissions passed through the exhaust system. The liquid is sold in the United States as AdBlue. This system required drivers to have the urea tank refilled periodically at a service center.A different system was installed in the Golf and other small cars, partly because the SCR system required more space than was available. This version did not require refills; it used a nitrogen oxide trap located before the exhaust valve and catalytic converter to capture and reduce emissions. The vehicle used about 4 percent more diesel fuel when the trap was operating at full power. Some industry experts claimed that traps were less effective than urea-based systems.VW engineers changed the vehicle’s software to turn off the nitrogen oxide trap or catalytic scrubbers during the “on road” mode that was used for normal operation of the vehicle. This boosted the vehicle’s overall speed and acceleration but reduced fuel economy while increasing emissions by a factor of 40. VW’s diesel emissions control systems also increased the price of each vehicle between U.S.$5,000 and U.S.$8,000. Catching the CheatGovernment reliance upon manufacturer testing can be problematic. According to Zeynep Tufekci, an assistant professor at the University of North Carolina, smart cars and other smart devices should be tested in realistic conditions, not in a controlled environment. Companies should not be able to use copyright and intellectual property laws to restrict inspection of proprietary software, especially when the code is used in important processes such as voting and public safety. Developers should also include logs and audit trails in their software, to help document its operation.Volkswagen’s “dyno” or cheat mode was discovered in 2014 by researchers at West Virginia University (WVU) who measured the emissions of VW diesel vehicles during long-distance driving tests. One vehicle had a nitrogen oxide trap, while two other vehicles used urea-based SCR systems. WVU was contracted by an NGO, the International Council on Clean Transportation (ICCT), to perform these tests after European investigators noticed discrepancies in their emissions tests of VW and BMW diesel vehicles. U.S. emissions testing is more stringent than European testing, and California automobile emissions standards are more stringent that Federal standards.While the WVU report only mentioned Volkswagen once, it was clear that the VW diesel vehicles produced much higher levels of emissions during the WVU road tests than were seen in dynamometer tests performed by the California Air Resources Board. ICCT posted the findings to its Web site in May 2014 and notified the EPA. Investigations by CARB and the EPA led to the EPA’s September 2015 announcement. The regulators refused to certify VW’s 2016 diesel vehicles for sale, leaving VW and its North American dealers with billions of dollars in new car inventory that could not legally be sold. On September 21, VW’s stock price dropped 23 percent.Over 11 million diesel vehicles worldwide had engines that were affected by VW’s unorthodox technology; 660,000 were sold in the United States. The EPA ordered a recall of over a dozen diesel-powered models. (See Figure 2)Figure 2Diesel Automobiles Recalled by the EPAAudi A3 (2010–2015)Audi A6 Quattro (2014–2016)Audi A7 Quattro (2014–2016)Audi A8 (2014–2016)Audi A8L (2014–2016)Audi Q5 (2014–2016)Audi Q7 (2009–2016)Porsche Cayenne (2013–2016)Volkswagen Beetle (2012–2015)Volkswagen Beetle Convertible (2012–2015)Volkswagen Golf (2010–2015)Volkswagen Golf SportWagen (2015)Volkswagen Jetta (2009–2015)Volkswagen Passat (2012–2015)Volkswagen Touareg (2009–2016)U.S. consumers were assured that they could continue to drive their affected vehicles while the recall was being organized. For 2015 and 2016 model year vehicles that used the nitrogen oxide trap, the repair was most likely a software patch, installed by a dealer. More extensive modifications were needed for SCR models.Marketing the Clean DieselBetween 2009 and 2015, VWoA bought significant amounts of advertising for diesel vehicles in the United States, which was one of the Volkswagen’s most profitable markets. Diesel vehicle sales accounted for about 5 percent of the North American market, but about 25 percent of VW’s sales were in the diesel category. While VW is a market leader in China, diesel engines are unpopular there. There are stringent emissions control rules in European countries, especially in cities such as Paris, but diesel vehicles held a 50 percent market share in Western Europe. Between January and September 2015, VW spent $77 million on U.S. television advertising for diesel vehicles, which was about 45 percent of the company’s total in that market.VW diesel ads used humor to emphasize the high performance and clean emissions of its diesel cars. In a 2015 campaign, three older women discussed the drawbacks of diesel cars while being driven in a VW diesel vehicle. The series, titled “Old Wives Tales,” focused on consumer complaints regarding diesel cars, including sluggish performance, loud noise, and the scarcity of diesel fuel. The passengers in the commercials were always surprised when their VW vehicle overcame the problems they discussed. Another 2015 VW advertisement showed precocious boys who cause chaos in a convenience store, to the sounds of Waylon Jennings’ country music song “Mommas, don’t let your babies grow up to be cowboys.” Their mother notices the boys are missing while she refuels their vehicle outside. A VW diesel Jetta drives by, and the viewers see the mother who is driving that vehicle while her three boys sit quietly.Another benefit that VW and Audi emphasized in their marketing was decreased diesel fuel consumption. During the 2010 Super Bowl, Audi ran a television advertisement for its A3 TDI hatchback that showed the car as the only vehicle that could pass through a fictional “green police” checkpoint. For the 2015 diesel Jetta, VW aired a television advertisement that claimed “When you’re driving, things aren’t always what they appear to be.” The advertisement only aired a few times before it was pulled in September 2015. After the EPA’s September 18 announcement, VWoA paused its national advertising through October 11, including the company’s non-diesel vehicles. Advertising for gasoline and electric vehicles resumed slowly, as VWoA managers and ad agencies scrambled to create new campaigns and content.Government InvestigationsOver 450 VW and third-party investigators conducted a probe during late 2015 and early 2016, coordinated by the accounting firm Deloitte and a U.S.-based law firm, Jones Day. There were many obstacles in VW’s internal reports and documentation on the affected diesel systems. VW engineers used dozens of code words such as “acoustical software” when referring to the emission control countermeasures. The investigators turned their focus on about 20 VW employees. Many persons interviewed during the investigation were “reluctant to provide insight because they were afraid of the legal consequences.” The German employees under investigation were not executives. However, the idea that VW executives were unaware of the diesel defeat designs “just doesn’t’ pass the launch test,” to quote John German, a former EPA official who became a senior fellow at ICCT and helped begin that group’s investigation of VW in 2013. French authorities launched their own investigation into intentional fraud by VW.German law exempts companies from being prosecuted for crimes; the German Penal Code or Strafgesetzbuch (StGB) stipulates that only individuals can be held liable for criminal acts. Six Volkswagen employees were under investigation for charges of corporate tax evasion. In the United States, Senators Ron Wyden (D-OR) and Orrin Hatch (R-UT) accused Volkswagen and VWAG of accepting as much as U.S.$51 million in tax incentive credits for diesel vehicles. Margo Oge, who was director of the EPA Office of Transportation and Air Quality in 2011, revealed that German Volkswagen executives had pressured the EPA for “special fuel economy credits for environmental friendliness” that were equivalent to those awarded to zero-emissions vehicles such as electric cars. Oge perceived that the German Volkswagen executives believed their diesel technology was superior to electric motors: “I never had a problem dealing with the Americans. The U.S. Volkswagen people would always come and apologize to us after meeting with the Germans. My sense was that things were being dictated by Germany.”Whistleblowers also came forward. David Donovan, who worked at VWoA in electronic discovery and information management, claims he was fired in December 2015 after he reported his concerns to the company’s legal department. Volkswagen acknowledged that there were at least 50 other whistleblowers.The legal responsibilities of Volkswagen and VWoA executives is also of concern. CIOs are responsible for finding and archiving data, messages, and other corporate information. In September 2015, U.S. Deputy Attorney General Sally Quillian Yates announced that the U.S. Department of Justice planned to increase its efforts to prosecute corporate executives for their involvement in corporate misconduct. Investors criticized Volkswagen’s executive compensation practices. Billionaire investor Christopher Hohn of TCI Fund Management wrote in a letter to Volkswagen’s executive supervisory boards that top management compensation appeared to be “excessive,” and was “unlinked to transparent metrics and paid in cash with no vesting or deferral, and has encouraged aggressive management behavior, contributing to the diesel scandal.”Michael Schrage, a research fellow at MIT’s Center for Digital Business, noted that Volkswagen had brought the crisis on itself by failing to acknowledge societal and technological change. The emergence of the Internet of Things (IoT), in which products are embedded with sensors and smart systems, coupled with societal acceptance of social media, made the revelation of corporate deception far more likely than ever before.Volkswagen Diesel Timeline2005: Volkswagen executives make diesel the focus of the company’s U.S. marketing efforts. A small group of Volkswagen engineers and employees in Germany decide to find ways to cheat emissions testing.2006: A Volkswagen executive prepares a PowerPoint presentation that describes how to cheat U.S. emissions testing.2007: Martin Winterkorn becomes CEO of Volkswagen.2008: Volkswagen opens a U.S.$1 billion production facility in Chattanooga, Tennessee, in return for U.S.$577 million in state tax incentives.2009: Volkswagen and Porsche merge. Diesel vehicles with the altered software go on sale. VWAG launches diesel vehicle marketing campaign in the United States.2011: Volkswagen opens a new manufacturing facility in Chattanooga, Tennessee.2014: Volkswagen decides to expand the Chattanooga plant instead of moving production to Puebla, Mexico, based on an additional $U.S.230 million in state tax incentives.September 18, 2015: The EPA orders Volkswagen to recall 486,000 because they used software designed to cheat emissions tests.September 22, 2015: Volkswagen reveals that 11 million diesel cars worldwide used the affected software.September 25, 2015: Winterkorn resigns as CEO. Matthias Müller, the head of the company’s Porsche unit, is named as his replacement.November 2, 2015: The EPA discovers cheating software on more cars than previously disclosed and, for the first time, also finds the illegal software in a Porsche model.November 3, 2015: Volkswagen announces that it understated emissions of gasoline powered cars in Europe.November 9, 2015: VWoA offers $1,000 gift cards to owners of affected diesel vehicles in the United States. Volkswagen later states that this offer does not apply to owners in the EU.November 11, 2015: Volkswagen halts production of the 2016 diesel Passat at its Chattanooga manufacturing facility.November 25, 2015: Volkswagen announces that a set of simple repairs could bring the affected diesel cars in to compliance with European standards.December 10, 2015: The chairman and CEO of VW presented the results of an internal inquiry, revealing that the decision by employees to cheat on emissions tests was made in 2005.January 10, 2016: CEO Müller claims in a radio interview that the emissions scandal was a technical issue, not an ethical concern. He changes his statement the next day.March 2, 2016: Volkswagen reveals that former CEO Winterkorn received a memo on problems with diesel emissions in Volkswagen vehicles in May 2014, but did not indicate if Winterkorn had ever read the document.April 22, 2016: Volkswagen agrees to fix or buyback almost all affected diesel cars in the United States.April 24, 2016: CEO Müller personally apologizes to President Barack Obama for the emissions scandal, during a state dinner hosted by German Chancellor Angela Merkel.May 24, 2016: Volkswagen claims that the U.S. Government has no jurisdiction over the emissions scandal. The company will continue its own internal investigation.Questions for DiscussionConsider the corporate culture of Volkswagen in Germany. How did it affect this situation?Why did Volkswagen engineers decide to cheat the emissions tests? Should the engineers have consulted with executives?What is your assessment of VW’s sense of business ethics and fair play as manifested in the emissions cheating scandal?VW has always been perceived to be a socially responsible corporation. In light of this, how could an emissions cheating scandal like this occur?What roles should government regulators play in terms of emissions and fuel economy testing?Assume that you are a consumer who purchased one of the affected diesel vehicles in 2014, before the EPA made its announcement. What might your reaction have been? What forms of restitution would you have sought from VWoA and Volkswagen?Do research into what has taken place in the VW case since the end of this case. Are circumstances looking better or worse for the company?