The plans were announced after Volkswagen board of directors ousted Matthias Mueller as CEO and discussed ways to overhaul the company, which spans motorbikes, buses, trucks and passenger car brands including Ducati, Bentley, Porsche, Audi, Scania and Skoda.
Mueller's replacement with VW brand chief Diess follows slow progress in reorganizing the group's car brands, a key pillar of "Strategy 2025" to transform the Germany's biggest car company into a leader in cleaner cars and to move on from its diesel emissions scandal of 2015.
For Volkswagen its the biggest overhaul since it became a multi-brand conglomerate under former chief executive Ferdinand Piech, a grandson of VW Beetle designer Ferdinand Porsche.
Under the plans, announced on Thursday, Volkswagen will divide itself into six new business areas, plus a portfolio for China, as part of an effort to decentralize responsibility and improve efficiency.
The carmaker will prepare its truck and bus division for "capital market readiness" by making it a public limited company as a prelude to a potential listing, confirming a Reuters report from last month.
The new car brands will be Volume, Premium and Super Premium. Earlier on Thursday, sources had told Reuters that VW would reorganize its brands into these groups.
Analysts welcomed the appointment of Diess, a former BMW executive who has more than doubled profitability at the VW brand since taking charge in 2015.
"Diess is a man of action, he is the most plausible choice at VW to lead the group into the next phase of its transformation," said Nord LB analyst Frank Schwope, who has a "buy" rating on Volkswagen.
Separately, VW said works council executive Gunnar Kilian, a close aide to labor boss Bernd Osterloh, will replace group human resources chief Karlheinz Blessing who will stay at VW as an adviser. Earlier this week, sources told Reuters that Kilian would replace Blessing.
Purchasing chief Francisco Javier Garcia Sanz, the longest-serving top executive at VW, will leave the company, the carmaker said.
VW will tighten leadership duties within the group and empower the heads of the three vehicle categories to take on company-wide responsibilities.
With VW's core namesake brand shouldering the bulk of development spending within the group, Diess will also become responsible for R&D activities across the group. Rupert Stadler, CEO of luxury division Audi will take charge of group sales.
Oliver Blume, head of sports car brand Porsche and newly appointed to the group executive board, will oversee production at the multi-brand organization, VW said, confirming a Reuters report.
Diess, Stadler and Blume will also take charge of the new groups Volume, Premium and Super Premium respectively, VW said, without giving more details.
The German carmaker's deliberations come as rival carmakers and suppliers including Fiat and Daimler work on ways to slim down and divest non-core assets.
Analysts at Goldman Sachs say there is 160 billion euros worth of "hidden value" in the European autos sector that could be unlocked through portfolio simplifications.