Breaking with the Laws of Automotive

Co-autored with Helmuth Ritzer

Wolfgang Hilpert and I had the pleasure of working together over the past years. We both started our individual careers in two different domains, software and automotive, two industries that increasingly converge as software becomes a key differentiating factor in most products today. Beside the many differences on what we worked on specifically, there is a common theme that always popped up on both sides, something we want to talk about here: how companies must work differently in order to build customer centric products in the future. It’s one of the themes that we think is vital for the next industrial or digital age.

This is part 1 of a series of articles we were eager to write for quite some time. We start with an assessment of the current situation in the automotive industry, which is right now under heavy change, taking Tesla as one of the most prominent challengers of the incumbents, following a part 2, which looks at new ways of working coming out of the software industry and finally close with part 3, where we talk about more concrete transformation scenarios that hopefully will help decision makers on various levels to make this an open ended race for the future customer rather than a done deal like some industry experts already think it is. Let’s go.

An Early Aha Moment

Early 2009 I was part of a small team at Daimler working on the car2go project, today known as Share Now. car2go was one of the key projects of a corporate incubator that was founded just a few months earlier inside Daimler. Leading the product development at car2go at the time, I had the opportunity to meet with a couple of Tesla people that visited us as part of a just recently announced 10% investment of Daimler into the company. Tesla had some serious financial difficulties and was in desperate need of fresh money. Part of the deal, beside other projects, was an initiative which allowed Daimler to speed up the development of its second generation electric SMART ED using Tesla’s latest battery technology. I was highly interested, as the electric version of the SMART was a key part of the car2go product from the day one and on the hardware side we also had to develop our own online connectivity, as there was nothing available at Daimler we could use off the shelf.

As part of those meetings I had the opportunity to talk to Tesla’s CTO back then J.B. Straubel, about various development topics around their next car, the Model S, and their plans to deploy a central control unit with a huge 17“ touch screen into the car, running their own operating system, custom apps, doing online software updates and many more ideas that would leverage such a powerful device inside the vehicle. Just two years after the introduction of the iPhone they literally intended to build a car around a huge „smartphone“.

I was fascinated by their bold ideas and guts to introduce such technologies in a car, knowing how difficult it was at an OEM to even get the basic things right, not even considering things like online software updates or apps. In those days all of this equipment including the software was outsourced to a couple of different suppliers as part of the development system. That being said, I couldn’t imagine that Tesla would ever become more than an expensive niche player and by no means someone the German OEMs would compete with head to head in the future.

Fast forward only 10 years, boy was I wrong. Meanwhile Tesla’s valuation is more than six times that of Daimler (actually twice as much as all the German OEMs combined value) and it is the number one manufacturer of EVs in the world. What has happened within just 10 years that led to this situation, that not only impacts Daimler, but all other major OEMs? Here is my take.

The Age of Kaizen

The German OEMs wrote a huge success story over the past 25 years. Beside the impacts of the worldwide economic crisis and the usual ups and downs of the individual companies, we’ve seen a steady increase of market share and production volumes. Each generation of cars topped the previous in terms of quality and performance. This growth came with a massive expansion of their respective product portfolios. Mercedes-Benz alone increased their passenger car model range from 5 models in the early 90th to more than 20 models (not counting all the subtle variants) in 2020 basically engineered with roughly same amount of people. More or less the same happened at Volkswagen and BMW during those days.

This impressive success was only made possible by the full adoption of the Kaizen philosophy also known as the Continuous Improvement Process (CIP) in the western world. Kaizen had its origins in Japan during the 60th. Eventually it became the core of the Toyota Production System in the late 80th. It involves all participants of an organization, from the worker in the assembly up to the CEO, by implementing a Plan → Do → Check → Act cycle of incremental improvements that over time raises the ability of an organization to improve its outcome. Following this approach led to major improvements starting in production, like improved quality, increased automation, just-in-time supply chains, reduced vertical integration and strong supplier partnerships, but in turn also impacted many adjacent areas like research and development (modular vehicle platforms and component designs), product management, sales and aftersales. On the Plan, Check and Act side of the cycle we’ve also seen the build up of a massive matrix organization using rigid product, program, quality and supplier management. 

What you end up with is an impressive fine-tuned organization that is predictively spitting out new models on a sacred 7 year product lifecycle, creating some of the best cars in the world for more than two decades.

The Innovator’s Dilemma

All good you might think: customers have access to increasingly better cars, in turn OEMs sell more cars with higher margins, which ultimately helps the overall economy. As a result, the automotive sector is one of the most important industries in Germany. But there is also a potential downside: when you are at the peak of such a highly optimized business model you find yourself exposed to a dilemma, which Harvard professor and businessman Clayton Christensen back in 1995 coined as the Innovator’s Dilemma. It describes how successful, outstanding companies can do everything „right“ and still lose their market leadership – or even fail – as new, unexpected competitors rise and take over the market. It’s a dilemma as companies knowingly fall into that trap, not being able to react appropriately. Think Kodak or Nokia.

In a nutshell, new innovative competitors have a kind of an “unfair advantage” over the incumbent, being caught by its own success. In the case of the car makers, this fine-tuned organization I was referring to, is not able to challenge its own success by questioning what they do and how they do things, potentially rendering their current product or business model outdated. It is easier, more predictable and presumably less risky to continue on your established path instead of branching off, which very often means you need to change almost everything you have been successful with in the past.

Kaizen or CIP does not prevent this, eventually it even makes you more vulnerable. Generations of engineers, product managers, program managers, sales people, etc. have been trained successfully to follow a proven approach of small but steady improvements, rather than fundamentally questioning what you do and how you do it. If you ask companies being held hostage by this dilemma, if they consider themselves being innovative, they will most likely say “yes, that’s why we are in this leading position”. In reality, what they really talk about are the small, continuous development cycle driven improvements, which by themselves could be of course very impressive, but don’t let you jump to the next innovation curve. You become vulnerable to a disruption caused by new entrants into the market that simply change the game.

The automotive industry experiences its Innovator’s Dilemma moment right now with the rise of many new competitors, Tesla being the most challenging. Even though Tesla, like all other car makers, is eventually building cars, the company with its products and its organization is challenging the automotive industry in almost every aspect of the automotive value chain, which makes this disruption so profound. 

Preserving the Status-Quo

Let’s look at the product first: the electric car. Battery electric vehicles or EVs, have been around since the early 20th century. At some point EVs were the predominant vehicles powered by an engine. Technically much simpler compared to internal combustion engine vehicles or ICE vehicles, easier to operate and no local emissions. But up until recently, there was a major issue which caused those vehicles to fall behind at some point: the battery. As the energy density of batteries had been orders of magnitudes lower compared to fuel, ICE vehicles were much lighter, could run longer and were faster to refuel. As engineers simplified the usage of ICE vehicles, very soon EVs were history for a long period of time. 

It took until the early 90th, when the California Air Resource Board (CARB) put a Zero Emission Vehicle (ZEV) mandate out that required the car makers to sell a certain percentage of ZEVs in California while still being able to sell traditional ICE vehicles. The plan was to increase that ratio over time with the goal to end up with ZEVs only. Several OEMs like Chrysler, GM, Ford, Honda, Nissan and Toyota took the challenge and started individual projects all of them focusing on EVs in order to comply with the mandate. The Saturn EV1 from GM gained some laurels as one of the first EVs usable in real life scenarios by the time. At the height of the program nearly 5000 vehicles have been deployed. 

But the industry also followed another approach in parallel. Behind the scenes, the OEMs as well as the oil companies were fighting against the mandate which obviously challenged their existing business model. (dubbed german version) In 2003 CARB finally caved to industry pressure and drastically scaled back the ZEV mandate. While the car makers were cutting down their ZEV programs, they put a red herring out as they promised to further focus on fuel-cell electric vehicles (FCEV), which despite all of the progress never became market ready due to the complexity and inefficiency of the technology.

It took another 5 years until Tesla eventually appeared on our radar for the first time by introducing their Tesla Roadster, an EV that for the first time used a new high density battery pack assembled from standard Lithium-Ion laptop cells. With a new battery management Tesla was able to achieve the range and durability required for a mass market vehicle. And this breakthrough on the battery side all of a sudden unlocked all the already existing advantages that EVs had right from the start: performance, efficiency, reduced complexity, less maintenance and zero emissions.

If you compare an EV and an ICE vehicle side by side, why would you continue to invest into a product that is already inferior in most aspects, knowing that the battery technology is going to vastly improve over time and also knowing that some issues of the ICE vehicle, like emissions, are an inherent deficiency that can not be removed all together. Any unbiased engineer could tell you where to put your money on. Not so if you are a car maker when all of your existing portfolio is relying on a technology that is at stakes. You try to optimize the heck out of your existing product in order to protect your investments and current profits. 

Even worse, as we learned in 2015, when the “Diesel-gate” was uncovered by the EPA, almost all OEMs, Volkswagen being the “boldest” in this regard, tried to deal with tougher emission regulations by simply cheating instead of innovating to solve the challenge.

The Un-Manufacturer

Mainly because of higher emissions standards, the OEMs have meanwhile ramped up their EV activities, but are still trailing behind Tesla. Of course with a clear focus on product development, they can and eventually will be competitive against Tesla and other manufacturers in this regard. But the EV technology alone does not matter here anymore, it just sparked a much bigger change. 

Tesla became a much broader threat to the OEMs as they innovate in so many areas at the same time which raises the pressure on the incumbents beyond the pure EV technology. Tesla has already evolved from a pure car manufacturer into a true technology company, working in so different domains beyond just building cars. Tesla is focusing more on the larger mobility and energy ecosystem than just the car or in other words the hardware. 

Without going into the details, here are some of Tesla’s competitive advantages along the value chain.

In most of those areas Tesla is already considered to be the industry leader with varying leads of up to 5 years. While challenging the industry on all fronts at the same time, the industry is hardly able to keep up the pace only in some of them. It looks like the CIP approach which was one of the reasons for the rise of the automotive industry is now becoming its biggest enemy. 

The Osborne Effect and Supposed Strength

Then there is the so-called Osborne effect: as new better products are about to enter the market and gain visibility, customers at some point are no longer willing to buy the old products. Either they immediately buy the first products from a new entrant (early adopters) or at least defer their current purchase decision until the new products are good enough for them to make the switch (fast followers). Both customer groups are most likely lost for the incumbents. Those are usually very valuable customers interested in the brand new, top-line products and they are highly influential among their friends and contacts. 

Let’s look at this a bit closer: one thing you typically hear while comparing Tesla with its competitors is the “not so perfect” or bad build quality and as we know, this is something which the OEMs are very proud of. And yes, Tesla owners give bad ratings in comparison to the competition. But at the same time, if you ask those if they are satisfied with their car, you will get some of the highest satisfaction ratings. It seems like those buyers value other product features higher than the pure build quality. The quality is simply good enough for them and not a key decision criteria. All of a sudden your unique selling proposition is gone.

Another area where the incumbents see a change in customer behavior is around their complex product portfolios. Premium OEMs have been very strong in offering vehicles in all segments for almost every lifestyle addressing almost every niche. For a long time they have been proud of not building two identical cars. But huge product portfolios come with a price tag in terms of very complex product and program management, lifecycle management and limited agility to innovate across the whole portfolio. It takes years to make certain innovations available across your portfolio. Don’t forget we still talk about hardware here. On the customer side this freedom of choice is no longer considered to be such a plus, as most of those products look and feel very similar (even across car brands) and all sharing the same limitations compared to the products coming from new players. They usually have a very much simplified product portfolio, in the case of Tesla just offering 4 different models at this point. Customers are rather willing to “compromise” here instead of buying an outdated product. For those customers a product portfolio with a few outstanding products seems to be more attractive. 

Sounds familiar? This is how Apple changed its product strategy after their turnaround, by massively cutting down their product portfolio only focusing on a few outstanding product categories with minimum variety in terms of color, storage size and performance. And guess what, this is exactly how Tesla is managing its portfolio: 5 colors, maximum two battery sizes and standard and performance models.

Nowadays customers rather buy into a comprehensive ecosystem than into a highly fragmented, cannibalizing product portfolio. Too far fetched? Maybe for the die-hards or petrol heads. In the end we talk about consumer products and user experiences. And we can already see a change in product strategy on the OEM side: various model ranges that have been just introduced in recent years are under scrutiny or already stopped as margins are becoming smaller. We are going to see more of that.

Fast Learning Organization

Small, agile players today simply overload the huge automotive organizations, which are overwhelmed by the amount of change that is required not only in one aspect, but in almost every aspect of the value chain. It’s one thing to build a product that is better than the competition, but if your organization is learning, innovating and delivering faster than the competition, there is almost nothing that can stop you while the competition is still trying to catch up. Again, we can recognize the Innovator’s Dilemma here. You don’t have the ability to catch up with your competitor as you carry your legacy as baggage with you, that always reminds you of how you would have done things successfully in the past. Even worse, you can not leverage those areas anymore where you still seem to have an advantage over the newcomer. There are many examples that showcase how fast an organisation like Tesla works, decides, innovates without the burden of a command and control organization and the typical blame game in case something goes wrong.

A Done Deal?

For some industry experts Tesla’s current valuation is just overrated and not sustainable, while others are convinced of Tesla’s capabilities and bright future, at the same time not believing in the approach of the traditional OEMs. Having worked the majority of my career for one of the OEMs, unsurprisingly it was for me up until a few years ago to believe that this model is outdated and can not be evolved. But it’s actually very difficult to find positive examples of companies of similar size and history that were able to successfully execute a transformation from within to overcome such situations. Decades of success and experience as a company don’t make you immune to such things.

But as I don’t want to end here on a negative note, let’s look at this with a more positive spin and assume it is not yet a done deal. First and foremost, this requires a massive change in the company culture. This is not about technology, not about the domain skills of engineers or investments into new products. The OEMs have access to great technology, they can attract great people and they still have the money to invest. What needs to change is the mindset of the organization and a new way of working that breaks with the legacy of the old cost and quality driven CIP culture you’ll find everywhere. What they don’t have though is time. What took at least a generation of people in the case of Kaizen and CIP, is probably too long when it comes to the current change.

A Necessary Cultural Shift

The cultural shift is a crucial aspect of this journey, but as much as a cultural shift is desirable – there is no known „knob to turn“ in order to change the culture via a “quick fix”. The culture will only change as a result of combining the required mind shift, with a skills shift, process and structural shift and with a behavior shift. A behavior shift will only happen if led appropriately:

„Leaders are the ones who have the courage to go first and open a path for others to follow.“
(Simon Sinek).

And there you need new leaders that follow the new mindset and ideally are not a product of the company culture that you want to overcome.

So be warned when your CEO asks for the next task force, directly reporting to him on a daily basis, as soon as the next important deadline is in danger. Current organizations are known for these hero patterns. And this is also not about yet another random cost-cutting driven reorg, flipping between central and decentral org setups or just reflecting new reporting and controlling structures within these companies. In the past we’ve seen this usually happening every 5-10 years anyway as a new CEO arrived. This is nothing less than a complete rebuild. What this could look like is something we leave for the following parts of this series. So stay tuned.

Please feel free to comment and share your view …

The original version of this article appeared here.

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