Electric vehicles are a tiny piece of the global car market, but Volkswagen is making a huge bet on them. It doesn’t have a choice.

The Volkswagen ID.3 electric hatchback.

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The Volkswagen ID.3 electric hatchback.
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Volkswagen

  • No automaker that makes gas-powered cars has announced electric-vehicle investment plans as ambitious as Volkwagen‘s.
  • By 2023, Volkswagen says it will spend over $30 billion on electric vehicles, a sum roughly equal to the company’s combined profits from 2015 through 2018. By 2030, Volkswagen intends for electric vehicles to comprise 40% of its global sales.
  • For Volkswagen’s targets to be attainable, demand for electric vehicles will have to grow significantly from the first half of this year, when they accounted for just under 2% of global light-vehicle sales.
  • Volkswagen doesn’t have much of a choice in deciding whether or not it wants to invest in electric vehicles due to tightening regulations and the aftermath of its Dieselgate scandal.
  • But the company’s size could increase the upside and limit the downside of its ambitious electric-vehicle strategy.
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In 2006, Volkswagen took a risk. The automaker installed software on diesel-powered vehicles that would help them pass government emissions tests conducted in a lab, then allow the vehicles to produce higher emissions outside of the lab. That decision backfired spectacularly, costing the company billions in fines and recalls and damaging its reputation.

Now, Volkswagen is taking a more virtuous risk: betting big on electric vehicles over the next decade without knowing how much consumers will want them.

The auto industry is headed toward what could be its most transformative period in the past century, as electric vehicles appear set to eventually replace their gas-powered counterparts and self-driving technology has the potential to one day eliminate the need for steering wheels. Volkswagen’s peers are also making significant investments in future-oriented technology, but when it comes to electric vehicles, no automaker that makes gas-powered cars has matched Volkwagen’s ambitions.

“Nobody has announced a more aggressive spending plan than they have,” said Michael Ramsey, an analyst at Gartner.

2019 Volkswagen e-Golf

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Volkswagen

Volkswagen doesn’t have much of a choice

By 2023, Volkswagen says it will invest over $30 billion in electric vehicles, a sum roughly equal to the company’s combined profits from 2015 through 2018. By 2030, Volkswagen intends for electric vehicles to comprise 40% of its global sales. No automaker aside from Tesla is even remotely close to a quarter of that number today.

For Volkswagen’s targets to be attainable, demand for electric vehicles will have to grow significantly from the first half of this year, when they accounted for just under 2% of global light-vehicle sales (not including plug-in hybrids).

To some degree, Volkswagen doesn’t have much of a choice in deciding whether or not it wants to invest in electric vehicles. Tightening regulations in Europe mean it would be very expensive for Volkswagen to do nothing, said Richard Hilgert, an equity analyst for Morningstar. The company would pay around $10 billion in fines every year starting in 2021 if the emissions produced by its product mix remained at 2018 levels, Hilgert wrote in a September report.

And a 2016 settlement with the US government related to Volkswagen’s cheating on emissions tests required the company to invest $2 billion in electric-vehicle charging infrastructure and promote zero-emissions vehicles.

But there are commercial reasons for Volkswagen’s plans as well. The company sold more vehicles than any other automaker last year, and most of those sales came in Europe and China, where electric-vehicle adoption rates are higher than in the US due to government subsidies and regulations.

China, “probably more than almost any country on the planet, can dictate what its citizens purchase,” said Karl Brauer, the executive publisher at Cox Automotive.

And in European countries, there are nonpolitical reasons, like their high population densities and a tendency among their citizens to care more about the environment, that give electric vehicles a better chance of catching on in the near-term than in the US, said Dan Edmunds, the director of vehicle testing at Edmunds.

Volkswagen ID.R

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Volkswagen

Volkswagen doesn’t expect EVs to hurt profit margins

One of the biggest questions the auto industry faces over the next decade is the extent to which investments in electric vehicles and autonomous-driving technology will hurt profit margins amid a potential dip in sales of gas-powered vehicles. Auto companies already earn thin margins due in part to the high costs of manufacturing; retraining employees and converting factories designed for gas-powered vehicles to produce electric ones won’t help, at least in the near-term.

As one of the world’s largest automakers, Volkswagen’s size could give it a head start in establishing economies of scale for electric vehicles, Ramsey said, but a big investment alone won’t be enough to seize market share in an industry where competitors fight over fractions of a percentage point.

“Just because you’re first, doesn’t mean you’re going to win,” said Rebecca Lindland, the founder of the website Rebeccadrives.com and a former analyst for Kelley Blue Book.

To build a more lasting competitive advantage in the transition to electric vehicles, Volkswagen will need a blockbuster product, Ramsey said. The company has had a few in its history, like the Beetle and Golf, and it hopes the ID.3 hatchback will become the electric version of those era-defining vehicles. Set for release next year, the ID.3 will start at under $34,000 and have a range between around 200 and 340 miles (based on European testing standards, which tend to be more generous than in the US).

Volkswagen CEO Herbert Diess said in October that he doesn’t expect electric vehicles to hurt the company’s profit margins due to the dedicated platform it has designed for use in a wide range of models and its sharing of battery suppliers between its twelve brands.

While requiring an upfront investment, that platform, called “MEB,” should lower development and production costs in the future, because models will share parts and a basic architecture. Volkswagen has an agreement with Ford to sell its MEB platform, allowing Volkswagen to spread its development costs over an even larger number of units. Coordinating the purchase of batteries between brands should, presumably, give Volkswagen more negotiating leverage than if each brand bought batteries alone, creating the opportunity to secure bulk discounts.

Tesla Model S P100D Supercharger Kettleman City

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Bryan Logan/Business Insider

There are questions about how much EV demand will grow

But it’s not entirely clear if customers will want electric vehicles enough to support Volkswagen’s sales goals due to concerns over range, price, and the availability and speed of charging stations.

“It’s hard to imagine, in my view, a big shift to electrification until we see better parity with an internal-combustion engine in a lot of different areas,” Ramsey said.

So far, only Tesla has been able to sell electric vehicles for reasons other than their environmental friendliness, Ramsey added. Like Tesla, Volkswagen seeks to eventually turn electric vehicles into mass-market products. But even China might not be able to induce enough demand for them if its citizens aren’t interested in them, Brauer said.

Volkswagen’s size will limit the downside in a scenario where demand does not rise as fast as expected. Unlike a startup like NIO, which has struggled to establish steady sales growth, Volkswagen has enough engineers to work on multiple kinds of vehicles at the same time, Ramsey said, so unexpectedly soft demand for electric vehicles won’t put the company out of business.

And Volkswagen does not appear to be in a situation similar to the one General Motors, Ford, and Fiat Chrysler faced in the years leading up to the financial crisis of 2007 and 2008, Brauer said, when rising fuel prices hurt demand for the SUVs and pickup trucks they have become increasingly reliant upon for their profits and helped pushed them to or near bankruptcy. Volkswagen can always shift its focus back to gas-powered cars.

If Tesla had to bet its continued existence on its first mass-market vehicle, the Model 3 sedan, Volkswagen’s electric-vehicle investment plans are not so perilous. In fact, the downside of not being prepared for the eventual transition away from gas-powered vehicles may be greater than the risk of being overprepared.

“I think that their thought process is, look, if we don’t do this at all and we keep building what we have and then, all of a sudden, fuel prices rise dramatically or the European Union won’t let us sell our vehicles, that’s a downside risk we cannot afford,” Ramsey said.