VW and luxury? Pischetsrieder wants to remake the "people's car" company. Can it be done?

Rolling into Volkswagen showrooms these days is a 17 1/2-foot-long, low-slung sedan that embodies all the engineering and technical know-how the German automaker can muster. Even though VW's motto was once "think small," there's nothing small about the new Phaeton, especially its price tag: up to $95,000. The Phaeton is designed to move the VW brand upscale and compete with luxury powerhouses BMW and Mercedes. But the lux car has not exactly sprinted out of the starting blocks, and that has unleashed a stream of criticism about VW's premium car strategy in the press and in investment circles.

VW Chairman Bernd Pischetsrieder is the target of most of this criticism even though he's carrying out a strategy that was authored by his predecessor. Pischetsrieder is feeling the heat for sinking profits, a declining share price, slow product sales and quality problems.

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This will clearly be a watershed year for Pischetsrieder and VW, Germany's biggest and the world's fourth largest car company. Yet the Volkswagen chief doesn't act besieged. In fact, he exudes confidence. He is intent on transforming the auto industry icon into a new kind of company, one that is less Eurocentric and directed from the top to one that is more inclusive of key managers in Germany and abroad.

Pischetsrieder's task is especially delicate because his predecessor, Ferdinand Piech, who handpicked Pischetsrieder for the job, is still very much in the picture as chairman of VW's supervisory board. In U.S. terms, that job is equivalent to a chairman of the board whereas Pischetsrieder's role is equivalent to CEO.

But Pischetsrieder, a tall, 55-year-old who sports a pepper and salt goatee, bristles at any suggestion that he is handcuffed by Piech's strategies that he inherited when he became VW's CEO in 2002. Pischetsrieder implies that he would have declined the job if he did not agree with Piech's foray into the luxury segment. "I would have chosen a different route to get to the objective," he acknowledges. "But there's no point in second-guessing."

As development costs go nowadays, the Phaeton did not consume a huge amount of capital to develop. During a tour of the company's factory in Dresden, Germany, where the Phaeton is assembled, a VW executive told reporters the project cost about $212 million. The company won't say how many Phaetons it must sell to break even, but initial sales targets are modest. The Dresden plant produces just 30 to 40 Phaetons every day. But there are plans to increase that to meet higher sales targets. In 2003, VW sold 6,000 Phaetons, mostly in Germany. Pischetsrieder forecasts about 15,000 Phaeton sales in 2004 worldwide.

Pischetsrieder argues that the Phaeton's significance transcends mere sales numbers. The car was conceived of as a challenge to VW's engineers to set a standard of engineering excellence for the entire brand. The many innovations in the Phaeton are expected to trickle down to the company's mass market models, pulling them up to premium status in their niches.

While the Phaeton may reinvigorate VW's image, Pischetsrieder is also attempting to make the company immune to the cyclical boom-and-bust pressures that prevail in the auto industry. Sitting in a private room overlooking VW's sprawling exhibit at the North American International Auto Show in Detroit early this year. Pischetsrieder said his main goal is to make VW "solidly weatherproof." That's his term for recession-proof. "Everything else is a tool for achieving that," he says.

The way to become ever more resilient, in his view, is to keep finding new markets. "What drives our company is a need to disperse sources of revenue," he says. "We need more products."

Pischetsrieder won't predict how long it will take him to achieve his targets. "You can't say when you've made it," he says, "You close one gap and you uncover another one," he says. "One of our chickens is always ill."

He says Volkswagen needs to overcome its existing mentality. "We only do proven things rather than take the risk of doing something new," he says. Another obstacle to overcome is VW's overly Teutonic approach to the marketplace. "You can make mistakes by aiming products only for Germans," he stresses. That's why he has put so much effort into seeking advice from executives in other markets.

For instance, sales in the U.S. fell last year after several years of surging volume. China has actually surpassed the U.S. as VW's second biggest market after Germany. "He not only lets us manage our markets, but he also asks us what we need," an insider says. He cites this as proof that VW has become less "Eurocentric." As Pischetsrieder circles the world, he's constantly seeking input on local vehicle opportunities for VW. "What do you guys in America need?" is a typical query from Pischetsrieder, the insider says.

Piech's neglect of U.S. trends tied the hands of executives who clamored for an SUV for more than a decade. After much pressure, VW finally produced the Touareg, which went on sale in the U.S. last year, SUVs account for more than 50 percent of the U.S. market. Without one, VW was competing in less than half the U.S. market.

Pischetsrieder's management style is also making VW less autocratic. He has an almost zen-like calming effect in the executive suite on the 13th floor of VW's headquarters in Wolfsburg--even though he is an outsider, one who comes from a feared and ferocious competitor. He was chairman of BMW until 1999, when he was ousted for a disastrous financial mess resulting from a failed takeover of Rover in Britain. The Quandt family, which controls BMW, blamed Pischetsrieder for losses of more than $500 million.

Pischetsrieder strongly defends the Rover acquisition. "BMW didn't have the patience to solve the Rover problems," he insists. "Dr. Piech called me at home the day after I left BMW and offered me a job."

After 18 months of biding his time in other assignments at VW because of a non-compete clause, Pischetsrieder took over a company with multiple brands, ranging from the ridiculously expensive Bugatti, Lamborghini and Bentley to mass market producers such as Audi, SEAT, Skoda and VW itself. VW operates 44 plants in 17 countries and employs about 330,000 people globally.

Since taking over, Pischetsrieder has embarked on a less magisterial course than Piech, who brooked no dissent and sometimes left top executives quaking when they wavered from his directed path. Piech frequently dispatched or exiled those who disagreed with him. In contrast, "Pischetsrieder delegates more than Piech," one executive who desired anonymity says. "But he wants people to be responsible and accountable."

Like Piech, Pischetsrieder is an engineer deeply focused on vehicle development. But Pischetsrieder is more interested in the processes the company uses to achieve its goals and concentrates on his mantra of making VW weatherproof. "The fewer questions top management must take, the better," he says.

His philosophy is to delegate projects based on size and investments and concentrate his own time on making major decisions. His immediate goal is to improve profitability. "I would love to be among the top three manufacturers," he says, "but not at the expense of profitability."

The ability to move into luxury segments and command high margins for vehicles is crucial to this target. Pischetsrieder wants VW customers to buy its cars because of their perceived value. He is determined to limit VW's use of incentives.

The company already has stumbled on one near-luxury entry. It introduced the Passat W8 into the U.S. in 2003. The car handled like a Mercedes and was priced below $40,000. But Americans didn't go for it, and the company cancelled the W8.

Far from being deterred, Pischetsrieder's plans call for more high-margin vehicles to be introduced. One model, code-named C1, has already been approved. It will slot in below the Phaeton.

Pischetsrieder also wants to get premium prices for less expensive vehicles such as Golf and Jetta. The fifth-generation Golf, which recently debuted in Germany, has gotten off to a slow start amid criticism that its quality is poor. Pischetsrieder says this is untrue. Despite its slow start, selling only 60,000 Golfs by the end of 2003, he predicts the company will sell 600,000 Golfs this year.

Overall, Pischetsrieder wants to increase VW's sales by about 40 percent by 2008. That optimistic plan hinges on an improved economy and on increasing sales in markets such as China, where VW is the leading brand. It also depends on core products like the Golf reaching sales targets.

The burning question is how much time Pischetsrieder has. Sales declines and a weak dollar are expected to cut profits when 2003 financial results are issued (see chart, page 44). In fact, the company says it doesn't expect to climb back to 2001 profitability levels until 2006.

An American CEO would be out of a job for that sort of profit slump, but Pischetsrieder's plans are probably okay with VW's biggest stockholder, the state of Lower Saxony that holds 18 percent of its voting stock. Political leaders are more interested in keeping voters working than in pumping up the bottom line. What's more. VW is protected against a hostile takeover. The European Union ruled in January that Germany could enforce its law prohibiting any company or individual from owning more than 20 percent of voting shares in a company. This effectively thwarts a hostile takeover.

That obviously was a key ruling for Pischetsrieder. One implication is that "the board will give him several years" to pull off the transformation of VW, predicts George Peterson, president of AutoPacific in Tustin, Calif. If Pischetsrieder succeeds in turning "the people's car" into an icon of luxury, it will be a feat worthy of a master magician.

VW Faces A Profit Squeeze. Can It Recover?

(Millions of euros)

                2001   2002   2003   2004   2005

Sales           88.5   86.9   87.1   91.0   97.0
Pretax profit    4.4    4.0    1.7    2.6    3.7

Source: Company reports, Lehman Brothers estimates 2003-2005