The Innovation-Driven Disruption of the Automotive Value Chain (Part 1)

Introduction

In the last two years I have spoken to many business, technology, and corporate venture executives about their companies’ innovation goals and the initiatives they establish to address these goals. Several of these leaders are involved in the automotive industry and through our conversations I have concluded that a) in the next 10 years we will create more innovations that will impact the automotive industry than we have created in the previous 100, b) these innovations will be embraced because of certain important problems that must be addressed and will couple technology with other forms of innovation, c) because of the disruptive innovations that were introduced to the market in the last 3-4 years, and the ones that will be introduced in the near future, particularly those relating to the electric-autonomous-connected car, the automotive industry is approaching a tipping point of disruption.

In this post I review the two value chains that have been built around the automobile, discuss the societal problems that must be addressed and how the technology and business model innovations being developed to address these problems are disrupting the automotive industry. I also present companies that are pioneering these innovations while offering fresh visions on personal transportation.

A Few Facts About the Automotive Industry

Before discussing some of the innovations that can disrupt the automotive industry and in order to appreciate the potential impact of these innovations, it is useful to present a few facts about the automotive industry.

The automotive industry (approximately $1T in annual sales today) is dominated by a group of 14 very large automotive OEMs, with their several dozen brands, shown in Figure 1.

Figure 1: The largest automotive OEMs and their brands

The reason there are so few automotive OEMs is because starting one today is extremely capital-intensive, creating high barriers to entry. For example, see the capital raised by Fisker Automotive and the capital raised by Tesla Motors (including through its IPO and beyond). Suffice it to say that Tesla Motors was the first automotive OEM to go public since the Ford Motor Company went public in 1956.

New car sales in 2015 worldwide are projected to be over 83 million vehicles and represent $500B of the market’s size. Of these, about 16 million will be sold in the US. In addition, in the US alone, 44 million used cars will be sold.

Over the years OEMs have transitioned from being vertically integrated companies to become highly efficient integrators of components in car platforms they define and own. Their supply chains are global and are optimized through constant incremental improvements giving them cost advances a new entrant cannot achieve but also making radical changes to this chain difficult, if not impossible.

While initially these were hardware-only platforms, today’s cars can be thought of consisting of a software platform, of mostly embedded and proprietary software that controls major functions of the car, and a hardware platform. According to a report published by the Center of Automotive Research the automotive industry spends $100B/year on R&D, which equates to $1,200 per vehicle produced. As is shown in Figure 2 below, most of this investment is made on the car’s hardware platform and on the elements that control this platform, make it safer, more efficient, etc. but still based on the principles of a gas-powered engine and associated powertrain with all of their complexities. This type of R&D investment is characteristic of companies aiming at innovations that enable them to sustain and improve on their existing business models, processes and supply chains; in this case models, processes and supply chains related to gas-powered vehicles.

Figure 2: Typical automaker’s R&D areas of focus

But as my good friend Lou Kerner helped me realize, while when we talk about the automotive value chain we typically think about OEMs, their suppliers and dealers, the automotive value chain should actually be organized into two broad parts: the car manufacturing and sales part, and the car use part. Car manufacturing and sales (shown in Figure 3) includes the OEMs, the very large number of hierarchically organized suppliers, the logistics companies that are responsible for moving the parts and bringing the new vehicles closer to the consumer, and the thousands of dealers (today there are about 17,000 new car dealers by the most recent industry estimates).  The car use part of the value chain is shown in Figure 4.

Figure 3: The car manufacture and sales part of the automotive value chain

Figure 4: The car use part of the automotive value chain

The car use part of the value chain is:

• Far more fragmented with each area having its own ecosystem of established companies and startups, e.g., car rental or infotainment. Some areas have low barriers to entry, e.g., driving analytics, while others have high barriers because they are more capital intensive, e.g., ride sharing, or car parking, or require regulatory approvals, e.g., insurance.
• Still in flux with new categories, entrants and disruptors particularly in the areas of Driving Services and Mobility Services. For example, Infotainment, expected to be the next battleground of the automotive value chain, used to be dominated by established hardware suppliers that have been part of the car manufacture and sale value chain. More recently, Google and Apple entered this area through the car use value chain based on their software and content solutions. Startups like Truvolo and Mojio are entering through a combination of hardware/software solutions. Finally, automotive OEMs are also getting into this space through acquisitions.
• Diverse with more participating industries, e.g., insurance, car repair, refueling, etc. For example, the introduction of electric vehicles automatically made the utility industry part of this value chain, the introduction of broadband connectivity made the telco industry part of this value chain, and the use of personal navigation made companies like Google, Apple but also Waze parts of the value chain.

Automotive OEMs had already entered some parts of this value chain, particularly in Financial Services. More recently, a few OEMs (Tesla Motors, BMW, Daimler, Ford) have started entering the mobility services area. For example, Tesla is establishing charging stations, BMW has established the DriveNow car-sharing division, and has invested in and partnered with Chargepoint, a network of electric charging stations.

Problems Starting to Shape our Automotive Thinking

I’m an advisory board member in the Center for Urban Science and Planning (CUSP). The Center is looking on approaches to collect, manage and analyze data to address the needs of cities, and specifically megacities, starting with New York. According to a UN report in 2014 more people lived in urban areas (54%) than in rural area. By 2050 an additional 2.5B people are projected to live in urban areas. Today’s megacities (metropolitan areas with more than 10M people), such as NY, Mumbai, Beijing, Mexico City, Sao Paulo, will continue to grow and many new will be added, mostly in Asia and Africa. Megacities must address several different problems but two are directly related to transportation, particularly personal car use, and one where transportation is a significant contributor.

Problem 1: Productivity Loss. We are starting to realize that as each megacity’s population continues to grow, particularly its road and parking infrastructures cannot expand proportionately in a way that will support today’s car ownership and use models. By looking at the commute times in megacities like Mexico City and Beijing (shown in Figure 5), and the productivity loss that is associated with long commutes, we should understand that this is already a serious problem and will only get worse if we continue to rely on the existing car ownership and use models.

Figure 5: IBM’s compute pain index for various cities and megacities

Problem 2: Pollution. Even more important to loss in worker productivity is the negative environmental impact of gas-powered vehicles in urban (and suburban) settings, as this is exhibited through the air quality in megacities due to carbon emissions.

Problem 3: Climate change. Many have argued far more eloquently about the impact of gas-powered transportation on greenhouse gas emissions that climate change. Though now a little dated (they only include data up to 2006), figures published by the US Department of Transportation show that in the US transportation contributes 28% of greenhouse gases, with over 50% of that coming from passenger cars and light duty vehicles, a category that includes sport utility vehicles, pickup trucks and minivans. If we are to look at available data from Asia we conclude that transportation has been responsible for 19% of emissions, and is projected to be 31% by 2030.

Two Ways to Address these Problems

Unfortunately there is not a single “silver bullet” solution to these problems. We can’t solve the productivity loss just by building more roads and parking garages, we can’t fix the pollution problem just by lowering vehicle CO2 emissions, and we can’t address global warming just by dealing with personal cars. The solutions will have to come from a combination of

1. Changes in the car ownership and use models, combined with innovative business models.
2. The application of technology combined with innovative business models.

Car ownership and use

For generations owning a car has been a primary aspiration in developed and developing economies. In such economies the car is placed at the center of every person’s life and we often use it to define our self and net worth. Affluence is demonstrated first by owning a car and later by having bigger, faster, more luxurious, less fuel-efficient vehicles (until Teslas arrived), as well as with having more vehicles per household. Economic expansions have been reported in terms of increased car-buying activity and recessions by reversals in such activity. However, recently we are starting to see a transition from the notion that puts car ownership at the center to one that puts car access at the center. Even during this time of economic expansion this trend is seen particularly among Millennial consumers many of whom are still struggling to find decent permanent jobs (here and here) while they carry higher debt due to their student loans. Income disparity is fueling the sharing economy (and here) that is broadly used by Millennials to benefit from its services but also to contribute income-producing services.

In addition to driving, consumers are re-thinking many aspects of car ownership: purchasing, financing, insuring, and servicing a vehicle. Based on surveys conducted by Arthur D. Little, the separation between car sharing, rental, leasing and ownership for both consumer and corporate vehicles is diminishing in the eyes of the consumer. According to these surveys the car is starting to be viewed as only one of the means that can move us through our daily life rather than something that defines us. Changing the car ownership and use models will benefit all three of the problems listed above. It will imply fewer cars on the road, thus reducing the need for expanding infrastructure while reducing emissions, and will improve productivity, as passengers are able to use their travel time more productively, particularly as more of cars are equipped with broadband connectivity. An illustrative example of this case can be seen in the internet-equipped buses being used by the employees of high tech companies in Silicon Valley.

Innovative technology and business models

Specific technologies combined with innovative business models can also have a disruptive impact on the identified problems. Specifically, electric propulsion, Fuel Cell Vehicles (and here), and lighter cars built through additive manufacturing and the use of lighter materials (and here) will decrease pollution and eventually stabilize climate change. While estimates vary, I don’t expect more than 25% of the vehicles by 2025-30 to be electric (up from 5% today) and able to meet or exceed the emission standards targeted for 2025. For this reason I’m assuming that automotive OEMs and their suppliers will be able to continue improving the emissions of gas-powered engines through their existing sustaining innovation initiatives in ways that will allow them to achieve the 2025 emission standards.

It is important to note that today the materials being used in additive manufacturing are not able to satisfy the car safety standards while meeting the OEMs’ cost considerations. Automotive OEMs and their suppliers are already using additive manufacturing to produce certain parts of a vehicle, e.g., exterior trim. However, other critical parts of the vehicle, e.g., frame or powertrain, today cannot be produced at an acceptable cost in order to meet the established safety standards. Producing materials that can meet the stated safety standards is a field of active research and some startups, such as Divergent Microfactories, Carbon3D through its partnership with Ford, and Local Motors, are making significant progress in this area. Of interest is also BMW’s partnership with Techshop. The companies have established a corporate accelerator for additive manufacturing. Broader application of additive manufacturing will lead to product innovations, the transformation of supply chains and the emergence of innovative business models particularly for parts suppliers.

Autonomous driving is another disruptive technology (or family of technologies) that in combination with other technologies and business models will be used to address the productivity, infrastructure and pollution problems. It will also be at the core of other transportation solutions such as providing mobility options to the handicapped and the elderly, and improving safety. We typically talk about four levels of vehicle autonomy. Today a growing number of OEMs are already selling cars with level 1 and level 2 autonomy and vehicles with level 3 autonomy will be introduced in the next 2-3 years.

In my opinion the big disruption of the corporations in the car manufacture and sale value chain will come from the introduction of electric-autonomous-connected (EAC) cars, and specifically EAC cars organized in transportation networks (more discussion on this issue is provided in the next section). For example, as was recently reported autonomous-connected taxis, even without using electric propulsion, could greatly contribute to the reduction of greenhouse gas emissions of light duty vehicles. I should also mention the recently announced partnership between Local Motors and University of Michigan that aims to produce fleets of autonomous cars built using additive manufacturing. EAC vehicles may be privately owned or be part of transportation networks that offer mobility services (MS).

Software, Internet and big data technologies will play a big enabling role in EAC vehicles and will also be critical in mobility services. These technologies are already transforming the car’s platform and the on-board experience. In recent years the car had already started becoming a multiprocessing distributed computing system. Autonomous driving and always on, broadband, IP-based connectivity require the further increase of the on-board computing power to run the software that controls the car, e.g., ADAS capabilities. This is resulting in irreversible changes to our traditional notion of a car as an electromechanical platform. Electric propulsion requires additional reliance on on-board computers and associated software. The EAC car is a new platform that will run on infrastructure and application software that is based on open standards and delivered as a service, much like every other enterprise and consumer application is. Autonomous cars will also necessitate software-based, vehicle-wide operation simulations of unprecedented scale. Automakers today lack the software expertise to create such complex software and analyze the volumes of data that will be generated through these simulations.

In addition, big data that is being generated by the car (telematics, vehicle to vehicle and vehicle to infrastructure communication, navigation), the data that is collected through car-related services (sales inquiries, maintenance records, insurance records) can be used to create a complete understanding of the vehicle and its drivers enabling the optimization of the vehicle’s performance, the improvement of the car’s usage economics, and in general for the participants in the automotive value chain to better serve driver and passenger (see Figure 6).

Figure 6: Big data uses in the automotive value chain

The car’s connection to the Internet is enabling more than infotainment. It is enabling these software and data capabilities to become a reality and impacts the automotive value chain. As a result, Internet connectivity has to be treated as an integral part of the vehicle’s design and value proposition. In addition, the connected car is already giving rise to new business models that are starting to impact the automotive industry (e.g., car-sharing, ride-sharing), the insurance industry (e.g., usage-based insurance), and the entertainment industry (e.g., streaming radio), just to name a few.

Software-, Internet- and big data-driven capabilities are not only important for the car’s operation but, combined with the right consumer electronics, they enable the personalization of the overall on-board driver and passenger experience, as well as the provision of services that improve this experience (see Figure 7).

Figure 7: Services enabled through always-on Internet connectivity

If the car becomes just one of the means for moving through daily life then passenger and driver would want the car to be able to take into account their context prior to entering the vehicle in order to personalize and provide them with a continuous experience while in the vehicle. For example, because of the central role of mobile devices in our lives, automotive OEMs and infotainment device suppliers are starting to lose control of defining and controlling the dashboard specification, though few OEMs of luxury cars may still continue to own the entire user experience. This role now goes to Google and Apple since theirs are becoming the dominant mobile platforms. Google is using a business model similar to the one it used for its Android mobile business. Similarly, the changes of the on-board experience will disrupt the value chain resulting in new leaders and will also necessitate new considerations and regulations.

The EAC vehicle is a highly configurable and constantly updated platform with new features and capabilities that can be introduced on a continuous basis rather than on a model year basis. It is leading to the emergence of a completely new ecosystem of suppliers and OEMs and new business models. It is disrupting the existing value chain including in areas such as safety regulations, actuarial considerations and financial underwriting considerations, as well as cybersecurity and data privacy.

The broad use of the Internet is not only an enable of EAC vehicles and of mobility services but also disrupts both parts of the automotive value chain. It removes the middleman by establishing a direct and increasingly rich relation between provider (car dealer, rental agent, insurance agent, financing agent, taxi/limo dispatcher) and consumer. It also introduces transparency in all transactions and ensures that the customer switching costs become and remain low, forcing providers to strive for unique value propositions and superior service.

Four Companies At the Core of Automotive Disruption

Today the companies I discuss below in some detail are providing the beginnings of a vision that includes electric cars with connectivity and some level of autonomy, mobility services that can be offered with gas-powered or electric car fleets. All of these companies, along with some others shown in Figure 8, are starting to disrupt the automotive value chain and combine technological with business model innovation.

Figure 8: Companies disrupting the automotive value chain

Like in many other industries many of the disruptions are coming from companies outside the traditional automotive ecosystem. Several of these companies are venture-backed startups and are often based in Silicon Valley, but also in Detroit, Israel, and China. I focus on four companies that I consider at the core of the disruption: Tesla, Zipcar, Google and Uber. All of these companies started as venture-backed startups with three of the four having their roots in Silicon Valley.

• Tesla. Tesla disrupts both parts of the automotive value chain. The company’s disruptive innovations start with the electric-connected vehicle (and here) and its components, e.g., batteries. Tesla will also offer an EAC vehicle with certain levels of autonomy being available on a testing basis as early as this summer (and here) and full autonomy on a broad basis in the next few years. But the company’s innovations go even further. They include its charging stations, the company’s car and battery manufacturing processes, as well as its direct to consumer sales and service model, personalized user experience inside and outside the vehicle, and automatic software updates. Tesla’s in-car innovations are driven by software and big data analytics and are enabled by the vehicle’s Internet connectivity. For example, the telemetry being gathered from each car can be used to analyze the entire fleet’s usage patterns (that in turn can be used to improve capabilities, such as the vehicle’s battery range, introduce new features, etc.), detect crashes, identify need for maintenance that can improve vehicle performance, and find lost cars. By many Tesla is already considered a big data and software company. Tesla has already started reporting early data on the positive impact of its cars to the environment. With the introduction of Model 3 I wouldn’t be surprised if Tesla starts offering car-share and ride-share mobility services, as third-party companies are doing today, allowing Tesla to offer EAC+MS.
• Zipcar. Zipcar is part of the car use value chain through car-sharing mobility services. Zipcar’s innovations include membership-based, car-sharing disruptive business model that was combined with its data-driven software platform and novel software-driven user experience. In the short term Zipcar disrupted the car rental industry, i.e., the use of the car part of the value chain, and that’s why Avis acquired the company. Zipcar now analyzes the data it collects and uses the analyses to identify new locations to place cars, i.e., having a more distributed rental network, better re-balance its fleet (fleet re-balancing based on usage is a big issue since one-way rentals represents 12% of North American car sharing membership), offer one-way rentals at more competitive prices than full service companies, and offer lower prices/hour of usage.
• Uber. Uber is part of the car use value chain through ride-sharing mobility services. The company’s innovation is a hybrid of Zipcar and increasingly of Google. In addition to its business model (and here), Uber’s innovations also include its mobile application (software, Internet, big data) which allows for the presentation of routing information and transparency for the arrival time, ability to rate drivers thus establishing driver reputation, and demand-based dynamic pricing. The company is expanding globally with blinding speed as it aims to build barriers to entry in addition to what its first mover advantage provides. More recently Uber started work on an autonomous car that will enable it to offer mobility services with a transportation network of autonomous connected, maybe even electric, vehicles. This is the primary reason they acquired Microsoft’s mapping assets and know-how; autonomous driving requires extremely accurate maps for navigation. By initially disrupting the taxi and limousine industries, i.e., a small part of its market potential, Uber is well on its way of becoming a company with $1B in annual revenue. In addition to disrupting the entire on-demand delivery industry, Uber’s model could also start disrupting the manufacture and sale part of the automotive value chain by starting to use EAC cars built according to a specification it provides, or even enables modifications to existing cars through after-market kits that are also based on its specification.
• Google. Google is disrupting the automotive value chain with two platforms. Today its Android Auto mobile platform can control the car‘s dashboard, including the navigation system making Google a disruptor in both the manufacturing and sale, as well as in the car use parts of the value chain. The data collected from this platform is combined with Google’s data analysis capabilities to provide an increasingly personalized in-vehicle experience, as well as an in-context experience when entering the vehicle. Google’s self-driving car platform with Level 4 autonomy will be offered as a specification to automotive OEMs to build vehicles around it. Such vehicles will be running on Google’s software platform, in a way that will be similar to the approach Google took with the Android operating system. Google would want to own the data generated by each car build on such a platform and maybe even have the exclusive right to monetize this platform through data-driven advertising. In addition, Google is another company that will develop a transportation network of Electric-Autonomous-Connected cars and offer a ride-sharing mobility services, putting it in the EAC+MS business. By using big data analytics on this network Google could develop applications that offer dynamic ride pricing to optimize the network’s usage, optimize the number of vehicles that will be needed to serve a population, and other such applications.

Apple is emerging as a fifth major disruptor of the automotive industry. Today it is disrupting with its CarPlay platform that controls the car’s dashboard, similar to Google’s Android Auto, making it a disruptor in both the manufacturing and sale, as well as in the car use parts of the automotive value chain. It is also rumored to be developing an Electric-Autonomous-Connected car. It is not clear yet whether it will make it available through a transportation network like Google or offer it for individual ownership like Tesla. Apple can disrupt the automotive industry in two significant ways.

1. Apple is all about the user experience. If it decides to enter the automotive market it could disrupt not only the car’s software and hardware platforms (another EAC+MS entrant), but also the overall car-buying experience, car-servicing experience, etc. very much like it did with its mobile devices (iPod, iPhone, iPad). Since it already owns retail stores around the world, Apple will be able to follow Tesla’s model and offer cars directly to consumers without relying on dealers
2. Because when it enters a market Apple takes control of the entire supply chain, as it demonstrated with the mobile devices, it has the potential of re-imagining and thus disrupting the automotive supply chain, an area that OEMs consider their core competence. To achieve this, Apple will need to identify a manufacturing partner to play for the “Apple car” the role Foxconn plays today for Apple’s mobile devices. It will also need one or more support partners with knowledge of the automotive regulatory environment to play the role wireless carriers, and particularly AT&T, played when Apple introduced the iPhone.

Earlier in the post I mentioned that the automotive industry is extremely capital-intensive. It is important to note that these four, or five, disruptors have access to abundant private and public capital, as was most recently demonstrated in the case of Tesla, Google and Uber. In addition to their balance sheets, Google, Tesla and Apple can also use their high market capitalization to fuel their automotive goals.

Our need to address three important societal problems is leading to innovations that are starting to disrupt the automotive industry. While many innovative startups from around the world are starting to disrupt various parts of the automotive value chain, five well-capitalized companies are beginning to address these problems by offering fresh visions of personal transportation. In the next blog I will discuss the automotive industry’s response to these disruptions.