Understanding business model disruption in the mobility industry
The fundamental features of cars haven’t changed much for about 100 years and neither has the business model that sustains their production. The current automotive supply chain is a pyramid and the coolest place to be is on top, where carmakers currently stand.
Below the carmakers are several tiers of suppliers that develop parts according to the needs of the automakers.
By sitting at the top of this pyramid, carmakers are able to squeeze the margins of their suppliers by playing them off against each other and thereby cut the costs of vehicles. The carmaker also gets to put its badge on the vehicle, even though most of what it does is assemble pieces supplied to it through its supply chain. This is the reason why you’ve probably never heard of suppliers such as DENSO, QNX or NXP, but you’re familiar with the companies they supply to: Toyota, Ford, BMW, etc.
Car companies have been leveraging their resources in a rather straightforward formula for the last hundred years, while the underlying technology has stayed relatively unchanged:
- Spend heavily on vehicle R&D (directly and indirectly through an elaborate supply chain) to create differentiated, high-end, higher-margin vehicles while features trickle down from high-end to mass market vehicles over time
- Spend more on advertising these vehicles and growing a brand which intermediates between the carmaker and its customers (for instance automotive is the largest segment of Super Bowl ad spending)
- Leverage an elaborate distribution network of dealerships that ensures these vehicles reach consumers without having to deal directly with them
This formula has worked pretty well, even though it has allowed immense inefficiencies (average vehicle utilization = 4%) and a pretty bad customer experience (75% of Americans would never set foot inside a dealership if they could avoid it). Competition amongst carmakers and between their suppliers has ensured a steady flow of new features entering vehicles, but both the general structure of vehicles and their supply chain has remained relatively unchanged. Until now.
Competition dynamics and the point of no return
Various kinds of innovation allow carmakers to differentiate their technologies and therefore charge a premium for their product.
However, competitors will quickly notice the new differentiated technology and seek ways to replicate it.
The same dynamic is at play for suppliers (where much of the innovation is happening) and they too must compete in order to offer differentiated products that allow them to make larger margins.
Sometimes a supplier offers a unique and essential technology that gives them significantly greater leverage over the companies they supply to. One such company is Mobileye, an Israeli company that supplies advanced driver assistance technology to carmakers and has seen meteoric growth over the last few years.
So long as a company offers a technology that is desired and has few substitutes, it will have sufficient leverage to make outsized profits.
Historically innovation in the automotive industry has proceeded along stable axes: better performance, design, safety features, etc. However, new technologies, in particular digitization, automation and electrification, are beginning to significantly shift the rules of the game, resulting in a new paradigm.
This new paradigm allows new players who are better adapted to the new rules of the game (e.g. startups such as Mobileye, Tesla and Uber and tech companies such as Google and Apple) to enter and succeed while forcing established players to reinvent the structures that allowed them previously to succeed, a significant challenge since their success was built on a strategy that was optimized for the old paradigm.
Tesla has attacked each piece of the carmaker strategy playbook:
- Tesla has vertically integrated key components, most notably batteries built in its Gigafactory, while focusing on electric vehicle innovation, a technology that most carmakers ignored
- Tesla has also used digitization in order to build a direct relationship with its customers — not only can its customers use the internet to buy a vehicle or request maintenance, but over-the-air software updates have allowed Tesla to offer new services over the lifetime of the vehicle
- Instead of relying, as other carmakers do, on a distributed network of dealerships to sell and maintain their vehicles, Tesla sells their vehicles directly to customers
Tesla, however, is still committed to a traditional automotive business model of primarily selling vehicles directly to customers (even though the company is actively pushing autonomous vehicle technology and exploring new shared vehicle business models).
While Tesla is modularizing vehicles to allow direct sale to customers, bypassing dealerships, Uber is modularizing trips. This has allowed Uber to insert itself above carmakers and become the brand that consumers interact with. The value chain in a world where Uber is dominant looks like this:
Uber aggregates various vehicle brands under its platform, weakening their value by replacing them as the consumer-facing brand. However, because drivers (rather than Uber itself) purchase or lease vehicles, Uber has limited leverage over carmakers.
Uber, like Tesla, also has a direct relationship with the customer since each customer holds an account with Uber and that account contains the customer’s credit card information and trip history. Uber is seeking ways to leverage this relationship — for instance, you can link your Spotify playlists to your Uber account and play your music during your ride.
But the most disruptive change that Uber has brought is per mile pricing.
The implications of per mile pricing
Uber’s per mile model has repercussions for the rest of the automotive supply chain and these effects will proliferate as this model grows in terms of market share:
Sharing: When you pay for individual trips, you no longer need to own a vehicle which means that one vehicle can be shared amongst many users. Furthermore, products such as UberPool mean that vehicles are not only shared on aggregate, but that individual trips are shared. Both of these trends will reduce the total number of vehicles needed, although increased demand given lower cost and greater convenience could offset this shift.
Design: Vehicles are currently designed around the driver experience since the driver is making the purchasing decision. With the pay-per-mile model, however, the passenger is the customer, meaning that the vehicle will increasingly be designed around her needs. This will include rear seat HVAC and infotainment controls as well as more comfortable rear seating.
Electrification: Shared vehicles will cover significantly more mileage, making marginal costs more of a priority than fixed costs. This will favor a shift to electric powertrains since the higher upfront fixed costs of batteries will be amortized over many trips while the significantly lower marginal costs will mean lower total cost of ownership.
Replacement cycle: Because shared vehicles have higher utilization, their service life will be shorter and the rate at which they will be replaced will be higher (they may also be designed in a modular way such that some parts can be replaced more frequently than other parts). As replacement cycles shorten, new features will enter these vehicles faster, increasing the rate of technological improvement. Software built on top of this hardware platform will update at an even higher rate.
Autonomous vehicles will complete the shift to the new business model that Uber has pioneered while significantly deepening the market to which this model will apply. By removing the driver, automation will lower the price per mile by about 70%. And by creating a self-driving fleet, the fleet operator will make collective vehicle purchasing decisions, increasing leverage over carmakers and removing the mediation that Uber drivers currently provide.
When carmakers say that they do not plan to become the Foxconn of the automotive industry, this is the business model reconfiguration that they are referring to.
The airline industry and the opportunity for aggregation
The airline industry is instructive for what might happen to the ride-hailing industry in the long run. It used to be that customers would buy their tickets directly from each airline. However, as technology improved, aggregation sites like Expedia and Priceline allowed direct comparison between different providers by aggregating the results of any search across different airlines. The same thing might well happen in ride-hailing. Currently, the dominant position of Uber has prevented this from happening, but if the market becomes more fragmented (as is happening to some extent with the entrance of new players like Juno), customers will probably turn to an aggregation service in order to find the best solution (Google Maps is already starting to do this). This would mean the modularization and commoditization of existing transportation network companies (TNCs) such as Lyft, Uber, Juno, Gett and Via.
There is reason to be skeptical that the current ride-hail market will fragment given Uber’s dominant position and the network effects it enjoys on both the demand and supply side. However, autonomous vehicle technology might quickly become commoditized, available to anyone willing to pay to license it. In that case, the barriers that Uber has developed to protect its business — particularly the largest share of the finite supply of human drivers — will be weakened and the industry could become fragmented with new entrants able to provide a similar service if they invest sufficient capital.
Ownership vs mobility
Right now, most vehicles are owned and we are very much at the beginning of a shift to new mobility technologies and business models that enable them. That means, amongst other things, that even though Uber is dominant in the ride-hail market, its leverage over carmakers is still limited.
However this is changing. Ride-hail vehicles have proliferated in densely populated urban areas while slowly diffusing to less populated areas. Autonomous vehicles, due to their significantly lower price and greater convenience, will greatly accelerate this trend: they will likely capture the lion’s share of the market in urban areas while expanding the reach of mobility services well into suburban and exurban areas.
In the the less densely populated parts of the world, including in large sections of America, vehicle ownership will endure and autonomy will primarily arrive in the form of driver assistance systems. For these markets, the tradition ownership based structure and the supply chain dynamics that support it will likely persist, but in a significantly diminished form.
Implications for carmakers
Already various carmakers are developing new business units or brands to address the need to build direct relationships with customers while selling them miles rather than vehicles. Examples include Ford Smart Mobility, GM’s Maven, Volvo’s Lynk & Co, Daimler’s moovel, BMW’s ReachNow and VW’s recently announced Moia.
To take the first as an example, the intended structure looks something like this:
The goal is to create a new customer facing brand while the per mile product offering serves as a sales channel for the existing vehicle business. In parallel to pushing these new brands, these carmakers are also making aggressive announcements about their autonomous vehicle development.
Carmakers have historically been successful because they are effective at producing vehicles in high volumes with high levels of reliability. This requires expertise in manufacturing and quality control. However, in order to succeed in the new paradigm, carmakers will need to develop expertise in areas currently outside of their core competency.
Services: The kind of services and digital relationship that Tesla and Uber have managed to develop requires the ability to collect and leverage data in order to generate actionable insights about the user. It also requires an intuitive user interface that allows users to communicate their needs and receive appropriate responses. Most car infotainment systems offer an experience that leaves much to be desired and automakers are increasingly introducing Apple CarPlay and Android Auto as replacements to their own systems. This does not bode well for their ability to capture a significant portion of the value that autonomous vehicles will generate as a digital platform in the future.
Ride management: When offering a service of on-demand vehicles, there are many complex scheduling and routing problems that must be managed. Furthermore, the user interface has to be designed in a way that is simple and intuitive. Uber offers an app that is simple on the surface but on the backend is seamlessly able to manage millions of bookings, including for pooled rides. Both sides of this system will be hard for carmakers to develop. Vehicle sharing programs also require management of a large fleet of vehicles including amongst other things maintenance, cleaning and repair.
Autonomous functionality: Autonomous vehicle technology requires very specialized expertise, above all in machine learning. In order to recruit the limited supply of machine learning experts they will need to develop autonomous vehicles, carmakers will need to compete not only with their peers, but also with tech companies such as Google or Facebook which pay generously and offer comfortable working conditions as well as with startups which offer significant equity upside and a greater sense of mission.
Given these significant challenges, it will be extremely difficult for carmakers to transform themselves into mobility service companies without some help. In order to be successful, they will need to partner with new participants in the mobility tech ecosystem and many are already beginning to do so. Examples include working with connected car service providers (Ford & Blackberry, Renault & Microsoft, numerous carmakers & otonomo*), ride-share enablers (GM & Lyft, VW & Gett, BMW & Ridecell*) autonomous vehicle developers (GM’s Cruise acquisition, Volvo & Electrobit, BMW, Intel & Mobileye). Access to new mobility innovation ecosystems, especially in the Bay Area and in Israel, will be essential for carmakers seeking to find the right partners to allow them to offer compelling mobility solutions.
Implications for suppliers
For players lower down in the supply chain, disruption at the top isn’t necessarily a bad thing. There are at least three reasons for this:
- Many components of suppliers’ current business will remain intact: cars sold by the mile will still have most of the same fundamental components (with some exceptions), even if they are arranged differently
- New technologies will be needed and this will reward suppliers able to develop and harness innovative technology and deploy creative strategies
- Suppliers whose margins have been squeezed by carmakers strong leverage at the top of the stack will have freedom to form partnerships with new entrants as the supply chain realigns, perhaps even leapfrogging to a different tier in the supply chain
However, new technologies will also create distinct challenges for suppliers:
Electrification: As shared vehicle use pushes towards more ubiquitous deployment of electric vehicles, simpler electric powertrains will replace internal combustion powertrains, which will be disruptive to those that have built up IP and expertise in traditional powertrain technologies.
Digitization: Computers have been introduced into vehicles, like lego blocks, in a modular manner similar to other components of the vehicle. This has worked well to the extent that new functions have been added without disrupting the existing manner in which vehicles are assembled. However, sooner or later, we are likely to see an end to this sort of distributed processing and movement towards higher efficiency, lower latency, centralized computational architectures. Not only will centralized architectures serve as better platforms for digital services and autonomous vehicle processing requirements, but an integrated approach will also help mitigate some of the current cybersecurity vulnerabilities enabled by the absence of a system level digital integrator.
Data: The key challenge for suppliers will be access to the data that their components generate. Developing strategies that focus on ensuring access to data and that leverage that data productively will be key. New entrants are certainly seeking to do this.
There has been a lot of speculation about what Apple is working on. What seems to be clear is that Apple is no longer attempting to build its own vertically integrated vehicle and instead has pivoted to a software focused approach. Apple may be seeking to disrupt the supply chain by capturing its core digital components and vertically integrating them.
This strategy is likely to include four core components:
- Leverage Apple’s strength in semiconductor design to produce highest performance, optimized automotive silicon components with an improved network architecture
- Build out the middleware required to create a universal vehicle OS that leverages the underlying silicon to create a compelling user experience and platform for an ecosystem of services
- Develop autonomous vehicle technology that controls the vehicle’s movements and becomes a key enabler for its platform of applications
- Use its existing relationship with customers to integrate this platform into the rest of its ecosystem, leveraging Apple IDs that contain user preferences and payment information
The mobility platform
Right now, the traditional automotive paradigm in which vehicles are sold is being replaced by the new mobility paradigm in which miles are sold. But in a world in which mobility by the mile is cheap and readily available, mobility will serve as a platform for data and digital services.
What is interesting about this platform paradigm is that it will allow an explosion of new services built on the foundation of cheap mobility in a manner similar to what has happened in the smartphone industry on the basis of cheap connectivity and data. The full extent of what will be created is not yet clear, but assuming that per mile mobility is cheap (<30¢/mile), some interesting things become possible:
- Selling experiences: Cost will become a less important axis along which services compete and experience will become more critical with in-vehicle media serving a critical role in creating such experiences
- Social mapping: Already it is possible to meet friends at an undisclosed, highly rated bar with Uber handling the pickup and drop-off — expect more of this as social geography supersedes physical geography and discovery becomes a social adventure
- Bundling mobility: Cheap miles will mean that service providers such as doctors or beauty parlors could include free transportation as part of their service as will mall operators interested in driving foot traffic
- Freight and passenger transportation become de-siloed: People effectively become a type of freight in a world of mobility services and the separation between fleets will blur as vehicles can be designed to move people and freight at different times of day or simultaneously
- Tourism: When traveling to new locations, curated tours could be built on the foundation of predetermined routes in which mobility is simply the medium
- Food: Food delivery becomes so cheap that people might not need to have their own kitchens
- Hardware: Laundry could cheaply be collected and delivered, removing the need for personal washing machines and dyers; power tools and other expensive, low utilization hardware could also easily be shared
These examples help give a sense of the depth and breadth of the changes that a mobility platform will enable. The automotive industry is at the early stages of this transition, but a services ecosystem built on the foundation of the new mobility platform will generate unexpected and transformative opportunities. This ecosystem is the end goal of the forces disrupting existing automotive business models, driven by digitization and being executed according to rapidly shortening update cycle.
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