2018/3/23 Carmakers take electric fight to the factory floor

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Patrick McGee in Frankfurt MARCH 18, 2018

When Henry Ford introduced the Model T in 1908, the automobile had already been around fortwo decades. The revolution he engineered was not the car, but the system that made it.

Ford introduced standardised, interchangeable parts, followed by assembly line production. By1914, according to HSBC, Ford’s output was greater than all other carmakers combined and itsproduction costs tumbled from $850 per car at launch to $260 by 1920. Thefounder’s predecessors had succeeded in building “horseless carriages” for the rich, leaving Ford toreap the profits of ramping up production.

A century later, executives at some of the world’s biggest automakers are growing confident thatthey can pull off a similar trick for electric vehicles.

While General Motors, Volkswagen and Toyota all make around 10m cars a year, each is playingcatch-up on long-range, zero-emission vehicles. But by “adopting, adapting, imitating, innovatingand acquiring”, as Goldman Sachs puts it, they are revamping facilities to produce electric cars atscale and for profit — two achievements yet to be seen at Tesla despite the huge disruption the USelectric carmaker has brought to the market.

Henry Ford revolutionised car production in the early 1900s

Ford only had to build one model. “The Model T was so successful because they were able to delivera car for everybody,” says Lutz Meyer, a BMW executive focused on future vehicle architectures. “Ithad to be cheap. They couldn’t produce variety, like a lot of colours.”

The Big Read Electric Vehicles

Carmakers take electric fight to the factory floor

With VW and GM pouring billions into production facilities for electric cars, Tesla’s supremacy

is far from assured

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Today, established carmakers flaunt their ability to manufacture all kinds of models, fromhatchbacks to sport utility vehicles, on a single production line. Their challenge is to revamp theseoperations to produce electric vehicles in high volumes, reinforcing barriers to entry in an industryunder siege from technology companies and start-ups.

Instead of coming out with an array of unprofitable electric cars today, the incumbents are puttingthe bulk of resources into production facilities that will mass-produce models from 2020, oncebattery costs fall and economies of scale kick in. Analysts suggest this approach leaves theimpression the incumbents are lagging far behind Tesla. But once the game actually starts, sayexperts, the carmakers will be in a strong position to dominate the market.

“None of the traditional car manufacturers will have problems scaling up electric vehicleproduction,” says Klaus Stricker, co-head of the global automotive practice at Bain & Company.“That’s exactly what they do best.”

Yet if the stock market is any guide, investors are more sceptical. Valuations of the bigcarmakers are among the most depressed on the S&P 500, Germany’s DAX and Japan’s Nikkeiindices, according to Bernstein. Yet Tesla is valued like its products are set to dominate the carmarket the way Apple conquered mobile phones.

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Tesla’s market value of $55bn is about $2.3bn more than GM’s, though for every car it built lastyear the latter group produced 100.

This large valuation gap reflects a view that traditional carmakers’ core capabilities of assemblingand distributing cars is an “old world” competence with little relevance to an electric future. AsHSBC analyst Horst Schneider wrote in September: the big carmakers “may lack any advantage”over new competitors because they are not involved in battery cell production.

Feeding this prevailing belief is the idea that barriers to entry are much lower than previouslyimagined. Tesla was the first successful American car company to emerge since Chrysler in 1925.The Silicon Valley company run by Elon Musk launched the first long-range electric cars — theRoadster in 2008 and the Model S in 2012. It looked poised to make headway last year with theModel 3, aiming to build 5,000 vehicles a week by late 2017.

This idea is now being turned on its head. Tesla has postponed its production target, twice, to theend of June, and even this new deadline is met with scepticism. The bulls at Morgan Stanley, whoconsider Tesla undervalued, concede it would be a “leap of faith” to expect 5,000 cars a weekanytime this year.

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Mr Musk has a reputation for setting, and then rescheduling, ambitious targets. In this case thedelays look more serious, as the Model 3 was Tesla’s first foray into the mainstream. Rather thantaking on the big carmakers, the Model 3 problems may simply be highlighting their advantages:plentiful financial resources, decades of manufacturing expertise and global sales networks.

“Elon Musk is definitely big picture thinking,” says Kristina Church, analyst at Barclays,“but the established carmakers really know how to engineer vehicles, and to engineer themprofitably. That is a whole lot of learning that Tesla is trying to catch up with.”

In motion: the body of a Tesla Model S is transported at the company's Fremont factory in 2011 © Reuters

Tesla’s production troubles are a reminder that in automotive history, it is how to buildcars, rather than the merits of any particular model, that is key to success. After Ford displacedcraft production with mass assembly in 1908, it was overtaken by GM in the 1920s with “flexiblemass production” that could produce an array of models, from entry-level to luxury brands, andrespond to customer preferences. In the 1980s, both companies were disrupted by Honda andToyota’s methods of lean production. The Japanese groups outsourced a majority of taskspreviously considered critical. With parts arriving “just in time” on the assembly line, they largelydid away with inventories.

The success of German manufacturers, whose volumes more than trebled from 4m units in 1990 to15m last year, was largely based on “platform sharing” that let multiple models use the same designunderpinnings. VW Group, the world’s largest carmaker, uses common building blocks under “theLego principle” to share engines, transmissions and components across its 12 brands.

These progressive changes were all based on superior methods of producing cars, forcing rivals toadapt or die. “Efficiency was always the cornerstone of success in the automotive industry,” saysOliver Zipse, head of production at BMW. “As soon as you were not able to produce in a particularcost frame, you were out of the market.”

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Carmakers are today investing in production plants that integrate reams of data with processesacross the supply chain. Assembly times are being accelerated and downtime is being cut by fixingproblems before they occur.

“The whole system is becoming enormously complex all of a sudden,” Mr Zipse says. He refers tothe need for carmakers to incorporate new drive trains and autonomous technology, while keepingthe speed of production cycle at just 60 seconds. “If you’re not able to [keep] this complexsystem working 100 per cent faultless, you will never do 60 second [manufacturing] cycles, and ifyou’re not doing 60 second cycles, you’ll never build 300,000 cars.”

Mr Musk acknowledges the importance of what he calls “the machine that builds themachine”. Last month he told analysts: “The competitive strength of Tesla, long term, is not goingto be the car. It’s going to be the factory.”

So far, the threat posed by Tesla has not been based on a superior production method. So as the bigcarmakers shift into electric cars, numerous executives believe they have a decisive advantage.

“You’re going to see some really, really good electric vehicles coming from the traditionalcarmakers,” says Don Walker, chief executive of Magna, which assembles cars for contract. “Theyare going to be extremely well-built, extremely reliable — from the buzz, squeak and rattle to the fitand finish.”

The stock market view is that carmakers have been too slow to adapt. Unquestionably, Teslabuilt up a phenomenal brand by taking risks others would not take. But in comparing Tesla and

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Apple, it is clear the incumbent carmakers are not willing to play the role of Nokia or Motorola.When the iPhone launched in 2007, Nokia recorded €7.2bn in net profit. By 2012, its sales hadcollapsed and it posted a loss of more than €3bn.

The first game-changing smartphone, the BlackBerry 5810, debuted in 2002. A decade later,smartphones accounted for half of all US mobile connections. Globally, the 50 per cent thresholdwas passed in 2016, according to GSMA Intelligence.

Electric vehicles will need decades to claim half the global market. In Europe, Barclays expects halfof all cars sold to be electric by 2030, with global penetration reaching 50 per cent after 2040 —about 30 years after the Model S first rolled off a production line. The boldest forecasts assume anEV market share this year of less than 3 per cent.

Tesla founder Elon Musk © Reuters

Carmakers must act quickly, but they have a luxury of time that handset providers never had. Sincethe Model S was introduced in June 2012, traditional carmakers’ sales and margins have not evenbeen dented. Collective operating profits from Volkswagen, Daimler and BMW swelled from€27.8bn in 2012 to €39.8bn last year. Each earned more profit in 2017 than the $11.7bn Teslabooked as revenue.

“That is what the market has missed,” Ms Church says. “The firepower of the traditional carmakersis phenomenal.”

Despite a widely held view among investors that conventional car production facilities are aliability, it is the growing sales of petrol-guzzling SUVs and saloons that have enabled Volkswagento earmark €34bn for electric and self-driving technology over the next five years. According toGoldman Sachs analyst Stefan Burgstaller this “should be more than funded by cash generation”and take up about one-fifth of capital expenditure and R&D by 2022.

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Analysts also say global distribution networks and the ability to manufacture locally are beingundervalued by the stock market. BMW sells electrified cars in 74 countries and conventionalversions in 137 markets. “We know what it takes to put cars in every country,” Mr Meyer of BMWsays. “That’s an asset.”

For new entrants without manufacturing plants in China — the world’s largest car market — it isdifficult to see how they can dominate. And while combustion engines could be obsolete in a matterof decades, there is little evidence that the traditional players will necessarily lose out from Tesla’sfirst-mover status in electric cars.

Arndt Ellinghorst, analyst at Evercore ISI, says Tesla has been a “universal wake-up call” forthe industry. “Musk is pushing an industry that would have just kept pushing the same product,”he says. But, he argues, the resources, capabilities, and ability to partner with technology suppliersplace the incumbents in a better position to mass produce EVs.

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“The incumbents may look [like they are] behind today, but everyone in the tech world wants tobuild with the major car companies. They have established a network to get this done globally.That’s not trivial. If you want to sell cars globally, you need to make them globally.”

As Mr Musk struggles to scale up production and diverts his attention to rocket launches at SpaceX— one of his companies which last month sent a Roadster into space — some car companies arestarting to treat him less like a major threat and more like a marketer.

At the Geneva Motor Show this month, visitors were greeted by a billboard advert from Hyundaifor its compact electric SUV. “Your turn, Elon,” the bold lettering proclaimed.

“The ad is intended to highlight the fact that some companies — including Hyundai — are bringingreal solutions to the market,” the company said, “while others are just talking about them.” BMW’sMr Zipse is more blunt: “We prefer to bring our cars to the street instead of sending them to theuniverse.”

How to build ‘Electric-only’ or hybrid approachdivides makers

In the quest to build electric vehicles at scale, a rift has emerged as the world’s biggestcarmakers adopt two fundamentally different approaches to production. Some, like GM,VW and Toyota, are following Tesla with electric-only architecture in which the

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Copyright The Financial Times Limited 2018. All rights reserved.

underpinnings of a car resemble a skateboard, with the battery, wheels and axles forminga common platform for a myriad designs to go on top.

These companies insist that designing electric cars from the ground up willproduce superior designs and enable them to optimise space.

“You get a lot of freedom for the design of the car [and] can make more interior spacewith the same footprint,” says Herbert Diess, head of the VW brand.

Others such as BMW and Jaguar Land Rover are emphasising flexible platforms that canaccommodate conventional, hybrid or electric engines. The flexible option should becheaper and could better respond to different levels of electric car take-up around theworld.

“We all know electrification is coming, but no one [is] aware how quickly it will arrive,”Hanno Kirner, an executive director at JLR, told investors last week. “We don’t knowwhen, where, or what customers will buy in the future.”

BMW says predictions are too uncertain to rely on a single solution. In 2025, it expectsthat up to a quarter of its new car sales will be electrified — a “major shift”, says BMWexecutive Lutz Meyer, but one that still involves it selling about 2m conventional vehiclesper year. “The key to success is not a solitary platform, it’s the architecture thatresponds to every demand.”

Mr Diess, by contrast, rejects the notion that electric cars can be built on flexibleplatforms without compromise. “This is not a question of philosophy,” he says. “It’s aquestion of scale. We can afford a new platform.”