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Friday, July 1, 2016

BEVs, AVs, Mobility 2.0: Disrupters?

Michael Smitka, Professor of Economics, Washington and Lee University
Judge, Automotive News supplier PACE Awards

The media are enamored of electric cars, autonomous vehicles, and "new mobility" as disrupters. "Just look at Tesla" is the logic and evidence: they have it all! Well, look quick, because Tesla continues to burn through cash at a prodigious pace. But the lack of a compelling path towards commercialization is only half the story. Alongside diminishing returns for additional features, the supply side also presents the challenge of increasing costs. For better and for worse, that pairing means that in 2030 self-driven internal combustion engine vehicles will still be how people commute to work, get their kids to soccer and do their shopping.

...the business case for new technologies is problematic...

From an analytic perspective, both the supply side and the demand side are a function of multiple, deeply embedded social structures, from where we live versus work and shop, to how roads and fueling and legal liability are organized. Changing one piece of the puzzle is very hard, a reality urban planners have longed faced: improving urban transportation incrementally by widening roads in bottlenecks does not solve problems. Here I'm thinking of the I-66 corridor west from Washington, DC, where I've seen 30 years of steady improvement. To the road, that is. The bottom line is that more people find living west of Dulles airport an option, so that not only does congestion continue, it continues for many more miles than in the past. Now I can provide a counterargument for this specific case. My point is that there are no simple fixes to complex systems.

look quick ... Tesla continues to burn through cash at a prodigious pace

So...we already have had autonomous vehicles on the road and in the air. Let me start with the latter: planes can and do fly themselves, and yet we have both a pilot and a co-pilot. Flying remains safer than driving, but we can point to clear instances of pilot error (including fly-into-a-mountain suicide) among the very small set of commercial air crashes. These sorts of systems are very, very hard to change.

What of passenger vehicles? Many of the requisite technologies were on vehicles by 2000, such as adaptive cruise control. These include electronic steering, brake-by-wire and radar to "assist" drivers. Self-parking was on the road in 2008. Yet uptake of the latter has been limited. Yes, early systems had challenges. But equally important was how much vehicle purchasers would be willing to pay for a car that would handle the challenge of parallel parking. Adding features adds costs. Cars will now keep you in your lane and brake automatically if the car you're trailing stops – in fair weather. How much are they willing to pay to have the capability in a greater range of road conditions? Clearly less, while such systems will cost considerably more. Yes, that equation will improve over time, but the challenge of finding a successful business case for additional capabilities remains. I won't go through the technical issues, or the legal.

Mobility 2.0 points to a different set of issues and a seemingly compelling business case. We have perhaps $3 trillion in assets in the NAFTA vehicle "park," registered if not regularly driven. Indeed, few are regularly driven. Let's say that vehicles are used an average of 1 hour per day (my family pickup truck seldom leaves our driveway, even when used). That's 4% of the time, so you've a lot of assets sitting idle. If you can monetize 1% of those assets, then potentially $30 billion are in play. Entrepreneurial mouths water. But that calculation is of the stock of vehicles, not the flow. The impact on new car markets will be small and spread over years. With NAFTA new car sales of 20 million units, new mobility models may generate a few billionaires but won't measurably shift the car market. (Now I started from a different point: if 5% of the vehicle fleet can be used 10% of the day, that's .1% of $3 trillion or $3 billion. But if the return on comparable investments is 20% (not what my retirement investments get!) then the amount of money at play drops to $600 million a year. Of course, shared mobility has been a option for a century. What is different today that will lead to widespread ride-sharing? Still, Autolib' in Paris deserves watching.

Then there are electric vehicles. They were the largest segment in many markets until a bit over a century ago. For example, internal combustion engines began pulling ahead of steam and electric in the US by 1904, but electric taxis remained on the road in New York City for another decade. Despite an intervening century of R&D, the low energy density of batteries compared to gasoline remains a barrier. Now a quiet revolution means that near-electric capabilities are more widespread, with start-stop systems far more widespread than more capable hybrid systems. There is steady progress in batteries. However, and contrary to expectations of 2 decades ago, there has likewise been steady progress in downsizing and improving the efficiency of standard internal combustion engines and particularly diesel engines. With the current level of gasoline prices, there is no good value proposition for the ordinary driver. Will that set of factors change?

...the benefits of adding incremental improvements falls, while the cost rises...

I believe that in the long-run we will be in a world of all-electric vehicles, but that will not happen quickly. Government policy can accelerate that transition, through the provision of better charging infrastructure. The various current policies of subsidization however are not sustainable. Rebates of 50,000 vehicles a year are one thing, those on 5 million are another. Similarly, rolling out showcase charging projects can fit inside government budgets, but building out a nationwide system quickly runs into budget constraints.

There is one other problem common to all three: that 300 million "park" [note: all round figures here]. Modern passenger vehicles last a long time, now an average of 12 years (my pickup truck is 28 years old). Somewhere on the order of 12 million vehicles are scrapped a year; 16-17 million are added. Put that into a spreadsheet, and even if in 2020 a full 100% of new vehicles are (say) autonomous, it takes another 10 years before half the vehicle would be. But new technologies don't roll out that quickly. First, they have to be designed into vehicles, and the drivetrains for model year 2020 are already pretty much locked into place, even if there's still room to play around with styles. So adding these will take place in stages, model by model. The core portion of Ford's F-150 probably won't be changed for another 6 years, maybe longer, and adding electric steering on large vehicles is more challenging than on small. But that's the biggest selling vehicle on the market. So even with a highly optimistic scenario we're looking at 2035 and more likely 2040. Interim technologies will be pervasive – lots of electric motors will be necessary to hit new fuel economy and emissions standards. But change will be evolutionary, not revolutionary. Put another way, piston makers continue to work on technologies that they don't expect to launch until the mid-2020s. Given that they sell into a growing global market, Mahle and Federal-Mogul expect to be making more pistons in 2030, not fewer.

So in the short run these technologies present long-run challenges to vehicle assemblers. They are not short-run threats. Sensibly or not, incumbents are also investing lots of funds in all three areas. Now there can and likely will be new entrants, but the Tesla's of this pending new world will account for only a trivial share of global production. In contrast, incumbents – here I'm thinking Nissan-Renault – already sell more electric vehicles.

This may be an opportunity for suppliers with big footprints in vehicle electrification, sensors and the like. Some new players will turn these into the core of their business, though the hurdles are great. The chip sets that go into a vehicle have to operate from -40ºC of northern climates to the 60ºC [140ºF] inside temperature of a car sitting in the sun in a desert. They have to withstand vibrations that on a cumulate basis resemble dropping a cell phone on the floor continuously for a month. And they have to keep working for 15 years. Furthermore, initial quality has to be extremely high, with defects of single-digit parts per million. Going from lab to vehicle is done all the time, but new entry is harder than at first glance. Meanwhile for the incumbents of the world, the Delphi's and Denso's and Bosch's, these are extensions of existing product lines. For companies that earn profits of $1 billion or more a year, new technologies won't have a (positive) impact on their bottom lines anytime soon.

...new technologies won't have a (positive) impact on bottom lines anytime soon...

What of Auto Alley in the US and the Auto Corridor in Europe, in which production is currently concentrated (see the work of Thomas Klier and Jim Rubenstein for data and analysis)? Yes, car companies are setting up R&D facilities in Silicon Valley, alongside in-house venture capital funds. But actually incorporating new systems into vehicles requires working closely with supplier and OEM engineers. That means locating somewhere near the Detroit-Ann Arbor Michigan nexus, that includes substantial facilities for the Detroit 3, Honda, Toyota and Hyundai, as well as virtually every global supplier. The reality is that Silicon Valley is setting up engineering operations in Ontario, Michigan, Ohio and Illinois. [Nissan, too – they employ about 1,200 in Farmington Hills, north of Detroit.] Apple and others are establishing their own partnerships, in Detroit. I don't have data, but my suspicion is that there's a net flow of jobs into the core US region, not out of it.

My thanks to the members of the "ToTo" Toronto-Torino conference for the opportunity to develop these ideas earlier this week at the University of Toronto. And happy Canada Day to one and all!
Bruce Belzowski of UMTRI is my source for the implications of vehicle park and the gradual roll-out of new vehicle models for the length of time it takes for new innovations to become dominant on US roads. For more on Mobility 2.0 from an investment perspective see Morgan Stanley's Bluepaper on Autos & Shared Mobility [the fully study is available only to clients], and also Arthur D Little The Future of Urban Mobility 2.0. Sources on electric vehicles and autonomous vehicles are too numerous to need links, but see a July 1, 2016 Bloomberg post "Fatal Tesla Crash Spurs Criticism of On-The-Road Beta Testing" that includes links and analysis of social and legal issues in which autonomous vehicles are embedded.