What’s behind Volkswagen’s scandal?

Lots of ink has been wasted discussing the implications of the recent Volkswagen scandal. However, few articles tried to uncover its underlying reasons beyond a large investment in a new diesel motor that provided a fantastic performance but at a huge environmental cost (between 30 and 40x allowed emissions in the US).

Behind this battle is the battle in the automotive industry for being number 1. Toyota and its innovative Prius caught the whole sector by surprise and created a need to counterattack with a performing, high mileage  and environmentally conscious car. 

The new diesel engine looked like the best and easiest solution to counter the threat of a sweeping victory by the new hybrid models.

However, was it a simple fix for a bigger problem ?

The consequences of the fiasco go far beyond the cost of fixing the 11M+ cars involved, a number that increases every day. To list only a few,

1.- Car owners are not going to be happy with a much less performing car. How are they going to react to suddenly becoming proud owners of an “average” or “less than average” performing car.

2.- Ambientalists are probably going to sue Volkswagen with class action in the US and outside. The link between emissions and deaths is strong enough to demand huge compensations.

3.- Stockholders will also fill a class action to cover from the fall in the stock price. Stock price reached a 30% decrease in the recent days and nobody really knows where could be the the support line as the matter develops. 

4.- The consequences for the image of quality and trust of the German industry are not easy to quantify. German industry depends a lot on Germany as a brand strongly linked to trust and quality. This scandal hits its bottom line.

We are all becoming aware that this scandal is rapidly mounting to be the worst fiasco of the German industry ever with consequences well beyond car manufacturers.

Why all this happened? Was only a mindless shortcut in a hyper-competitive industry or we have to look deeper?

Volkswagen, like many other companies normally competes on price/quality. In cars the general awareness on environmental issues, the raise of the price of oil and the new technologies have disrupted competition with companies and models such as Tesla or Toyota Prius. German companies have been slow to react while some of these innovations aimed at their core business addressing many of the concerns and needs of their larger customer segment. This was the case with hybrid cars where competitors were able to create an image of a cool, modern car well beyond the savings in oil.

The new diesel engine was a way to counteract all this, but, as we know now, it was fake.

From the outside the whole story looks like the response of an incumbent that tries to compete with all weapons available into a new scenario that is being disrupted.

Was this the case?

In fact, competition in the car industry has been moving to innovation while Volkswagen and many other companies were still competing with efficiency – the price/quality ratio. This change in the way companies compete is at the core of this story.

Therefore, perhaps this is not only one case of a massive cheating but a failure to compete in a world where the rules changed and if so, it has implications for the company and the whole industry that go far beyond the scandal itself.

If you want to uncover how a company competes, one way to do it is to look at its organisational structure. There is a link between company structure and its capabilities in terms of innovation and therefore how it competes on innovation.

Integrated companies must compete with their own resources, with the help of their partners and contractors, but mostly with their own projects. They enjoy an extraordinary capacity to manage, allocate and govern their resources with complete control.

However, many companies are not completely integrated. Many choose a network structure where different organizations take responsibilities of important parts of the final product. Car companies are normally structured this way, in networks with different tiers of suppliers that enjoy a fair amount of control on the design, innovation and production of their part of the product.

Recently, new forms of organization appeared based on platforms encompassing a large variety of different actors with no contractual links. Apps are the best well know example of them. These new organisational structures are inherently conductive of innovation because of the diversity of actors involved and the openness in the competition that is driven mostly by new innovative proposals.

Therefore, car companies find now themselves forced to competed on innovation while endowed of an organizational structure that is naturally conductive to quality, repeatability and productivity but not so much to innovation.

Let’s take a look at why this happens.

Organizations structured in a hierarchy are prone to have isolated branches leading to silos that don’t talk to each other. This structure limits the possibilities that an innovation in one field translates to another, one of the most common forms of diffusion of innovations, and therefore limits innovation.

Also a network structure based on tiers incentives the relation between companies and group leaders or the central company while disincentives any relation among peers that could eventually be substitutes. Secretism more than sharing is a mechanism for success and therefore widely used. Again, this is not conductive to innovative outcomes.

Finally, long term contracts with time and quality penalties favour predictability. In this environment companies try to avoid any risk that could jeopardise existing contracts. This low risk, no exploration attitude is certainly not conductive to innovation at least not to radical innovation.

Incremental innovation, innovation in processes, materials or organizational forms where risk can be evaluated and under control fit well in this type of organizations. It is not by chance that this has been the outcome of the car industry.

Until recently, new car models have been quite similar to the old ones, this scenario where incremental innovation powers competition based on efficiency has been substituted however by a new one where companies such as Tesla, Google or Apple threat to completely disrupt the market.

In fact we all assist to a revolution in the sector driven by three new developments: self-driving cars, the sharing economy and electric cars that are poisoned to become a perfect storm that could change completely the industry.

Self-driving cars could redefine not only how we look at cars and how are they conceived but also the meaning that cars have for us. Our relation with cars will loose the materiality of driving, the intimacy of the car as a manifestation of our personality. Cars will probably become more an utility and loose part of the emotion and that will change the industry in many ways, possibly making car sharing more feasible.

The sharing economy together with self-driving cars will allow a more efficient use of cars that could pick up different people and coordinate routes in order to serve them all. Possibly this will initially be in the same family or organization but there is little reason to think that won’t translate fast to a model where cars are treated as on-demand services instead of a property.

Finally electric cars mean cheaper cars, easier to build, more efficient and with a level of consumption orders of magnitude below the actual one. Transport will become extraordinarily affordable.

Taking these three new tendencies together we could see a tremendous amount of change in our cities where now such a big space now devoted to cars, will become available. More efficient ways of transport can easily slash up to 10x the need of space devoted to it. Cities will finally become more human.

These scenarios and many others that we can think of, have one thing in common: Innovation. A tremendous amount of innovation that will dramatically change the industry. Nevertheless, the incumbents are set for other priorities, such as productivity and effectiveness. Not even their organisational forms are the best suited to explore and innovate and when they have to compete on innovation they could be prone to take shortcuts not always respectful of their customers or the law, such as in this case.       

Behind the scandal in Volkswagen there is an industry in a process of change. Many times incumbents don’t survive to disruption processes but we know that this is not written in stone, that there are cases where elephants can dance and dance well.

Will this be the case of Volkswagen? Time will tell, but maybe this incident is the opportunity that the company needs to trigger what they need to survive in this new world: CHANGE !