How VW Can Get Hot Again

By By Daren Fonda

In Greek mythology, Eos was the goddess of dawn, a frisky immortal who liked to shack up with hunky gods and, on occasion, kidnap men for pleasure. Nowhere in Homer does it say anything about Eos and transportation. Yet in Volkswagen's retelling, Eos has morphed into an elegant two-door convertible. The new VW Eos features a retractable hard top that's a marvel of engineering, stowing in the rear at the flip of a switch and transforming a buttoned-up coupe into a sun-loving hellion. A car with features like that used to set you back at least $65,000. But VW priced the Eos at just under $29,000 to attract midmarket shoppers--and, the company hopes, to help kick-start the brand.

VW could certainly use a sexy model to turn heads its way. Only a few years ago, VW was riding high with iconic cars like the Jetta and New Beetle, vehicles that delivered performance and brand charisma. But BMW's Mini swiped the Beetle's cool factor, and lots of competitors have been making midsize value machines better than Jetta. Sales in the U.S. plunged 37% from 2001 through 2005, when VW sold just 224,195 cars. With a market share of just 1.4%, it's outsold even by Kia. The North American business is a bleeder too, losing nearly $2 billion from 2004 through 2005 (including sales of VW's sister brand Audi). Worldwide, the Volkswagen Group posted revenues of $112.8 billion and profits of roughly $1.3 billion in 2005--a slim net gain.

Eos may help fuel a modest turnaround. Sales in the U.S. are up 11.8% through September of this year, thanks to all-new versions of the Jetta, Passat and Golf (now going by its old name, Rabbit), and Eos has sold out since debuting last month. But analysts estimate VW will lose an additional $800 million in the region in 2006, and they aren't sanguine about 2007. Until VW can address some production and quality issues, it can forget about profitable growth. "North America is one of VW's intractable problems," says Stephen Cheetham, an analyst with Bernstein Research in London.

Like many other manufacturers attempting a comeback, VW is engineering a revamp that involves both new products and cost cutting. At the Los Angeles auto show in December, the company is expected to unveil a small SUV called the Tiguan, due in 2008. A minivan, to be built in partnership with Chrysler, is also planned for 2008. There's even talk of importing another retro favorite, the Scirocco, which is being revived in Europe. VW aims to double sales in the U.S. over the next five to six years. "If we're going to be a global player, we have to address our underperformance in the world's biggest car market," says Adrian Hallmark, executive vice president of Volkswagen of America.

Perhaps most distressing for a German brand is VW's dismal reputation for quality. VWs still handle crisply and feature the sharpest interiors in their price category, but owners complain about everything from puny cup holders to noisy brakes. Consumer Reports does not recommend any VWs, while J.D. Power ranks VW 35th out of 37 nameplates in its latest survey of initial vehicle quality. VW representatives point out that the company's scores are improving, which is true. But so are almost everyone else's. "Shame on us that we haven't moved up the rankings," says Hallmark.

Another element of VW's strategy involves heading downmarket, reversing a silly foray into the luxury segment with its $68,000-plus Phaeton sedan, which flopped. The company has slashed sticker prices on the Jetta (lowered $1,400, to $16,500) and Rabbit ($1,000, to $15,000), hoping to recover profits with higher volume. And future models won't contain as many standard features, according to Hallmark. The idea is to produce cars that can compete more effectively in the midmarket. Designing cars for the local competitive landscape is precisely what the Japanese have done for decades, of course. But, Hallmark says, "it's a huge change in perspective" at VW headquarters in Wolfsburg, Germany.

For the plan to work, VW must figure out how to act nimbly. It has a long history of drifting from profitable years to lean ones. Instead of following up hits from the '90s like the New Beetle and Passat, the Germans were either late or missed virtually every automotive trend: hybrids, crossovers, small SUVs. VW got so out of touch with U.S. consumers that in 2005 the company sent a group of employees, dubbed the Moonraker team, to the U.S. to spend a year figuring out what Americans wanted in a car. The answer: models designed specifically for this market.

If VW really wants a comeback in America, however, it will have to reshuffle priorities. The U.S. sales team has been fighting for more Rabbits, which are selling well. But VW can't reproduce enough Rabbits to meet demand; it supplies other markets first. VW often exports new models to North America only after taking care of Europe, where it enjoys a market-leading position that it wants to protect. The Rabbit, for one, launched in Europe as the Golf two years before it came to America; the next edition will arrive first on the Continent too. "They're trying to change," says Cheetham, "but VW's mentality regarding North America has always been that of an opportunistic exporter."

What no one in Wolfsburg wants to admit is that VW may have a broken business model in the U.S. Unlike BMW or Mercedes-Benz, VW can't charge the rich prices necessary to offset the cost of exporting from Germany. And unlike its German rivals, VW doesn't make cars in the U.S.--its one American plant shut in 1988--a problem given the dollar's slump versus the euro.

Each of Volkswagen's big shareholders has a hand on the steering wheel too--making VW notoriously unwieldy. Representatives of government, trade unions and Porsche, which owns a stake in VW, follow their own interests, so decisions can take eons by American standards. The state of Lower Saxony, for instance, holds a stake in the company, and Saxon politicians routinely pressure VW to maintain jobs and generous benefits in the hinterland. VW's unions, also powerful, recently agreed to extend the workweek--to 35 hours for factory workers, up from 28.8 hours. In return VW promised to keep production of the next-generation Golf in Germany. "Such deals rob VW of the flexibility you need in this business," says Ferdinand Dudenhoeffer, a German auto-industry expert.

The good news for VW shareholders is that the man now in charge may have a good grasp of the U.S. market. Wolfgang Bernhard became chairman of the VW brand in May 2005 after spending several years in Michigan as Chrysler's chief operating officer. A young and energetic executive who once rode a 500-h.p. Tomahawk motorcycle onto a stage at an auto show, Bernhard helped lead a turnaround at Chrysler, streamlining production and advocating boldly styled models like the 300 sedan. "He has a balanced mind-set of American expediency and German precision," says David Cole, head of the Center for Automotive Research.

Bernhard's influence is already being felt. He has abandoned some technologies that he regards as unnecessary, like a radio antenna integrated in the rear window. And he's reining in designers who have been "acting out their creativity too much," says Hans-Gerhard Seeba, a former VW executive. Bernhard also pushed the Chrysler project, opting to have his old company build VW's new U.S. minivan rather than re-engineer a European version. The deal marks VW's first major foray into contract manufacturing in North America, a risky but necessary move. It's part of his plan to populate the U.S. fleet with a wider variety of models, including more that are produced locally.

In marketing, VW is taking a similarly wide approach to recapture buzz. Commercials for the GTI feature hyperactive Germans "unpimping" the cars of hip-hop kids with new models. Jetta's ads focus on safety, depicting jarring accident scenes, while spots for the New Beetle enlist the musician John Mayer playing guitar. "We look at ourself as more idea-centric than ad-centric," says Kerri Martin, director of brand innovation. But it seems fair to ask: If a bold new era is really dawning at VW, will anyone notice?

For a review of the Eos, go to time.com/vw

With reporting by Joseph R. Szczesny/Detroit, Ursula Sautter/Berlin