The German auto giants face an existential challenge

A few weeks back, a friend of mine bought himself a used Nissan Leaf. Even though it is fully electric, this car is a long way from being a Tesla—its range is less the 100 miles and quite honestly, it is kind of ugly. Even so, I am pretty sure that no purchase in his life has made him happier. It actually makes him giggle.

Based on this small sample size, I am quite willing to announce the day of the electric vehicle (EV) has arrived. Yes they are still quite expensive although his used 2015 with less than 20k miles on the odometer cost about $11,000. Yes their low range and high recharging times make them still something of a hardship to own. But the upside is a luxuriously quiet ride combined with hiccup-quick acceleration and premium handling due to a very low center of gravity. This is in addition to a seriously reduced need for routine maintenance, lower costs for fuel, and the satisfaction of knowing your vehicle is arguably the cleanest set of wheels around. But just to make sure my friend has plenty to giggle about, Nissan has built in an incredible electronic feature set. His favorite seems to be the announcement of available chargers whenever his range drops below 20% complete with directions for finding them.

But even if EVs are the future, the current reality is that they still constitute less than 1% of cars on the road. And nobody is making money selling them. This leaves the auto giants with a monumental problem. If they spend the big money developing EVs, they will be manufacturing a money-loser that will take sales away from the highly profitable vehicles they already sell—a least for the foreseeable future. And so the temptation to not change anything is very high. This problem is especially acute in Germany where the automakers sincerely believe that they already make the best cars on the road.

The Arrival of Tesla—German Auto Giants Face an Existential Challenge

BMW, Daimler and Volkswagen have been struggling to adapt to the advent of the electric car, held back by conservatism and internal challenges. Now, Tesla is making inroads in Germany -- and the country's automakers face an uncertain future.

Simon Hage, September 15, 2017

At the start of this year, Karl-Thomas Neumann was planning a minor revolution. His plan was to transform German carmaker Opel, known for basic models like the Astra and the Corsa, into a purely electric brand. Electric cars were to be designed at Opel's R&D center in Rüsselsheim, near Frankfurt, destined for the world market.

As the head of Opel at the time, Neuman was convinced that the end of the internal combustion engine was closer than many believed. He now hoped he could bring the necessary technology to Germany.

His idea was also born out of necessity. As a small manufacturer, it is especially challenging for Opel to adjust its internal combustion-powered cars to increasingly stringent emissions standards. Opel vehicles had attracted unwanted attention because of their excessive emissions and Neumann was at least trying to treat the diesel crisis as a chance to start over.

His ambitious electric plan for Opel failed, however, when the company's U.S. owner, General Motors, suddenly lost interest in the European market and sold Opel to French rival PSA in the summer.

Neumann no longer works for Opel, but he still believes his ideas are the right ones. The former CEO fears that the auto industry - especially BMW, Daimler and Volkswagen - has underestimated the momentum of the transformation, and that it is resting on its laurels instead of developing new concepts.

The German auto industry needs "a clean break," says Neumann. It has to "accept that diesel is gradually going extinct." Of course, he adds, the auto industry can still make money with internal combustion engines for a number of years. "But it's time to reduce complexity, that is, develop a much smaller number of different engines," says Neumann. He recommends car companies use the money they save to invest heavily in electromobility.

He has a warning for the entire sector: Unless the auto industry consistently reforms itself, it "runs the risk of being outpaced by new competitors from China and the United States."

Customers and, in some cases, companies, are still skeptical. The arguments against electric cars cited by critics include their lack of significant range, high costs and questionable carbon footprint.

But does that mean that automobile manufacturers should simply continue pursuing the status quo?

Unprecedented Pressure for Carmakers

For decades, the auto industry kept building bigger, faster and more powerful vehicles outfitted with gasoline and diesel engines. And business has been good. In 2016, BMW, Daimler and Volkswagen reported €465 billion ($552 billion) in sales and close to €30 billion in profits. But their growth came at a high price.

The systematic deception got started in the companies' development departments about 10 years ago. Unable to satisfy increasingly stringent emissions requirements, the engineers resorted to software that was designed to cheat the system. It guaranteed good emissions results in vehicle testing stations, but allowed the supposedly clean vehicles to emit harmful nitric oxides on the road. In the United States, Volkswagen has already admitted to committing emissions test fraud and obstructing justice. VW and Daimler are currently under investigation in Germany. Only BMW has been spared the judicial scrutiny.

After DER SPIEGEL in July exposed decades of collusion between the three companies on technology, suppliers and exhaust-gas-cleaning systems, the three major German automakers could face further legal troubles. They are making intensive preparations for possible investigations or searches. At BMW, which denies any wrongdoing, 18 lawyers are now analyzing data and documents spanning almost three decades.

The suspicions of collusion are also complicating the plans of BMW, Daimler and VW to cooperate more closely on topics like mobility services and autonomous driving. "From now on, there will always be a lawyer present at any meeting with a competitor, no matter how harmless," an auto company representative explains. Instead of a collective spirit of optimism, a feeling of mutual mistrust reigns.

The German auto industry has never faced this much pressure. Auto executives describe it as a "perfect storm." The old business model is increasingly coming under pressure, both legally and economically.

More and more countries are planning to phase out combustion engine technology. Great Britain and France want to ban cars with gasoline and diesel engines by 2040, while Norway plans to take the same step by 2025. China is expected to impose a minimum sales quota for electric cars starting next year. Surveys show that 60 percent of Chinese car buyers could imagine buying an electric vehicle as their next car.

To be able to sell its products in the future, the auto industry needs alternative, low-emission engines. It also needs to offer mobility concepts like car sharing and ride services. Otherwise the business will no longer be run by BMW, Daimler and Volkswagen in the future, but by foreign competitors.

Tesla Arrives in Germany

The biggest cause for concern in the German auto industry is an American rival, Tesla. Founded in 2003, it has achieved what the German manufacturers failed to do for years: build an electric car that many customers want.

More than 450,000 consumers have already pre-ordered Tesla's new Model 3, and the company says that it is receiving another 1,800 orders a day. "Tesla now has a cult status that other brands can only dream of," says Neumann.

The German carmakers' identity crisis comes at a convenient time for Tesla. While the U.S. company has been restrained in its public statements, Tesla Managers speak off the record about "illegal manipulations in the context of the diesel scandal."

The U.S. company smells an opportunity to finally gain a foothold in Germany, a country that has had relatively little affinity for Tesla in the past and is the home market of Daimler, BMW and VW. The company has more than doubled its German sales in the first half of 2017, for a total of 2,000 vehicles. This is an impressive number for Germany, which lags behind other developed nations when it comes to electric cars.

Management at BMW, Daimler and VW are working on counter-offensives.

The office of Klaus Fröhlich, BMW's head of development, is dominated by model cars on the window sill, relics from the old auto world. The collection ranges from long-extinct brands like the NSU Ro 80, car of the year in 1968, to the Porsche Carrera and the Land Rover Defender, a muscular SUV.

Fröhlich actually wants to talk about BMW and his planned electric strategy, not about the competition. But he keeps coming back to the company's California rival. The BMW executive mentions the word "Tesla" 16 times within 60 minutes.

He sees BMW as being "neck and neck" with Tesla, but plans to have trumped his US rival in no more than three years. Like Tesla, BMW will place a stronger emphasis on "emotionalizing" its electric cars in the future, with wider tires and more dynamic designs.

Fröhlich draws three curves on a piece of graph paper. They illustrate the likely increase in electric car sales in the coming years. The first curve represents sales in China. Starting in 2020, it points almost vertically upward.

BMW plans to produce cars more efficiently to satisfy exploding demand. Plants and vehicle designs are being upgraded so that every car can be flexibly outfitted either with an internal combustion engine, a plug-in hybrid or a pure electric powertrain. As demand increases, the company expects to be able to start producing hundreds of thousands of electric cars by essentially flipping a switch. As such, says Fröhlich, BMW will be ready if consumers in China decide to buy only electric cars.

Fröhlich's second curve represents the east and west coasts of the United States. According to his calculations, the electric car boom will begin there in about 2025. Germans will follow suit about five years later. Fröhlich describes Germany as a country "where they like to talk about e-mobility" but where "relatively little is being done." He blames policymakers, pointing out that Munich, for example, currently has only 50 charging stations.

The Auto Giants' Dilemma

Like all German manufacturers, BMW is trying to perform a balancing act. The company wants to continue selling gasoline and diesel vehicles while simultaneously preparing for the electric age. It has announced 25 electric vehicle models for 2025, but the startup costs are massive. BMW has already invested sums in the double-digit billions in sustainable drives. The Munich company is making a bet on the future. At the moment, it is losing money on every electric car it sells.

The auto industry's dilemma is that its new business, which is still losing money, is cannibalizing its profitable, existing one, creating incentives to delay the necessary change.

Some of the companies' efforts to prepare for the future seem half-hearted. In late 2016, Daimler, Ford, BMW and VW announced a joint initiative for rapid-charging stations. The project was scheduled to begin in 2017, with about 400 locations across Europe planned in the first phase.

Nine months have passed since the announcement and the current number of charging stations is still zero. The first charging station is expected to open this year, allegedly with charging technology superior to Tesla's. By comparison, Tesla has already installed more than 6,300 of its so-called Superchargers worldwide. It aims increase that number to 10,000 by the end of the year.

The U.S. company still isn't making a profit on its electric vehicles, but unlike the German automakers, Tesla does not have to worry about a massive existing car business. This helps explain Tesla's aggressive approach to marketing, which makes it seem like the company is less interested in selling cars than in changing the way the world uses energy.

That doesn't mean it's true. Tesla founder Elon Musk is, of course, pursuing uncompromising economic interests. But his message sounds more convincing than that of the German auto industry, which constantly fluctuates between commitments to electromobility and statements of loyalty to the internal combustion engine. Their mantra is that the diesel engine is far from finished.

The industry spent decades resisting overly substantial changes. Anyone who talked about electromobility or car sharing in the 1990s was immediately mocked.

VW offers the most prominent example. Top executive Daniel Goeudevert wanted to reform the brand back in 1991 by introducing smaller, more fuel-efficient cars, but failed. He was also working on a car-sharing joint venture with German national railroad Deutsche Bahn. His conclusion, at the time, was that fewer and fewer people wanted to own their own cars in favor of using shuttle services.

When Goeudevert predicted the demise of the diesel engine, the Volkswagen leadership decided it had had enough. In his last meetings with VW, Goeudevert was told something he never forgot: "You will be amazed at all the things we can still get out of diesel."

The 75-year-old now lives in a town near the Swiss capital Bern, rides an e-bike and regards the vehicle industry from a distance. "Because of its great successes, the auto industry has become blind to the true needs of customers," he says. "For much too long, Volkswagen and the others were only interested in speed and luxury."

In his view, German carmakers' only hope is to drum up enthusiasm among young people. Many teenagers feel more of a connection to the Apple logo than the Mercedes star.

A quarter of a century after his departure, Goeudevert's ideas are now treated as common sense. His former employer, Volkswagen, wants to become hipper. Designers and futurologists run riot in its Future Center in Potsdam outside Berlin, in an idyllic location on the Havel River. People wear sneakers, speak a lot of English and reject formality.

Its latest development is a concept vehicle called Sedric, which VW hopes will serve as a driverless robot taxi in urban areas sometime in the next decade. The designers are especially proud of its futuristic interior, which includes a large display for multimedia applications, such as karaoke, a tool that is meant to appeal primarily to Asian customers.

New Ways of Working

The VW employees in Potsdam are also trying to come up with new ways of working. In conversations with retirees, for example, they discovered they had to simplify the process of ordering a robot taxi as much as possible. The designers developed a remote control with only one button, aptly named the One-Button. VW is even seeking the advice of small children. The Future Center recently played host to the neighboring kindergarten.

"We are just getting started at establishing direct contact with our retail customers," says Thomas Sedran, who has been the chief of strategy at the Volkswagen Group for about two years. This is "a real challenge for a company that has before now primarily been shaped by its focus on engineering." As absurd as it sounds, for years Volkswagen had almost no idea who was driving its cars and what services VW drivers would like to use. Volkswagen interacted mainly with its authorized dealers.

The company is now painstakingly trying to approach its customers through apps and shuttle services. Starting next year, VW plans to offer a kind of on-call bus service in Hamburg. The new service, which will initially consist of 200 electric shuttles, is a test to determine whether VW can make money with taxi services. Most of all, though, it is an attempt to create long-term brand loyalty among customers.

Chief strategist Sedran believes that VW can no longer afford to miss out on any new development. He predicts a "major shift in the entire auto industry," which could even include the disappearance of individual brands.

Whether Volkswagen, Daimler, and BMW will be among the survivors depends on whether pioneering thinkers like Sedran prevail. Many managers remain unconvinced that deep-seated reforms are truly necessary. Some even believe that the diesel crisis is somehow over.

They feel persecuted by their critics, including Deutsche Umwelthilfe, an environmental group fighting in court for diesel bans. And by the politicians who are sharply critical of the automakers' manipulation of emissions values. And, finally, by the press for its reporting of these stories. "A key industry is being criminalized here," is a sentence often heard at the auto companies. VW Chief Executive Officer Matthias Müller believes that there is an "ongoing campaign against the diesel engine."

Many managers also express the hope that the Tesla problem will eventually resolve itself. They argue that their U.S. rival's battery technology isn't mature, which keeps Tesla from producing its cars in a cost-effective manner. "A company like that, which is only losing money, could never exist in Germany," said a top executive with a German automaker.

His analysis is not exactly wrong. Investors could in fact lose patience and cut off Tesla's funding. But would that change anything? Even a Tesla bankruptcy would not stop the transformation, because other manufacturers, especially from China, have also discovered the appeal of electromobility. And they are doing their utmost to achieve global market leadership.

Ten years ago, another technology sector made the mistake of underestimating its challenger: the mobile communications industry. Manufacturers like Nokia and Blackberry had long been the undisputed market leaders, but success made them sluggish. New, more innovative competitors had hardly appeared on the scene before the former pioneers were forced from the market.

One anecdote from an executive meeting at RIM, which produces the Blackberry, has now become legendary. It is said that when managers delicately passed around an iPhone, most of those present just shook their heads. The phone with the large screen would not make it, the managers believed, because the battery performance was insufficient.

The good old mobile phone, they argued, was far from dead. more