(FORTUNE Magazine) – VOLKSWAGEN is starting to show its old zip again. Just two years ago the once indomitable West German builder of the Beetle was spinning its wheels. But in 1985, thanks largely to the success of its new Golf, VW scrambled to first place in the crowded European car market for the first time. U.S. sales rose 25%. Profits more than doubled. And while most European carmakers are saddled with excess production capacity and too many workers, VW has put on 18,000 new workers and plans to continue Saturday shifts through May to catch up with orders for hot-selling new models. Says Carl H. Hahn, 59, chairman of VW's management board, ''We haven't begun to realize our potential.'' Hahn intends to use 1985's impressive turnaround as a platform to launch Volkswagen on a third major postwar surge. He wants to restore the company's reputation for engineering excellence while reducing costs and boosting output and sales in Europe. The centerpiece of VW's new strategy is Hahn's insistence that Volkswagen cars offer superior performance for the price wherever in the world they are produced. ''Our competitive edge is our German engineering tradition,'' he says. ''We tended to bury that in the past by trying to bend to what we guessed local tastes wanted. A Volkswagen has to stand for technically advanced transportation.'' To help rebuild its position as a maker of economical subcompact cars, Volkswagen in February bought 51% of the state-owned Spanish carmaker SEAT (pronounced say-ott). Along with VW's plants in other low-cost manufacturing centers such as Brazil and Mexico, Hahn wants to use the Spanish operation to help cut prices and boost profit margins in its major markets in Europe and the U.S. Over the next five years, Hahn has earmarked some $13 billion for capital investment outside West Germany. Cash flow is strong. VW has nearly doubled its cash hoard to $3.7 billion since 1983. Volkswagen was one of the most profitable of Europe's mass car producers in 1985. But Hahn's goal is to lift earnings from 1% of sales to a level roughly equal to major American and Japanese competitors, about 3%. In a sense, Hahn was born to the job. The son of a co-founder of a company that later merged to form Audi, a Volkswagen subsidiary since 1965, he was educated at a Swiss university and worked for a time as an economist in Paris. He joined Volkswagen in the mid-1950s as the protege of VW's strong-willed boss Heinz Nordhoff, who put him in charge of VW's U.S. operations during the Beetle's salad days of the early 1960s. He returned to headquarters in Wolfsburg to direct worldwide marketing, but left in 1972 to head Continental Gummi-Werke, a money-losing West German tire company that he transformed into a profitable industry leader. He was summoned back to head the VW board when predecessor Toni Schmucker was stricken with a heart attack and forced to resign. Tall, trim, and patrician, Hahn speaks English, French, and Italian with nearly native ease. A wan smile manipulated by a slight twitch of his thin lips can convey either satisfaction or scorn, but his eyes are alive with winks that exude cheerful camaraderie. He knows how to sidestep the rigid bureaucratic culture that often plagues large German companies. ''As a young executive in America,'' he recalls, ''I learned to do what was necessary for the company to succeed first, and tell the people back at headquarters why I was right later. I've had a chance to see VW from the outside twice in my career, and I try to keep in mind what it looks like from that perspective.'' He has an American wife, Marisa, whom he met and married in San Francisco, and four college-age children. Three were born in the U.S.A. and help remind him that VW's world doesn't begin and end in Wolfsburg. Rearranging Volkswagen's world outside Wolfsburg has been Hahn's chief preoccupation. Back in the Beetle era, VW's task was beautifully simple. Build a sturdy car in Germany and send flotillas of Bug-infested boats to America, where economy-minded drivers loved its low price. Witty ads celebrated the homeliness of the Beetle's shape as camp beauty. In 1968 sales topped 400,000 cars, making VW the unrivaled king of the U.S. small-car market. That strategy went off the track in the early 1970s. German labor costs soared and the end of fixed exchange rates raised the value of the mark. Instead of a funny- looking cheap car, the Beetle became a funny-looking relatively expensive car, and technically backward to boot. Cheaper Japanese imports offering snappier styling began to cut deeply into the Bug's market. To remain competitive, Volkswagen rolled out the Golf, or Rabbit as it was called in the U.S., in 1974. In German Golf means gulf as well as golf. Volkswagen says the name was derived from Golfstrom (Gulf Stream). TO GET COSTS DOWN, Volkswagen pushed off shore. Hourly pay for German auto workers overtook U.S. rates in the late 1970s. VW expanded production in Brazil and Mexico to make greater use of cheap labor. With Wolfsburg's blessing, local managers tailored Volkswagen cars to the local tastes. By 1979, VW had grabbed nearly half the Brazilian market. But as hyperinflation racked Brazil and Mexico veered toward economic collapse, both markets evaporated, saddling VW with around $250 million in cumulative losses between 1979 and 1983.

For the U.S. market, VW invested some $750 million in a plant in Westmoreland County, Pennsylvania. The second oil-price shock lit a fire under small-car sales in the U.S. and kept the Westmoreland plant breeding American Rabbits at a rate of 200,000 a year. But poor quality eventually cut VW's share of the U.S. market from around 6%, at the height of the Beetle boom, to below 2%. Dealers defected by the hundreds. ''We were making all our money on our used car lot and service department,'' says Daniel J. McKenna, a VW dealer in Huntington Beach, California. ''It was a hand-to-mouth existence.'' VW lost $144 million in the U.S. in 1983. James R. Fuller, a vice president of Volkswagen of America, concedes that the company failed to deliver what consumers expected of a Volkswagen. ''We screwed around with the Mona Lisa,'' he says. After a decade of sagging sales with the Golf/Rabbit, industry watchers expected Volkswagen to pull anything but another Rabbit out of its hat when it announced a model change for 1983. Volkswagen did little to dampen expectations. Company stylists labored three years, all the while leaking drawings of futuristic aerodynamic cars, before finally unveiling what many car buffs derided as a slightly inflated near-clone of the boxy old Golf. Says Donald L. Kress, a Paris-based automotive consultant for Booz Allen & Hamilton: ''Lucky for Volkswagen that the car experts in Europe don't buy enough cars to keep a plant busy for more than a couple of days. They sure didn't like the conservative styling of the new Golf.'' Beneath the new Golf's look-alike exterior, however, the engineers developed an entirely new car. With a roomier passenger compartment and more powerful engines, VW transformed the original Golf from a putt-putt into a car that can hang out in the Autobahn passing lane without being blown away by Mercedes and BMWs. ''The new Golf is an honest design, not grand opera,'' says Ernst Fiala, 57, head of Volkswagen research and development. ''But from the point of view of performance, the car has a completely new personality.'' VW will stick to its tradition of making styling changes only rarely, so the Golf will have to carry Volkswagen into the 1990s. But Fiala's engineers want to maintain at least a two-year head start over the European competition by introducing new features to improve the car's performance and keep buyers interested. VW began delivering Golfs equipped with power-packed 16-valve engines in January, and will introduce a four-wheel-drive model later this year. Future performance-enhancing additions are likely to include anti-lock brakes, available so far only on more expensive cars. High tech is also at the heart of the way the Golf and its notchback sister, the Jetta, are built. VW invested $194 million to build the world's most highly automated final assembly plant in Wolfsburg. Since coming into full operation in 1984, Halle 54 -- named for its location in the sprawling complex -- has become something of a West German theme park. Electric buses ferry visitors down wide aisles to gape in amazement at the army of robots. The machines mate motor and undercarriage assemblies to body shells, twist batteries into position, and even tuck the spare tire into the trunk, adjusting with cool indifference to whether the model being built is to be a Golf or a Jetta, a humble economy model or a souped-up convertible. Some 25% of the final assembly is carried out by robots and other automatic machines. Automation has slashed the time needed to build cars by 20%. Cars are rolling off the assembly line at the rate of 3,200 a day. With production hitting full stride, Hahn and VW group marketing director Werner P. Schmidt see a major opportunity to grab a bigger slice of the European market. Volkswagen has long been the market leader in West Germany, where it accounts for 28% of all cars sold, but it has only recently begun to make headway elsewhere. In Italy, France, and Britain, where it competes with strong domestic carmakers, VW manages a meager 6.8% share on average. Schmidt wants more. ''We've accepted for too long our small share of other markets,'' he says. ''It's not unreasonable for us to expect to raise our share to 12% outside of West Germany.'' VW made a good start last year. In Italy sales soared 66%. Overall VW had a 24.2% increase in European sales outside Germany last year, compared with 2.1% at home.

VOLKSWAGEN has scored its biggest European sales gains in Spain. Since entering a production agreement with SEAT in 1982 to build Santanas, Passats, and subcompact Polos, VW boosted its share of the 500,000-car-a-year Spanish market from less than 1% to 8.5% in 1985, without spending a pfennig in capital investment. With majority control of SEAT, Hahn should be able to push that share to around 25%. At first glance SEAT looks like a prize not worth winning. It lost the equivalent of $210 million in 1984 on sales of $1 billion, paying a crushing 22% of sales in interest on its debt. Hahn insisted that SEAT clean up its balance sheet before he bought in. In December the Spanish government agreed to absorb SEAT's $1-billion debt and inject another $114 million into working capital. With SEAT, VW will gain capacity to build up to 400,000 vehicles a year. Through SEAT's dealer network, VW will have unparalleled access to the Spanish market, Europe's fifth largest and one of the few with significant growth potential. But the Spanish connection will give Volkswagen its biggest boost in production of subcompact cars like the Polo. Subcompacts account for 30% of all European car sales, but VW's share of that market is now a paltry 5.5%. VW plans to attack the small-car market by cutting prices. Wage rates in Spain are substantially lower than West Germany's, and Ford and GM maintain that their Spanish-built cars are up to rigorous German quality standards. ''We'll be one of the most aggressive price- setters, without sacrificing profits,'' says Schmidt. North America is still Volkswagen's land of most opportunity. But the Westmoreland assembly plant remains a profit-smotherer. Hourly labor costs at UAW-organized Westmoreland are over $20, about what GM and Ford pay, compared with $15 for VW workers in Germany. Volkswagen spent $200 million to convert U.S. production from Rabbits to new Golfs, but with just 70,000 Golfs sold in the U.S. last year, the plant is turning out fewer than half the cars it was designed to build. Hahn insists VW can afford to keep Westmoreland operating indefinitely. He calls the plant his insurance policy against U.S. protectionism and a collapsing dollar. But Volkswagen of America President Noel Phillips, 51, a brawny South African hired in 1982 to restructure U.S. operations, is doing his best to minimize Hahn's insurance premium. Phillips slashed the work force from 10,000 in 1981 to 6,000 and sold a plant in Sterling Heights, Michigan, to Chrysler. Last November, Phillips announced he would phase out production at a parts plant in South Charleston, West Virginia, and import parts from Volkswagen plants in Mexico and Brazil. That will reduce the U.S. content of Westmoreland-built Golfs from 75% to around 55% and save the company millions annually. PHILLIPS IS SUCCEEDING in the bigger job of winning back the confidence of American car buyers. The ride and handling of the American-built Golf are identical to those of models built in Germany, and Golfs are gaining the same reputation for quality in the U.S. that they have in Europe. Volkswagen rose from 22nd position to eighth in last year's J.D. Power & Associates survey of buyer satisfaction, and Motor Trend named the Golf GTI its 1985 ''car of the year.'' Sales of luxury Audis, fueled by the U.S. introduction in 1984 of the top-of-the-line Audi 5000, have soared by more than 50%, scoring a second consecutive record year in the U.S. in 1985. Imported Jettas, priced about $1,000 higher than the Golf, are an even bigger hit in the U.S. than in Europe. Jetta sales skyrocketed 120% to 84,000 units in 1985. ''The Jetta has a potential to become the poor man's Mercedes,'' says Leonard Sherman, a New York-based auto consultant with Booz Allen. ''It's clearly that good a car.'' Dealers are ecstatic. ''Our dollar volume is 25% ahead of our best year ever,'' says Peter T. Liebman, a New Jersey VW dealer since the Beetle days. Two years ago, the company says, its cars cost 20% more than comparably equipped Japanese cars. Today the gap has narrowed to less than 5%, and it is shrinking. Against some low-end rivals, the gap may be gone. The base price of a 1986 Golf is $7,190, $149 less than a Honda Civic CRX and about $160 less than a Toyota Corolla. For the lowest-price segment of the market, Volkswagen will begin importing a Brazilian-built car priced around $5,500 late next summer. The new car, code- named Project 99, will compete against half a dozen other new entrants -- including the $3,990 Yugo and South Korea's $4,995 Hyundai Excel -- for a slice of market that is expected to grow to around two million cars per year by 1991. Volkswagen executives think the Brazilian import can more than hold its own against low-priced rivals. Autoworkers in Brazil earn $2 an hour, about the same as South Korean workers, and because the new car is a beefed-up version of a model VW and has been selling in Brazil for four years, development costs were low. Volkswagen expects to sell about 50,000 the first year and then build up to 100,000 a year. Fuller, the Volkswagen of America vice president, thinks the car can help boost sales of higher-priced models. ''It can be the appetizer for a lifetime of buying Volkswagens,'' he says. HAHN IS PLANTING SEEDS for further international expansion in markets that have so far been virgin territory for European carmakers. Volkswagen has a licensing agreement with Japan's Nissan Motor to supply kits to build 20,000 Santanas a year for sale in Japan. In late 1984, Hahn entered a joint venture in China to build Santanas in Shanghai. This year the company is selling engine-making equipment to East Germany, and it has been holding exploratory talks with the Soviet Union. ''Our location on the East German border puts us on the fringe of the world economy,'' he says. ''But if East and West start doing business together, we have more to gain than any other carmaker in the world.'' It's too early to tell whether Volkswagen can match the successes of the 1960s and 1970s with its new worldwide strategy. Krish Bhaskar, director of auto industry research at the University of East Anglia in England, predicts that VW will increase profits from last year's estimated $243 million to more than $600 million by 1988, closer to Hahn's goal of matching the 3% return on sales of U.S. and Japanese automakers. Hahn knows VW still has a long road to travel. ''Easy success comes only in the movies,'' he says.

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