German carmakers face mobility revolution
If one product symbolises Germany’s post-Second World War rise to being an economic powerhouse, as well as its current export prowess, it is a luxury car made by Mercedes-Benz, BMW, Porsche, or Audi. Vehicles ‘Made in Germany’ are considered hallmarks of reliability and quality across the world. The fate of the car industry in Germany - a nation which prides itself on having invented the automobile, and still resists speed limits on its Autobahns – is often seen as a barometer of the entire country’s economic health.
But the VW emission scandal – dubbed ‘Dieselgate' - has dealt a heavy blow to German carmakers’ claim to global technological leadership. The timing could not have been worse. Companies are facing a perfect storm created by the ‘mobility megatrends’ of electric engines, autopilot vehicles and carsharing.
“I wonder who would place a bet that the German car industry will emerge as a winner from the pending structural changes? Currently it is an open race and the carmakers are increasingly aware of what is at stake,” says Christian Hochfeld, head of new mobility think tank Agora Verkehrswende*. He adds: “The emissions scandal is a worst-case scenario for the global trust in carmakers – in the meantime not only limited to Germany.”
The row has brought into sharp focus the question: “To what extent are German carmakers still welded to the conventional engine?” It remains a business model which earns the companies phenomenal profits - but faces extinction in the coming decades if the transport sector is to become fossil-free.
The Paris Climate Agreement leaves no room for doubt: Germany will have to cut its emissions to virtually zero in the coming decades in order to keep its commitment to fighting global warming. The cuts must take place in every sector, including transport - where emissions have remained largely constant for 25 years (the CLEW dossier The energy transition and Germany’s transport sector gives an overview of the entire sector, whereas the present dossier focuses on passenger cars).
It is not surprising that Dieselgate has led to a growing chorus of warnings from industry insiders, mobility experts, and politicians alike, that many car managers have been asleep at the wheel and need to wake up to the challenges ahead.
But the crisis has also been a loud wake-up call for German auto manufacturers. BMW, Daimler and VW have now vowed to fight and defend their global leadership position against powerful new competitors such as Google, Apple, Tesla, and Uber.
Germany’s shift to a greener future – the Energiewende - has already wreaked havoc in the energy industry, where old utilities were too slow to adapt to rapidly rising renewable power generation. Companies such as E.ON and RWE put their own survival at stake by resisting change instead of embracing it.
The fate of the utilities should serve as a warning to carmakers as the Energiewende reaches the transport sector. Given the car sector’s enormous size, much more is at stake for the whole country.
The auto industry is a true giant of the German economy: Its 1,300 companies employ more than 800,000 people, according to official statistics. In terms of turnover, it is the largest manufacturing sector, clocking in sales of more than 400 billion euros in 2015.
The question looms large as to whether the iconic firms can continue to blossom in a future mobility world, which might be characterised by fleets of self-driving vehicles powered by electricity.
As Henning Kagermann, chairman of Germany’s National Platform Electric Mobility (NPE), put it: “The crucial question is no longer whether we enter a new mobility era, but what role Germany will play in it."
The triple megatrend challenge
Most mobility experts agree that three interrelated “megatrends” will transform the industry in the years ahead, each with worrying consequences for traditional carmakers: Stricter environmental regulations, autonomous driving technology, and the rise of the shared economy.
Firstly, stricter environmental regulations which will eventually force the industry to shift from the combustion engine to electric propulsion. The German Federal Environment Agency says the entire “transport sector is required to be effectively greenhouse gas neutral by the year 2050”.
Carmakers’ traditional strengths, such as powerful combustion engines, gearboxes, and so forth, might well become worthless with the arrival of the electric engine.
“Far fewer parts are necessary for an electric engine. Combustion engines have become incredibly complex, but all of that won’t be necessary in the future,” argues car expert Stefan Bratzel from the Center of Automotive Management (CAM). “Fewer parts mean fewer people. The number of jobs could be reduced by a factor of five at least. That’s not only a question for the carmakers, but also for suppliers. Tens of thousands of jobs could be on the line.”
The second megatrend is autonomous driving technology. This is likely to appear gradually in new car models. Opinions vary greatly among experts when these will eventually result in fully self-driving vehicles.
The innovation once more questions the future value of German carmakers’ traditional pride. Autonomous driving is likely to drastically cut the risk of accidents, according to experts – thereby reducing the need for huge car bodies and security features. In addition, self-driving cars will create huge amounts of data, making data management and IT connectivity more crucial. This is also not part of the companies’ classic strengths.
The eventual impact of self-driving vehicles is likely to go well beyond questions of technology. It looks set to reshape mobility lifestyles, as car travel time can be used for activities other than steering a vehicle, with potentially deep repercussions for the industry. “This step will have an enormous impact on the question of what a car really is,” said Nicolai Müller, who is an automobile expert and partner at business consultancy McKinsey.
The third megatrend is the rise of the shared economy and its impact on the transport sector. This is already underway, with shared car schemes springing up in cities all over the world.
These services might also herald big shifts in lifestyles, enabling a growing share of the population to make do without their own car. As a consequence, the car’s standing as a prestigious status symbol might be undermined further, potentially reducing the number of vehicles sold.
This triple challenge means that the industry is facing a “watershed moment”, according to consultancy Alix Partners. “In the coming years, the automotive industry will face its biggest upheaval since before Henry Ford."
New kids on the block: Apple, Google, Uber, Tesla
The upheaval in the industry means that new players are enjoying a unique opportunity to conquer the massive market.
Firstly, newcomers suddenly stand a chance because electric cars are much easier to build. This threat is powerfully illustrated by the example of Tesla, whose e-car Model S outsold Daimler’s premium S-Class in the USA and many other markets in 2015.
The same is true for autonomous driving: “The development of a self-driving car could enable a newcomer to leapfrog the first development stages, or get them from suppliers, and to disruptively change the competitive situation,” according to a study by the Cologne Institute for Economic Research. “At the core is the question whether carmakers buy electric components or whether digital companies buy the cars.”
Mobility expert Hochfeld even sees the possibility that a huge internet company like Google or Apple will build vehicles on their own, potentially degrading carmakers and their main partners to pure hardware suppliers, similar to the Chinese iPhone manufacturer Foxconn. “Becoming the Foxconn of the car sector for Apple or someone else really would be a nightmare for the German carmakers."
The example of Uber shows that the trend of ride sharing - similarily to car sharing - creates an opportunity for yet another new class of powerful competitors, who don’t even deal in hardware. “Investors pour billions into the business model of an app that is basically only a new way to connect supply and demand. In terms of hardware, nothing changed,” according to Hochfeld.
McKinsey’s Müller warns this development could spell serious trouble for German carmakers. “Imagine the evolution of a shared mobility giant who orders huge numbers of cars – it would put a middle man between carmakers and their current end customers.”
The mobility revolution creates new business areas which question concepts fundamental to traditional carmakers’ success, such as individual car ownership and car differentiation.
The industry was characterised in the past by incremental changes. But the transformations driven by the megatrends make disruptive changes more likely in the future. It remains unclear whether the trio of German carmakers will emerge victorious or as victims of the looming creative destruction.
The companies themselves insist they don't treat the challenge posed by the new players lightly. "We take all competitors very serious," VW spokesperson Tim Fronzek told the Clean Energy Wire.
But it is little wonder that politicians are growing increasingly concerned about the future of the carmakers.
German transport minister Alexander Dobrindt warned: “Given the development we are experiencing, we don’t know whether today’s top carmakers will also be the top producers in ten years’ time.”
EU Commission vice president Maroš Šefčovič also urged the auto industry to “finally get moving”. “With the combustion engine, the European auto industry is top, but when it comes to alternative drives, it lacks behind,” Šefčovič told newspaper Die Welt.
Strategies to cope - Lobbying to preserve the status quo
One of the carmakers’ core strategies to cope with the new challenges was, at least until very recently, to resist change by shielding their traditional combustion engine business model, and attempting to extend its life-span for as long as possible.
For example, the companies successfully used their strong political influence to prevent stricter emissions limits at EU level in 2013. This meant they could continue to sell their main money-spinners, powerful combustion engines, as revealed by internal government papers published by Süddeutsche Zeitung.
“It often happened in the past that carmakers pursued a lobbying strategy. They said: ‘The new targets are too ambitious, we won’t manage’ – only to delay them and to prove afterwards that it is technologically feasible,” Peter Mock, Europe Managing Director from the International Council on Clean Transportation (ICCT), told the Clean Energy Wire.
Ironically, they often cite the future challenges as a reason to continue their old ways – including in appeals to policymakers. “The industry often argues that it must use the high margins of their premium segment with powerful engines to finance research and development for new propulsion technologies,” says Hochfeld.
These pleas are echoed by some German politicians. Transport state secretary Rainer Bomba told an e-mobility conference: “Huge investments are needed for e-mobility, and that money will have to be earned with diesel and petrol engines. This is why they can’t be phased out now.”
The trio of auto manufacturers have a lot to lose as their traditional business of selling conventional cars has been hugely successful.
BMW almost doubled its revenues within ten years to 92.1 billion euros in 2015, when it recorded a pre-tax profit of 9.2 billion euros. Daimler boosted sales by 15 percent last year alone to 149.5 billion euros, while net profit jumped 19 percent to 8.7 billion euros. The VW Group increased sales five percent to 213 billion euros, but the Dieselgate scandal pushed the company into the red last year. In 2014, it booked a profit of 11.1 billion euros.
But Hochfeld warns that lobbying to preserve the status quo might be an own goal in the long term. “Successful lobbying by the car industry in Germany and Europe might be the largest obstacle to its pending transformation.
The diesel engine – carmakers’ “boon and bane”
Since the emissions scandal, the fate of the diesel engine has been a particular focus in the debate about the future of transport.
The car-making industry tends to stress that diesel engines have a better climate footprint than petrol motors, and that conventional engines in general still offer room for further emission reduction.
Matthias Wissmann, head of the German carmakers association VDA, said: “Petrol and diesel still have a significant potential. We expect to increase the efficiency of classic engines by at least 10 to 15 percent in the years ahead.”
The industry is researching synthetic fuels that are “practically climate neutral”, he said, adding: “With fuels like these, diesel and petrol cars would have a long life expectancy.”
But industry expert Bratzel warns this strategy does not promise success for long. “Without electrifying their fleet, carmakers won’t manage to comply with ever-stricter emission limits.”
Mock says the reliance on diesel engines is a particularly troublesome problem for German carmakers because it has been so profitable. “It is the boon and bane for the industry. It’s a typically German development, and earned the carmakers much success in the past. But now it becomes a problem because it won’t be cost effective for long to reduce emissions sufficiently.”
Mock believes that “a fundamental rethink is in progress” at BMW, Daimler, and VW after Dieselgate. He adds: “The scandal put things in motion and forced the carmakers to reconsider where this journey will lead. They now wonder whether the diesel is still a future-proof technology, and whether it is worth investing more money to develop a new generation of engines, or whether the money might be better spent elsewhere. This is currently the big question."
The auto manufacturers stress that conventional engines will remain an important business pillar for a long time to come because of their global reach. "Even if sales of alternative engines slowly gather pace in regions like China, the US, and Europe, there will be other regions where conventional engines will be needed for different reasons," says VW's Fronzek.
Daimler spokesperson Madeleine Herdlitschka agrees: "It will be impossible to electrify everything overnight. There are many different markets, and not everyone will move as fast as Germany and California." But she adds: "We are on the threshold of the next era in mobility, and it's clear to everyone in which direction we're headed."
Divided government lacks coherent strategy
VW’s emissions manipulation was also a wake-up call for many German politicians. They realised that Germany and its mighty automotive companies lag behind when it comes to sustainable mobility.
All three major carmakers have already ventured into new mobility business areas, such as electric vehicles and car sharing. But these businesses remain miniscule when compared to conventional sales.
On an international scale, change might be coming fast. The global share of electric vehicles is currently below one percent. But the tide will quickly turn, according to projections.
McKinsey estimates that as soon as 2030, up to half of new cars sold might be at least partially electric-powered. Bloomberg New Energy Finance expects that between a third and a half of new sales will be fully electric by 2040.
Progress in Germany has been slow. Few expect the government to keep its target of having one million e-cars on the road by 2020. In early 2016, a paltry 25,502 were registered in the country (For more details, read the CLEW dossier The energy transition and Germany’s transport sector and the factsheet Energiewende in transportation: Vague goals, modest strides.)
To kick-start e-mobility, the German government introduced a buyer’s premium of up to 4,000 euros in the spring of 2016. But the incentive has so far been a „flop“. Experts say this is because the incentive itself is too small, the charging infrastructure insufficient, and the e-cars on offer are not attractive enough.
According to press reports confirmed by industry experts, the car industry again used its lobbying prowess to prevent government plans for a more ambitious buyer’s premium. The original incentive would have included a binding e-car quota for the carmakers, as well as a levy on combustion engines depending on their size. But the car lobby successfully fought what it saw as a “stigmatisation of larger vehicles”.
Critics say progress is slow because the government lacks a coherent strategy on renewable mobility. They claim this is partly because the government itself is deeply divided on the issue: the environment ministry would like to move forward, for example with diesel bans in cities, but the ministry of transport is widely considered close to industry, and an obstacle to change.
This issue was also brought into focus by the publication of the transport ministry’s Transport Infrastructure Plan 2030, which earmarked the largest part of the budget to building roads rather than focusing on renewable mobility.
But Mock believes policy priorities have started to shift in the wake of the emissions scandal. “Politicians start to wonder: ‘What is really in the interest of the car industry? Should we protect it in the short term? Or should we not better try to give it a good position for the longer term?’"
A new dawn?
Recent announcements by carmakers and their CEOs suggest the companies are now ready to overcome their reluctance and embrace the mobility challenges in earnest.
In mid-2016, VW announced its “Strategy 2025”, which included a “major electrification initiative”, and also a push into digitalisation and autonomous driving. The company said it expected to sell between two and three million e-cars by 2025 – which would mean around one in four VW cars sold at that date would be electric.
VW CEO Matthias Müller said his company faced the “largest transformation of its history”. He added: “The word evolution is much too weak to describe what lies ahead […] not only automobiles face dramatic changes, but mobility will be defined in a new way.” (For further details on VW’s plans, read the CLEW factsheet Dieselgate forces VW to embrace green mobility)
Experts consider VW’s plan a fundamental shift for the whole industry, not just the company. “If they are serious about their announcements on e-mobility, this is a gigantic step, and could transform the entire market, because VW produces such huge car volumes,” says Mock.
“Daimler will radically develop into a different company within the next ten years,” Zetsche said. He explained that the company would become a service provider and launch its own sub-brand for e-cars. “The fundamental change has begun,” he added.
A Daimler manager, who did not want to be named, told news agency Reuters shortly after Zetsche’s announcements: “We said before that if you are too early, you lose money. Now the view is if you are too late, you lose the market.” (For more background on Daimler’s plans, consult the CLEW factsheet Reluctant Daimler plans “radical” push into new mobility world)
Many experts still consider BMW the leader in the field of new mobility among German carmakers. It founded the electric sub-brand “i” years ago, and is so far the only German carmaker to have launched an electric vehicle - the “i3” - which was not based on a model originally developed for a combustion engine.
But i3 sales have remained lacklustre, and BMW was torn about whether to accelerate e-car development in early 2016. Following shareholder criticism, CEO Krüger announced in late September that the company would launch the first electric Mini car in 2019, followed by an electric version of the BMW SUV X3. (For details, please refer to the factsheet Early e-car starter BMW plans new mobility sprint.)
Most industry experts agree that senior members of the carmakers’ management have realised they need to move fast to avoid being left behind.
“Recent CEO statements show the future challenges are now top of the agenda,” says McKinsey’s Müller. “There is no doubt about it. It doesn’t show up yet in new car models, but huge amounts of money is funnelled into development capacities.”
The outlook for German carmakers in new mobility world - Culture Wars
But it will not be easy for the companies to change course because this will require a profound cultural change within the carmakers. Each company has hundreds of thousands of employees, many of which have worked on combustion engines for decades. Therefore, there is a power struggle between new mobility business sections and the traditional core business areas.
“The monolithic image of carmakers is no longer valid,” explains Hochfeld. “Within the carmakers, there are forces, individuals, and sections that have understood what is at stake, and try to force change, and others who put their foot on the brake. Even if the change agents are still a minority today, the balance of power might look different in the near future.”
Mock agrees with this analysis. “For example, the electric ‘i’ brand within BMW has an interest in pushing electric vehicles. But, on the other side, there is a very large conventional part that wants to sell its technology as long as possible, and tries to influence laws accordingly. The lion share of profits continues to be generated by the conventional business, which therefore enjoys top priority.”
Exacerbating these problems is the fact that new mobility businesses risk “cannibalising” old business sections. The spread of shared car ownership, for example, is likely to eat into total car sales, and e-car sales hit sales of combustion technology.
But VW's Fronzek says his company is not concerned new mobility businesses will eat into existing ones: "We believe new business areas will offer us the opportunity to grow and offer new choices to our customers." He adds: "The development of conventional and alternative engines has been running parallel at Volkswagen for many years. We don't see this as a contradiction."
Likewise, Daimler spokesperson Herdlitschka says new mobility services will supplement existing business models, rather than replace them. "We will increasingly turn into a service provider. But our research shows that people's desire to own a car will persist. Car sharing is not a question of 'either/or', but of 'also'."
But when it comes to transformation, new competitors such as Google enjoy important advantages: Unlike carmakers, they have rapid and even disruptive change built into their DNA, and do not carry the baggage of a venerable combustion heritage that might suffer from the success of any new mobility ventures
A question of money
Carmakers must also confront the challenge of dealing with the massive investments needed for a successful transformation. This is particularly urgent for VW, as the company has to pay more than 15 billion euros in fines and compensations to settle the emissions scandal.
The topic will be delicate for all German carmakers - even as they continue to be hugely successful, reaping billions of euros in profits from increasing their market share in many countries all over the world.
But they may, of course, face leaner times in their traditional businesses, which would make an investment push more difficult to finance.
The “spectacular growth” of recent years in markets such as China might be coming to an end, according to McKinsey’s Müller. “Going forward, we will see a slowdown in many former growth markets – with related questions of overcapacities, increased competition, and price pressures. This is a very important trend that should not be forgotten when talking about the pending technological changes.”
Müller argues that stricter environmental standards will put further pressure on profits: “It has been repeatedly shown that consumers are not prepared to pay more for ‘greener’ cars. Therefore, it will exert enormous pressure on profitability if carmakers need to invest to develop cleaner engines.”
Another obstacle for massive investments in new technologies are the carmakers’ owners as their shareholders want to see regular dividend payments.
“The pressure from shareholders, and quarterly reports, are an important obstacle for such a fundamental transformation,” says the ICCT’s Mock.
He said companies with a different shareholder structure - such as Japanese Toyota, which is largely family-owned - find it much easier to pursue long-term goals, which might be risky in the short term but eventually pay off. “The German carmakers do not enjoy this luxury. They are often trapped by betting too much on existing technologies, and trying to market them as long as possible, instead of managing the transition to new technologies.”
Yet again, new US competitors might enjoy important advantages in the area of financing. Google and Apple sit on enormous amounts of cash that make the carmakers’ budgets pale in comparison. Tesla and Uber, on the other hand, have acquired large amounts of venture capital from investors who encourage risk-taking and do not expect dividend payouts anytime soon.
But McKinsey’s Müller argues that the likes of Google and Apple might face their own difficulties when it comes to financing. “The average returns in the car industry are far below what these IT players are used to. They will have to ask themselves whether the mobility business will satisfy their high expectations. The incumbents, on the other hand, are 100 percent committed to this segment, and used to operating in this yield environment – this is definitely an advantage.”
Hochfeld believes carmakers may have to split new and old business areas to secure access to more capital. “It’s a very big question if they can remain attractive for investors with their old model, which implies financing new mobility areas with income from the conventional business.”
“Financial markets can be an important driver of structural change,” he adds. China’s largest carmaker BAIC, for example, split off its e-car subsidiary to gain access to venture capital to finance research and development, says Hochfeld. Financing troubles were also a major reason for the split of major German utilities E.ON and RWE.
Premium technical leadership
Internal divisions and resistance, as well as problems with access to capital, might be crucial shortcomings for German carmakers in the race for the future of transport. But experts warn against writing off BMW, Daimler or VW. They believe the incumbents have at least one massive card up their sleeve: Their technological know-how, and a proven capacity to innovate.
“Many people simply do not fully appreciate how complicated it is to build a car,” says Mock. “The traditional carmakers have a gigantic head start in this area – even if time is not on their side.”
Many experts stress that German carmakers are particularly well positioned because of their large presence in the premium segment, where innovation traditionally plays a prominent role, and large margins give the companies money to invest.
German carmakers have captured 72 percent of the global market for premium cars, according to the Cologne Institute of Economic Research. Study author Hubertus Bardt argues that the key is the carmakers’ ability to innovate.
He also stresses the fact that German carmakers have a strong presence in the mass market. “The combination of strong and independent brands in the premium and mass-market segment is a unique advantage of the German car industry,” argues Bardt.
Bardt uses the number of self-driving patents as an indicator for innovation capacity: 58 percent of global patents in this area are registered by German companies. Top of the list is supplier Bosch with 545 patents, followed by VW subsidiary Audi with 292, and supplier Continental with 277.
The statistics also show that Google has more self-driving patents (198) than either Daimler (156) or BMW (142). Nevertheless, industry experts believe Daimler CEO Zetsche was not joking when he remarked earlier this year: “Technology wise, Tesla has nothing that we couldn’t have too.”
Müller adds: “I believe the level of engineering and car technology knowledge will enable German companies to build the best e-car.
“It’s a definite advantage for the incumbents that cars are an extremely complicated and tightly regulated product, with extreme demands on security. It requires an enormous know-how, which can be found in the carmakers […] We must not underestimate the technological developments and innovations the car industry is capable of, in conjunction with suppliers.”
The closely-knit network between German carmakers, suppliers, engineering firms and research is also often seen as an advantage for the incumbents. According to a Deutsche Bank study: “The structure of this automotive cluster in Germany is probably unique worldwide and enables continual productivity gains and innovations […] Germany is well placed to still be one of the most important manufacturing nations in the global automotive industry in 2025.”
Mortal danger offers huge opportunity
But some experts say it is still an open question as to how important a lead in classic vehicle hardware technology will be. “The core competence of the future is the question how the car can be digitised, steered, and integrated into the entire transport network,” says Mock.
The production of battery cells might be another important part of the car’s value chain, and it currently looks unlikely that German carmakers will enter that market. Bratzel argues that the carmakers should join forces in this field. “In the medium and longer term, Germany can’t afford to have an important part of e-mobility’s - and therefore the future car’s - value chain abroad.”
BMW, VW subsidiary Audi, and Daimler already cooperated when they agreed to buy Berlin-based Nokia mapping unit HERE for almost three billion euros in 2015. Digital maps form the basis for driverless cars, and the carmakers wanted to avoid reliance on Google and Apple mapping services.
But it remains an open question how important carmakers’ core strengths will prove to be. The technological figureheads of the German car industry are the engine and vehicle integration, both of which are easier in electric cars.
Similarly, carmakers’ reliance on the premium segment might be a disadvantage in a new mobility world, which might be dominated robotaxis.
Müller says: “In the past, a premium car made in Germany had the brand, power, design and emotion that was honoured the world over. We will have to see whether the future will offer the same opportunities for differentiation.” But he believes the German incumbents’ advantage won’t be lost. “A new powertrain does not mean a vehicle’s other attributes become obsolete. There will also be a premium segment in the new mobility.”
Mock agrees: “Premium does not necessarily mean combustion engine. The premium segment can also be entirely redefined. I’m quite optimistic as far as the German carmakers are concerned. They do not face an abyss. I believe the most probable scenario is that carmakers recognise the transformation and manage to adapt.”
Even though some experts, such as Bratzel, put the chances of German carmakers failing in a new mobility world at 50:50, Müller stresses the companies should see the expected revolution in a positive light.
“Most people prefer to read danger scenarios. But you can also describe all this in a positive light: An incredible change is underway, which opens up entirely new possibilities for German carmakers in the future.”
*Like the Clean Energy Wire, Agora Verkehrswende is a project funded by Stiftung Mercator and the European Climate Foundation.
The Energiewende and German carmakers