No margins, no disruption: the New Mobility Challenge

Mike Smitka
Washington and Lee University

If you want to disrupt an industry, you need to pick one with fat margins. That's the real challenge for the entire family of "new mobility" models, and more generally for "disruptive" technologies in the automotive footprint. It's one thing to be able to arbitrage regulated monopolies, which is what most incumbent cab companies are. But that only works if your strategy provides you with entry barriers, and the monopolies you break into earn piles of money. Local cab companies are however perfectly capable of developing their own cell phone apps, benefitting from the high ratio of "locals" in the customer base. That's true up and down the automotive value chain: all operate with thin margins. They are thus NOT ripe for "disruption."

...why would anyone want to try to disrupt a market with thin margins?...

At base, motor vehicle manufacturing, distribution, repair, and the final market of transportation services have few monopolies. Yes, if you want to develop the next-generation diesel engine there are only two players who are capable of the underlying material science and have the ability to manufacture with the requisite quality in the requisite volumes. (These two are Federal Mogul and Mahle.) There are however multiple firms capable of "mature" piston production. The same is true for every other component that I can think of: there are often a small handful of "leading" firms but there are also commodity producers of older technologies. The only way to preserve margins is to keep innovating.

Furthermore, it's a complex chain. Assembling vehicles, as Tesla is learning, is the easiest part – and they don't yet have their Model 3 assembly line up and running, despite having more employees than the normal volume assembly plant. But that's the tip of the iceberg: they have yet to solve the national distribution challenge in a cost-effective manner. Assuring that component supply lines can meet your production plan, and that you can take tradeins, provide financing and repair vehicles quickly, all that takes a lot of people and a lot of physical assets. Experience helps, too. If you're to grow rapidly, those have to be in place beforehand. Some resources can be borrowed, including the financing, as happens in the "traditional" franchised dealership system (though Tesla has decided not to do so).

It took over a decade from their establishment of a solid footprint for Honda, Toyota and VW to succeed – and as VW has demonstrated, laurels can be lost. After all, in the early 1960s and again around 1968 VW was THE import market in the US. They're now barely a player. The VW vertically integrated, single model mass production strategy worked for a while, as did Henry Ford's monomaniacal focus on the Model T and nothing but the Model T. Neither VW nor Ford were ever able to lower costs sufficiently to develop a sustainable advantage against the evolving products of rivals. In contrast, Tesla is a high-cost producer with a high-cost distribution system. High costs aren't an insuperable barrier if you aim to break into the premium car segment, but even then you have to keep renewing your product. High costs don't work if you aim for the high volume, middle-segment of the market.

Ditto Uber on the downstream transportation service end: taking over the taxi business would be great, but only if the underlying business was unusually profitable. But it's not. There's little room for cost reduction – materials, labor, overhead. It's not as though existing taxis are new and drivers well-paid. There not much room to cut economic costs, even if in the short run costs can be shifted to unsuspecting parties (Uber's owner/driver contractors). The only way Uber can provide reliably better service than incumbent Yellow Cabs is to have higher peak load capacity, with the requisite assets of vehicles and drivers. Superior service at a comparable price lets them grab market share, but they've not expanded the market. And without a bigger market they can't sustain their high-cost strategy. A cell phone app doesn't lower the cost of a car, or lower the minimum wage paid by alternate jobs. To reiterate: creating a big taxi company does not provide a route to healthy long-run margins.

...creating a big taxi company does not provide a route to healthy long-run margins...

So don't be fooled by the apparent ease of entry by disruptors. Yes, Tesla can draw upon the base of automotive suppliers to launch a car, something that would not have been possible in the more vertically integrated world of the 1960s. Numerous Chinese domestic players have done the same, and one or two may even survive if not thrive, the Geely's and Great Walls. But Tesla can't rapidly expand in the mature markets of NAFTA and the EU, absent a revolution in battery costs that decades of leading-edge chemistry research has yet to deliver. They can't compete in costs against the still-improving technology of the internal combustion engine. They can't compete by eroding the fat margins of incumbents, because margins aren't fat.

Autonomy is much the same. The suite of sensors need to be integrated into a vehicle, software integrated into the actuation of steering, braking and so on. Everything then needs to be tested. Car companies are good at that – that's why they're called assemblers. Many of the pieces are already in place, but consumer acceptance is still uncertain, and the only way average transaction price can rise is if sales fall: the average new car purchaser can only finance so much, given stagnant incomes amidst a driving population that is virtually flat. In other words, implementing a costly technology won't help margins. Indeed, it's already gotten the CEO of Ford fired.

...govt policy can disrupt the (auto) market, but not Tesla, not Uber, not Waymo...

There is one exception: government policy can disrupt the market, by enacting direct and indirect subsidies (such as California ZEV credits or safety mandates). But not Tesla, not Uber, and not Waymo. What is amazing is that, given automotive margins, they purport to have "disruption" as their strategy. It may work on the stock market, at least for a while. It won't work in the automotive market.