Volkswagen and the Cost of Culture

Thanks to Volkswagen, we now have an idea of the cost of failing to maintain an ethical culture, roughly $18 billion US (emphasis added in the quoted text below by me):

Volkswagen’s financial disclosure on Friday, in a preliminary earnings report, came a day after the company agreed on the outlines of a plan to settle some legal claims in the United States, which would include giving owners of about 500,000 affected vehicles the option of selling the cars back to the company or having them repaired.

Volkswagen is still negotiating the size of the fines it will pay to the United States government for violations of clean-air laws, as well as how much additional compensation it will provide to owners. The money set aside by the company on Friday provides an indication of what Volkswagen expects the total global costs of the scandal to be, although the figure could rise further.

Since the scandal broke in September, 2015, the news has steadily worsened. Last December, Volkswagen’s chairman admitted that the cheating found was not an isolated lapse:

…the decision by employees to cheat on emissions tests was made more than a decade ago, after they realized they could not meet United States clean air standards legally.

Hans-Dieter Pötsch, the chairman of Volkswagen’s supervisory board, said the cheating took place in a climate of lax ethical standards.

“There was a tolerance for breaking the rules,” Mr. Pötsch said here on Thursday during his first lengthy news conference since the company admitted in September that 11 million cars with diesel engines were rigged to fool emissions tests.

Volkswagen’s executive leadership explanation at the time:

Mr. Müller and Mr. Pötsch conceded that the deception reflected organizational shortcomings.

For example, the people who developed the software were the same ones who approved it for use in vehicles. At other companies, it is standard practice for one team to develop components and another to check them for quality. Volkswagen said it would correct those procedures.

Mr. Müller also said he wanted to change the company’s culture so that there was better communication among employees and more willingness to discuss problems. His predecessor, Martin Winterkorn, who resigned after the scandal, was criticized for creating a climate of fear that made managers afraid to admit mistakes.

“We don’t need yes men,” Mr. Müller said, “but managers and engineers who make good arguments.”

I would argue that what’s needed more than “good arguments” is a corporate culture where it’s understood that refusing to break the law is not only allowed, but expected. Given that the size of the loss reserve has more than doubled since then, perhaps they’ve realized that now as well.

What is not needed, however, is the traditional response to high-profile issues, layering on additional ad hoc rules and regulations with an eye toward making sure this “never again happens”. For one thing, there’s no indication that anyone was not aware of the fact that this behavior was wrong. Additional compliance theater is unlikely to improve anything in that respect, and may actually cause new problems in addition to exacerbating the root problem, VW’s culture.

A recent study (reported on in The Atlantic) by Simon Gächter and Jonathan Schulz, University of Nottingham, reports that corrupt cultures breeds corruption. In this study, they:

…asked volunteers from 23 countries to play the same simple game. The duo found that participants were more likely to bend the game’s rules for personal gain if they lived in more corrupt societies. “Corruption and fraud are things going on in the social environment all the time, and it’s plausible that it shapes people’s psychology, what they can get away with,” says Gächter. “It’s okay! Everybody does it around here.”

This study also has implications for Volkswagen’s ability to fix the problem:

Causality could eventually flow in the other direction. “If people are dishonest or think it’s okay to violate rules, it would also be harder to fight corruption and install institutions that work,” says Gächter. “In the long run, these things move together. But to show that, you’d need a 20 year project measuring this on an annual basis.”

Volkswagen, however, probably does not have twenty years to fix their problem. In the US alone, VW will have to fix or buy back (at the owner’s option) over 500,000 vehicles. I suspect VW’s reputation is severely impaired with those that opt to have their vehicles repaired and I would be willing to bet that the majority of those who sell their cars back won’t be returning as customers. This loss for Volkwagen is only the beginning of their financial problems, and it could all have been avoided.

Back in November, Matt Balantine floated an interesting (and very plausible) theory:

https://twitter.com/jetpack/status/667670950540943360

That may well turn out to be the case, but I also have to agree with what Grady Booch tweeted when the scandal first broke:

Shame also on the software developers who wrote that code and didn’t have an ethical bone in their body to object. http://t.co/sklTIjDHuU

— Grady Booch (@Grady_Booch) September 21, 2015

There’s plenty of blame to go around, but ultimately I believe only a systemic fix, top to bottom, will have any chance of correcting the problem (not that I’d be willing to give VW very good odds on remaining in business long enough for that to take effect). Their value going forward may be to serve as empiric confirmation of Gächter and Schulz’s work. Their bad example may serve as a wake up call for others to pay attention to the culture they’ve fostered (and are fostering) before their employees, innocent and guilty alike, pay the price.