Literally, the word "volkswagen" means "people's car." In Germany, the idea of a people's car wasn't exactly a new one. Before the 1930's, there had been many efforts to create simple cars that everyone could afford, but none met with profound success. Almost all cars before 1930, even if they were designed to be simple enough for the average person, ended up costing more than the average worker's yearly wage.
Meanwhile, the year is 1930, and Ferdinand Porsche had just set up an automotive design company, which became known as the Porsche Büro. The company patented a sophisticated independent front suspension system, which consisted of transversely mounted torsion bars connected to two trailing arms on each side. At the time, this was lighter than most other common types of suspension. In 1931, a German motorcycle company, Zündapp, asked Porsche if he could design a suitable car for them. Porsche came up with a streamlined 2 door sedan, which had lines similar to the Beetle. It was designated the Type 12. Zündapp wanted to put in a 1.2 liter radial engine from one of their motorcycles...this was the end of the line for this design, as it didn't make it any further.
Porsche then designed a car for NSU in 1933 that was known as the Type 32. This car looked even more similar to the upcoming KdF Wagen than the Type 12 did. This car looked similar to the Tatra V570, and shared many mechanical similarities. After World War II, the Volkswagen company paid Tatra for compensation, since Tatra believed its technology and design was pirated in development of the KdF Wagen. Eventaully, NSU dropped the Type 32 project.
Later in 1933, Adolf Hitler met with Ferdinand Porsche to discuss Hitler's idea of a volkswagen. Hitler proposed a people's car that could carry 5 people, cruise up to 62mph, return 33mpg, and cost only 1000 Reich Marks. This was an opportunity for Porsche to push his idea of a small car foward, as was it to help Hitler get a real people's car for the citizens of Germany.
Initially, Porsche designated this design the Type 60, but it was soon changed to the V1 (experimental 1). Hitler also proposed to have a convertible version produced: it was designated V2. Porsche was not able to make the deadline to finish the first two prototypes, as there was not enough time to physically design the cars and to built them. In any case, they were completed and driving by 1935. Soon, the V1 design was updated, and three cars were produced. This new design was the VW3. These cars were put through rigorous testing in 1936.
These cars looked very similar to the KdF Wagen, that was to appear later. Eventually, the VW3s had metal floors, swing axle rear transmissions, Porsche's front independed suspensions, and backbone floorpans. Several engines were tested, and eventually a flat four cylinder aircooled four stroke engine was chosen. Surprisingly, the engine that was chosen was cheaper and more reliable than some of the four cylinder two stroke engines that were tested. This 22.5 hp four cylinder "boxer" engine was roughly the same as the engines that would later be incorporated into Volkswagen Beetles that are still produced today.
After data was collected from the tests of the VW3s, the next version, the VW30 was created, and in all, 30 were produced. Due to Hitler's regime, control of the company and testing of the VW30 was given to a government organization called the DAF. Now, members of the SS were required to drive the VW30s to confirm that all the problems of the V3s were fixed. For the most part, these tests showed that most of the problems in earlier cars had been fixed.
In 1938, construction began on the KdF Wagen factory, and on the town that was going to be next to the factory. In 1939, several VW38s (pre-production) and VW39s (demonstration cars) were produced just to show that the factory did work, and to show what the final version of the car would look like. These cars were different from their predecessors in that they had front hinged doors (all the VW designs before had "suicide" doors), split windows in the rear, larger hoods, and many other minor differences. This edition of the car was the basis of the Beetle after the war was over.
When the V38s were introduced, Hitler abruptly changed the name of the car to KdF Wagen. KdF stood for "Kraft durch Freude" which meant "Strength through Joy." This upset Porsche, as he was not a member of the Nazi party, and he didn't support Hitler's use of propaganda when advertising the car.