Sunk costs

In 1972, I talked my dad into buying a Saab 99. Saab was mainly an aircraft company financed by the Wallenberg Bank in the late 1930s to build fighters for the defense of Swedish neutrality. After the War, they decided to take their skills into automobile manufacture. They hired the rising star of Swedish industrial design, Sixten Sason, who would go on to design the Hasselblad camera that NASA sent to the moon on Apollo 11. So a company full of aircraft expertise built a car they believed would be better with a little airplane built in. The 99 was brimming with innovation. For example:

1. The structural integrity of the passenger compartment was superb. Monocoque, stressed-skin design combined light weight with a crazy-strong roof. Saab's early promotion included winter rallying. Their driver rolled his car so often while continuing the race he got the nickname Carlsson på taket (Carlsson on the roof).
2. The cockpit was the first real manifestation of sound ergonomics. The seating and driving position was excellent. The instruments were clear and easy to understand.
3. Four-wheel disc brakes had multiple backup systems.
4. It was versatile with a fold-down rear seat.
5. And it was the only sorted-out front-wheel drive car sold in USA. (In snowy Minnesota, that was a big deal.)

Saab is no more. by 1990, every car-maker on earth had a version of the Saab 99. Some, like the Toyota Camry, had taken all those good ideas and refined them significantly. Cheaper and more reliable is a winning combination.

Right now, Tesla is at least as far out in front of the EV pack as was the Saab 99. Below is an excellent description of the institutional problems facing the established car companies. They have BIG bucks invested in a way of producing a product that is rendered obsolete by fun, comfortable, exciting, electric cars. Yes, they are dragging their feet. But giving what they face, you would too.

The cautionary tale of Saab is a reasonable outcome for Tesla. Yes, its competition will lag. The Germans, Americans, and Japanese may well be hindered by the Institutional inertia. But that leaves the Koreans and the Chinese. Either one has the potential to swamp Tesla.

The Germans have the largest amount of Institutional inertia. But this may be changing. According to DW, they are finally realizing that the future of transport will be electric and are beginning to make serious investments in batteries, etc.

Why Automakers Try To Slow & Stifle The EV Revolution

November 11th, 2018 by Zachary Shahan

This is a repost from two years ago. The story is more or less the same today. The original title was, “What goes on in the minds of auto execs?”

I’ve had a lot of fun recently while highlighting 50 “tips” for slowing the electric car revolution and writing about what the end of gasmobiles could look like, but the discussions left some people scratching their heads. Why would automakers conscientiously try to delay a switch to electric vehicles? Why would they not try to create attractive electric cars once they were shown how popular Tesla’s models have been?

I’ve written about this plenty of times before, such as here, here, and here. The short summary is this:

A transition to electric cars threatens the “financial health” of conventional auto companies. Many shareholders would be pissed to see so much investment in gasoline car technology “wasted.” Executives who built their careers on engine expertise would become much less valuable. Automakers would have to shift much of their business strategy, operations, factories, and workers. They’d be tossing many highly valued patents & knowledge down the drain.

However, that’s all just a simple summary. It hit me that a more detailed theoretical rundown would help more people to visualize the problem — to understand why BMW is trying to compare the 330e to the Model 3 in advertisements, why Ford is boasting about range on a plug-in hybrid that has only 22 miles of electric range and is advertising its cars using Captain America, why most electric models sold in the US aren’t available in most US states, why no automakers other than Tesla have cars with superfast charging, why Chevy isn’t creating this car (which a consumer designed) and BMW isn’t creating this one (which a consumer designed), why Fiat’s CEO told people not to buy the Fiat 500e, why Toyota is still hyping hydrogen, etc.

With the long preface out of the way, let’s dive into a thought experiment.

Numbers (… Fake Ones)

I’m not going dig through decades of investments from big auto companies, but below are some fake numbers from automaker “Bord” to play with in order to get rolling….

Bord has 84 factories
$84 billion has been invested into these factories
18 of these factories (~21%) are engine factories
6.5 million Bord vehicles were sold in 2017 for $150 billion in revenue and $7 billion in net income
Bord had a 6.5% automotive gross margin in 2017

Essentially, Bord is making 6.5 million vehicles a year ($150 billion in revenue, $7 billion in net income) using factories that it put $84 billion into (with $17 billion going into the engine factories alone). After adding in cash used for other overhead, operations, etc., Bord walks away with a healthy little profit each year and sends some of that back to investors.

The Groundbreaking Q4 2018 Bord Shareholder Letter

Now, let’s say that Bord’s CEO sees that electric vehicles are the future, that they’re already essentially competitive, and that the most logical thing for the long-term health of the company is to switch to electric vehicles fast. Mr. Constable C. Smuggins, CEO of Bord, tells shareholders in a shocking quarterly letter:

We are planning to switch over 100% to electric vehicles in the next 3–5 years. We would do it sooner, but it takes time to create these new EV models and ramp up battery production capacity. Doing it later would be stupid, because people won’t want to buy our gasmobiles in 5 years when compared with our electric vehicles or other automakers’ electric vehicles.

Unfortunately, this means that our engine factories (which we put $17 billion into) are soon going to be useless. Well, the land and building shells will still be useful, but nothing we currently have or do inside will be. These factories will have to be completely revamped to produce batteries and electric motors. In order to do that, we will need to invest another $17 billion. Actually, we will need to invest $33 billion on top of that $17 billion for additional battery factories in order to keep producing the same number of vehicles we sold in 2017. This is a good thing, because we will have a competitive advantage in the industry from our $50 billion worth of battery factories. Don’t worry about us choosing the right batteries and manufacturing machines, though — we’ve got this.

Our other factories will need to be reworked to support the many new models we are introducing based on new electric powertrains. That’s another $50 billion.

We have a cash balance of $50 billion. Quite a lot, eh? Unfortunately, that’s clearly not enough to cover this quick transition. (If we could somehow spread the transition outby 2–3 decades, that would be much easier, but we don’t see that as sensible.) So, we will need to borrow a lot of money, and we are going to cut off dividend payments for several years. No worries — we’ve got you covered in 2025 or 2030, and we know you are long-term investors who also care about humanity and want to see a quick transition to clean technology that helps to stop costly and horrendous global warming, so we’re sure you won’t bail on us.

To be honest, though, we don’t know a lot about batteries and don’t have experience making compelling electric cars, so we hope we don’t screw up too much while pouring $150 billion into this. (Oh, did I mention that we need to do some massive staff re-training, R&D, set up new supply chain partnerships, license new tech, and acquire a bunch of patents?) By the way, yeah, um, our thousands of engine-related patents are basically useless now, so we’re just going to toss them in the trash.

I know you’d rather get a few more dividend payments before we jump in, but frankly, everyone in the industry sees the light and is now going to do this, so we have to get moving fast.

Back to Reality

Yeeeeah. … Most shareholders of GM, Fiat Chrysler Automobiles, Ford, BMW, Nissan, Daimler, Toyota, Hyundai, and Honda wouldn’t be thrilled to hear such plans, and many would try to stop the move. (Volkswagen is getting away with something slightly approaching this thanks to the pickle it landed in by being a massive cheater and liar. Lucky VW!)

Overall, the question is: If you’re in the shoes of these large automakers, how do you dump your huge investments (sunk costs) and competitive advantages (which are centered around the internal combustion engine) in order to jump head first into a new technology? How do you tell shareholders that you’re going to go from making billions of dollars a year in profits to borrowing money for several years? How do top executives who built their careers on engine expertise suck it up and say that it’s time to retire the old dirty beast under the hood? Tough questions.

I know I demonize automakers a lot for doing a horrible job on their EV efforts and promotion, but it’s not really about demonizing them — the goal is to push them into a better approach, and to help inspire other consumers to do the same. But when you look at the challenges they face, this simplistic idea becomes less potent. That leads into a topic for a coming article — how I think these companies can and should proceed. First, though, I never got to the main question in the title: “What goes on in the minds of auto execs?”

Who the hell knows? These people vary in personality, career focus, and culture quite a bit. How much they understand that electric cars are the future, how much they understand the existential threat electric cars present to their businesses, how much they consciously think through the finances or run spreadsheets on the matter, how much they care about global warming and air pollution, and how much they genuinely try to delay an electric car revolution probably vary a great deal.

If you find any more interesting tidbits on how any of their minds work and what they are thinking, drop us a note. In the meantime, fanboy/fangirl or not, I think you have to give some thanks to Tesla. If Tesla wasn’t around, the transition would be going much more slowly, the plans of automakers would be even much worse, and there’d be a lot less inspiration in this market and in the world in general. more