In 2018, three U.S. automakers accounted for nearly 46% of the U.S. car industry’s market share by volume. General Motors (GM) led the market with a 17.9% share, followed by Ford with 14.7%, and Chrysler with 12.9% (Exhibit 4).14 Toyota was the leading non-U.S. manufacturer with 13.5% by volume. Tesla held a 0.2% market share. (See the Competitors tab in the Tesla case workbook for additional financial data.) Automakers, who were sometimes referred to as original equipment manufacturers or OEMs, had historically earned low returns on their investments. The operating margins (operating income as a percentage of sales) of GM, Ford, and Chrysler were 7.4%, 6.4%, and 3.2%, respectively.
a Passenger cars include sedans, hatchbacks, SUVs, 4x4s, and other related vehicles that have four wheels and have no more than eight seats in addition to the driver’s seat. b A fuel cell car is a type of electric vehicle that uses a fuel cell instead of or together with a battery. A fuel cell uses hydrogen and oxygen to produce electricity.
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OEMs faced significant barriers to exit. The automotive sector employed nearly 3 million people in the United States – nearly 1 million in manufacturing and 2 million in retail – and politicians at the federal, state, and local levels were keen to protect those jobs.15 The automakers’ resources, including factories and brands, were highly specialized and could not be easily redeployed to other uses. Not one of the “Big Three” U.S. manufacturers had left the market, even during the 2008 Great Recession when their manufacturing capacity utilization fell below 33% (Exhibit 5). Both Chrysler and GM declared bankruptcy in 2009. The federal government rescued GM, and Chrysler was acquired by Italy-based Fiat. Within two years, GM had returned to profitability, although it continued to earn low returns on investment. Customers demonstrated little brand loyalty when it came to the cars they bought. Eighty percent switched brands when trading in a car and buying a new one. Customers of Toyota’s luxury brand Lexus were the most loyal; but even among Lexus owners, only 30% replaced their trade-in with another Lexus. Replacement rates for other luxury brands were lower, considerably so for some: Mercedes-Benz, 28%; BMW, 24%; Porsche, 22%; Audi, 16%; and Jaguar, 12%.16 Wall Street was not convinced that the traditional automotive OEMs were well positioned to respond to significant industry shifts brought on by startups like Tesla and technology companies with deep financial pockets like Google and Apple. New entrants were investing heavily in EVs, autonomous driving, and mobility services – technologies and services that enabled goods and people to move around more freely.17 As the industry moved from selling cars to providing mobility services, the sources of industry revenues and profits were projected to shift (Exhibits 6a and 6b).18
New Entrants
The barriers to entering the auto industry were high. New entrants had to contend with creating brand loyalty, building manufacturing capabilities and factories, developing a dealer network, and attaining the capital requirements to develop and build a new car, which could be as much as $6 billion and take up to six years.19 Research and development (R&D) expenditure for OEMs based in the United States was about 5% of revenue. Six automakers were among the world’s most valuable brands, including Toyota with an estimated brand value of $45 billion, Mercedes-Benz ($34 billion), BMW ($31 billion), Honda ($26 billion), Audi ($14 billion), and Ford ($14 billion).20 Exhibit 7 shows how much the ten largest OEMs spent on capital expenditure, R&D, and acquisitions between 2006 and 2016. While there had been no domestic entrants at scale in the United States since the 1920s, there had been entry by non-US manufacturers. Japanese (Toyota, Honda) followed by Korean (Hyundai, Kia) automakers entered at the lower end of the market in price starting in the early 1980s and moved up to higher-end brands (e.g., Lexus) once they had established a firm foothold. In 2018, OEMs headquartered outside the United States were producing more cars in the United States than GM, Ford, and Chrysler combined.21 Companies like Toyota, Daimler, BMW, and Nissan were building and
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expanding factories and workforces across the southern and southwestern regions of the United States. Daimler was investing $1 billion in its Alabama-based plant, which produced 286,000 cars in 2017, and BMW was spending $600 million to expand its South Carolina plant, which produced 370,000 cars.22 Toyota’s four U.S. factories, which together produced nearly 2 million cars in 2017, were about to become five after the company announced in January 2018 that it would be building a $1.6 billion shared factory with Mazda in Alabama, which would result in 4,000 new jobs.23
Suppliers
Globally, over 11,000 companies supplied automobile manufacturers with parts (tires, batteries) and systems (braking, electrical). These suppliers ran 60,000 production facilities and employed 7 million people worldwide. The $2.2 trillion global automotive supply business was highly fragmented. The top five players – Robert Bosch, Continental, Magna, Denso, and ZF Friedrichshafen – accounted for 8.1% of revenue.24 (See the Suppliers tab in the Tesla case workbook for additional data on suppliers.) There were three tiers of suppliers. Tier 1 suppliers (e.g., Robert Bosch) sold components and sub- systems that integrated multiple parts, such as a steering system, directly to OEMs.25 Tier 1 suppliers had deep technical capabilities that allowed them to diversify beyond the automotive industry.26 More than 40% of Bosch’s revenue, for example, came from the company’s non-automotive business. The company sold solutions that integrated smoke detectors, climate control, and appliances into what it called a “smart home” system. Tier 2 suppliers sold parts such as interior trim, bumpers, wires, and cables to Tier 1 suppliers. Like their Tier 1 counterparts, many Tier 2 suppliers sold to customers in multiple industries.27 Tier 3 suppliers sold undifferentiated raw materials such as steel or rubber to OEMs and to Tier 1 and Tier 2 suppliers. On average, a car manufacturer had hundreds of suppliers. Ford, for example, purchased 80% of its parts from 100 suppliers.28 Automotive suppliers were typically more profitable than automakers (Exhibit 8). Tier 1 suppliers were investing in new technologies in preparation for a future dominated by electric vehicles, which would require far fewer parts. An internal combustion car consisted of up to 30,000 discrete parts while an EV had about one-third as many components.29 This contrast was clearly evident when comparing the engines. An internal combustion engine (ICE) required hundreds of moving parts while the induction engine used in EVs had only a few. ICE cars had anywhere from six to 10 gears while EVs had one.30 Tier 1 suppliers were expected to capture a larger portion of a vehicle’s value by selling subsystems, such as advanced driver assistance systems and infotainment systems that enhanced safety and the driver’s experience.31 Suppliers of new technology and software were predicted to capture 11% of profits by 2030, up from 4% in 2015.32 In addition, because they provided the majority of fuel-saving technology in R&D and production capacity, Tier 1 suppliers were reaping the benefits of new fuel
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economy standards and renewable fuel standards. One industry analyst predicted that between 2014 and 2025, automakers would spend $110 billion on fuel-saving technology, of which $90 billion would be paid to suppliers. 33
Customers
Car Buyers In 2018, there were 113 million registered passenger cars in the United States.34 Average vehicle retention was at an all-time high of 11.6 years.35 Most of these cars spent 95% of their time parked. Approximately 75% of workers in the United States commuted alone by car.36 Millennials, a generation of 75 million people, had a lower rate of car ownership than previous generations at their age. One study found that 92% of 20–24 year-olds had a driver’s license in 1983, a rate that had dropped to 77% by 2014.37 While the 2008 Great Recession delayed their entrance into the car-buying market, Millennials were the fastest-growing segment of car buyers, and J.D. Powers predicted that by 2020 they would make up 40% of new car purchases. Compact cars and some crossovers were their cars of choice. Before entering a dealership, they spent significant time on the internet researching makes and models, and conferring with acquaintances on social media.38 According to a study by Autotrader, they spent an average of 17 hours researching vehicles before making a purchase.39 As one industry observer noted: “Millennials buy cars more pragmatically. Maybe they missed that moment when you deeply fall in love with cars, or a car, or personal autonomous transportation. And they are forever going to be more on the pragmatic car-as-commodity, car-as- appliance part of the equation.”40 Millennials’ parents were also starting to think differently about car ownership. According to a 2015 Zipcar study, Baby Boomers – those born between 1946 and 1964 – were moving to the city in large numbers to take advantage of shorter commutes and the cultural experiences urban life offered.41 Eighty seven percent of the study’s respondents said that having a shorter commute was an important part of urban life while 65% said that getting around without a car was a key attribute of urban living.42 Many relied on ride-hailing services as customers as well as a source of income. A 2015 Uber study determined that 39% of its drivers who drove over 30 hours per week were 50 years and older.43 In making purchasing decisions, a survey of over 2,000 car buyers ages 18–64 found that safety, fuel efficiency, and high quality were the most important buying factors, whereas spaciousness, price, and brand were ranked least important (Exhibit 9). For Millennials, the top five desired features when looking for a car were navigation systems, satellite radio, Bluetooth, MP3 players, and mobile integration.44 Dealerships In 2018, there were over 18,000 new car dealerships in the United States, down from nearly 22,000 in 2007.45 Sales of new cars accounted for roughly 30% of a dealership’s profits (dealers earned approximately 2% of the purchase price of a new car in profit).46 Dealerships made between 45% and 60% of their profits through servicing cars and supplying replacement parts, although those
