Electrification, automation and many new entrants. Those are perhaps the key issues facing the automobile industry, spanning legacy manufacturers to current and future suppliers. To help understand where the industry currently stands and where it’s going, Industrial Exchange recently assembled a group of automobile industry executives, investors and consultants. Participants at the virtual roundtable, moderated by Industrial Exchange CEO Jon Cooper, were:
- Tom Fennimore, CFO, Luminar Technologies, a vehicle sensor company based in Palo Alto, California.
- Martin Gehring, a Partner at the management consulting firm of Simon-Kucher & Partners in Cologne, Germany
- Peter Harms, a Partner at the management consulting firm of Simon-Kucher & Partners in Boston, Massachusetts
- Jake Hudson, a Managing Partner at Atlas Holdings, a control-oriented private equity firm based in Greenwich, Connecticut.
- Christopher Pierce, a Managing Director at Nautic Partners, a middle-market private equity firm based in Providence, Rhode Island.
- David Proctor, a Partner at Milestone Partners, a lower middle-market private equity firm based in Radnor, Pennsylvania.
- Tyler Schinto, a New York-based Director at Sumitomo Corporation, a Japanese holding company.
- John Stewart, Founder, MiddleGround Capital, a private equity firm based in Lexington, Kentucky that invests in industrial and specialty distribution companies.
Their comments, edited for clarity and brevity, follow.
Jon Cooper: It’s safe to say the automobile business is in the midst of great change, with two important drivers of that change being electrification and autonomous driving. What are your views on these and other trends affecting the industry?
David Proctor: I agree those are interesting trends. Let me point out two others. First is the mix between sedans and trucks/SUVs. About a decade ago, 60% to 65% of the cars sold were sedans; today, trucks and SUVs account for that percentage. Second, the mileage requirements under the Obama administration had a major impact on car design and use of aluminum and lighter weight steel to improve gas mileage. I think those trends will still be with us in terms of the likeness of the vehicles that are coming. Another big issue is safety; it’s amazing how prominent that has become. Because of safety, cars are engineered to collapse around the drivers and passengers, which means that if you get into an accident, that car will be totaled a lot quicker than it used to.
Martin Gehring: Mileage improvement gets to an issue that becomes even more important with electrification: range. Electric cars are much heavier than internal combustion engine cars, which is why bringing down the drag coefficient through aerodynamic design is so important.
David Proctor: And which is why, if I may interrupt, the bodies of most cars are now so similar.
Martin Gehring: So true. Other technology trends we see are autonomous driving, digitalization and connectivity. To go from technology to customers, there’s the issue of subscriptions and online services. With subscriptions, you have the whole maintenance and fleet management issue, and the OEMs really don’t know how to do that. As online grows, OEMs may start going directly to consumers, like Tesla, but that’s difficult in the US and super expensive. But it offers opportunities to cut costs in the dealership channel.
Jake Hudson: This may be too early to call a trend, but I see potentially large changes coming in the supply chain dynamic and a move away from just-in-time that’s been so dominant for so long. There is fear among OEMs about the unreliability of supply chains and a willingness to invest in one that’s more reliable and more local.
I think there are two components to this. First are the all the COVID- and semiconductor-related issues having to do with interruptions and shortages. Then there is the separate prospect of increasing tensions with China. We’ve seen a greater interest among Chinese investors in owning assets in North America as sort of a hedge in case they can’t ship parts from their factories in China.
Martin Gehring: That sentiment is evident in Europe, too.
Tom Fennimore: You could look over the last three or four years and see disruptions such as tariffs, the rockier China geopolitical relationship, COVID and, now, chip shortages as one-off items. But taken together, you sense that risks are increasing, which is causing everybody to revisit supply chains and rethink things overall to take risk out of the system.
John Stewart: One trend that I think is really interesting is fragmentation. If you look at production forecasts for the next 10 years, the number of vehicles expected to be produced is basically flat. But on top of the 15 or 20 historic global OEMs, there is now an influx of capital coming from the likes of Apple, Google, Amazon and Uber, and competition from several startups. To me, that suggests rampant consolidation is coming, with big tech companies acquiring some of the OEMs in order to get access to manufacturing capacity. But I also see this as a big opportunity in the supply chain. Systems integrator businesses may be able to really increase their margins, because they’re going to have increased importance as the OEMs fragment.
David Proctor: I’m wondering what directors of big oil companies are thinking. Some may see electrification as leading to the loss of big demand for their product, which may lead to rethinking of themselves as maybe in the extracting business, rather than just the oil business. That could lead them to focus on the rare earth materials used in batteries. Or maybe they’re thinking of ways to take advantage of their retail distribution by perhaps buying charging station companies.
Martin Gehring: Those are good points. I would also like to add that fragmentation is happening on the OEM side. For example, Saudi Arabia is considering starting an electric carmaker. And we’re working on two new Chinese brands and a Turkish brand, and we’ve been approached by a Vietnamese brand — all producing electric cars. I don’t know which of them will be here in 10 or 15 years, but everybody wants to go into electric vehicles.
John Stewart: There has to be a massive consolidation. Fisker, for example, wants to build a facility in the US to make 150,000 cars, but it’s very hard to manufacture 150,000 cars profitably.
Martin Gehring: I totally agree with you. There are new players coming in and established players fighting against them, but there’s only so much demand and it will not grow that much. With state-backing for some of the new players and the tech guys, there are deep pockets out there, so it’s going to be interesting.
John Stewart: That’s why I think there is opportunity with the systems integrators. If you’re making 150,000 cars, you can’t afford to develop all your systems independently. There has to be some combination of them, which is why Dana and others that have the scale could really pick up some market share in the supply chain. We should remember that Tesla is 15 years old and makes only 500,000 cars a year. If they were able to make five million cars a year, they arguably could sell them, but they are able to make only 500,000.
Jon Cooper: I’m curious about one thing: If everyone is trying to increase computing power, the amount of copper required for these cars is going to keep rising. Will the auto industry run into copper pricing problems?
Tom Fennimore: That’s a good question and I haven’t seen any analysis about the impact of being able to collect an increasing amount of data in the vehicle and then moving it in and out of the vehicle. I do know that there’s a lot of investment going on to making the connectors. And let’s call it the data piping within the vehicle to make that a lot more robust. It’s easy to move data if the car is parked at home and connected to a home Wi-Fi, but that creates a lag between when the data is collected and when it’s returned to the cloud. The infrastructure to move data in real time is just not there and it’s actually quite costly. The OEMs are working on that.
Martin Gehring: I’m currently working on the topic of 5G and its value to the automotive industry, because that’s actually exactly what you need for many applications, including autonomous driving. That’s related to the need for data storage in the car, which we also see, because you need to get the data in and out of the car.
John Stewart: That’s where America is behind. Europe’s already decided they’re going the 5G route. But there’s no standard yet here in the US. I sit on the Transportation Research Board for traffic control devices, and it seems like a weird thing for a founder of a private equity firm to do that, but I do it for the sole purpose getting the insights into where the technology is going. Let me say, that here in the US, we’re a ways away from the connected car. I hate to say it, but government action is necessary to advance some of these technologies, because OEMs and suppliers will be wary of investing until they see real standards emerge.
Jon, regarding your point about raw material costs, my advice is to be careful about committing to multi-year contracts.
Martin Gehring: Let me switch gears and talk about a few things. First is battery technology, which is evolving very quickly. I know of one company looking into battery technologies based on egg shells. No kidding, they really work as a power storage medium. People are really thinking about this because we are too dependent on materials coming from certain regions of the world and because producing batteries is really dirty.
Second, which also has huge business implications, is that every new electric car entrant is planning to use the direct sales model. Of course, this then means digital sales.
Third, if the last internal combustion engine car in Europe is sold in 2032, for example, there will be at least another 20 years over which existing cars will have to be served. With the right strategy, this might be really profitable.
Finally, monetizing the data a car generates will become a highly profitable business segment for car manufacturers and a totally new business for others. This might not be a big business, but it’s high margin.
Tyler Schinto: We’ve been active in making investments that cover some of those things. We’ve invested in a handful of businesses involved in innovative battery technologies and one that recycles old EV batteries. We’ve also been involved in startups that are partnering with OEMs. Regarding data, I see concerns around who actually owns the data generated by the vehicle — the customer or the OEM — and who gets to repair and service the sensors. There’s a business there because the systems need to be recalibrated periodically or they just shut down. We’re looking at how to monetize data through all the various businesses we own.
Tom Fennimore: The data play use is very interesting, and I agree who ultimately owns that data and shares in the monetization is going to be a big debate. One anecdotal story that I heard is Mobileye, who dominates the camera space. They’ve been trying to get into this into the mapping space and one of the benefits that they’ve found is utilities don’t know where all the manhole covers are in their municipality or in the Rio. And so cars are actually able to be the mapping, figure out where all the manhole covers are and thus are able to monetize that and sell it to the local utilities. So they know that. Yeah, he says there’s a lot of tangential benefits to this to this data gathering. And how you go about monetizing that he takes the lead in that and who shares in it is something that the system is going to have to work out.
Jon Cooper: Since the collectors of data actually have the clearest window into driver safety. To what extent do you think the OEMs or data providers will become de facto insurance companies?
Tom Fennimore: That’s already starting to happen. Tesla got into the insurance business largely for that reason, because their cars, on average, get into a third fewer accidents than ordinary cars. Legacy automotive insurance companies price their business off actuarial tables, and they take years to adjust their pricing for new technology. So Tesla decided to get into the business to compete against them. I think there are going to be a lot of opportunities in the automotive insurance space in the near term.
Martin Gehring: Manufacturers who have their own financial service units and have been selling insurance can do that now in a much better way using this data. But most manufacturers don’ yet know what to do with the data. OEMs come to us and ask how they can sell data by the megabyte; they don’t have a clue.
Jon Cooper: A follow-up. When you sell a lidar (light detection and ranging) system that measures ranges, is there a recurring fee charged the OEMs to cover the cost of constantly updating the algorithm? Do they charge end -users for the upgrades as an ongoing service cost? Essentially, how are you guys working together to deal with that ongoing service aspect of all this?
Tom Fennimore: So far, we’ve found limited interest in a subscription model for the ultimate vehicle. For its high-end autonomous software packages, Tesla is now charging the consumer $10,000 a month, and they’re going to move into a monthly subscription model to try to amortize that cost over the life of ownership and avoid some of the sticker shock. We are seeing other OEMs wanting to follow on that model. I think it’s going to be difficult for us to charge our OEM customers a monthly subscription if they’re not getting a monthly subscription from the ultimate end consumer.