While the scandal around Volkswagen’s emissions fraud is still unfolding, one thing is clear: it’s going to be costly in any aspect. And it may be the demise of iconic Volkswagen.

What is known today is that some people at Volkswagen thought that cheating is acceptable. And it blew up in their face big times. But what gave them the believe using software that cheats emission tests is the way to go?

How do emission tests work?

Volkswagen had to admit that their Diesel cars had a piece of software installed that changed the way the cars ran when they detected an exhaust emissions test situation. During a test situation, which is normally conducted at a test facility, a number of parameters look different. There is no load on the car, the tires may not be rolling, and many more. A modern car features hundreds of sensors and is basically a big data producing machine. When a car is driving on the road, all these sensors generated data. Now a piece of software can subscribe to all these sensors and get a lot of information from what the car is doing. When it’s just standing in a test facility with engine running, the software knows that.

Disclaimer: I have conducted hundreds of emissions tests for my PhD thesis in the 1990s on oil-fueled heating systems, so I have some experience with how this is done and can be influenced.

First, tests in a laboratory under ideal conditions with the experts adjusting a fossil-fueled system allows to practically bring emissions down to very low levels. Emissions are dependent on a lot of different settings, and bringing down one chemical substance from the exhaust gas is possible, but the effect is that it brings up others. And in the case of Diesel engines low exhaust emissions also mean higher fuel-usage. The miles-per-gallon ration decreases.

Second, the conditions in the real world are very different. People drive cars very differently. The roads, climates, and seasons cars are driven change all the time. How heavily loaded the car is varies, and fuel quality comes within a range. If the engine is cold or warm influences emissions hugely, stop and go city traffic versus driving on the highway as well. And then when your last maintenance was and what the mechanics did make every car unique.

When you test it in a facility you also use a standard fuel, which the labs have analyzed before and make the car’s emission comparable to other cars. In other words, testing emissions is a bit of dark art. And the differences between test and real-life conditions are significant.

What went wrong?

Nowadays the existing fuel burning technology is at a stage where the big gains are not possible anymore. Like with other areas, it’s been easy to get the first 80% right, but doing the next 20% takes way more effort. Unless you find a disrupting technology, reducing emissions significantly more becomes more and more costly. And from a chemical point of view, you’ll never make exhausts go away.

Why now did Volkswagen not invest into finding disruptive technologies? That phenomena is know as the sunken cost fallacy. Too many resources had been invested over the years to make Diesel engines efficient and environmentally friendly. Those investments are in the books and have to be earned. Milking the cow is what big companies are good at. Managers are trained and incentivized to scale and execute, but not on how to disrupt and innovate.

Although Volkswagen spends a large amount on R&D, the innovative output is not what you’d hope to get. In 2014 Volkswagen spent $13.5bn on R&D, which makes it the top spender, but it did not translate into the perceived or real innovation impact that one would expect.

This may be very likely a reason why Volkswagen managers hang on to Diesel engines and try to come up with ways to get them on the road. And somewhere along the way some important people thought that a cheat-software is a good option to go. I have spoken on Evil Creativity in the past, but VW’s approach has been really really stupid.

What will it cost?

The amounts that are now being thrown around that VW will have to pay in damages are looking astronomical. Alone the punitive fine in the US could reach $18bn. The class action lawsuits by VW car owners filed due to the loss of resell value, misleading the believe that they bought an environmentally friendly car, the subsidies that VW received in some US states for their plants, the class action lawsuits to be expected from shareholders and the history of multiplying the fines for frauds are indicating already now billions more that Volkswagen faces. And this is only the US. The European Union opened investigations, Australia asks for answers and this goes beyond the 500,000 vehicles in the US, but we look at more than 10 million vehicles worldwide.

Don’t forget that the brand image is severely damaged. Volkswagen had a long history of a friendly brand image with their iconic VW beetle and VW bus. When I drove behind a brand new VW golf yesterday on highway 101 in San Francisco, I couldn’t stop thinking of “What an unlucky guy. He just bought the car and now he must be really feeling bad.” And I am saying that as somebody who grew up with Volkswagen. My parents had three models in my childhood, I had one in Germany. And I am generally happy when I get one as a rental car. Reliable, friendly, just as you want a car. This feeling has gone.

The stock price is a reflection of that: From a high this year of $120bn the market cap dropped the last few days to $55bn. Given the output of nearly 10mio cars per year and a revenue to comes over $200bn annually, the company stock is very low. Given what is coming towards VW it may be way to high. We are talking here $30-$50bn in fines and even more in collateral damage on the brand and image of German companies that VW inflicted.

Just to put this in relation: the market cap of electric car manufacturer Tesla is currently at $34bn. Tesla currently produces around 25,000 cars per year, a long shot from the 10mio that VW manufactures.

What could have been done?

Given the profit that VW had in the past, it would have been cheaper (and much wiser) to invest in really innovative technology instead of fraudulent activities. The short term thinking of the Volkswagen management has made them believe that saving a few hundred million dollars in added technology through a fraudulent code will get them through. And VW may not be the only company as we are hearing now. BMW is also under investigation now.

How is Volkswagen reacting? Well, first their CEO Martin Winterkorn – who just had won a power-struggle with Ferdinand Piëch – had to resign. And today VW nominated Matthias Müller – current Porsche CEO – as the new VW-CEO. The same Matthias Müller who just a week ago was quoted in the German auto motor und sport magazin on innovative technologies with this sentence: “I am always wondering how a programmer can decide whether a self-driving vehicle is crashing into a truck on the right side or into the small car on the left.”

Certainly we have the benefit of hindsight. But if one thing is clear: it’s always a better strategy to innovate and disrupt from within than letting others disrupt you. Given the money that VW has this should have been a no-brainer. The Stanley was the first autonomous vehicle operated by a Stanford University team and it was built on – guess what – a Volkswagen.

The nomination of Matthias Müller as the new VW CEO doesn’t give a signal for the future. A manager made and soaked within the VW culture, who has shown an adversity to innovation, and whose outstanding quality in the VW group has been – according to Spiegel Online – “having made not really enemies.”

Conclusion

While the scandal is still unfolding and may take down other car manufacturers as well, there is one big lesson: Innovation Angst will kill your company sooner or later. We are witnessing the implosion of at least one iconic brand. There are many smart people at Volkswagen, but together they can act really stupid. That’s a wake up call for every company that spending money on innovation and creating an innovation culture is much much cheaper in the long run.

The good thing: innovation and creativity can be learned, but it takes the will and understanding to do so. And a culture that’s based on making an honest impact on the world and not making money through cheating.