Why Volkswagen is expanding into car-sharing, a notorious loss-making business

Volkswagen hopes to avoid gargantuan EU fines potentially running into the billions in part by foisting expensive electric vehicles onto one reliable customer that won’t balk at the price: itself.

The world’s largest automotive group plans a major rollout of WeShare—a car-sharing program born in Berlin—to an additional seven European cities this year including Paris, Madrid and Milan. VW estimates the market in Germany could grow 16% annually to 3.84 million users alone come 2022.

The numbers aren’t all that big, but what makes VW’s scheme so important is that all 8,400 cars planned for the car-sharing platform would run exclusively on batteries. Company officials see “zero-emission” carsharing fleets as a somewhat easy sell to smog-battling municipal authorities who nonetheless have to approve hundreds of new cars potentially clogging up city centers and occupying valuable parking places.

It also means these EVs could help Volkswagen stay within new EU-wide carbon caps that went into effect this month, and avoid those big penalties. Under the EV car-sharing plan, it would count the shared cars as new vehicle registrations.

“You need to find clever ways like this to get these vehicles registered for CO2 purposes, so it’s an interesting idea,” said Stefan Bratzel, Director of Germany’s Center of Automotive Management. “Not to mention the more people that see electric cars on the road, the more it boosts acceptance of the technology over time.”

Strictest emissions rules anywhere

To meet a new EU law, Volkswagen needs to reduce its European fleet emissions to roughly 100 grams per kilometer this year, and to 95 g/km in 2021—at least on paper, the most stringent such legislation to be found anywhere. The latter corresponds to a fuel-efficiency rating of 4 liters of gasoline per 100 km, or roughly 57.5 miles per gallon.

In 2018, the latest year for which VW has published figures, its European fleet emitted 123 g/km. Under the current emissions system it would stand to pay over 8 billion euros every year in fines were it to take no action. The trend hasn’t been helpful either. Emissions have been rising, not falling, since 2016 as an industry-wide slump in diesels shifted demand toward more carbon-intensive gasoline cars.

Volkswagen’s answer has been to shift to EVs. But battery-powered cars still comprise less than 2% of the European market even after sales doubled during the first nine months of last year.

Uptake of the technology closely correlates with higher wealth. According to the European auto industry association ACEA, more than 80% of EV demand is concentrated in just six countries, all with some of the highest GDP per capita.

The Netherlands alone accounts for a quarter of all charging points in the EU at 37,000 versus just 125 for Romania, despite the latter being nearly six times larger in area.

A major concern among carmakers is therefore whether enough customers will want to drive out of showrooms in an EV due to the substantially higher price tag, limited range and patchy charging infrastructure. One key side benefit of VW’s plan is it might spark greater interest in the environmentally friendly powertrain, in which it has invested billions.

“In a way you can think of carsharing as a paid test drive, and if you can combine that with customers getting behind the wheel of an EV, then you kill two birds with one stone,” Bratzel told Fortune. After all, the target demographics of carsharing users overlap heavily with those of EV buyers—young, urban and digitally-savvy.

In a survey published last week, McKinsey found that consumers respond best to an EV’s driving performance such as instant acceleration. The consultancy firm recommends carsharing as a tool to expose a reluctant public to the advantages of the technology. “The first test drive in an electric car is for many a real a-ha! moment,” argued associate partner Patrick Schaufuss in the study.

The economics of car-sharing

Trying to meet CO2 targets by inflating carsharing fleets does have its downside. Unlike ride hailing, it’s an asset-heavy business requiring considerable startup capital, one prone to substantial losses as operators chase growth.

As long as a vehicle sits dormant waiting for a fare rather than productively earning money for the owner, it just accumulates depreciation charges. As a result, carmakers have been reluctant to publish the full set of financials.

Months before VW launched its Berlin pilot last June, close rivals Daimler and BMW combined their carsharing fleets last February into one encompassing unit with over 20,000 cars serving four million customers in 30 metropolitan areas.

By joining forces, the duo hoped to save costs while expanding the business. But results thus far have disappointed. Come March, their fleets in London, Brussels and Florence will cease to operate, and the two will exit North America entirely. As a result of this retrenchment, Daimler reported last week that cumulative write-downs on its 50 percent stake in their umbrella joint venture Your Now stood at 600 million euros already, and said it was open to new investors.

Perhaps that is why Volkswagen is taking a cautious approach. Volkswagen told Fortune that it had abandoned plans to hike the price it charges for Berliners who opt to use its carsharing program WeShare by half, to 29 cents per minute. Around three-quarters of the 50,000 users that have registered are considered active, but that only means they’ve used the service once in the past three months.

“Initially carsharing is a real money pit of course, and I don’t believe it will be a profitable business in the coming years. But it’s a simple calculation for automakers,” explains CAM’s Bratzel. As long as VW’s running costs for each EV sold to their carsharing fleet are lower than potential fines, then the equation works.

If that fails, there’s another substantial customer group that VW could call upon for help. “If need be, it can also get its own employees to lease these cars as well,” he said.