UNIVERSITY OF NEW YORK IN PRAGUE

European Business Administration

Effect of European Union’s Environmental Policies on Corporate Strategy of Audi AG

by

Ján Filipský

2016 Mentor: Kevan Lyons, MBA

Table of Contents

ABSTRACT...... 1

ACKNOWLEDGMENTS...... 3

I. INTRODUCTION...... 4

II. METHODOLOGY...... 7

III. OVERVIEW OF Audi AG………………………………………………………...8

IV. ENVIRONMENTAL LEGISLATION...... 9

a. Background...... 9

b. CO2 emissions...... 14

c. Monitoring CO2 emissions from passenger cars……………………………...15

d. Methods for monitoring emissions…………………………………………...16

e. Calculation of manufacturers’ performance…………………………………..17

f. Effect of the average fleet mass on the targets………………………………..18

V. THE ‘DIESELGATE’ EMISSIONS SCANDAL………………………………...18

VI. BUSINESS STRATEGY OF Audi AG………………………………………...... 20

a. The “volume and diversity” strategy……………………………………...….21

b. Quality strategy……………………………………………………………….23

c. Technologies developed to meet CO2 requirements………………………….23

i. Cylinder on demand ………………………………………………….25

ii. Improved aerodynamics………………………………………………25

iii. Weight reduction……………………………………………………...25

iv. Alternative drivetrains………………………………………………...26

v. Fuels of tomorrow…………………………………………………….26

VII. SUSTAINABILITY OF PRODUCTS AND PROCESSES……………………...29

VIII. STRATEGY FORMULATION…………………………………………………..30

a. Porter’s five forces analysis…………………………………………………..33

b. PESTLE analysis……………………………………………………………...35

c. Marketing and sales strategy………………………………………………….41

d. Production…………………………………………………………………….43

e. Competitive profile matrix (CPM)……………………………………………45

IX. CONCLUSION…………………………………………………………………...46

BIBLIOGRAPHY………………………………………………………………...50

APPENDICES……………………………………………………………………53

GLOSSARY………………………………………………………………………58

Statement of Originality

I, Ján Filipský, hereby declare that the material contained in this submission is original work performed by me under the guidance and advice of my mentor, Kevan Lyons, MBA. Any contribution made to the research by others is explicitly acknowledged in the thesis.

I also declare that this work has not previously been submitted in any form for a degree or diploma in any university.

Ján Filipský, 27.04.2016 in Prague

ABSTRACT

The issue of our environment and its preservation for future generations has never been more valid and pressing at the same time. To be able to at least maintain the amount of greenhouse gases, many institutions need to cooperate. In case of European Union, it is necessary to employ reasonable environmental policy and set reasonable targets. ACEA

(European Automobile Manufacturer’s Association) which directly cooperates with European

Commission on issues of environmental policy making helps to set achievable goals both for

European Union and auto industry. However it is clear that sustaining the environment depends on much more than policy and technological innovations. End user needs to take part as well, for example aggressive driving style behavior negatively affects fuel consumption to an extent that a vehicle could produce up to 200% of emissions claimed by the manufacturer.

In this paper I focus on interaction between European Union’s environmental policies and contextual strategic approach of Audi AG to meet required standards and yet stay profitable.

My goal in this paper is to analyze business strategy approach of Audi AG in response to ever stricter environmental policies. I am looking for and trying to pin-point particular adjustments

Audi makes to its strategy in response to environmental policy development.

I analyzed past, present and future trends in environmental policy in Europe. Generally, main focus of policy is to reduce GHG (greenhouse gases), particularly CO2 and NOx, which are the main contributors to increase in average temperature.

As I progress with research, it becomes clear that main indicator for car manufacturer of whether their strategy is successful is cost management. Since the evermore stricter policy makes the internal combustion engines, both diesel and petrol more complex, Audi has to invest more into research & development. If Audi manages not to reflect the extra costs into

1 the final cost of goods sold without sacrificing their margin, and at the same time meeting policy requirements, they can say that the strategy is successful.

From EU’s perspective, when new regulation is put into action and the standards are not met, as recent events concerning Volkswagen Group (Audi including) is a perfect example of insufficient design and implementation of policy.

My hypothesis is:

European Commissions environmental policy making significantly affects every part

of corporate strategy of Audi AG and to comply with CO2 regulations, to stay

financially competitive and not to project increased costs which are consequential to

higher technological demands into cost of goods sold.

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ACKNOWLEDGEMENTS

I would like to dedicate a few words of gratitude to people without whom completion of this work would not be possible. I thank Kevan Lyons, MBA who guided me throughout my research all the way from beginning until the end, who was supportive and available at all times to help. I would also like to thank my expert interviewees, Dr.h.c. mult. prof. Ing. Juraj

Sinay DrSc. and professor doc. Ing. Ján LEŠINSKÝ, CSc of Slovak Technical University in

Bratislava for providing me with their expert opinions and insider information.

I thank my girlfriend Erika who’s been supporting me all the way not only through writing this thesis, but throughout my studies at UNYP.

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I. INTRODUCTION

The purpose of this work is to inform the reader of developing trends in the European

Union’s environmental policies aimed at auto industry, to show in this case how Audi AG accounts for these regulations in their strategy.

In today’s world, the subject of the environment and its preservation is more important than ever. According to ACEA, in 2013, EU28 (28 European Union member countries) produced

15 million passenger cars accounting for 21% of all passenger cars world-wide. (Acea.be,

2015) Therefore, it is important for the EU to be the leader and example in emission reduction. And, therefore, I chose this topic, to dedicate my share of effort toward more sustainable environment. At the same time I wanted to educate myself as a business student and be able to use the knowledge I acquired throughout this research in my prospective future career.

Until the recent scandal or “Diesel Gate” of Volkswagen Group, of which Audi is part as well, everyone thought that we were on the right track. This event brought up a lot of questions and doubts whether Volkswagen did what they did to maximize their profit or whether the legislation was simply too strict and Volkswagen could not figure out a better way to comply with emission limits. Also if Volkswagen was the only one to manipulate software in their cars, or if more manufacturers are guilty as well. As it turns out, Mercedes-

Benz, BMW, Peugeot and Opel/Vauxhall took part as well, consuming 50% or more of the claimed fuel consumption.

Interestingly enough, on April 22 BBC News published an article regarding Japanese

Mitsubishi manipulating emissions results as well. (Mitsubishi Motors Scandal Widens, 2016)

According to TopGear Magazine, Mitsubishi has admitted to falsifying fuel consumption test

4 data since 1991. As a result, shares of Mitsubishi are now down 40% and according to

President Tetsuro Aikawa, only 6 models are affected, however since this has been going on since 1991, we can expect that more models not meeting the emissions will arise. (Emissions scandal latest: Mitsubishi admits cheating since 1991, 2016)

Since I have had already decided to investigate this topic before the Volkswagen “scandal” surfaced, it only assured me that it is the right time for my paper and that I am going in the right direction. Even though I chose Audi to be the target of my research, it is not a problem since Audi is a part of Volkswagen Group and their motors were affected as well.

From the greater perspective, Audi is a great example of company driven by innovation. Not only in sense making their product safer, more luxurious, but also making it efficient. This year, Audi is celebrating 25 years of their trademark TDI diesel engines. Even after 25 years of constant development and improvement of not only TDI (turbo diesel injection) engines, but also FSI (fuel stratified injection) and TFSI (turbo fuel stratified injection) petrol engines have great potential for further improvement of the combustion process and thus efficiency.

One of many great examples being cylinder on demand technology (COD), which deactivates half of cylinders at low to intermediate loads, reduces fuel consumption during moderate driving by up to 20%. (Audi-cr2014.de, 2016) Even though it is not product of Audi,

Start/Stop technology is definitely worth mentioning. It is relatively simple piece of technology that shuts off the engine when automobile stops on an intersection for example, or in traffic. According to Ford, “start stop system has potential to boost the real-world fuel economy by up to 10%.” (Colwell, 2016) I argue however, that even though it is good when cars shut off their engines in the city centers and traffic jams, this system also draws a significant amounts of electricity from cars battery to start the engine, which needs to be replenished by an alternator which is powered by the engine. So effectively, fuel is spent to save fuel. Also engine’s cooling system is shut off together with the engine, which allows for

5 heat to accumulate and hurts the engine in the long-run. It is very hard to quantify the damage caused to the engine and amount of fuel saved over 200.000 kilometers for example.

“Vorsprung durch technik” – advance through technology is the motto of Audi and they stay true to this statement. Audi thinks ahead and is already a leader in development of not only alternative drivetrains, but also alternative fuels – Audi e-fuels. These fuels do not require biomass, do not compete with food production and offer substantially higher potential than conventional bio-fuels. The primary pillar of Audi e-fuel strategy is development of Audi e- diesel, e-gasoline and e-ethanol.

ACEA – European Automobile Manufacturer’s Association claims that the downward trend of emissions has been sustained without legislation, which would mean that European

Union’s policy making does not have any effect on strategy of Audi. On the other hand however, European Commission has phased in targets of average CO2 emissions – from 2012 onward, all newly registered vehicles must comply with limit of 130g/km. “If the average

CO2 emissions of a manufacturer’s fleet exceeded its limit value in any year from 2012, the manufacturer has to pay an excess emissions premium for each car registered.” (Ec.europa.eu, 2016) The premium amounts 5€ for the first gram of exceedance,

15€ for the second gram, 25€ for the third gram and 95€ for each subsequent gram.

Thus I claim that European Commissions environmental policy making significantly affects every part of corporate strategy of Audi AG and to comply with CO2 regulations, to stay financially competitive and not to project increased costs which are consequential to higher technological demands into cost of introducing the automobile to the market.

In Audi, research & development costs are recognized as an expense. Interestingly, between

2009 and 2014 investments in research & development almost doubled, from 2,050 million in

2009 to 3,685 million in 2014.

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II. METHODOLOGY

I strived to provide research as objective as possible. Therefore I researched sources of academic standards, sources of policy making institutions and expertly journals. I reviewed

Audi corporate publications such as the Annual Reports, Strategy consumer report,

Environmental Declaration and Product consumer report mostly for quantitative data and technical specifications and information, since these tend to be very subjective in their claims and statistical results in favor of the publisher. Still, with some degree of reservation toward them, I was able to extract interesting information.

I also conducted interviews with Prof. Doc. Ing. Jan Lesinsky of Slovak Technical University in Bratislava, who actively participates in developing studies and technologies for automotive industry and has more than 30 years of experience.

I was also very lucky to be able to personally speak with Dr.h.c.mult. Prof. Ing. Juraj. Sinay,

DrSc., who is currently the President of Slovak Automotive industry. Slovakia currently being among the automotive industry, professor Sinay offered me insider perspective on how manufacturers approach the pressure from European Union.

Further I drew information of reports from various consultation agencies that take part in discussion forums with policy makers and auto industry representatives. Agencies such as

ACEA – European Automobile Manufacturer’s Association, in which also takes part

Professor Lesinsky, AEA – an energy and climate change consultancy firm, working by order of European Commission, EEA agency which provided technical background for my research.

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III. OVERVIEW OF Audi AG

Audi Group is historically one of the most successful car manufacturer in premium and supercar segment.

Tradition of Audi goes back to 19th century, when the company was established by an engineer August Horch. The four rings in Audi logo represent four companies that joined together to become Auto Union in 1932. In 1965 Auto Union was acquired by Volkswagen and after launching Audi F103 model series, Volkswagen merged Auto Union with NSU

Motorenwerke in 1969 – creating the company we know today.

The name Audi is based on the translation of founder’s surname “Horch”, meaning “listen” in

German, into Latin, which becomes “Audi”.

Part of Audi Group are Italian motorbikes manufacturer Ducati and super sports cars manufacturer Automobili Lamborghini.

Audi stands for: “Vorsprung durch Technik”, which in translation to German means: “ahead through technology”.

In past fiscal year, Audi Group delivered 1,933,517 cars to customers, which is an increase of

10.5% comparing to year before last.

Audi is best known for its characteristic design features, innovative technologies and high quality standards.

The brand values are “sportiness, progressiveness and sophistication.” (Audi.com, 2016)

The Group headquarters are in Ingolstadt, Germany and house a large proportion of production, technical development, sales and administration.

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Audi also owns number of production and assembly facilities around the world, for example in Győr (Hungary), Audi Hungaria Motor develops and manufactures engines, Audi Brussels exclusively produces models of the A1 family, SUV models Q7 and Q3 are manufactured in

Bratislava (Slovakia) and Martorell (Spain). Two sites in Changchun and Foshan (China) produce special long wheel-base A4 L, A6 L, A3, Q3 and Q5 specifically to local market conditions.

In addition, in 2015 Audi started production of A3 and Q3 models in Curitiba (Brazil).

Currently, Audi is building a new plant in San Jose Chiapa (Mexico), where the next generation of Q5 model will be built.

IV. ENVIRONMENTAL LEGISLATION

In this section I discuss the evolution of major European environmental regulations that affect the auto industry from the first ever regulations introduced before 1980, Euro standards and

CO2 emissions. Further, I discuss how regulations are developed, whether and how they are enforced and what potential impacts they may have on auto manufacturers, their competitiveness and strategy.

a. Background

The first European vehicle emission standards were developed in mid-1980s by the Economic

Commission for Europe (EEC) and only then adopted by individual countries. However the regulation was not implemented due to requirement of unanimous agreement, which was not met. With Single European Act, which entered into force in 1987, consensus was replaced by

9 majority voting, which allowed for establishment of common ground for future vehicle emissions regulation. (Eur-lex.europa.eu, 2016)

The European Community issued its first directive (Directive 70/220/EEC) in 1970. The directive limited emissions of carbon monoxide and hydrocarbons from gasoline engines and for the first time introduced “type approval”. (Eur-lex.europa.eu, 2016) Type approval is a process, where vehicles design attributes are tested against the requirements of the directive.

Type approval is required for every car to be sold within the European Union.

Tables 1-1 and 1-2 below, illustrate the development of EURO standards from EURO 1 introduced in 1992 to EURO 6 introduced in 2015 for category M1 - light commercial vehicles. Table 1-1 illustrates requirements for compression ignition engines (diesel) and table

1-2 illustrates requirements for spark ignition engines (gasoline). EURO standards limit the emissions of carbon monoxide (CO), nitrogen oxides (NOX), hydrocarbons (HC) and particulate matter (PM) – only for diesel/compression ignition engines for all new cars sold in the European Union.

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Table 1-1 Compression Ignition

Stage Directive Date CO HC HC+NOx NOx PM

(g/km) (g/km) (g/km) (g/km) (g/km)

EURO 1 91/441/EEC Jul.1992 2,72 - 0,97 - 0,14

(Eur-lex.europa.eu,

2016) EURO 2 94/12/EC Jan.1997 1,0 - 0,7 - 0,08

(Eur-lex.europa.eu,

2016) EURO 3 98/96/EC Jan.2000 0,64 - 0,56 0,5 0,05

(Eur-lex.europa.eu,

2016) EURO 4 2007/715/EC Jan.2005 0,5 - 0,3 0,25 0,025

(Eur-lex.europa.eu,

2016) EURO 5 Reg. 715/2007 Sep.2009 0,5 - 0,23 0,08 0,005

(Eur-lex.europa.eu,

2016) EURO 6 Reg. 715/2007 Sep.2014 0,5 - 0,17 0,08 0,005

(Eur-lex.europa.eu,

2016)

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Table 1-2 Spark ignition

Stage Directive Date CO HC HC+NOx NOx PM

(g/km) (g/km) (g/km) (g/km) (g/km)

EURO 1 93/59/EEC Dec.1992 2,72 - 0,97 - -

(Eur-lex.europa.eu,

2016) EURO 2 96/69/EC Jan.1997 2,2 - 0,5 - -

(Eur-lex.europa.eu,

2016) EURO 3 2002/80/EC Jan.2001 2,3 0,2 - 0,15 -

(Eur-lex.europa.eu,

2016) EURO 4 2007/715/EC Jan.2006 1,0 0,1 - 0,08 -

(Eur-lex.europa.eu,

2016) EURO 5 Reg. 692/2008 Jan.2011 1,0 0,1 - 0,06 0,005

(Eur-lex.europa.eu,

2016) EURO 6 Reg. 692/2008 Sep.2015 1,0 0,1 - 0,06 0,005

(Eur-lex.europa.eu,

2016)

When comparing both tables a few things are easily noticeable. First, that spark ignition engines produce considerably lesser amounts of greenhouse gases than compression ignition engines. We can also see in table 1-2 that development of both, policies and engines, was not as vigorous as was development of compression ignition engines and regulation of those.

Overall, the progressive decreasing of emissions happened by improvements in engine technology and combustion cycles. As an example, all vehicles produced after 2012 are fitted with three-way catalysts, which remove up to 75% of CO, HC and NOx emissions. Diesel

12 vehicles require substantially more technological advancements than gasoline engines. Diesel fuel is a by-product of gasoline production and its combustion produces substantially more greenhouse gases and solid particles than combustion of gasoline as is illustrated by tables 1-1 and 1-2.

Diesel engines are today fitted with electronic, electronic fuel injection that uses extreme pressures to inject fuel into cylinders and oxidation catalysts rather than mechanical fuel injection used in the past.

The worst product of diesel combustion process health and environment-wise is particulate matter (“PM” in table 1-1). It is “the black smoke” that was observable coming out from exhausts of cars with diesel engine in the past. This particulate matter is carcinogenic to humans when inhaled and minimizing the amount of particulate matter from the exhaust was the greatest improvement, again thanks to a combination of new technologies, but the most important one after direct injection and turbo charging is diesel particulate filter or DPF. (See picture 1.) The DPF is a constructional part of the exhaust system of the car. As you can see in the picture 1, the filter is an extremely fine screen that captures microscopic particulate matter. The particles are then combusted in secondary combustion cycle in filter itself.

“In 2013, diesel vehicles represented 52.5% of newly registered vehicles in the EU. The average CO2 emissions of diesel and petrol engines dropped by 4.6g of CO2/km and 5.3 g of

CO2/km respectively compared to 2012.” (European Environment Agency, 2014, p.16)

According to EEA, the efficiency gap between petrol and diesel vehicles has continued to decrease. “In 2013 an average diesel vehicle emitted 126.9g of CO2/km, only 1.55g of

CO2/km less than average petrol vehicle.” (European Environment Agency, 2014, p.16)

However, in my opinion based on my empirical observation, that may be true based on ‘type approval’ testing. Emissions and consumption in real traffic tend to be higher than claimed,

13 due to many factors that are affecting the consumption in real life which are not present in laboratory when testing. One of the most important factors is driving behavior. Consumption can reach numbers double the value of claimed consumption when driving aggressively. Also, diesel engines’ consumption is not as sensitive to driving behavior as is petrol engine. So even though petrol engines seem to be catching up with diesel engines, that is in most cases not reality.

The New European Driving Cycle (NEDC), which is part of the ‘type approval’ testing represents only very small part of the vehicle engine operation under both load and speed.

Type approval tests of fuel consumption are conducted on chassis dynamometer using resistance settings provided by the manufacturer. It appears that the actual resistance values are higher than the ones provided by manufacturers – manufacturers perform tests in ideal conditions (tarmac condition, weather, vehicle run-in, tire dimensions, trained drivers, etc.)

Unfortunately, these settings are confidential. In their study, Mellios et al., revealed that using real vehicle resistances instead of type approval alone, increased consumption by up to 17%.

(Mellios et al., 2011)

b. CO2 Emissions

In EU27, road transport accounts for 20% of total CO2 emissions. In 1995 European

Commission set out a target of reducing CO2 emissions from new cars to 120g/km by 2005.

(EUR-Lex - 52007DC0019 - EN - EUR-Lex, 2016) Due to delays in implementation, this goal was met in 2012. (Public consultation on the implementation of the renewed strategy to reduce CO2 emissions from passenger cars and light-commercial vehicles, 2009)

Since average emissions were decreased from186gCO2/km in 1995 to 161 gCO2/km in 2004.

To European Commission it seemed unlikely that target of 120gCO2/km would be met by

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2012, the Commission presented a new strategy to regulate CO2 emissions on 7 February

2007 called EC 443/2009. The strategy outlined legislative framework to meet the target average of 120gCO2/km. (EUR-Lex - 52007DC0019 - EN - EUR-Lex, 2016)

In our interview I asked professor Lesinsky: How are these environmental policies developed? Who comes up the final quotas? What ensures that the quotas on CO2 and other greenhouse gases are reasonable? Are manufacturers present and do they have any say into the policy formation?

Professor explained to me the whole process of policy making as he also takes part in the process in name of ACEA. He ensured me that association of European car manufacturers is present during proposals of policy, delivers its own proposals in name of all manufacturers represented and takes part in negotiating acceptable compromise. I asked these questions in relation to Volkswagens scandal to find out whether too strict a policy and inability to meet the limits were the reasons for Volkswagen to manipulate the electronic management systems of their cars.

As I only found out later, the reason was regulation, however not European but American, which was at the time in 2005 6-fold stricter than European. The issue is discussed in more detail further on in the writing.

c. Monitoring CO2 emissions from passenger cars

To duly understand the process of developing strategy, it is necessary to understand how emissions and manufacturer’s performance is measured across Europe.

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“The European Environment Agency (EEA) supports the European Commission in the monitoring of CO2 performance of passenger cars, in accordance with regulation (EC)

443/2009”. (European Environment Agency, 2014)

d. Methods for monitoring emissions

“Since 2010, the EEA has been collecting data from passenger cars registered in all EU

Member States.

Member States record information for each new passenger car registered in its territory and transmit the information to European Commission by 28 February each year.” (European

Environment Agency, 2014)

The EEA performs several quality checks to evaluate the dataset and publishes preliminary database.

At the same time, the EEA notifies the manufacturers of their provisional CO2 performances.

The manufacturers have 3 months to notify the commission of any errors in the data.

The EEA assesses the manufacturers’ corrections, and, where justified take them into account for the calculation of manufacturer final average CO2 emissions and specific emission targets.

(European Environment Agency, 2014, p.7-8)

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e. Calculation of manufacturers’ performance

Average CO2 emissions are calculated as a weighted average of the manufacturer’s fleet in a particular year. The average emissions also take into account the following modalities:

 Phase-in

 Super-credits

 Eco-innovations

A phase-in schedule applies for calculating average specific emissions for 65% in 2012, 75% in 2013, and 80% in 2014 of the best-performing registered cars to determine the performance of manufacturers. For the period from 2015 to 2019, 100% of the new cars produced by each manufacturer will be subject to measurement.

Super-credits are a motivation for manufacturers to develop ultra-efficient cars and include them in their portfolio (even though the service station infrastructure, for example charging stations for electric vehicles may not be adjusted). Each new passenger car that produces less than 50g of CO2/km, is given greater weight in calculating the average specific emission.

Each new car producing less than 50g of CO2/km is considered to be equivalent to 3.5 cars in

2012 and 2013, 2.5 in 2014, 1.5 cars in 2015, and 1 car in 2016.

Eco-innovations – some of the innovative technologies cannot demonstrate their abilities to reduce consumption under the current type approval test procedure, thus, to support technical development, a manufacturer can apply to the Commission for approval of such innovative technologies. If the manufacturer fits its car fleet with an approved eco-innovation, maximum

7g of CO2 will be subtracted from the actual emissions. An example of such eco-innovation is

Audi Matrix LED lights that are several fold times more efficient than xenon or halogen lights. (European Environment Agency, 2014, p.9)

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f. Effect of the average fleet mass on the targets

Emission targets are set individually for each manufacturer according to average mass of the fleet, using a limit value curve. The curve is set in such a way, that if a manufacturer fleet is

1372kg, the target for the manufacturer will be 130g CO2/km. (for illustration, see figure 3.)

In order to ensure that the target weight-to-emissions ratio is representative to the evolution, it is appropriate to use only those mass values that have been verified and accepted by manufacturers.

V. THE ‘DIESELGATE’ EMISSIONS SCANDAL

The recent scandal of the Volkswagen Group received a lot of attention around the world. It is worth mentioning, since Audi was involved too.

The scandal dates all the way back to 2005 when Volkswagen launched an aggressive campaign on selling diesel cars to United States of America, which at the time had extremely strict regulations for diesel cars, allowing only 31mg/km of nitrogen oxides to be emitted, that is six fold less than at the time active EURO 5 norm within the EU.

To meet the budget and approaching deadline, a group of engineers within the engine development department of Volkswagen began to modify the engine management systems software, so the cars would pass the tests in the U.S. In total, they modified 15.000 algorithms in the ECU. (Saarinen, 2016)

In September 2015, US Environmental Agency (EPA) found out that Volkswagen had built diesel cars with a ‘defeat device’ designed specifically to cheat emissions test. The device would recognize that the vehicle is tested for emissions and modify air to fuel mixture ratio

18 and other parameters to produce acceptable results. Tests conducted during standard driving conditions revealed that cars produced more than 40 times of allowed nitrogen oxides (NOx).

In total around 11 million of vehicles are affected worldwide, Skoda and Audi admitted that around 3.3 million of their cars are affected as well. Particularly, 1.2, 1.6 and 2.0-litre diesel engines are affected. Surprisingly, specifically for two reasons, the CEO of Volkswagen

Martin Winterkorn admitted to have known about the device being installed into the engines from fall 2014. First of all, how could he possibly not have known about it for the first 9 years this was going on? And secondly, it is hard to understand why anyone would knowingly put their company at such risk.

Winterkorn resigned immediately after the scandal surfaced and is now facing prosecution for possible fraud in Germany. Volkswagen has until April 26. Of this year to come up with clear plan of how to fix all the vehicles and is also facing a lawsuit for 20$ billion from US

Department of Justice which acts on behalf of the Environmental Protection Agency.

(Passary, 2016) To this day (May 1st), as I am finalizing this thesis, the decision has not been made by the Department of Justice.

Information for vehicle owners about the affected vehicles are readily available at the

Volkswagen official website and all the owners of those affected vehicles will be offered a voucher from 400$ to 1000$ to spend for OEM equipment or as a discount on new car.

Clearly Volkswagen did what they did for financial reasons. U.S. is the largest market in the world and proportion of diesel to gasoline vehicles was very low. Therefore this was a great opportunity for Volkswagen. The problem was however, that the deadlines for the project were set by the management and engine development department did not have enough time in

2005 to develop technology that would allow their engines to comply with much stricter regulation in the U.S., so they managed to pass the tests in their own way.

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Is this the perfect case of ever stricter environmental policy pushing the manufacturers in the corner and not giving them another choice? I don’t think so. The policies are strict, but the advancements in technology should easily allow manufacturers such as Volkswagen or Audi to meet the requirements. Whether the policies are reasonable, to answer that question would require another thesis.

VI. BUSINESS STRATEGY OF Audi AG

When we boil down all aspects of corporate strategy, we will be left with profitability. Every strategy is created with success and profitability in mind.

In their book Car Firms’ Strategies and Practices in Europe, Michael Freyssenet and Yannick

Lung analyzed two essential conditions that are prerequisites for profitability. First, the relevancy of the “profit strategy” to the “growth mode”. Second is the “company governance compromise” between firm’s principal protagonists, a meeting of the minds that enables to invent or to adapt a “productive model.”

There are six sources of profit: economies of scale, diverse offerings, guarantee of quality, innovation, productive flexibility and permanent cost reduction. (Freyssenet and Lund, 2007)

Until today, no firms have been known to exploit all of these profit sources simultaneously. It is due to contradictory nature of the sources’ pre-conditions and means of implementation and therefore car manufacturers must choose amongst possible combinations of profit sources, or to invent ways to overcome contradictions.

Today, we can observe four different strategies in the European automobile sector: combination of economies of scale and diversity, quality, permanent cost reduction, and innovation and production flexibility.

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Each profit strategy has certain requirements that the firm must satisfy by means of product policy, productive organization and employment relationship. Creating coherence between these instruments infers the building of a company government compromise between firms’ executives, shareholders, banks, employees, labor unions, suppliers, etc. (Freyssenet and

Lund, 2007)

a. The “volume and diversity” strategy

This strategy was invented by General Motors during the Inter-War period in the United

States.

Volume and diversity strategy means that an auto manufacturer designs different car models on basis of utilizing the commonization of parts – using the same platform for different models, even marques.

In Europe, 6 firms are pursuing the profit strategy called “volume and diversity”.

Volkswagen, PSA, Fiat, Opel, Ford and Nissan. Volkswagen has been only one to successfully implement the strategy in durable and profitable way. (Freyssenet, Mair,

Shimizu, Volpato, 1998) The essence of this strategy is platform sharing. The ability to build many different models, with different brands, designs and parameters on the same chassis components that are adjustable length, width and height-wise. This communization of components has significant advantages in contrast with individual approach to chassis design of each model, such as lower cost for development and production since platform development accounts for nearly 50% of total product development costs (EVALUESERVE,

2012) not mentioning that the cost of development and production will be proportionally divided into individual parts for each brand and model that will use that particular platform

21 for their model. In case of Volkswagen, the cost will be redistributed across Audi, Skoda,

Seat, Volkswagen, Bentley and Porsche.

For efficient platform consolidation, it is critical that manufacturer manages to achieve strong intra-platform components commonality and global production flexibility (EVALUESERVE,

2012)

Possible challenges to platform sharing arise paradoxically from its greatest benefit: ability to use one platform for many different models and possible lack of diversification between those models. Two or more models that use same platform may cannibalize themselves or result in lower “sale per model.” Good example directly from Volkswagen Group is Volkswagen Up!,

Seat Mii and Skoda CitiGo. Three different badges, three identical cars and three different prices. The most interesting example however, comes from Aston Martin. Aston Martin only produces high-CO2 emitting cars, so they needed at least one economical car to bring down average fleet emissions, so Aston Martin adopted Toyota Aygo and rebadged it to Aston

Martin Cygnet. It is the same car, looks the same and has the same interior, engine and gearbox and costs 3 times more than Toyota.

For future of platform sharing, manufacturers focus on emerging markets such as China,

South Asia and South America. These markets will continue to be the focus for manufacturers’ strategies in coming future, influencing product development, marketing and manufacturing strategies to achieve economies of scale.

Volkswagen Group has been using common platforms for the entire fleet of the group since

1974. Today, Volkswagen’s MQB platform is used for all front wheel drive vehicles from

VW Polo, across Audi, Seat and Skoda vehicles. It is the second highest volume platform in production after Toyota’s MC platform at close to four million units. Volkswagen also uses common platforms for its large SUV’s VW Touareg, Porsche Cayenne and Audi Q7. All three

22 are being made in Bratislava. Three completely different cars, with price gap of around

150.000 euros between cheapest Touareg configuration and most expensive turbo configuration of Cayenne. Yet, they share the same underpinnings.

b. Quality strategy

Quality strategy is implemented by defining the quality of processes and standards for products.

One of the important characteristics of vehicles produced by Audi is quality. Quality not only in sense of well-built and reliable, but also social distinctiveness, unique design and technologies, utilization of luxury materials inside and out and brand-related prestige. This strategy is very much relevant to time and space. Economic development globally and locally, determines whether the strategy will succeed or fail. During recessions demand for high-end luxury vehicles decreases, and on the other hand demand for more affordable vehicles increases despite recession. Therefore it is crucial to have wide price range portfolio. In this case, Volkswagen owns 99,5% of shares of Audi, so during recessions, higher demand for cheaper Volkswagens, Skodas and Seats will compensate for possible decrease in demand for

Audi, Porsche or Lamborghini.

c. Technologies developed to meet CO2 requirements – the innovation strategy

Innovation strategy is most appropriate especially in auto industry, where competition is so fierce. Innovation strategy is used and should provide the company with competitive advantage by developing new technologies. This strategy is carried out by research &

23 development department, which develops new technologies and finds ways to implement them into new automobiles.

According to Audi CR report from 2014 three primary measures will enable Audi to reduce the average consumption of its fleet to meet 95gCO2/km in 2020.

 Roughly 50% of the desired CO2 reduction can be achieved by optimizing the

combustion engines, mainly by further developing the technologies for reducing fuel

consumption, making the drivetrains more efficient (decrease power loss in transition

from crank shaft to road) and engine rightsizing.

 Alternative drive concepts, such as hybrid, plug-in hybrid and gas-powered vehicles

save an additional 30%

 The remaining 20% needed will come from reduction in total vehicle weight by means

of Audi lightweight construction with an intelligent multi-material mix. (Audi AG,

2014)

Audi groups together its diverse technologies for reducing fuel consumption not only by means of making individual components such as engine and transmission work more efficiently, but also by using assistance systems. Since 80% of conventional vehicle’s emissions occur during the usage phase, Audi developed assistance systems such as:

Economical route guidance, Dynamic congestion avoidance, Gear-change indicator, Adaptive cruise control, predictive efficiency assistant (PEA) and many more to further improve fuel consumption.

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i. Cylinder on demand technology

Cylinder deactivation technology allows the engine to shut down half of its cylinders at low to intermediate loads, which allows a V8 engine to run as a 4 cylinder. This allows for reduction of 20% in average fuel consumption. In 2014, the technology was available in 19 models.

ii. Improved aerodynamics

“By linking aerodynamics, body development, vehicle design and vehicle concept, it is possible to save six to seven grams of CO2/km.” (Audi AG, 2014)

iii. Weight reduction

As it is explained further in my paper that average fleet weight plays a crucial role in assigning CO2 limits for each manufacturer individually, weight reduction is among the most important factors in Audi’ research and development department’s strategy.

Using lightweight construction materials is costly, but has many benefits as well. It makes car lighter, thus more efficient, aluminum space frame allows for use of less material and allows the extra space to be used more sensibly for safety, or practicality in form of larger storage space, more room for the passengers. For purposes of demonstrating how new technologies allow for overall a better car, I like using the Q7 as a reference model, since it has only been recently launched and demonstrates all the technological advancements Audi can offer. For example, in relation to using aluminum space frame construction, the designers have been able to make the new Q7 smaller in the exterior in all dimensions, yet increase space in the interior in all dimensions and at the same time reduce weight of up to 325 kilograms. That is

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10% weight reduction, which makes for not only significant increase in fuel economy, but also more usable, better handling automobile.

iv. Alternative drivetrains

In fall 2014 Audi launched the A3 Sportback e-tron, a plug-in hybrid of the latest generation.

It features a 1.4 TFSI engine with output of 110kw (kilo-watts) coupled with 75kw electric motor. According to New European Driving Cycle (NEDC), this vehicle emits only 35grams of CO2/km, which corresponds to a consumption rate of 1.5liters/100km. The electric motor is powered by lithium-ion batteries and it takes approximately 3.5hours to charge from conventional outlet. (Audi AG, 2014)

Audi assesses its processes holistically: from the daily challenges of electric-powered vehicles, such as battery range and charging infrastructure, to the upstream fuel chain. This is because the cars draw their energy from the public power grid and because of the ways electricity is still produced. Most of the time it is both fire - and emissions connected to burning oil, coal or waste; or it is nuclear waste from nuclear power plants. Audi as a responsible manufacturer accounts for that fact when investing into helping the energy transition. Very small portion of electricity is produced from wind, sun or water. Not that if all energy was produced from renewable sources, it wouldn’t have any footprint on the environment, but it would be considerably lower.

v. Fuels of tomorrow

Electricity and electric vehicles are becoming popular as never before. Elon Musk with his

Tesla electric cars is currently the leader in utilizing battery and electric motor technology.

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Electric vehicles have some serious advantages over traditional gasoline or diesel-powered cars. Yet, the greatest issues with electric cars are (not necessarily in that order): range per one charge, consumer’s mindset – simply refueling the car and moving on, rather than waiting for their car to charge for at least 30 minutes and origin of electricity. Today, range of Tesla

P95D is approximately 500km/charge. I am confident that within next 5 years, the range per one charge will be over 1000km, charging stations infrastructure will be much more developed and charging process will be much more efficient.

Audi is not far behind Tesla though, it’s top of the line electric supercar R8 e-tron, manages

460km/charge.

The most important issue environment and logic wise, is origin of electricity which powers the car. Even though the car produces zero emissions locally, if the electricity was produced in a coal power-plant, it would be worse than if the car ran on diesel. In his article: “Is The

Tesla Model S Green?” Nathan Weiss explains that to produce 1kWh (kilo-Watt-hour) of electricity from natural gas-fired generation produces 1021g of CO2. (Weiss, 2013)

Considering that Tesla carries an 85kWh battery and ranges 500 kilometers per one charge.

When we do the math, it would produce 173,57g of CO2/km which is slightly better than Audi

Q7s 3.0TDI V6 engine that produces 193 CO2/km.

That means, unless we will manage to produce electricity from renewable sources, that truly produce “zero” emissions, battery powered electric cars are not justifiable, however they provide solid foundation for future mobility. By that I mean that unless all electric vehicles take their electricity from renewable energy sources such as sun, water or wind, they won’t be more ecological than standard vehicles. Also, unless the companies develop batteries that work on different principles than exchange of toxic chemicals, electric vehicles, again, won’t be more ecological overall. However, if we want to move forward, we have to start

27 somewhere. That is why I see current technology of electric vehicles as a solid foundation for future research & development.

Audi stays true to its slogan “Vorsprung durch technik” in every aspect of their activity. Fuels of tomorrow that Audi is experimenting with, will most probably be “necessary” 50 -70 years from now. In their TFSI and FSI engines Audi already utilized technology for burning CNG

(compressed natural gas) and LPG (liquefied propane gas) – this approach helps to reduce emissions, since gas combustion is substantially “cleaner” compare to gasoline combustion and helps to reduce emissions, however it is also only temporary solution, since earth may once run out of natural gas, just like it will eventually run out of oil.

Therefore Audi in November 2014 joined with company Sunfire, to launch a power-to-liquid plant for producing diesel fuel from water, carbon dioxide and green electricity, called Audi e-diesel.

The process of producing the e-diesel is truly fascinating: “The carbon dioxide is extracted from ambient air. In a separate process, an electrolysis unit powered by green electricity splits water into hydrogen and oxygen. The hydrogen is then reacted with carbon dioxide in two chemical processes conducted at 220 degrees Celsius and pressure of 25 bar to produce Blue

Crude, which is made up of hydrocarbon compounds.” (Audi AG, 2014) For illustration, see figure 2.

To my question: “How do you see future of auto-mobility in regard to fuels”, Prof. Dr-Ing.

Ján Lešinský answered that he sees great potential in hydrogen fuel. Audi has already utilized hydrogen production by means of electrolysis of water for its Audi e-gas project. So hydrogen could one day power fuel-cell vehicles, the problem today is however, the absence of infrastructure of hydrogen “gas stations.”

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VII. “SUSTAINABILITY OF PRODUCTS AND PROCESSES”

“A company can develop sustainably only if economic, ecological and social interests are assigned equal importance.” (Audi, 2015) (Latest report available is from year 2014, published in 2015.) That is why sustainability of products and processes are anchored as corporate goal in Audi’s corporate strategy.

Audi in its corporate responsibility report recognizes 5 main areas of focus, or KPI’s (key performance indicators) – operations, product, environment, employees and society, to which it clearly assigns very specific goals that can be measured or to be subject of continuous development, together making up for 55 goals. Each goal is assigned a measure which is to be taken to successfully meet the goal, date by which that is to be accomplished and a degree of completion.

All goals presented in the corporate responsibility report are connected to sustainability.

However, for purposes of this work I chose a number of product and emissions related goals.

1. “To reduce CO2 emissions from the Audi new car fleet by 25% (base year 2008) was

to be achieved by 2016 by reducing fuel consumption by the use of modular efficiency

platform, but mainly by expanding availability of vehicles with emission figures

below 120g of CO2/km, which in 2014 was completed to 60%.

2. Expand range of electric drive concepts offered under the e-tron umbrella brand by

starting the production of Audi A3 e-tron as a plug-in hybrid with value of CO2/km

produced equaling to 37g which significantly contributes to the decrease of average

fleet emissions. This goal was to be achieved by 2014 and according to the report, this

goal was completed to 100%.

3. Develop and manufacture carbon-neutral fuels from renewable energy sources by

2014 and by means of implementing an e-gas solution across Germany through

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existing service station infrastructure. This goal was also successfully completed and

the e-gas project is functional in Germany.

4. Expand the range of CNG (compressed natural gas) drive concepts under the g-tron

umbrella brand by developing further engines and vehicle concepts with CNG drive,

to be completed by 2017. In 2014 this project was completed to 50%.

5. Market introduction of further Audi e-fuels by 2019. In 2014 this project was only

taking off and was completed to 10%. It will be a great challenge to scale up the

project from laboratory to industry size, but if the project succeeds, it will be the

greatest accomplishment for Audi.” (Audi, 2015)

These objectives are agreed upon on the corporate level and are managed at brand and Group level by central functions, committees and work groups.

VIII. STRATEGY FORMULATION

In every case of strategy formulation, 3 essential ingredients are required: Vision, Mission and

Goals for the company.

Vision is the most general of the three and states what the ultimate goal is for the company, or what the company should ultimately become in the future. Audi’s vision is to become number

1 premium brand.

Mission defines the actions through which the company can achieve its mission. Audi’s mission is: “We delight customers worldwide.” In order to delight customers worldwide, Audi defined four areas of activity for their brand that are continually reviewed, substantiated and refined: defining innovation, creating experiences, shaping Audi and living responsibility.

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Goals for Audi are available in previous chapter, on pages 29-30. I selected 5 goals, which I think are of the highest importance and relevance for meeting the EURO standards.

Strategy formulation for company the company size of Audi requires comprehensive understanding of the “big picture”, internal and external factors that influence the not only the company, but also the market in which Audi operates. Even though Audi publishes Strategist

Fred David recognizes four levels of strategies in large companies such as Audi, starting from the corporate level and chief executive officer, division level and president or executive vice president, functional level consisting of finance, marketing, research & development, manufacturing, information systems, human resource department and finally, operational level consisting of plant managers, sales, production and department managers. For illustration, see figure 4 in appendices section.

In his 13th edition of Strategic Management: Concepts & Cases, Fred David explains that strategy formulation is a set of subjective decisions based on objective information, to achieve long-term goals, or the vision of the company. The final strategy should be derived from the vision, mission and goals, external and internal audits in the first stage, followed by

SWOT/TOWS, SPACE, BCG, IE and Grand Strategy matrices in the second, or matching stage.

SWOT analysis is essential for building strong strategy. Acronym SWOT stands for

Strengths, Weaknesses, Opportunities and Threats that company is faced with.

SPACE matrix can be used as basis for SWOT analysis. SPACE matrix helps the company to decide which strategic approach to use. Each matrix is composed of four quadrants, each representing one approach. Approaches are: Aggressive, Defensive, Conservative and

Competitive. By evaluating firm’s internal and external factors, SPACE matrix will show which approach is most suitable. (Netmba.com, 2016)

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BCG matrix is a tool for identifying potential competitive advantage within firm’s portfolio of products. Portfolio is divided into four parts in this matrix 1. Dogs – products with low market share and low growth rate. They neither consume nor generate significant cash flow. 2.

Question mark – products referred to as a question mark in BCG matrix have low market share and consume a lot of cash. However, they also have potential to become Stars. Due to unpredictability of market, these are referred to as question marks. 3. Stars – products with large market share and large cash consumption. If the star can maintain its market share, it has potential to become a Cash Cow as the market growth rate starts to decline. 4. Cash Cows – products with return on investment larger than the market growth rate. Cash Cows bring in the cash needed to turn Question marks into stars.

IE matrix (Internal/External) – helps the company to make decision whether to: “grow and build”, “hold and maintain”, or “harvest or divest” according to Internal and External factors evaluation. (Maxi-pedia.com, 2016)

Grand Strategy matrix is a tool for evaluating different strategic approaches similarly to other matrices mentioned above. This matrix however uses specific factors, according to which, decision will be made. The factors are: Market growth (Rapid/Slow) and Competitive position

(Strong/Weak)

For purposes of this work I conducted Porter’s five forces and PESTLE analyses, which point out and analyze the main factors and forces acting on the company and which should be taken into account when formulating the final strategy.

32 a. Porter’s five forces

This analysis illustrates competitive advantage or disadvantage of Audi.

- Power of suppliers: Low

Audi or Volkswagen Group in general employ thousands of suppliers. These suppliers

are highly horizontally integrated into manufacturing process, which means they are

highly specialized for that particular manufacturer. Audi also helps to finance its

suppliers and brings their production facilities into their own production area. That

means that suppliers have very low bargaining power. On the other hand, if a supplier

collapses, the whole production of Audi would stall due to missing components.

Therefore it is a two-way street, where Audi has to have clear communication

channels established between itself and suppliers.

- Power of consumers:

Business or government customers – Medium/High

Traditional customers – Medium/Low

As firms or governments usually purchase whole fleets of cars, they are able to create

larger pressure on the manufacturer than traditional buyer who buys 1 car.

- Threat of substitutes: Medium/Low

Even though European Union and governments around the world are promoting

environmentally friendly transportation, I see threat for Automobiles to be substituted

by public transport for example as rather low, at least for next 15 years within the EU.

However, in large cities like New York, London, Paris, Tokyo, where public transport

is much more efficient, the threat of substituting automobiles is considerably higher.

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In case of Czech Republic and Prague in particular, the threat of substitute is rather

low. Even though the public transport in Prague is among the best in the world, the

status of owning and driving a car outweighs the benefits of public transport.

- Threat of new entrants: Low

Automobile industry today has large barriers that prevent new firms from entering the

market. Entering automobile market would require immense production start-up costs,

setting up dealership and maintenance networks, licenses, trust in the brand and many

other components. To illustrate how much it costs to enter an automobile market

today, Tesla will serve as a great example. Tesla started as Elon Musk’s ow project,

into which he invested 8.5 million of his own dollars. To start producing the latest

Model S, Tesla needed financial injection of roughly 650$ million. (The Making of

Tesla: Invention, Betrayal, And The Birth Of The Roadster, 2014)

- Competitive rivalry: High

Direct competitors for Audi in Europe are: Mercedes – Benz, BMW and Porsche.

The competition is as fierce as it has ever been. These four manufacturers are on the

same technological level, even releasing new models and technologies within few

weeks or a few months from each other.

Based on this analysis, my preliminary conclusion is that Audi’s position in the market

place and automobile industry is relatively safe as long as Audi stays true to its motto:

“Ahead through technology”.

34 b. PESTLE Analysis

I conducted this PESTLE analysis to illustrate and briefly discuss opportunities and/or

threats directly connected to Political, Economic, Social, Technological, Legal and

Ecological factors. Many times it happens that factors are interconnected and

dependent on each other. I conducted this analysis according to information I learned

over the course of my research on this topic to view and understand issues

manufacturers face from their perspective and to be able to better understand strategic

approaches or solutions for particular problems, respectively to be able to see what

issue was being solved by each particular change in strategy. According to strategist

Fred David, PESTLE analysis is among the most appropriate tools for conducting

strategy analysis.

Political

 Introduction and enforcement of new law and regulation related to safety and

emissions.

 Changes in EU legislation in relation to product life cycle, recyclability of

materials.

 Stability/Instability in developing countries and markets for both sales and

production purposes.

 Instability in the EU, situations such as ‘Brexit’

Economic

 Volatility of exchange rates in regard to derivatives trading – mainly EUR-

USD, JPY, CNY

 Volatility in costs of crude materials, such as aluminum, steel, copper, platina.

 Recessions in markets where Audi operates – sells and/or produces

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 ECB interventions

 Taxes (vehicle registration tax, road tax)

Social

 Changes in attitude of consumers toward more affordable brands

 Ageing population in European market

 Changes in family patterns (number of children) – customers prefer more

affordable, mostly MPV of SUV configurations. (Audi does not offer MPV

category automobiles)

 Rising life expectancy in EU

Technological

 Increasing demand for “green” automobiles and technology

 Technological advancements in manufacturing, such as human-robot

interaction, automatized paint shops and assembly facilities.

 Technological advancements in vehicles – piloted driving, internet-enabled

technology and driver assistance systems.

 Rising demand for alternative fuels and propulsion systems

Legal

 Changes in law, regulation and directives related to automobile industry

 Intellectual property, patents, copyright related to inventions of new devices,

processes and technologies (Patents of Audi: http://stks.freshpatents.com/Audi-

Ag-nm1.php)

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 Changes in employee health and safety regulations

 Changes in standard European test cycle

Ecological

 Consumer awareness – increasing demand for “green” cars.

 Changes in standard European test cycle

 Pressure from environmental NGOs.

 Improvements in waste management – water treatment from production plants,

recycling of metals, e.g.

 New, ecological fuels

Political

Introduction of new regulation related to greenhouse gases emissions is one of the greatest concerns not only for Audi, but for all manufacturers. Recyclability and product life cycle are also among major political factors that influence strategy and manufacturing processes of

Audi.

Political stability in developing markets such as Russia, China, India or Brazil is crucial because these markets can offer considerably cheaper labor force than Germany and new- untapped customer base. However, if the political situation is unpredictable, the investment to build new assembly line or manufacturing unit and training the labor force would be too risky.

In regard to possible ‘Brexit’, no one really knows what would happen. Without too much speculation, I believe that even if Britain exited European Union, the trade would continue without establishing new barriers to trade, since the economies are today interconnected to such degree, it would hurt both sides.

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Economic

Performance of Audi is subject to a number of economic factors of which it has limited, or no control over. For example recent GDP fluctuations in European Union’s countries could severely impact buying power or customer’s decision making process when buying a car – potentially look for cheaper, economically safer alternatives.

Social

Social factors affecting strategy and performance of Audi are among the most crucial and

Audi approaches these factors pro-actively and with great amount of respect - publishing consumer reports, informing stakeholders about the achievements in reducing emissions, plans for the future to make stakeholders and customers feel involved in the process.

Audi with its size affects lives of millions of stakeholders world-wide and must care for these people as for their customers, to be able to maintain reputation for reliable, trustworthy and concerned manufacturer and employer – especially after “diesel gate” scandal.

There are however externalities such as changes in consumer behavior, namely purchasing habits, or changes in family patterns which are hard to anticipate and the company in its structure and strategy needs to be flexible, to be able to quickly react and adapt production to changes in demand.

Technological

Technological factors are probably of the highest importance among other factors. Without the advancements in technology and design Audi would not be able to develop cars that would comply with strict regulations. Thanks to advancements in technology cars are better,

38 lighter, safer and more efficient than ever before. It will be crucial for Audi during following years to remain at the top of the game, since the greatest challenges like implementing full electric vehicles, or connecting cars to the infrastructure still lay ahead. Audi is using the advancements in technology not only to make cars consume less fuel, but also to minimize the carbon foot-print of their production processes and to develop synthetic fuels, the Audi e- fuels.

Legal

“Audi is confronted with a highly complex, country-specific regulatory framework. The regulations include tougher CO2 legislation, accreditation systems and safety-relevant standards.

Legislative changes bring a risk of legal uncertainty.” (Audi AG, 2016) If the regulation changes too often, Audi may not be able to adapt to those changes and the result would be either leaving the market, or pay resulting fines from not meeting the legal requirements.

Change of Standard European Test Cycle for measuring emissions was to change or changed unexpectedly, it would cause great problems for all manufacturers. Current Test Cycle is relatively benevolent and provides a lot of lee-way for manufacturers, so the reality is such, that on paper (according to the test cycle conducted in laboratory) all cars being sold in the

EU comply with the regulation, but in real driving conditions except for electric cars it is virtually impossible to achieve claimed fuel consumption or CO2 emissions.

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Ecological

Besides ecological factors such as fuel consumption and greenhouse gas emissions which I mention above, the most important issue is product life cycle – how long should the car last and what should happen when the life cycle ends. Again, it is issue of minimizing the natural resources needed to build a new car and thus recyclability of the old car. Audi should incentivize recycling of old cars – essentially disassembling them and recycling plastics, metals and glass. There is a great potential for savings in decreased need for purchasing raw materials and at the same time the company is being responsible by safely disposing of waste and reusing it.

And that leads me to one of the greatest issue with petrol/electric hybrids or electric vehicles.

They all need batteries. Batteries today have limited life span and need to be replaced at some stage of cars life. Lithium-Ion batteries most commonly used in EVs has extremely high electrical potential. However, lithium is not only flammable and highly reactive, but the EPA also linked the use of extremely powerful solvents in the creation of lithium batteries to diseases such as cancer and neurological diseases. Specifically, cobalt, which is used in the creation of the most potent batteries is poisonous and extremely carcinogenic. So the batteries are extremely toxic and virtually unrecyclable at this point of time. (Braun, 2013)

As I mentioned before, Audi is pioneering a project called Audi e-fuel, where they are able to extract CO2 from atmosphere and hydrogen from water to create synthetic diesel which can be produced limitlessly and at the same time removing CO2 from atmosphere. Before officially releasing this fuel, Audi now only needs to find solutions to scale up the project to be able to at least partially supply the demand.

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Even though Audi publishes information regarding strategy in their CR report, the information is vague and it is clearly published as a part of being transparent, responsible company and to satisfy stakeholders.

Still, I was able to find and identify key trends in areas of development such as marketing, production, sales and financial statements that indicate the direction in which Audi is going.

Audi is entering into partnerships with organizations that support the environment through variety of projects. For example, recently Audi announced that by the end of 2016, it will introduce the A3 e-tron model into the United States. Along with each car sold Audi will purchase carbon credits equivalent of 50,000 kilometers of driving. (3degreesinc.com, 2016)

c. Marketing and Sales Strategy

In 2014 Audi delivered 1,933,517 cars to customers, setting new record. (Audi, 2014) First quarter of this year, the 2016, has been the strongest in Audi history and it’s expected to set another record by the end of the year.

Concept of electric hybrid vehicles has been around for some time now and people are slowly starting to trust cars using this technology. Hybrids have proven themselves to be reliable just as standard petrol engine equipped cars, yet to be much more efficient. For example, 2016

Audi Q7 e-tron claims to consume only 1,8l/100km of diesel. However hybrid vehicles have their disadvantages too. For example price – the Q7 e-tron costs 20,000 euros more than standard model and the return on such investments is too far in the future to persuade the buyer into choosing hybrid over standard gasoline or diesel.

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It is marketing department’s role to show people that hybrid cars are a reasonable choice by highlighting the positive attributes of hybrid electric vehicles (HEVs), showcasing the cars and their capabilities.

Audi has been successfully utilizing petrol or diesel/electric hybrid concepts in their 24H

LeMans racing vehicles, winning for eight times in a row.

One of my hypotheses was that marketing would be among the key strategic tools that Audi uses to promote and sell hybrid cars. Surprisingly, this hypothesis turned out to be false. Even though Audi invested 6 billion euros into advertising in 2015 globally, only a very small portion must have been invested into advertising of Audi e-tron lineup. Furthermore, in the sales figures and deliveries section of the 2014 Annual Report, Audi does not differentiate by any means standard combustion engine equipped cars from hybrids. Therefore, it is impossible to find out whether Audi sold any hybrids at all. The three best sellers in 2014 were Audi Q5, A6 sedan and A4 sedan, none of which offer e-tron configuration. Only model that was offered as e-tron in 2014 was the A3 sportback, of which Audi sold 176,211 units, however, the numbers regarding types of engine configurations are not published.

To even greater surprise, in 2016 Audi is still offering only two models available in e-tron configuration. The A3 and recently launched Q7. I expected that by 2015 Audi would have had covered at least the three best-selling models, which would in my opinion naturally boost sales of hybrids.

This leads me to think of two possible conclusions regarding sales and marketing, or rather lack thereof.

1. Audi has been popular for pioneering the TDI technology for over 30 years and

brought it almost to perfection. Models equipped with TDI engines are also the most

popular among European customers and bring in the highest portion of revenue and

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therefore these models are of highest priority to Audi and at least for now, Audi offers

hybrid models mainly for purpose of reducing the average fleet CO2 emissions.

It seems that diesel/petrol technology is climbing toward its maturity in the product

life cycle and sooner or later we will see a decline. At the same time we can see

growth in the Hybrid/Electric technology. I estimate that in horizon of next 7 years we

will start seeing decline of diesel/petrol engines and hybrid/electric automobiles will

be reaching their maturity.

2. Another possibility I see would be that Audi never planned to focus on electric

mobility. It rather appears from the 2014 Annual Report that Audi will again go its

own direction and develop synthetic fuels for existing combustion engines. These

fuels will be produced only by using renewable sources, also the energy needed for

production of these fuels will be provided from renewable sources. This way Audi will

be able to “close the loop” and theoretically provide fuel for everyone without creating

any pollution forever. Audi has already achieved to produce first liters of synthetic

diesel in cooperation with Sunfire Company. Now they need to find a way to produce

this fuel on industrial level.

Only future will show if my theory is reasonable, but I still think it would be the

easier, more logical way to go.

d. Production

Production of cars has experienced drastic change over past decade or so.

Manufacturers strive to make the process as efficient and effective as possible, using

as little workers as possible on as little land as possible, using as little time as possible.

This mindset has basically eliminated production as such from Audi and other

manufacturers. More suitable name would be assemblers rather than manufacturers,

43 since they barely manufacture anything anymore, except for some parts in Audi R8 supercar.

Audi has created a vast supplier chain, which gives them great flexibility for growth and significantly reduces costs, since Audi does not have to employ, train and pay workers to manufacture every single part of the car. Each part, for example seats, multi-media systems, wheels of the car and electronic control units are made by companies specializing in production of those parts and they often produce parts for more than one manufacturer.

By bringing these suppliers as close as possible, Audi is able to use just-in-time inventory which again reduces costs for transporting the parts and by being able to have less inventory, since supplier gets notified via unified information infrastructure that assembly line is running out of parts.

Along with just-in-time inventory Audi of course uses TQM or Total Quality

Management, also known as Six-Sigma approach. It is vital that in combination with

JIT, TQM is used. It is because if supplier fabricated batch of faulty parts, these would be installed into hundreds if not thousands new vehicles, which could have terrible consequences if the faulty part was vital to vehicle safety or structure. There is simply no room for mistakes.

Audi is among first manufacturers to use human-robot interaction on assembly lines.

Of course, robots are used by most manufacturers, but they are always separated from people for safety reasons.

44 e. Competitive profile matrix Audi vs. Mercedes-Benz and BMW

I conducted this CPM Matrix with focus on competitiveness of Audi, BMW and

Mercedes-Benz, who are considered to be main competitors among German luxury car

makers. The matrix illustrates which manufacturer’s fleet has achieved lowest

emissions, highest revenue/profit ratio, number of hybrid, or other ‘green concept’

models.

The results of this analysis will show the effectivity of Audi’s strategy in context of

competitiveness among its two main rivals.

Audi Mercedes-Benz BMW Weighted Weighted Weighted Key Success Factors (KSF) W(eight) R(ating) Score(W*R) R(ating) Score(W*R) R(ating) Score(W*R) Research & Development 15,00 4 0,6 3 0,45 4 0,6 Number of Hybrid/Electric Models offered 5,00 1 0,05 3 0,15 5 0,25 Average fleet CO2 emissions 30,00 1 0,3 1 0,3 1 0,3 Revenue/Profit ratio 20,00 3 0,6 1 0,2 5 1 Average fleet mass (kg) 5,00 5 0,25 1 0,05 3 0,15 Market penetration 10,00 3 0,3 4 0,4 3 0,3 Range of models offered 5,00 4 0,2 5 0,25 4 0,2 Number of recalls (high rating = little recalls) 7,00 4 0,28 4 0,28 4 0,28 Marketing 5,00 3 0,15 2 0,1 4 0,2 TOTALS 1,0 ------2,7 ------2,2 ------3,3

Sources: (Hoovers.com, 2016); (finance.google.com, 2016); (Finance.yahoo.com,

2016); (Audi.de, 2016); (Mercedes-benz.de, 2016); (Bmw.de, 2016);

Results and comments:

Totals of weighted score indicate the ‘winner’ of the three competitors, which is

BMW. I conducted this matrix purely on objective data acquired from manufacturer’s

websites and annual reports. I rated each key success factor and each manufacturer’s

performance related to the factor on a scale from 1 (poor) to 5 (outstanding).

Surprisingly, none of the manufacturers meets the 120g of CO2/km according to my

calculation done according to available data on main website of each manufacturer. I

calculated average fleet emissions based on information published on each of the

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manufacturer’s website and received: 160,4g of CO2/km for Audi, 152g of CO2/km for

Mercedes-Benz and 163g of CO2/km for BMW.

IX. CONCLUSION

Over the course of my research I learned that most of the time nothing is as it seems if

you look closer.

I found out that the regulations for emissions are strict, but easily by-passable. It is

clear to me now, that if the car manufacturers in Europe didn’t participate, it would be

probably much worse. Yes, there are limits over which manufacturer should not go,

today it is 95g of CO2/km. That however does not mean that each car must produce

less than 95g of CO2. The whole fleet, or portfolio if you will, must not produce over

95g of CO2 on average. That means that Audi can still produce and sell cars that

produce 300g of CO2/km, like the Q7 or R8, it only needs to also offer a car that

produces significantly less than 95g of CO2/km to get the average right.

Interesting is that no one controls or cares for average fleet emissions of sold cars. I

think that would be a much better indicator of how policy does not work at all since

the best sellers for Audi are SUVs, crossovers and large limousines that emit the

highest numbers of CO2, and sales of low or zero emission cars are still a drop in the

ocean.

I realize that it’s easy to criticize from my position, especially considering lack of my

insider information that would require personally interviewing policy makers and Prof.

Rupert Stadler, the CEO of Audi AG, which unfortunately was not in my power.

Yet, through my research I was able to find sufficient information to answer my

question: How do the environmental policies and regulation affect strategy of Audi

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AG. At the beginning of my research I thought I would find so many different adjustments to strategy and overall behavior of the company as new regulation emerged over time. From the outside the process of implementing new policies and regulation seems so dynamic, yet in reality you can barely find any evidence that something has changed due to introduction of particular policy or regulation. The simplest, most stripped down answer would be that: To comply with environmental policies and regulations set by the European Union, specifically the CO2 emissions target of 95g/km, Audi introduced e-tron, petrol/electric hybrid models that on paper, according to standard European test cycle produce only 35g of CO2/km (Audi A3 e- tron), which is significantly below the required average.

This strategy should be sufficient to allow Audi to fit within the limit for shorter term,

Audi is however looking further ahead and working on overall sustainability of their business. Audi has to try to foresee the trends in transportation for the future and manage to keep ownership of a car attractive for people to sustain their business.

Therefore Audi is not only trying to make their cars as environmentally friendly as necessary, but they are also working with representatives of largest cities in the world and designers to find space for cars in cities in the future.

From higher perspective though, the answer is much more complex. Strategy of company with such complex structure as Audi, requires complex strategic approach.

To my surprise at the beginning, I realized how complex of a thing strategy is. Since

Audi closely guards the key secrets of their strategy, they publish enough information to be able to find elements of different approaches. Each department needs to have very carefully and clearly defined strategy, since all the departments are interconnected and dependent on each other.

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Even though the outcome of the strategy is essentially only two new models, the process of making and developing those two models required changes in all departments of the company.

Starting with department of corporate strategy. First of all, the department had to identify the obstacle and find a way to get around it without affecting investment/revenue ratio too much. Logically, the development of new models and technology supporting the cars cost money. Here we arrive at financial department, which had to allocate funds for the research and development.

Research and development department has the toughest assignment, to think up the concept and develop technology that will make it work, meet the goal that was set, which may be and probably is, outstanding performance, with low consumption, that is not too costly and can be up-scaled to industrial level and at the same time maintain the occupants safety regulations. Converting an existing car into hybrid requires intervention into chassis components. Batteries and electric engines are heavy, need to sit as low in the chassis as possible not to increase the center of gravity which could severely impact the roll over stability of the car and need to be protected to highest possible degree. If lithium-ion battery is punctured and the chemicals react with oxygen, battery bursts into extremely high temperature fire.

Once these conditions are met, production department’s role in the process is to modify existing, or develop brand new assembly line facility and find the most time and cost effective way of assembling the final product.

Marketing and sales would be the key departments, if the legislation required not only to offer these cars, but also to sell them, to achieve determined average emissions of sold cars. In this case, Audi can account for the expenditures related to development of

48 e-tron technology as business expense, to be able to continue in the business and forget about it. I am not saying they have done it, however there is no evidence that

Audi would put much effort into marketing and selling these cars in larger numbers.

Without going too deep into speculation, maybe Audi is waiting for the charging infrastructure to be more developed and only then these cars will gain attractiveness.

For now I only see them as a strategy tool for Audi and other manufacturers as well, to be able to continue in business. Another possibility I find very realistic for future is that Audi is mainly focusing its efforts and funds toward scaling up the production of e-fuels. By utilizing this technology, Audi would not have to focus on hybrid/electric vehicles at all. Eventually we will see decline in life cycle of hybrids too and the e- fuels seem like a solution that would outlast both hybrid and electric vehicles.

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APPENDICES Figure 1.

DPF (Diesel Particle Filter)

Figure 2.

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Figure 3. (European Environment Agency p.13, 2014)

Figure 4.

Corporate Level CEO

Executive vice Division Level president

Functional Level Finance Marketing R&D

Plan Department Sales Production Operational Level Managers Managers

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Figure 6.

Figure 7.

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Figure 8.

BCG matrix

Figure 9.

Grand Strategy matrix

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Figure 5. Volkswagen shares after the ‘dieselgate’

Figure 10. Volkswagen stocks currently

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GLOSSARY

ACEA – European Automobile Manufacturer’s Association BCG – Boston Consulting Group (BCG matrix) CEO – Chief Executive Officer CNG – Compressed natural gas COD – Cylinder on demand CO – Carbon Monoxide

CO2 – Carbon dioxide CR – Consumer Report CPM – Competitive profile matrix DPF – Diesel particle filter FSI – Fuel Stratified Injection EC – European Commission EU 28 – 28 European Union member states ECB – European Central Bank EEA – European Environment Agency EPA – U.S. Environment Protection Agency EU – European Union EV – Electric vehicle GDP – Gross Domestic Product HC - Hydrocarbons HEV – Hybrid-Electric Vehicle IE – Internal-External matrix LPG – Liquefied Petroleum Gas MC – Toyota front wheel-drive automobile platform MQB - Modularer Baukasten (GER) / Modular Transversal Platform (ENG) NEDC – New European Driving Cycle NGO – non-governmental organization NOx – Nitrous Monoxide

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PM – Particulate matter SPACE – Strategic position and action evaluation matrix SUV – Sport Utility Vehicle SWOT- Strengths, Weaknesses, Opportunities and Threats analysis TDI – Turbo Diesel Injection TFSI – Turbo Fuel Stratified Injection

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