Operational risks and opportunities

For this risk category, the likelihood of occurrence is classified as medium (previous year: high) and the potential extent of damage is classified as medium (previous year: medium).

The most significant risks from the QRP lie particularly in our procurement markets and in the area of quality.

Supply chain risks

Our products and services depend on a complex global supply chain that we need to manage.

Our production depends on the quality of the parts, components, subcomponents, commodities and other materials, as well as reliable and timely delivery by suppliers. The transformation of the automotive industry towards e-mobility adds further risks in our supply chain.

The industry-wide transformation towards e-mobility and the associated restructuring of supply chains has in the past led and could in the future again lead to bottlenecks in supplies and price increases of certain critical materials (e.g. lithium, rhodium or cobalt) and subcomponents (e.g. semiconductors) that could limit us from scaling new technologies profitably. The technological transformation will require significant changes to our supply chain, as we increasingly source parts and supplies designed for new technologies, which also requires finding and developing constructive relationships with new suppliers. Such planned changes are usually challenging. We continuously analyze and assess trends in raw materials and demand on an interdisciplinary basis to enable steps to be taken at an early stage in the event of potential bottlenecks.

We generally source automotive parts and components from several suppliers, however, in some cases, we depend on one or a few suppliers for the delivery of certain parts, components, subcomponents and other materials and therefore face increased risks should the suppliers not fulfill delivery obligations. For example, supply risks arise particularly in the area of battery cell production due to the dependence of automotive manufacturers on a limited pool of suppliers, technological developments and the service life of battery cells. To counter these risks, the Volkswagen Group maintains multiple strategic supplier relationships while extending the scope of its own activities along the value chain, for example with regard to raw material extraction or cell production, at the same time.

Commodity risks can be partially mitigated through backward integration of the value chain. We use partnerships and long-term supply agreements with commodity suppliers, for example, to ensure the supply of the relevant material while also achieving competitive prices.

There is a risk that a potential supply breakdown may not be recognized early enough and that countermeasures may not be initiated in time to maintain adequate production levels.

A significant shortage of a key component within our supply chain or the supply of components that are not in accordance with our specifications has in the past disrupted, and may in the future disrupt our operations or increase our production costs if such components cannot be readily sourced from a different supplier within a reasonable timeframe. Suppliers have, on occasion, been unable to deliver components in a timely manner or in accordance with agreed specifications. This may also occur in the future due to range of factors including production issues, limited availability of materials, shipping problems, restrictions on transactions with certain countries or companies, geopolitical tensions, natural disasters, escalation of hostilities and the increased frequency of climate-induced extreme weather events.

Financial distress of individuals in the supply chain, highlighted by the industry’s transformation towards e-mobility, has resulted and may result in some of our suppliers experiencing financial distress or filing for insolvency which could lead to delivery bottlenecks and prices and cost increases. Suppliers are further challenged by surging commodity, energy and personnel costs, as well as increased financing expenses and tighter lending conditions, which constrain their ability to invest in new projects or expand capacity. Procurement employees specialized in restructuring and supply reliability constantly monitor the financial situation of our suppliers throughout the world, taking measures designed to counter the risk of possible supply disruptions.

The supplier risk management department in Procurement at the Volkswagen Group evaluates in particular the financial situation of suppliers, before they are entrusted with the implementation of projects. Procurement takes into account the recommendations of the supplier risk management department.

Additionally, if vehicle sales decline significantly across the automotive market, competition in the automotive industry will increase, potentially harming the financial stability of some of our suppliers.

Supply risks should be identified in Procurement by means of early warning systems, and task force and mitigation structures to reduce these risks. In addition, strategic measures are to be taken to avoid future impacts in the long term. Moreover, measures to counteract further risks include comprehensive safety and emergency response concepts such as fire prevention, property protection, hazardous goods management and task forces, and we take out corresponding insurance coverage where this makes economic sense.

Procurement costs and raw material risks

Prices of certain raw materials we require have been and continue to be highly volatile.

Increases in prices for commodities, raw materials, subcomponents, energy or other inputs as well as personnel costs that we and our suppliers use in manufacturing products, systems, components and parts, such as steel, precious metals, non-ferrous metals, critical minerals or other similar raw materials, or increases in logistics and related costs, have led and may continue to lead to higher production costs for parts, components, subcomponents and vehicles. More specifically, elevated cost, or reduced availability, of critical materials for our EV propulsion systems, including lithium, nickel, cobalt and certain rare earth metals, could lead to higher production costs for our EVs and could impede our ability to successfully deliver on our EV strategy.

Bottlenecks in the producing countries can lead to shortages of raw materials and energy or price fluctuations.

Trends in raw materials and demand are continuously analysed and assessed on an interdisciplinary basis to enable steps to be taken at an early stage in the event of potential bottlenecks.

Supply chain compliance

As a result of complexity of our supply chain we face social obligations and both we and our suppliers are required to adhere to a range of legal and human rights obligations globally. Failure to meet these requirements, by us or our suppliers, may result in significant fines, penalties, damages, or other materially adverse consequences.

Social or environmental issues may lead to financial costs, reputational harm, or supply instability. The complexity of our products and reliance on suppliers increase our risk if suppliers fail to meet human rights or environmental rights obligations. This risk is particularly significant when sourcing metals for electric vehicle batteries from countries with low sustainability standards and weak enforcement of labor and environmental laws. Compliance with such regulations has previously required, and may continue to require, us to allocate resources to the analysis of our supply chain. Future legislation can also increase financial risks due primarily to fines, import restrictions or exclusion from public procurement tenders.

To address these risks, we conduct gap analyses to compare legal requirements with existing processes and develops measures to close identified gaps. In 2022, we implemented a Responsible Supply Chain Management System designed to identify, prevent and mitigate human rights, social and environmental risks throughout the supply chain. This system is based on risk analysis and includes both preventive and reactive standard measures as well as deep-dive measures, such as the Human Rights Focus System, the Raw Materials Due Diligence Management System, and collaboration with external partners to advance sustainability within the supply chain.

There is no assurance that our suppliers will always adhere to these standards or that we will always be able to identify and rectify any violations. A breach could result in supply shortages, delivery delays for affected vehicles, reputational harm and possible legal penalties.

Business interruptions

Unforeseen business interruptions to production facilities may lead to production bottlenecks or downtime, and deviations from planning in connection with large projects may hinder their realization.

We have numerous production facilities worldwide and rely on the international network of our suppliers. Both our production facilities and those of our suppliers may experience disruptions or interruptions in their operations.

Disruptions can be caused by external physical risks – such as extreme weather events like floods, droughts, severe storms and heatwaves, or the release of environmentally or health-hazardous substances. At several sites, the Volkswagen Group has already examined the specific exposure to climate hazards and has taken countermeasures. In the coming years, the effectiveness of these countermeasures will gradually be analyzed at additional production sites. The Group’s own assets are secured with appropriate insurance policies. These policies are regularly reviewed and adapted to changing risk situations in collaboration with insurers.

Additional risks of interruption might arise from social and political changes, such as workforce availability, epidemics/pandemics, sabotage, or regulatory changes. These could cause operational issues that lead to regional, national, or international restrictions on our business activities or those of our suppliers, potentially resulting in reduced production output or temporary shutdowns at our sites. Countermeasures and precautions are implemented in line with risk management principles to mitigate each identified risk.

Disruptions to our operational capability may also result from the failure of critical infrastructure or from issues within the external part of the production network. The supply of electricity and other energy sources, water, components, services and stable data connections are necessary for uninterrupted production. The Volkswagen Group addresses these risks through measures to lower consumption and by increasing flexibility in the use of raw materials, provided this is economically viable. In addition, we prepare compensatory measures, such as an optimal allocation of resources, between locations that should reduce the economic effects of risks for the Volkswagen Group as a whole.

Furthermore, internal factors such as machine failures, system malfunctions, or human error can also affect production. Our comprehensive preventive maintenance concepts and emergency response concepts should prevent these failures or mitigate their impact.

Production capacity

We might not be able to adjust our production capacity sufficiently and in a timely manner in response to certain scenarios.

Fluctuations in overall or specific vehicle demand require regular adjustments to production capacity across our global facilities.

Excess capacity in global automotive production may result in increased inventories and tied-up capital, and, if demand for vehicles and parts declines, the Volkswagen Group may be forced to adjust capacities or intensify sales measures, presenting risks that could entail additional costs and increased pricing pressure.

Production capacity for each vehicle project is planned several years in advance based on expected sales developments. A significant change of demand for vehicles or their features could require adjustments to our production capacity. An unforeseen and prolonged decline in demand, resulting in excess capacity, might lead to restructuring measures or even site closures. Any inability to adapt production capacity adequately or in a timely manner might lead to inefficient utilization of our production resources. Overestimating demand could leave capacity unused, while underestimating might cause shortages and unmet customer needs. To mitigate this risk, an initial investment can be directed toward a defined minimum number of units, allowing the remaining planned units – or even additional units – to be financed flexibly as needed. Another option for preventive risk minimization is the use of the turntable concepts, in which the workload between production sites can be balanced.

If demand fluctuations exceed our organizational and technical flexibility, we or our suppliers might not be able to adjust production capacities in a timely and sufficient manner. This might result in higher overall costs. In addition, in certain scenarios we might not be able to adjust production capacity as planned for political, regulatory or legal reasons.Measures, such as the closing or relocation of production facilities, could lead to significant one-time costs.

The transition from conventional combustion engine vehicles to electric vehicles could lead to temporary capacity underutilization, particularly in cases where the transformation towards e-mobility occurs unevenly. The international production network enables us to respond flexibly at the sites and adjust capacity utilization between production facilities by means of turntable concepts.

Complex processes and technical systems associated with the variety of models and shorter product life cycles have contributed to an increased risk of production start delays for vehicles in recent years. We address this risk by drawing on the experience of past production starts and identifying weaknesses at an early stage to ensure – to the highest degree possible – that production volume targets and quality standards are met during the start of production of our vehicles throughout the Volkswagen Group.

Regulatory framework changes could impact production by temporarily narrowing the range of available products, which may concentrate demand on specific variants. Additionally, model variants that have not been registered could result in production interruptions. In such cases, until official registration is granted, production can be stabilized by producing and temporarily storing vehicles, including customer-specific vehicles. The resulting tied-up capital and the availability of storage areas are limiting factors.

Moreover, a slow outflow of completed vehicles might create a backlog, thereby restricting the number of production units. We counteract this risk through targeted measures, such as the short-term procurement of additional transport capacities or external storage capacities. Preventively, the risk is mitigated through the early contractual commitment of transport capacities.

Ability to maintain high quality

Our performance is, in part, dependent on complying with quality and safety standards such as safety and security for our employees, emissions or environmental standards, meeting customer expectations and maintaining our reputation for designing, building and selling safe, high-quality vehicles.

We aim to detect and resolve quality issues early in product development to prevent malfunctions and production delays. Due to the increasing use of modular components in our platform strategy, it is essential to quickly identify and rectify any malfunctions.

If internally or externally sourced parts, components, or functions do not conform to our specifications, this may require additional time and cost to address, potentially resulting in violations of safety and other regulations, customer complaints, litigation, penalties, fines, waste disposal orders, and recalls, any of which could also adversely impact the Volkswagen Group’s reputation. Additional challenges related to quality and safety arise in countries such as US, Brazil, India and China where we develop country specific-vehicles or rely on local suppliers and manufacturers due primarily to among others, local laws and regulations.

Failure to maintain effective quality management could lead to the loss of various certifications, which may in turn result in the withdrawal of type approval from certain authorities.

As part of system audits that include a conformity of production (CoP) component, we evaluate the compliance of series products at vehicle manufacturing facilities. Additional risks may arise from discrepancies detected during conformity of production assessments or in-service conformity (ISC) measurements.

Given the global nature of our business, these standards and expectations may vary across the markets in which we operate. In order to maintain high quality standards for our products and to comply with complex government-prescribed standards, we incur substantial costs for monitoring and quality assurance.

Failure to meet or adhere to required vehicle safety standards or applicable regulation or breach of applicable safety standards or regulation by our products or components or by components sourced from suppliers or by components or designs we supply to third parties could result in fines, penalties, other claims or liabilities. In such a case, we may be required to or voluntarily decide to recall vehicles years after a vehicle’s sale. Product recalls may also harm our reputation, force us to halt the sale of certain vehicles and cause consumers to question the safety or reliability of our products. Further, failure to provide adequate support to the customer in the event of issues or during product maintenance could result in warranty and goodwill claims. Moreover, several countries have implemented special, and in some cases continuously new, regulations aimed at protecting customers in their interactions with vehicle manufacturers, which might increase our compliance costs.

Furthermore, with vehicles becoming more technically complex through greater connectivity and shared platforms and toolkit systems in use across brands, ensuring the quality of supplied parts and software is increasingly important.

Quality problems may necessitate technical measures involving a considerable financial outlay where costs cannot be passed on to the supplier or can only be passed on to a limited extent. While we strive to identify and rectify quality problems at an early stage during the development of our products, we face risks for delays to the start of production. As we are using an increasing number of modular components as part of our platform strategy, it is particularly important when malfunctions do occur to identify the cause quickly and eliminate the faults. Nonconformity of internally or externally sourced parts, components or functions may necessitate time-consuming and cost-intensive measures, leading to recalls and therefore damage to the Volkswagen Group’s image.

We recognize appropriate provisions for warranty and goodwill cases. Nevertheless, it cannot be ruled out that recalls and field measures will lead to additional expenses.

Product quality significantly influences consumers’ decision to purchase vehicles. Customers increasingly demand that we assume the costs of repairs even after the guarantee period has expired.

To meet our customers’ expectations and minimize warranty and ex gratia repair costs, we are continuously optimizing the processes at our brands with which we can prevent potential quality issues. We have established quality processes so that the Volkswagen Group brands and their products fulfill all respective applicable requirements and local authorities receive timely notification of all issues requiring reporting. In this way, we reduce the risk of customer complaints or other negative consequences. For example, we have established the Ausschuss Produktsicherheit (APS – Product Safety Committee) to assess and address product safety risks, with responsibilities and processes defined in Group policies and implemented by individual brands and companies. The APS investigates safety defects, legal compliance concerns and quality issues, and manages related authority inquiries, while the Car Security Board (CSB) supports on cybersecurity matters. Central departments handle incoming reports on APS and CSB topics, using a transparent management and tracking system to monitor cases through to APS decisions without employee involvement. Regular training and events are held to raise awareness of safety risks and legal compliance, and the APS process is subject to ongoing internal and external audits to ensure compliance and minimise risks in decision-making.

Furthermore, we constantly analyze the conditions specific to each market and adapt our quality requirements to their individual needs. We counter the local risks we identify by continuously developing measures and implementing them locally, thereby preventing quality defects in the supply chain from arising.

We counter the risk of losing various certifications by continuously training the Volkswagen Group’s system auditors, while our quality management system and process quality undergo internal audits.

Additionally, we have established a system for monitoring the conformity of CoP and ISC measurements for manufactured vehicles. To achieve that the results of the emissions CoP and ISC measurements are analyzed systematically, we have implemented an IT system throughout the Volkswagen Group. This is used for status reporting and documenting the results of the series of measurements.

IT infrastructure risks and opportunities

Our ability to keep our business operating effectively depends on the functional and efficient operation of our information, data processing and telecommunications systems, including essential functional processes such as our vehicle design, manufacturing, inventory tracking, billing and payment systems, as well as other central information systems and applications, employee workstations and other information technology (IT) equipment.

These processes cannot be carried out without properly working IT systems and IT infrastructure. The IT infrastructure is adapted to existing requirements and future developments. In doing so, we also take into account the growing demands on data capacity. Our vehicles, processes and industrial facilities are becoming more computerized and increasingly connected to external cloud-based systems.

Our systems, infrastructure and applications along with the systems of our suppliers/service providers, may be vulnerable to damage, disruptions, or shutdowns caused by attacks from hackers and by artificial intelligence, computer viruses, or breaches due to errors or malfeasance by employees, contractors and others who have access to these systems and applications or otherwise be subject to IT downtime or other interruptions. Further, software and hardware of some of Volkswagen’s established IT systems might no longer be supported by their vendors, which could increase the difficulty of ensuring that they continue to operate properly and securely. Any such occurrence could compromise the operational integrity of these systems and applications and could result in data theft, loss of proprietary data, unauthorized access to, modification and extraction of sensitive electronic corporate, customer or employee data, interruptions or delays in our business operations, reputational damage, or damage to our financial performance and to our relationships with customers and suppliers, legal claims or initiation of legal proceedings, or regulatory sanctions as well as limited systems availability as a consequence of downtime.

New vehicle and software development requirements are also the focus of increasing cybersecurity guidelines and standards in the EU, the United States and China. Materialization of any of the IT risks such as unauthorized access to our IT systems, modification and extraction of our data or significant downtime of our IT system could negatively affect our brands and reputation.

We maintain high standards in data handling for both customers and employees, considering cyberattacks as a significant threat. Regulations such as UNECE R155 and data protection regulations guide our vehicle and software development, impacting IT systems and prompting interdisciplinary protection efforts supporting system security, transparency, autonomy and customer safety.

We manage IT risks by using state-of-the-art IT security technologies, defined incident response processes and strict access controls, including recurring identity checks and centralized administration. Backup strategies and system redundancies counteract data loss or service disruptions, informed by business impact analyses. Risks are regularly assessed and reported to top management, especially for critical systems and sensitive data.

An oversight committee, including Information Security, Data Protection, Legal Affairs and other stakeholders, manages information security and reports directly to the Board of Management. Technical measures are reinforced through employee training, awareness programs and crisis simulations. Our IT landscape is protected by state-of-the-art, market-standard technologies, with ongoing standardization and updates to ensure future readiness.

Continuously increasing automation enhances process reliability and the data quality within the process.

The further development and Group-wide use of IT governance processes, particularly the further standardization of the risk management process for IT and information security, also help to identify weaknesses at an early stage and to reduce or avoid risks effectively.

Another focus to reduce risks on IT infrastructure in the reporting year was the continuous advancement of Group-wide security measures to detect and respond cyberthreats. Artificial intelligence is playing an increasingly important role in this context.

In-vehicle IT systems risks

Any unauthorized control or manipulation of our in-vehicle systems could impact the safety of our customers and reduce confidence in our products.

Our vehicles contain increasingly complex IT systems controlling various vehicle functions including engine and battery, transmission, safety, steering, navigation, acceleration, braking and window and door lock functions. These in-vehicle systems could also be impacted by, or a cybersecurity incident might result from, the negligence or misconduct of insiders or third parties who have access to our networks and systems.

Hackers have in the past attempted, and may attempt in the future, to gain unauthorized access to modify, alter and use such systems to gain control of, or to change, vehicles’ functionality, user interface and performance characteristics, or to gain access to data stored in or generated by the vehicle. These disruptions are likely to increase in terms of sophistication and frequency as the level of connectivity and autonomy in our vehicles increases as well as a result of the development of the cybercrime and -espionage sector.

We might rely on third parties for connectivity and automation technology and services, including for the collection of our customers’ data. These third parties can unlawfully resell or otherwise misuse such information, or suffer data breaches.

A cybersecurity incident, unauthorized access to or control of our vehicles or their systems or any loss of data, or undiscovered software flaws or other malfunctions, could impact the safety of our customers or security of their private data, reduce confidence in our products, or result in legal claims or proceedings, liability or regulatory penalties.

The Volkswagen Group is continuously enhancing its Automotive Cyber Security Management Systems across all brands to better monitor and manage cyberattack risks. By harmonizing processes and sharing information, it shall be ensured that the Volkswagen Group can respond rapidly to incidents and prompt resolution of vulnerabilities. This integrated approach not only protects customers and products but also ensures compliance with UNECE cybersecurity regulations.

Reputation and brand image risks

The image of the Volkswagen Group and its brands is one of the most important assets and forms the basis for long-term business success. Our attitude and strategic orientation with regard to issues such as integrity, ethics and sustainability may face close public scrutiny. Issues in relation to misconduct or criminal acts by individuals and the resulting damage to our reputation can never be completely prevented. Media reactions could adversely affect the image of the Volkswagen Group and its brands. However, our transparent communication and effective crisis response strategies help mitigate the impact of negative media coverage.