The PACE of Automotive Innovation

Suppliers are integral to new technology in the auto industry to an extent not true since the early years of the 20th century, when ventures such as Ford began as mere assemblers, not manufacturers. That will be highlighted on Monday, at the 21st PACE "academy awards" for supplier innovation. (For those not in the know, Monday's the opening night of the SAE [Society of Automotive Engineers] in Detroit.)

Caveat lector: your not-so-humble author has been a judge from the competition's beginning.

General Motors began as a conglomeration of existing firms, both suppliers and assemblers. As it grew – and as Ford stumbled – it added more suppliers while dropping brands. By the 1960s it was highly integrated, with suppliers relegated to trying to make parts to GM's blueprints. Now that strategy had unintended consequences, as the route to the top became finance, with other functions such as making and selling cars treated as an afterthought. Be that as it may, come the 1970s, first emissions controls, then fuel efficiency mandates, and finally safety regulations forced car firms to engage with non-traditional, outside suppliers. Meanwhile, new entry meant that the comfortable Big Three oligopoly could no longer ignore the challenge of actually making and selling cars. One response was to spin off internal parts operations, and with it the ability to do the relevant component-specific R&D. Finally, alongside this demand-side story were two technology revolutions, those of materials science and of electronics and sensors that enabled these suppliers to turn to innovation as a way to build their businesses and preserve margins. The bottom line was that suppliers became central to automotive innovation.

This supplier-centric industry has lots of implications. For one, it may facilitate new entry; Aptera, Fisker, BYD, Chery, Geely, Great Wall, Tesla, Bright Automotive, Edison2 and others could buy drivetrains, transmissions, sensors and controls from existing, auto-tech-savvy suppliers. Not all have survived, due to a combination of undercapitalization, poor product strategy and bad luck. However none could have started had suppliers not controlled – and built their businesses around selling – core technologies. Exploring such implications, including for investors, is however a topic for subsequent posts.

Here let me briefly note the role of suppliers, using engines are an example. (My apologies to Europeans for focusing on gasoline rather than diesel engines.) Drawing from among PACE award winners, we see the following areas dominated by suppliers: fuel tanks, fuel pumps, fuel vapor recovery, injectors, injector electronics, spark plugs, valves, camshafts, pistons, piston rings, bearings, seals, sensors of many types, turbochargers and turbocharger escape valve technologies. There are other areas (engine block castings, machining) where car companies continue to dominate, but even there suppliers provide the machine tools that are critical to these operations. In short, while car companies may work on the configuration of the engine and the integration of these various components, the advances come from supplier technology.

It's not just engines. A wide array of vehicle systems are dominated entirely by suppliers, such as clutch components, transmissions, differentials and driveshafts, HVAC systems, lighting, ESC systems, tires, tire sensors, suspensions, ECUs and most other sensors and vehicle electronics, airbags, seatbelts, hot stamping, hydroforming, paints, structural adhesives, sound-proofing materials, water pumps, radiators, headliners, instrument panel surfaces and underfoams, starter/alternator systems, belt and pulley systems, timing chains, windshields and glass, wiper motors, wiper blades, radar, lidar and ultrasound sensors, cameras and image recognition systems, infotainments systems, and on and on. More important for Monday, you can find examples among the two decades of PACE finalists and award winners.

I've been privileged to judge this competition since its inception, thanks to the entre provided by my own research (my PhD dissertation was on automotive suppliers in Japan). As a result I've been able to visit 2-4 suppliers a year for in-depth presentations on technologies and their business case, and to sit with the judging panel to hear their summaries of similar visits. Along the way I've earned my PE degree as well. [P.E = pretend engineer] Now the entire process is under NDLs (non-disclosure agreements) so I have to be careful, but I have tried my hand (with co-author Peter Warrian) at analyzing the finalists using publicly available information for lessons on technology. You can find our initial paper here and a more recent analysis (incorporating 2015 finalists) here. photo: Federal Mogul's IROX engine bearing

Anyway, watch Monday night for the stream of press releases from the winners, and the Automotive News coverage of the entire award ceremony. I'll be there, in my tuxedo, enjoying the food and drink, and the celebration of innovation. It's a fun and thought-provoking event!

The Nano and the Model T: History Lessons Not Learned

Nano: no price is low enough

Back in 2007 the Tata Nano ultra-low-cost 4-seat car garnered attention; other companies were rumored to be starting their own projects. However, since its 2009 launch it has not sold well. While Japan has its "kei" cars (軽自動車), which are taxed less and until recently did not require proof of a parking spot, economy cars have not sold well. And while the "kei" cars are less expensive, they're not cheap, and come with amenities car drivers in developed countries expect, such as air conditioning.

...Tata fortunately didn't bet everything on the Nano...

We in the US have our own experience with a product similar in concept to the Nano: the Model T. At the onset it was still out of reach of the average American, but Henry Ford and his engineers improved production efficiency and otherwise lowered costs, so that while it initially sold for $850, when production ceased in 1926, it was selling for $350 [using the BLS inflation calculator, that's equivalent to about $4,800 today]. Or rather, not selling.

Instead consumers preferred two other vehicles. One was a Chevy, better appointed though at a higher price point. By 1923, customers could get a Chevy with an enclosed steel Body by Fisher painted in bright Duco colors, an electric starter and other amenities. The other vehicle to which price-conscious consumers gravitated was a used Model T. By the 1920s millions were available, and for farmers and others looking for basic transportation they went for half the price – or less if you were handy, as the Model T easy to fix.

Cars are aspirational products, and in India those wanting a vehicle opt for a Maruti Alto. Even though the base Alto costs 50% more than the Nano, in August 2013 Alto sales surpassed 17,000 units while the Nano sold under 2,000 units.

The other challenge is from below. Motor vehicles are durable goods (though less so on Indian than on American roads), and so the Nano faces competition from used cars. The Nano doesn't have a useable trunk, but all other models do – and a used Alto will set you back less than a new Nano.

Then there are motorbikes, for which India is the world's largest market. Bikes outsell cars by 7:1 – in August 2013 only 180,000 cars were sold, while the leading bike firm Hero by itself sold 460,000 units. At the most expensive end, a Hero Karizma will set you back over R100,000 [rupees], but most models run R40,000-R60,000. Compare that to the base Nano at R162,000 and the base Alto at R242,000. Bikes are utilitarian, too, and if you can hang on, they're capable of carrying more people than a Nano, for half the price.

Nothing New

Of course we've been here before, and we don't have to go back most of a century to find similar examples. In electric cars we had the Aptera at one end – a 3-wheel, strictly utilitarian vehicle – and the Tesla at the other. We know how that went. When Roger Smith wanted to experiment at GM, he set up Saturn. Now by refusing to overdealer he was able to claim a new "no hassle" purchasing experience, which many consumers liked, or to put it more bluntly, were willing to pay for. But by focusing on compact, utilitarian cars, Smith guaranteed the business would generate thin margins (and by insisting on all-new factories and designs, he built in high fixed costs). We also know how that went: Smith's successors could find no business case for continuing to invest in the brand. In contrast, what has GM successfully pushed in China? Not some stripped-to-the bone Chevy, but decked-out Buicks. They can't make them fast enough, the cash just keeps rolling in.

Tata fortunately didn't bet everything on the Nano. It also purchased Jaguar Land Rover, after Ford had restructured and turned them into profitable businesses. There is no upmarket for the Nano; it's already down the road and over the hill. There may be a higher-volume downmarket for JLR, which has passed the starting line with a good position and has yet to peak. Mixed metaphors, yes. Mixed performance, too. But an old story.

mike smitka