For Volkswagen, the bumpy road to electric vehicles starts to hit home

The carmaker’s bosses raised the prospect of a plant closure on Monday as it navigates an increasingly bumpy transition toward electric vehicles. The company said a “performance program" at its core Volkswagen brand that was agreed upon with union leaders last December would no longer be sufficient to hit profit targets, following a disappointing first half of the year.

“The economic environment became even tougher, and new competitors are entering the European market," said Chief Executive Oliver Blume in a statement.

The Volkswagen brand, the group’s largest in terms of sales, contributed less than 1/10th of total operating profit in the first half. Its margin was just 2.3%, or 3.6% excluding the costs of a severance program.

While the company doesn’t break out results for its EV business, a big bet on the new technology under former CEO Herbert Diess with products such as the ID.3 and ID.4 is one reason for today’s weak profitability, according to analysts.

A few days before Volkswagen announced its December deal with the union, the German government unexpectedly canceled EV subsidies. The technology has struggled to win over fresh cohorts of buyers who may be wary of patchy public charging infrastructure and high prices.

EV sales in Germany have plummeted this year, with Tesla’s registrations in the country down 41% for the year through July, compared with the same period of 2023.

“There are plants dedicated to EVs that aren’t producing at the levels expected and costs are out of whack," said Bernstein analyst Stephen Reitman.

To get the Volkswagen brand’s finances back on track, managers want to take more radical steps than were possible under the previous union deal, notably ending an agreement to rule out compulsory redundancies that has been in place since 1994.

Daniela Cavallo, the union leader who heads Volkswagen’s works council, vowed Monday to fight the move, which is a prerequisite for any potential plant closure in Germany.

In an interview with the company’s union newspaper, she blamed the brand’s poor performance on management missteps such as Diess’s dismissal of hybrids as a niche technology. Car buyers this year have gravitated toward hybrids as a way to get better fuel economy without the charging hassle and expense of an EV.

The emerging negotiations are already attracting scrutiny in Berlin. On Tuesday, Germany’s economy and climate-protection minister, Robert Habeck, called for long-term thinking and “close coordination with social partners" at Volkswagen. He said the government was preparing tax relief for EVs as part of a new growth plan.

Volkswagen can’t easily dial back its profit-sapping EV investments or production because its cars need to meet much stricter European emissions standards starting next year. Its fleet carbon emissions last year were 24.2% higher than they will need to be in 2025, according to data collated by Bernstein, compared with 19.6% for Mercedes-Benz and 9.7% for BMW.

The company will also need to compete with lower-cost, faster-moving Chinese EV makers, not just in China but increasingly in Europe, too. Chinese manufacturers have a cost advantage of as much as 30%, according to industry estimates.

In the first half, BYD, which last year overtook Volkswagen in China, sold roughly 17,000 vehicles in Europe, 14,000 more than in the same period of 2023, according to JATO Dynamics. This summer BYD sponsored the high-profile Euro 2024 soccer tournament and last week agreed to buy its German distributor.

While Volkswagen’s profitability in the first half was particularly weak, its performance has long been a drag on the group, which also includes lucrative luxury marques such as Porsche and Audi.

Other mass-market brands owned by the group, such as Skoda and SEAT, based in the Czech Republic and Spain, respectively, have reported higher margins than Volkswagen itself in recent years.

In his statement, Blume noted that “Germany in particular as a manufacturing location is falling further behind in terms of competitiveness."

Labor costs in Germany are the highest in Europe, according to an analysis by the German Association of the Automotive Industry. A German auto worker cost roughly €62 an hour last year—equivalent to roughly $68.50—compared with €23 for a Czech worker and €29 for a Spanish one. In Hungary, where BYD is building a factory to avoid European Union tariffs, auto workers are paid only €16 an hour.

Germany’s energy costs also have risen since the country lost access to cheap Russian pipeline gas as a result of the war in Ukraine.

Volkswagen has a long history of resisting redundancies. In 1993, when the company was losing money in an economic slump, its management and union agreed to a four-day week as an alternative to a plan involving 30,000 job cuts.

Veteran German stock analyst Jürgen Pieper expects the latest war of words that has broken out between Volkswagen’s management and union to end in some kind of compromise that again avoids shuttering plants. One option could be the sale of components businesses, he said.

“The challenge for management is that this isn’t a full-scale crisis. Volkswagen just gets a little weaker every year."

Write to Stephen Wilmot at stephen.wilmot@wsj.com