THE BLOG
09/28/2015 02:38 pm ET Updated Sep 28, 2016

Volkswagen and the Price of Reputation Risk

While the noxious smog is still spreading over Volkswagen's alleged emission-rigging, questions emerge about how and if the world's largest automaker by volume can regain its footing. Mr. Matthias Mueller, VW's newly appointed CEO hailing from the company's Porsche franchise, has an unenviable task before him. In order to clear the air and begin repairing the company's tarnished reputation, Mr. Mueller should borrow a page from Alan Mullaly's Ford playbook.

Reputation risk has a price

While some surveys identify reputation risk as one of the principal threats to global firms, this risk domain, by its very nature, has remained undervalued and amorphous. With one large scandal after the other, from BP's Deep Water Horizon disaster, to FIFA and Sony Entertainment's scandals, corporate leaders are beginning to give reputation risk the deference it deserves. VW's case, however, sheds new light on how reputation risk can fell even the most robust enterprise. In 2014, VW was number 3 in the automotive industry in Fortune's list of most admired companies. Today, with $26 billion in market cap eradicated in a matter of days along with the growing volume of lawsuits, regulatory fines and injunctions, VW's financial viability may be at risk. Worse yet, its reputation may be irreparably harmed.

Mr. Martin Winterkorn has stepped down as VW's ill-fated CEO. Even with this sacrifice an increasingly activist U.S. Justice Department may not be satisfied with a mere corporate settlement and monetary damages, they may very well seek criminal indictments against VW executives implicated in this case. Reputation risk now has a price and the entire automotive industry has been put on notice. Board rooms across all industries should take heed. Up until recently corporate malfeasance rarely produced individual punishment other than corporate leaders voluntarily stepping down, often falling on their own swords. This in part is driven by the so called "personhood" of a corporation shielding directors and officers from certain types of personal liability. Moreover, deep financial pools covering corporate directors and officers as well as product-related insurance defray many of the economic costs of these types of cases. VW, however, may have to go it alone, in that its insurers will likely claim along with courts and regulators that their tortious and willful acts invalidate any insurance coverage that might have been afforded.

Anything in the name of growth

VW, like Ford before it, has a large and disparate number of automotive holdings, including hyper cars for the 1 percent with Bugatti, Bentley, Lamborghini and Porsche, to the people's car wearing the Volkswagen, Audi, Skoda and Seat badges. In all, VW has 12 automotive brands in its holding structure, two more than the famous automotive conglomerate GM. VW's strategic impetus was to overtake Toyota as the world's largest automotive manufacturer. The difference, however, is that Toyota largely operates as a monoline franchise, with spinoffs such as the high end Lexus and the low end Scion brands largely developed on core Toyota platforms. VW's growth strategy on the other hand depended on cobbling together many non-core automotive holdings. Perhaps this is the reason VW lost sight of its core brand and embarked in an effort to manipulate performance by making certain diesel engined vehicles appear more efficient than they really are. Like most corporate risks, early warning signs were reportedly ignored dating back to 2007.

In late 2006, Ford had a similar automotive holding structure as VW, including mid-market and high end brands, such as Volvo, Jaguar, Land Rover and Aston Martin, among others. When the automotive manufacturer started undergoing downward pressure, eroding market share and quality in its core (legacy) brand, the company embarked on a concerted divestiture process. Spinning off all non-core holdings, Ford emerged a leaner more agile automaker, creating a "One Ford" strategy that saw the adoption of automotive platforms for world markets and a right sizing of the company's balance sheet. A decidedly smaller Ford emerged, yet the company's survival was no longer in question.

This type of bold change agenda required a leader from outside of the firm and outside of the industry. Alan Mulally, formerly Boeing's CEO, is largely credited with turning Ford around, making it the only U.S. automaker that did not require a direct government bailout during the financial crisis -- although a government line of credit was supplied . CEO's from Detroit's besmirched automakers where famously paraded in front of Congress for a public mea culpa and asked whether they drove to Washington or if they flew in their corporate jets. Public grandstanding aside, since the 2008 financial crisis the automotive industry has worked full tilt to keep its sprawling manufacturing base at capacity, often at the expense of safety and quality. While few global automotive firms are spared from the occasional product recall, VW's case takes this challenge to a whole new level with an estimated 11 million vehicles affected, and many new models facing a potential embargo, which will have a serious knock on effect on VW's dealer network. This may give VW the dubious distinction of having one of the largest automotive recalls in history.

However this case plays out in the coming months where it is likely to get much worse for VW, it is clear that Mr. Mueller and VW's sullied leadership will need to focus on their core. Divesting non-core brands on the higher end of the spectrum will not only create the capital that VW will surely need to fend off litigation and other costs, it will also enable the firm to reinvent itself and gradually regain the confidence of its customers, markets and regulators. VW has a long road ahead, whether it sees its way through this crisis depends as much on corporate focus, as it does on whether regulators want to make an example of the once great automaker. Just as VW took a calculated risk in allegedly manipulating emission results, so too U.S. regulators will have to temper their response as they may risk VW's more than 3,000 direct employees in the U.S. and thousands more in the company's dealer and supplier network.