The Innovation-Driven Disruption of the Automotive Value Chain (Part 2)

Companies in the automotive value chain are faced with a challenging future. While reporting record quarterly sales, they are also witnessing two alarming trends.  Because of problems such as pollution, climate change and loss of productivity due to long commute times, consumer attitudes towards car ownership and use are changing.  In the medium and long term, i.e., the next 5-30 years, these changes have a high probability to negatively impact automakers, their suppliers and their dealers,  along with insurance companies, finance companies, and many other industries that are part of the automotive value chain.  In addition, there is a growing consumer interest in electric cars (to address the pollution and climate change problems) and in self-driving, or autonomous, cars (to address the productivity problem, as well as a slew of other issues such reduced accidents and mobility for the elderly and handicapped).  The success of Tesla Motors, Zipcar and Uber, the growing consumer anticipation of Google’s self-driving cars entering broader service, as well as Apple’s anticipated entry in the car business are exerting additional pressure on the automotive value chain to change the way it innovates. In this blog I explore what the automotive industry has been doing to address the potential disruption, analyze the effects of these initial steps, and provide recommendations on what corporations could be doing better.

Automakers and their suppliers have not been sitting still to these macro trends and events discussed in the previous post. They continue to invest heavily in R&D.  In fact, during the last three years automakers have been increasing their R&D investments.   Figure 1 shows the top 20 R&D spenders in 2014, based on data compiled by PwC, where we see (in red) that six of the top 20 companies are incumbent automotive OEMs.

1	Volkswagen	11	GM
2	Samsung	12	Daimler
3	Intel	13	Pfizer
4	Microsoft	14	Amazon
5	Roche	15	Ford
6	Novartis	16	Sanofi
7	Toyota Motors	17	Honda
8	J&J	18	IBM
9	Google	29	GSK
10	Merck	20	Cisco Systems

Figure 1: Top 20 corporate R&D spenders in 2014

Despite their high R&D investments, automotive OEMs are not considered top innovators.  Figure 2 shows the results of a survey, also conducted by PwC, where executives from a variety of industries were asked to identify the top 10 most innovative companies of 2014. Notice that Tesla Motors, one of our four disruptors, is the only automotive company included in the ranking, while none of the incumbent automotive OEMs make the list.

Rank by Innovation	Company	2013 R&D spend (in US$B)	Rank by R&D Spend	R&D as % of Annual Revenue
1	Apple	$3.4	43	2.2%
2	Google	$6.8	12	13.5%
3	Samsung	$10.4	2	5.8%
4	Amazon	$4.6	30	7.5%
5	3M	$1.6	85	5.5%
6	GE	$4.5	31	3.1%
7	Microsoft	$9.8	5	13.3%
8	IBM	$6.3	16	6.0%
9	Tesla Motors	$0.3	377	66.3%
10	Facebook	$1.4	101	27.5%

Figure 2: PwC survey results of the top 20 most innovative companies in 2014

Figure 3 shows the results of a similar innovation leader survey conducted by BCG.  The results of this survey show that in addition to Tesla Motors, the top 10 innovative company list also includes Toyota Motors.

1	Apple	11	HP	21	Volkswagen	31	P&G	41	Fast Retailing
2	Google	12	GE	22	3M	32	Fiat	42	Wal-Mart
3	Samsung	13	Intel	23	Lenovo Group	33	Airbus	43	Tata Group
4	Microsoft	14	Cisco Systems	24	Nike	34	Boeing	44	Nestle
5	IBM	15	Siemens	25	Daimler	35	Xiaomi	45	Bayer
6	Amazon	16	Coca-Cola	26	GM	36	Yahoo	46	Starbucks
7	Tesla Motors	17	LG Electronics	27	Shell	37	Hitachi	47	Tencent
8	Toyota Motors	18	BMW	28	Audi	38	McDonald’s	48	BASF
9	Facebook	19	Ford	39	Philips	39	Oracle	49	Unilever
10	Sony	20	Dell	30	Softbank	40	Salesforce	50	Huawei

Figure 3: BCG survey results of the top 50 most innovative companies in 2014

The results of the PwC and BCG surveys lead us to conclude that other industries do not view automotive OEMs as top innovators despite their high R&D investments.  So, at the very least, automotive OEMs have a market perception problem.  But I think that the problem runs deeper.  While investing heavily in R&D, automotive OEMs had not been investing in technologies and business models that are now used by newcomers to disrupt them (software, big data, user experience, additive manufacturing/materials, energy storage, sharing economy, direct to consumer). For example, GM stopped producing its electric vehicle EV1 in 1999 (and here).  These technologies and business models are not in the automotive industry’s DNA.  Automakers and their suppliers could not attract, or didn’t try to attract, talent with know-how in these areas, in the same way that companies in other industries such as telco, retail, biotech and CPG did.  Moreover, culturally automotive companies prefer to at best be fast followers, rather than a first movers.  Many large corporations often prefer to be fast followers because they perceive that in this way they are reducing the risk associated with early technology adoption.  However, in the presence of accelerating innovation, the notion of fast follower must also change.  Fast follower no longer means that the corporation can afford to wait until a technology or business model are accepted by the early adopters, implying 1-2 years after the innovation’s introduction.  Instead a fast follower may need to make adoption decisions within months.

As such, the bulk of their R&D investments tend to focus on a) sustaining innovations, e.g., improving driver ergonomics but not radically re-thinking the driver experience (compare the Google Maps experience vs the in-dash navigation systems of 2013 model year passenger cars), and b) innovations that are necessary to comply with government regulations, e.g., increasing the use of plastic and aluminum components to make cars lighter and able to utilize smaller engines thus decreasing their CO2 emissions.  Admittedly, some of the innovations necessary for compliance with government regulations can be disruptive, e.g., Ford’s cost-effective use of aluminum in conjunction with new engine technology to make its F150 truck lighter and less polluting.  Finally, with its high barriers to entry because of the capital required, the automotive industry for many years had a false sense of security from disruptors.

The Automotive Industry Rethinks its Innovation Model

As they are considering how they will be impacted from the disruptions of electric-autonomous-connected vehicles and from mobility services such as ride-sharing and car-sharing, in a world that no longer values car ownership in the way it used to, companies in the automotive value chain, starting with automakers and their suppliers, are re-thinking their innovation model and the role that startup clusters, like Silicon Valley, Israel and other regions around the world should play in the new model.  Because Silicon Valley is at the forefront of autonomous driving, software-, Internet- and big data-driven disruption, and new business models, several automotive OEMs and suppliers have started working with Silicon Valley’s ecosystem.  In many cases these interactions take the form of visits by corporate delegations.  However, increasingly automotive companies are establishing a more permanent presence in Silicon Valley (Figure 4), through their interest remains technology innovation-centric; business models and other forms of innovation don’t yet play an important role in their thinking.

Figure 4: Automotive company presence in Silicon Valley

This presence is in the form of the innovation enabling organization types I have previously discussed while presenting my corporate innovation model:

• Research labs that are focusing on the technologies being developed in Silicon Valley, e.g., Daimler, Ford.
• Corporate Venture Capital groups, e.g., BMW, Delphi, Bosch.
• Incubators, e.g., BMW (and here), VW.
• Business and corporate development offices, e.g., BMW, Faurecia, through which they are making strategic investments in innovative companies, and acquire, (here and here), startups that could help them accelerate their innovation efforts and/or access talent with the right skill set.

Figure 5 shows how these efforts are organized by type.  (Along with every incubator we include the incubation model being used). Today these corporations employ about 550 people in Silicon Valley.

Corporate Venture Capital	Research Lab	Incubator	Business Office
BMW	BMW	BMW (Model 1)	BMW
GM	GM	Ford (Model 1)	Johnson Controls
Volvo	Daimler	VW (Model 1)	Faurecia
Nissan (via WiL)	Ford	FCA (Model 2)	FCA
Delphi	VW	Bosch (Model 2)
Bosch	Delphi	Honda (Model 1)
Nokia (Connected Car)	Bosch
Hyundai	Honda
Denso	Nissan/Renault
Magna	Toyota
	Continental
	Alpine Electronics

Figure 5: Automotive companies with CVCs, incubators and research labs

Figure 6 shows the areas of focus in each of these research labs.

Company	Research Lab Areas of Focus
BMW	Connected car Autonomous car Materials UX
Mercedes	Autonomous car Electric drive UX
VW	Connected car UX
Ford	Connected car Autonomous car Big data UX Multimodal transportation
GM	UX
Nissan/Renault	Connected car Autonomous car UX
Toyota	Connected car Electric car infrastructure Big data
Honda	Connected car Big data UX Security
Denso	Autonomous car Big data Security
Continental/Elektrobit	Connected car Autonomous car Mobility services
Delphi	Connected car Autonomous car
Alpine Electronics	Connected car Cloud computing
Bosch	Connected car Autonomous car Big data UX Energy storage

Figure 6: The areas of focus in Silicon Valley-based automotive research labs

Based on the data in Figures 5 and 6 we can reach the following conclusions:

1. The core automotive industry, i.e., automotive OEMs and their suppliers, is represented by as many companies as other major industries, e.g., telco, electronics, retail, financial services.  Unfortunately, other parts of the automotive value chain, e.g., car dealer companies, car rental companies, have not established a presence in Silicon Valley, or other innovation clusters. For example, car dealers are being disrupted by the direct sales model of Tesla and sales lead-generation innovations from companies like TrueCar. Insurance companies will be disrupted by companies that can offer premiums that are based on vehicle usage-based models and models that make broader use of big data-based, rather than today’s actuarial models and today’s regulatory environment.
2. Automotive companies show a definite preference to establishing research labs over the other types of innovation enabling organizations.  Very few appear to be realizing that today’s innovation involves more than technology.  Silicon Valley has definitely shown us that today’s disruption is driven as much by business model innovation as it is by technology innovation.  In many instances technology innovation comes as a consequence of business model innovation and not the other way around.  There are other aspects of Silicon Valley’s innovation approach that are missing from these efforts such as continuous and rapid experimentation, reinforcing successes and pivoting after failures.  Only BMW has established all four of the innovation enabling organizations and fewer companies than I had expected have established venture funds.  By contrast, in other industries, e.g,. telco, electronics, more corporations, e.g., Verizon, Telefonica, Swisscom, Samsung, have established all four types of innovation enabling organizations.   In addition to thinking narrowly and associating innovation only with technology,automotive companies prefer to establish research labs because they are using them to: a)  develop new platforms, e.g., autonomous car, b) establish co-development partnerships with local startups thus building an ecosystem around these new platforms, c) acquire over the horizon views of certain technologies but also to introduce new products and features as they attempt to react to the disruptors, e.g., developing cars with improved UX and even introducing electric vehicles, and d) start building their competence in certain important areas such as big data.
3. Connected car and autonomous vehicles, i.e., new platforms, appear to be top priorities.  Electric cars are less of a priority than I would have thought.  Focusing on connected car and autonomous vehicles provides a clear indication of where the automotive companies see the larger market opportunity, while they continue to take advantage of their existing supply chains and gasoline-based propulsion infrastructure.
4. Today the automotive companies employ a small number of people in Silicon Valley.  It is not clear yet whether these groups form a critical mass and can impact the thinking of the large business units about the pending disruption to their industry and business.  As they stand today I believe that these groups are just too small to have a transformational impact to their parent corporations in light of this disruption.

The Steps the Automotive Industry Should be Taking

Motivated by the risk of being disrupted by companies that are re-imagining transportation in order to address important problems and capitalize on emerging trends, automakers and their suppliers have been taking the first steps in re-thinking the way they innovate. Without disagreeing with any of these steps, I would like to make following suggestions and recommendations that are based on my corporate innovation model:

1. Establish the right approaches to work with each innovation cluster.  Working with the ecosystem of an innovation cluster requires more than one approach and each cluster may require a different strategy.  For example, as I mentioned, Silicon Valley is about focusing on business models as much as technology innovations, rather than just technology, continuous and rapid experimentation, and about the coopetition among its ecosystem’s member.  By choosing to focus their presence on research labs, automakers and suppliers miss an important advantage offered by Silicon Valley.  In addition to research labs, automotive companies working in Silicon Valley must acquire, invest, and incubate companies that are working in sectors and using business models that are at the core of the disruption (application and platform software that is based on open standards, big data analytics, user experience technologies, Internet of Things, service-centric and subscription-based business models (here and here).  For example, compare the portfolio of BMW’s iVentures with the portfolio of GM Ventures in terms of number of investments and focus sectors.
2. Create collaborative relations between companies in the two parts of the automotive value chain.  The arrival of the electric-autonomous-connected car requires that the companies in the car manufacture and sale part of the value chain to start working more closely with the companies in the car use part.  This means that automakers, suppliers and dealers will need to start working with electric utility companies, insurance companies, telcos, and companies that provide mobility services.  Alternatively they will need to determine under what conditions it will make sense to introduce similar services themselves.  For example, BMW, Daimler and, most recently, Ford started offering car-sharing and ride-sharing services.  BMW and VW have also partnered with Chargepoint, a company with a network of electric charging stations.  BMW’s iVentures has also invested in the company.
3. Improve the coordination between the groups working within the innovation ecosystems, the central R&D organizations of the parent companies and the business units.  Part of this misalignment is due to reporting relations.  For example, BMW’s iVentures reports to the executive responsible for car maintenance and dealer management. Another part is due to clarity of mission.  For example, some of the Silicon Valley-based automotive research labs are actually acting as research scouts or as a hedge, others conduct actual research, and yet others are part of a more nebulous business development function.
4. Establish the right culture, timelines and innovation KPIs. Automotive companies are governed by top down management style and a corporate culture that at best prefers fast followers, and suits sustaining innovations, instead of experimentation that often starts at the lower organizational levels, progresses in a bottom-up manner and leads to disruptive innovations.  This culture relies on processes that promote scale, is comfortable dealing with incremental changes occurring over very long time horizons, rewards the attainment of short-term operational KPIs, e.g., car sales per quarter, or the attainment of a quarterly profit margin goal.  The automotive culture needs to change to one that supports agility, risk-taking, entrepreneurial thinking at every organizational level, and that the idea that innovation comes from both inside and outside the corporation.  While an important start, establishing an innovation-driving culture at the corporation’s Silicon Valley-based center doesn’t mean anything without starting to change the culture in the automotive company’s business units and headquarters.  The timelines to innovation-driven ROI and success will need to change to correspond to the adopted approach to innovation but they must align with other corporate timelines. As I’ve mentioned before, accessing innovation that can lead to a brand new product, e.g., BMW i3, by investing in early stage startups has a different ROI timeline than accessing innovation by acquiring a mature private company to augment an existing product, e.g., VW’s incorporation of Google Earth into certain car models.  Finally, the corporation will need to establish innovation KPIs that are different from the operational KPIs business unit executives are measured and rewarded on.   So in addition to measuring the number of cars produced during particular period, also measure the percent of non R&D employees submitting project incubation ideas.
5. Attract the right talent.  Because of the talent gap in critical areas such as big data analytics, software applications, user experience, etc., automotive companies in particular will need to establish the right talent acquisition strategies.  They will need to determine how much talent they will be able to hire in the open market, and how much of the talent gap they will close through acquisitions (including opportunities to first invest in a startup and later acquire it), retraining employees, providing incubation opportunities to the most entrepreneurial of these employees.  Unfortunately for the automotive industry this is exactly the same type of talent sought by corporations in many other industries, and is located in places where the automotive industry does not have large presence.  For example, every year US universities award only about 2000 Ph.D. in computer science.  Companies like Verizon, Ericsson and Samsung have realized this war for talent they must fight with Google, Facebook, Amazon, LinkedIn, and a few other companies and are making big investments in Bay Area, opening large software development centers in order to attract such talent and create the appropriate critical mass in these areas of interest. The automotive industry must do the same.  It is only only about hiring a few people in each important discipline but to create a critical mass of new thinkers that can impact the decisions of the business units that are located away from the innovation cluster.

Due to the challenges and potential disruption they are facing in the medium and longer term from new societal trends, technologies and business models, companies in the automotive value chain have been re-thinking their approach to innovation.  As part of these efforts, in addition to increasing their corporate R&D investments, they have started working more closely with the ecosystems of innovation clusters such as Silicon Valley.  For this reason they represent important case studies on whether corporations can take advantage of innovations created by startups in such ecosystems and in the process avoid being disrupted.  As part of this analysis it is important to understand how corporations interact, collaborate with, invest in and even acquire startups, as well as how they should be engaging in such activities.  While they have started, and this in itself is an important first step for an industry that is not known for its speed, the industry’s efforts to date have been small compared to the size of the potential disruption.  Based on the data gathered on the impact of the industry’s activities to date, It is not clear yet whether these efforts will suffice and reduce the disruption risk the corporations in these value chain are facing.  In addition to the steps they have already taken, corporations must take a series of additional steps, some more important and considerably more difficult to implement, in order to become part of the disruption rather than the victims of it.

You can find Part 3 here.

© 2015 Evangelos Simoudis