VW emission recall could be the most expensive ever

Most car recalls are pretty straightforward: The automaker notifies the car owner, who takes the vehicle to a dealer and gets it fixed at the automaker’s expense. Case closed.

Volkswagen (VOW3.DE) has a much more complicated problem. It hasn’t issued a recall yet for nearly 500,000 turbodiesel models in the U.S. with “defeat devices” that shut down emission controls during normal driving. But it almost certainly will. The government won’t even let VW sell new models with the device until it fixes the problem, which has exploded into a scandal likely to involve hefty fines, lawsuits and possibly criminal prosecution.

It will take months or years to calculate the total cost of the problem to VW, but it could easily become the costliest car recall ever. Automakers don’t usually reveal the total damage from safety or regulatory problems, but VW has already set aside $7.2 billion to deal with recalls, fines, litigation and other costs resulting from what appears to be a deliberate effort to deceive regulators and customers. “That might be on the low side,” says Neil Steinkamp, a managing director at Stout Risius Ross, an auto-industry financial advisory firm. “This isn’t like a typical safety recall. It will be much harder.”

General Motors (GM) still hasn’t resolved all the problems relating to last year’s sprawling ignition-switch defect, but Morningstar estimates the total cost will be $7 billion or less. Toyota (TM) didn’t break out the cost of its 2011 recalls involving sudden acceleration, but analysts estimate the tally hit around $5 billion in fines, recall expenses, lost sales and lawsuits. The controversy involving Ford (F) Explorers equipped with Firestone tires in the late 1990s cost Ford about $3 billion. As automakers become more global, it seems, the costs grow higher when something goes wrong.

VW’s emission evasion will be costly because it can’t just send owners in for a new part or software upgrade, and call it a day. While the specifics aren’t yet clear, it seems likely that turning on the emission controls, which might be a simple modification in itself, will degrade the performance and fuel economy of the vehicles in question, making them more sluggish and less efficient. Given that VW’s turbodiesels, known as TDIs, tend to appeal to motoring buffs who care a lot about performance, VW could face a customer revolt.

VW is still determining how to fix the problem, but here are some ways it may try to make owners whole, in addition to modifying the cars so they comply with the law:

Offer owners “convenience repairs.” These would be free services, such as changing fluids, replacing wipers or rotating tires, that TDI owners would get at the dealer when they bring their car in to be fixed. The idea is to build goodwill so people most affected by the recall find a reason to feel good about their cars and stick with VW the next time they buy one. But if the recall causes a sharp drop in the value of affected models, a few modest freebies probably won’t appease owners.

Offer monetary compensation. Ford, Hyundai and Kia had to pay buyers after they got caught overstating fuel economy on models such as the Ford C-Max, the Hyundai Elantra and the Kia Soul. The amount was fairly easy to determine, by calculating the difference between claimed and actual MPG, then multiplying that by miles driven and the price of gas. Rebates came in the form of gift cards or lump-sum payments and ranged from about $325 to $667. It could be a lot harder to calculate a payout, however, where something as subjective as wheel feel is concerned. “How do you put a dollar figure on the smile on a driver’s face?” says Eric Lyman of research site TrueCar.

Offer to buy back vehicles. This could be very expensive, but it might be the most thorough way to earn back the trust of VW customers -- and placate regulators. And there’s precedent. Fiat Chrysler (FCAU)  recently negotiated a deal with the government involving fire-prone vehicles from 1993 to 1998, which required the automaker to offer to buy the affected vehicles back from customers at market price plus 10%. Other Fiat Chrysler recalls negotiated as part of the same deal include discounts up to $2,000 (on top of any other offers) on new Fiat Chrysler models for owners who trade in one of the qualifying recalled vehicles.

All of the above. “I think it will end up being a combination of these things,” says Steinkamp. “They have to rationalize what they’re willing to spend to maintain relationships with current VW owners and make sure they don’t switch to other manufacturers.” VW may also be better able to limit the impact of class-action lawsuits if they can demonstrate they’ve already compensated owners for economic losses.

Automakers seem to have learned from the mistakes of their competitors during high-profile recalls. The lessons for VW from GM, Toyota, Ford and others: Don’t appear combative. Take customer complaints seriously. Offer substantial -- not token -- compensation. And get all the bad news out at once instead of letting it dribble out indefinitely.

There’s one factor VW has on its side: Consumer apathy. Only about 65% of cars that are recalled actually get repaired, and that can be far lower when the problem isn’t related to safety. States such as New York and California that do regular emissions testing will be able to withhold certification for vehicles that don’t have a fix installed by VW, once it’s available. But in states that don’t do emissions testing, there may be no mechanism for forcing owners to have their cars modified in ways that might make them greener, but less fun. What happens between VW and its customers might just stay between them.

Rick Newman’s latest book is Liberty for All: A Manifesto for Reclaiming Financial and Political Freedom. Follow him on Twitter: @rickjnewman.