How traditional cars makers are being disrupted by new technologies like electric vehicles, autonomous driving, and 3D printing.
The auto industry is full of moats, but not all moats are created equal. Moreover, technologies like electric vehicles, software updates, and autonomous driving are changing the competitive landscape. We examine the auto industry using our framework for moats summarized here. Our main conclusion is that electric vehicles are disrupting internal combustion engine (ICE) transportation in multiple ways that only became apparent to us after working through our competitive moats framework.
Note: This is not investment advice.
Recall from our framework that there are five types of moats listed below in order of strength. We realize that this ranking is highly judgmental and will not be true for all industries.
We address each in turn.
1. Network Effects
Internal combustion engine (ICE) transportation rests on three very large network effects including the gasoline industry, system of roads and licensing for drivers. Early adoption of ICE vehicles was hampered by a lack of gas stations. Today there are gas stations approximately every three miles in the USA and within 10 miles for the rest of the industrialized world. Early adoption of cars was also hampered by a lack of paved highways and process for training and licensing drivers. Today, highways are ubiquitous and its fairly easy to get a license.
These three networks are powerful, but as we state in our framework, this power goes both ways. Adoption curves move as quickly as the less discussed rejection curve. The tipping point is a new technology paired with a better product. Today, that technology is batteries and that product is electric vehicles.
Two companies appear to have succeeded in creating mass market EVs that are superior to ICE. The first is China's "Build Your Dreams" which is currently the world's largest EV manufacturer. BYD dominates the taxi market in China using a model that only costs $15,000. Its not fancy, but when you use a taxi you don't really care about fancy. You just want to get from A to B cheaply and China's extensive network of charging stations has made BYD's EVs competitive even without purchase subsidies. For middle class families the flagship EV is the Tesla Model 3 which is currently priced at $39,000 up-front investment in the US for the base package and without any tax credit. That is not much more than the average car sale price of $37,500.
EVs are accelerating up the adoption S-Curve for several reasons. The first is cost, which we already mentioned. This has been driven by a fall in battery prices. EVs are also safer because they don't require carrying large amounts of explosive fuel. EVs are also far simpler, having less than 10% as many moving parts, and therefore cheaper to maintain. All in costs of a Tesla Model 3 may actually be comparable if not cheaper than a Toyota Camry. This ignores obvious difference in performance, future updates to autonomy, near zero noise, and other pluses we learned while visiting our local Tesla shop.
On the other side of the adoption curve is the rejection curve: The number of miles driven per person in the USA is actually falling along with the number of gas stations, albeit slowly. Systems of gas stations and pipelines are expensive to maintain and even more expensive to build. We wrote a separate piece listing eight reasons why car ownership and miles driven per person is falling. The implication here is that with fewer people driving the cost of maintaining this infrastructure may rise per person making it more expensive to own and operate an ICE vehicle.
In contrast, EVs don't require stations for 98% of travel needs because of far cheaper home plugins. For that last 2%, charging networks are popping up all over the world. You can check them out using a variety of websites.
More EVs also means more awareness of how they work and supporting industries such as charging networks and mechanics. When your neighbor buys an EV you may be more willing to because you perceive that they are finally practical for everyone, not just the wealthy. That makes every EV more valuable because it drives more investments like charging stations. More EV owners also means more support for ending dependence on fossil fuels. Factors like this are what drive tipping points in the adoption S-Curve.
Network effects are likely to be a present in autonomous (self-driving) cars, but we save that discussion for our second source of moat: "Switching Costs".
2. Switching Costs
Traditional car companies don't have much in the way of switching costs. They all pretty much work the same way. Its also easier to switch vehicles. Research time has been cut down by the internet. Financing costs are very cheap. However, new safety features and autonomous driving tools could be changing that.
We still drive a Hyundai Elantra that we bought in 2012. It lacks any rear view camera or sensors to detect proximity to nearby objects. One reason we are hesitant to buy a new car with these features is that we know we would have a hard time switching back. Likely, we would become as dependent on these features as we did our GPS. When was the last time you actually read a map? More sophisticated safety features are a big driven of rising car inflation.
Autonomous driving will be a game changing source of switching costs. Most people just want to safely get from A to B. EVs are safer, cheaper, less smelly, quiet, and good for the environment when powered by solar, but the driving experience is not radically different from ICE cars. In our view, test driving the Tesla Model 3 was mayby 100% better than our current Hyundai Elantra. Autonomy is more like a 1000% improvement.
Autonomy changes everything about the way drive, travel, insure, transport goods, and value vehicles.
Time is money, and autonomy will allow individuals to travel more safely while doing other tasks.
Taxis will cost $0.18 - $0.40 per miles compared to $3.50 today. No one will need to own a car.
Air travel will no longer be preferred over driving for long distance land travel.
Car insurance will be priced based on aggressiveness setting, crime rates, and locations.
Transportation of goods across land will be far cheaper just like taxi services.
Cars will be viewed as either luxuries or investments depending on their use case.
Investing in cars will be determined by demand and supply of autonomous fleets.
Many industries beyond just immediate car manufacturers could be disrupted in response to these monumental changes including air travel, rail transport, oil extractors and gasoline refiners, insurance companies, taxi services, gas stations, car repair shops, engine manufacturers, electric companies and contributors to the grid via solar technology, and real estate currently being used for parking lots (currently around 5 spots for every household around cities).
Autonomy also carries with it the potential for huge network effects.
Two types of brands in our framework seem applicable to the car industry. Positional brands and Search cost brands.
Positional Brands signal status, and are powerful moats in the car industry. For example, BMWs are very popular in China because everyone knows that BMWs are a stronger signal of success than a Honda Accord. But positional car brands are vulnerable to changes in performance.
Rolex is a strong Positional Brand because performance is not important. All watches have essentially the same performance. What matters is that it is expensive and everyone knows it’s expensive. You see the Rolex and you know that person has money and that they want you to know they have money. Rolex will not have a bad year where their latest update fails to meet expectations for reliability and performance causing a massive hit to the brand. Car brands carry this risk every day.
BMW seems like a weak Positional Brand. BMW’s M3 is a status symbol in large part because of its performance. That may have been true in the past, but is it true today? This video shows that a comparably priced Tesla Model 3’s performance is superior to the BMW M3 in essentially every single way. How long can BMW maintain its brand of high performance superior German engineering with YouTube video after video showing its top seller getting beat by Teslas?
This criticism of BMW likely applies to all high performance ICE manufacturers. EV acceleration feels instantaneous because the speed of electricity is much faster than the complex of fuel feeding into a traditional engine. Four million people have watched this video of a Tesla Model X P100D beat a Lamborghini Aventador SV and setting a new world record for drag racing. Google estimates that this Tesla costs $140,000 while this Lambo costs $500,000. Why would anyone want to buy a sports car for a ½ Million only to lose to an SUV that costs ⅓ the price?
Search Cost brands have also had an important role in the car industry. Our first car was a 1995 Honda Accord. We bought it because it provided reliable transport from A to B. Search Cost car brands are not as strong as they used to be because the internet has made it so easy to do research on how brands are changing. ConsumerReports found Subaru to be the most reliable car brand in 2018. Honda is still very reliable, but we would prefer a Subaru in terms of reliability.
Toyota, Honda, Hyundai, Subaru brands are built on affordability, reliability, and safety. The reliability component is probably the strongest because its impossible to measure up front. We only know the reliability of a car years in the future, and so we buy the brand that has performed well in the past.
That said, Toyota, Honda, Hyundai, and Subaru are direct competitors to some of the forces we discussed that are driving down car ownership rates such as Electric Scooters, urbanization, governments supporting more pedestrian and bike paths, and technology that makes it easier to work from home.
The key point here is that car brands are only going to hold water if the data is consistent with the brand. That means the brand isn’t much of a moat. For a car brand to be a powerful moat it would need to be independent of the data. YouTube videos and tools like ConsumerReports make car brands very data dependent.
4. Legal Barriers
Our framework includes three legal barriers: Legal Monopolies, Patents, and Licenses. None seem to be relevant to the car industry. Let us know if you disagree.
5. Cost Advantages
Our framework includes two types of cost advantages: Economies of Scale and Superior processes and niche markets.
Economies of scale are providing lower cost advantages to all car manufacturers. Scaled production is easier in part because of access to capital markets and cheap interest rates. Better manufacturing technology including robotics, 3d printing, and more powerful construction machinery are all making it far easier to start a car company or create car parts. This will continue to reduce a major moat for all car manufacturers that has helped lift the industry for decades.
ICE manufacturers have had a cost advantage over EVs until recently. EV technology is working down a much faster cost curve than combustion engines. This is putting pressure on any remaining moat that combustion engine car makers have. Environmental regulations are pushing this trend faster. While many regulations are subject to fast changes in response to election...this trend is likely to remain persistent because of growing obvious damage of fossil fuels to the environment such as smog in China. China is currently the largest market for EVs and is subsidizing this market rapidly in response to growing dissatisfaction with the air pollution.
We argue in our framework on moats that "Superior processes and niche markets" is the weakest form of moat. That said, there may be special qualities about some companies CEOs or culture. The trouble with measuring a "superior process" is that its very subjective.
We applied our framework for evaluating competitive moats to the car industry. We conclude that competitive moats in the traditional auto industry are eroding.
This is especially true for car manufacturers that are not switching over to electric vehicles. Internal combustion engines (ICE) are built on networks of oil pipeline and gasoline supply chains that could rapidly become expensive to maintain as more car buyers switch to electric which can usually be charged at home. EV adoption could follow an S-Curve as the many network effects we discuss take hold.
ConsumerReports and Youtube are making car brands highly data dependent, and the data shows "performance" ICE brands like BMW and Lamborghini are losing to far cheaper EVs. Moats from economies of scale are also shrinking thanks to cheap capital and new technologies like 3D printing.
Moats from switching costs may actually be rising. New safety features like rear view cameras and proximity sensors are easy to become dependent on and are a big contributer to rising car inflation. Autonomy could lead to very high switching costs as people stop learning how to drive and the elderly regain easy transport.
Thank you for your interest. This is not investment advice.