How VW's scandal threatens the reputation of 'German engineering'

More than diesel or unleaded, two words power every BMW, Mercedes and Volkswagen sold around the world: "German engineering." They are a promise of performance and reliability that double as the bedrock of Europe's most important economy, and consumers are suddenly questioning if they mean what they used to.

A widening emissions scandal at Volkswagen - an engineering feat of a more sinister kind, in which cars were wired to deceive air pollution tests - has now cost the company's top executive his job. It has enraged customers and devastated the company's stock price. Analysts are warning the fallout could infect Germany's economy, and the fragile eurozone with it.

In less than a week, the scandal has battered the reputation that the entire Germany auto industry guarded carefully for decades.

"This has tarnished a huge, iconic company, so it's going to be a long and slow process to restore this company," said Karen Brenner, a business professor who is executive director of law and business initiatives at New York University. "The damage is only beginning to unfold."

Thomas Donaldson, a professor of legal studies and business ethics at the Wharton School of the University of Pennsylvania, said the scandal had few historical parallels: "I've never seen a corporate Watergate of this stripe."

Economic forecasters around the world warned this week that the damage could spread beyond Volkswagen. They noted that the list of vehicles equipped with the cheating devices included the Audi A3, a luxury brand, and expressed worries over whether consumers around the world would turn away from other German automakers. That would deliver yet another jolt to the country's economy, where one in seven jobs are tied directly or indirectly to the auto industry.

Indeed, on Thursday, the German magazine Autobild reported that a test of BMW's X3 SUV found that the car emitted more emissions in the real world than what lab tests produced. BMW issued a statement saying that it "does not manipulate or rig any emissions tests." Nevertheless, the stock plunged nearly 7 percent in Thursday trading.

"While the German economy defied Greece, the euro crisis and the Chinese slowdown, it could now be facing the biggest downside risk in a long while," Carsten Brzeski, an economist for the investment bank ING, wrote in a research note. "The irony of all of this is that the threat could now come from the inside, rather than from the outside."

Consumers and analysts say that threat is particularly large because Volkswagen, unlike other automakers who recalled vehicles en masse in recent years due to safety concerns, has admitted it deliberately misled regulators and consumers. The company faces potentially billions of dollars in government fines for its actions, along with possible criminal charges.

Volkswagen said this week that 11 million of its vehicles worldwide, including nearly 500,000 in the U.S., were rigged to pass emissions tests, even while emitting nitrogen oxide at up to 40 times U.S. federal standards. Its chief executive, Martin Winterkorn, resigned on Wednesday as the fallout mounted.

"I am shocked by the events of the past few days. Above all, I am stunned that misconduct on such a scale was possible in the Volkswagen Group," Winterkorn said in a statement.

The consequences for the company - and possibly its home economy - are mounting.

Volkswagen's public stock has plummeted since last Friday, when the Environment Protection Agency announced that a "defeat device" was installed in some 482,000 U.S. cars, spanning model years 2009 through 2015.

The company now faces up to $18 billion in fines from the EPA and is under investigation by the Department of Justice.

On Thursday, the European Union urged all 28 member states to launch their own investigations into the company. Volkswagen said earlier this week it had set aside more than $7 billion to fix the problems with its cars and begin to repair its reputation with customers, but many analysts say that amount will fall far short of what the company will pay out in fines and car repairs.

The consumer advocacy group U.S. PIRG says the company should offer full refunds to anyone who bought one of the cars installed with the regulator-evading devices. Even if Volkswagen "fixes" the vehicles to restrict their emissions, the cars won't perform as advertised, said Ed Mierzwinski, consumer program director for U.S. PIRG.

"The harm is so severe, the deception is so severe, that how do you make the consumer whole without buying the car back?" Mierzwinksi said.

The scandal undercuts Volkswagen's green image, along with the reputation for craftsmanship that has helped German automakers gain market share in the United States, Europe and many fast-growing Asian car markets.

That reputation is summed up by Volkswagen's 2014 Super Bowl ad, which features a father telling his daughter, in the style of "It's a Wonderful Life", that every time a VW vehicle passes 100,000 miles, a German engineer gets his wings.

Volkswagen passed Japan-based Toyota this year to become the world's largest automaker. German automakers produce about half the cars sold every year in Western Europe and they've gained market share in the United States over the last decade, according to Deutsche Bank. A recent report from a German government trade promotion arm claims nearly eight out of 10 "premium" automobiles around the world are made by German companies.

Making "attractive and environmentally friendly" cars was key to its growth and its ability to weather economic trouble, Volkswagen wrote in its latest annual report.

That attraction has evaporated for many consumers. Drawn by the promise of an environmentally friendly car, they now fear the cars' tarnished reputation will weigh on resale values.

"The CEO resigning, it doesn't really impact me. I want to know what they're actually going to do for all of these supposedly clean diesel car owners," said Christa Mrgan, 34, of Portland, Ore.

Mrgan bought a 2011 Jetta SportWagen because it promised low emissions and enough room for her two kids. Now, she's planning to buy a cargo bike this week. "I don't want this car," she said. "It makes me feel sick that I've been driving this car for about four-and-a-half years and belching all these toxic fumes into the atmosphere."

Rebuilding that trust could be a lengthy process. After some Audi cars started accelerating out of control in the 1980s, it took a decade for its sales in the U.S. to recover, Deutsche Bank analysts wrote in a research note Wednesday.

"Back in the days Audi suffered a massive loss in reputation and this wasn't even about cheating," the analysts wrote.

Regaining trust will be especially difficult in the auto industry, because car buyers research their decisions carefully and Americans see their cars as an extension of themselves, said Trina Hamilton, a University of Buffalo professor who studies corporate responsibility.

"Whether you drive a Prius or a Hummer or a VW, you make some sort of judgment, however stereotyped, about people," said Hamilton, who drives a diesel 2013 Jetta SportWagen. "If you bought this as a signal of your environmental commitment, that is tarnished. I feel kind of conspicuous driving it now."

High-profile recalls have caused trouble for other automakers in recent years. General Motors this month agreed to pay the government $900 million to settle a criminal investigation into how it handled ignition switches that caused fatal wrecks and forced the recall of 2.6 million cars. And 11 manufacturers have recalled tens of millions of cars and trucks because of faulty airbags made by Takata, the largest auto recall in U.S. history.

What separates Volkswagen from those cases, Mierzwinksi said, is intent. "GM had a car that was defective," he said. "Volkswagen made their car defective on purpose."