Auto Industry: Incentivized To Not Change

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This article is about a dirty business I avoided to write about for years, a business that polarizes people, families and friends until they aren’t any more.

This article is about politics and its implications, along with a main disruptor of a major global industry the world has built its wealth on for the last century.

Every nation of this world will do its best to protect its industry for the good of the country’s economy and its people. Politicians are elected to make sure industries and jobs are doing well, to stabilize income, and to reduce risk. There is absolutely nothing wrong with this protection. Unfortunately, politics can, by trying its very best to support its industry, destroy it without even realizing what’s happening. This has happened before, and there is a large risk that it’s happening today in the largest automotive producing countries, like Germany, Japan, and the USA.

Living in Germany, I will take the German automotive industry and politics as an example, but similar processes are happening in the other countries in different variations, so feel free to adjust to yours. I believe that unintended destruction has been taking place for a while in Germany, driven by belief in doing something good that is in fact doing bad. An aim of this article is to shed light on a deadly combination of protectionism and its end result, the demise of an industry sector.

Some may call what I describe as a conspiracy, and I actually don’t like such theories, which are often based on a lot of wild and unproven speculation. But today I will explain why executives of the German auto industry should see certain “friends” as “enemies” instead. I will try to explain why all of the mess we are in, causing a constant stream of profit warnings and layoff notifications, is to a large extent a side effect from governments trying to do something good by working together with automakers.

When you are a kid, not all you ask your parents for is good for you. Regardless of how hard you try to influence their opinion, they will act in your best interest and often say no. Good parents know very well that doing all that your kid asks for would in many cases be counter to their responsibility, harmful to the physical or mental health of their children.

Industries are like kids asking for sweet candies every day, avoiding homework and exercise if possible. Instead of being good parents, our governments often act like parents who assume their kids know better what is good for them. Instead of raising, nurturing, and helping an industry to grow in a healthy manner, they give the companies a lot of sweet candies and wonder why the teeth are gone so soon.

We have seen this in the banking industry, where the mantra “too big to fail” or “systemic risk” was a blueprint and free pass for doing whatever they wanted without taking responsibility for their actions. At the end, it brought the world into a severe financial crisis that was only solved by bailing banks out with hundreds of billions of dollars of taxpayer money in an internationally coordinated act to avoid a global collapse and depression like in 1929. If you are a big enough bank, apparently, the worst can’t happen to you, and the same is true for the auto industry. As long as you can make the case for systemic risk, you are fine. To make that case is particularly easy in Germany, where every 8th employee is supposedly somehow directly or indirectly working in the auto sector.

Since politicians to a large part are measured in elections based on their economic performance — how well they do creating new jobs and keeping the old — politicians and business managers work together. Politicians are going to win elections if regulations and laws they enforced are creating jobs for companies who grow and prosper. To cooperate and work together, you need to understand each other. 

In Germany, the percentage of politicians who never worked in an industry is growing significantly, making them weak in understanding what a company, industry, and the economy as a whole is really about. But without a profound understanding of such topics, these politicians are often rightfully called unqualified and incapable of supporting the economy and its companies. This is actually one reason why most of the laws and regulations today are no longer written by the government, but by the relevant industry and its lobby groups. That is an astounding fact when you consider the previous metaphor — kids writing the rules for themselves. We all know where this could lead.

The auto industry has managed to dictate to politicians what it wants, especially when we talk about battery electric vehicles and the combustion engine. We are at a time when well designed balance to keep industry healthy and jobs in place is failing. The culmination of those times is often called a downturn or recession. This article is not a prediction that a recession will happen — the recession in the automotive industry is happening already. The list of tier 1 and tier 2 suppliers announcing bankruptcies, layoffs, and profit warnings in the auto business in Germany is increasing, and many are already initiating short-term solutions, asking their employees for salary cuts or laying them off.

If politicians and industry worked well together, the German automotive industry, which is the backbone of our nation, would be the strongest in the world and have the best products globally, but everybody who is claiming that is either full of illusions or badly informed. The reality is that if you give your kid all what he or she wants, you are limiting his or her ability to succeed in life, and the German government has done exactly that. 

The auto industry is slow in its pace of innovation and is like a kid only doing as much as it’s been firmly asked and persuaded to do. For a century, that arrangement worked well. If the combustion engine sales are going well, the pressure to innovate is low. When the pressure is high, on the other hand, the innovation rate does increase. That system makes sense as long as the innovation cycle is constant in its pace, but what we see today is a dramatically accelerating pace of innovation, in particular in battery technology from one single company (Tesla).

With battery improvements constantly released from Tesla, you would expect that incumbent automakers would increase their efforts to innovate as well, but the reality is that they did not for years, and even today they don’t. If any of them did, you would have heard them announcing a Battery and Drivetrain Day, as we hear from Tesla to proudly show the next breakthrough and step change in this arena. We did not hear from German automakers about such a day, did we?

Instead, most of the assets of incumbent automakers go into protecting profits, because that is what will make those who employ the managers (shareholders) continue employing them. A shareholder is only interested in high profits or high returns at a given time, and in most cases does not think much about long-term sustainability. For that reason, a manager of an automaker is incentivized to make sure profits continue to flow in the short term, and they do that by threatening politicians that they will lay people off unless they get incentives that mitigate their profit reduction or losses in a time when sales of an old technology do not perform that well anymore.

By receiving incentives, the pressure to innovate decreases, as the urgency seems to decrease. The threat of layoffs is now more real than before, as Tesla has innovated quickly and threatened their sales. Therefore, the automotive industry will ask politicians to provide even more incentives. You get the picture. The industry is caught in a vicious cycle, repeatedly delivering less and asking for more. The gap between expectations and reality is getting bigger, like the automakers’ demands to the government for help. 

A good and actual example for this is not only more incentives, but also the latest delays of the new German BEV incentive, which had been announced to be increased by 50% from €4000 to €6000 late in 2019. The incremental €2000 is a lot of money for most. The BEV incentive increase went through the media late in 2019 and was approved by the government, but it was not applied for in Brussels by the German Minister for Transportation in prompt order. The incentives have been approved now, but many who were in the market for a BEV in Germany held their purchase back simply because they wanted to be eligible for the incremental €2000 subsidy. 

All of this was happening at a moment when the following announcements were made:

• Daimler cutting production output for the EQC 40% due to battery supply shortages.
• Audi putting its e-tron production on short work due to battery supply issues and missing parts.
• VW announcing delays in the ID.3, with the affordable version scheduled for delivery in 2021, and software issues causing delays in 2020.
• BMW not delivering a next-generation BEV before 2021.

Since arguably the most attractive mass-market BEVs in Germany are not from German producers, companies like Renault, Hyundai, and Tesla suffered from the risk of a demand cliff due to incentives being like a carrot in front of your face that is shown but not given. The delay of the incentives did hurt their sales, much more than it did for German producers who needed more time to organize their supply chains better, work on production capacities, and struggle to provide enough supply. The former two, Renault and Hyundai, after filing many complaints to the German government, have in the meantime announced that they will compensate buyers to the same extent and beyond, as if incentives were implemented. Tesla, likely due to high overall demand in Europe, did not announce any compensation at all.

All of this can of course be pure coincidence, and may not relate to each other but the incentive delays are a welcome present for every German BEV manufacturer that has either supply, production, or demand issues. It gives them time to adjust, more time to keep profits, and limits the ability of the competition to take market share away from them. If you listen and read carefully you hear not a single complaint from the German auto industry about the incentive delay, and that is suspicious to say the least. In politics, you should not only listen to what has been said but also to what has not been said if you want to understand better what is happening. The same applies to the industry.

To believe this is a conspiracy theory is a fair claim, but the result is, regardless of whether that claim is correct or not, beneficial to the German OEMs. While certainly not true in all cases, it has in the past a winning rule to “follow the money” if you want to understand why something happened.

BEVs are, since the location of Tesla Gigafactory 4 has been announced here in Germany, more and more present in the consciousness of German consumers, and people who are searching for a vehicle are considering the company and its products more today than they did before since Gigafactory 4 will create jobs. Tesla is more often a subject of positive articles in the media. The stock price development of recent months shows investor confidence. Tesla will soon be a Made in Germany product from German employees. Once people earn their livelihood at Tesla Brandenburg, or Tesla Berlin as Elon prefers to call it, and Tesla pays taxes here in Germany, the sentiment will shift even more to Tesla’s favor.

Incentive delays are a minor issue, so why do I write about them at all? What may look like a small issue is in fact a huge problem. Not even because consumer demand may be negatively affected for the urgently required emission-free vehicles on our roads, but because the consequence of that politically motivated measure is lower pressure on the industry to innovate and catch up in a disruptive market. Instead of supporting the pace of innovation, reasons to do so are removed.

Delays are a relief for the industry, but not because they will now put more energy and focus on innovation to catch up. Instead, it will be less. They will optimize their ability to achieve short-term profits. Short-term profits are nice to have, and there is nothing negative about them unless you pay for them with your future.

Since incentives are a smaller issue and only temporarily delayed, the point I’m trying to make is that the politically motivated actions to reduce pressure on the auto industry to innovate are many. They are a systematic problem that you find expressed in many ways. 

Another good example is hybrid vehicle incentives, which are 75% those of a BEV yet keep automakers producing combustion engines. 

Another one is the lowered carbon emission regulations of 2015, when the auto industry renegotiated them with regulators from the EU in Brussels to put paragraphs in providing things like 5% of the most polluting vehicles can be put on the acceptable list, which lets them sell more SUVs that have the highest gross margin.

Another example is Germany not enforcing bans on vehicles with 8 times the emissions that they should have according to law.

I could continue with many more examples, but what they all have in common is that they benefit politicians and industry managers in their personal interests and pay for that by polluting our environment more and reducing the pace of innovation in the auto industry. Managers tell politicians that they need more time, but the last 10 years have proven that innovation does go slower when you reduce pressure, not faster. Reducing pressure is exactly what politicians are doing everywhere, and they still wonder why automakers are behind in innovation compared to Tesla.

The pace of innovation increases like an S-curve. The one in front moves faster away from the followers than at the start. It’s an exponential advantage and very hard to catch up with. 

Another way to express the effect is that what you gain in short-term profits is a fraction of the profits you would gain by putting all assets you have in an effort to catch up. The problem is that managers are not incentivized to catch up, but rather to make profits now. This has repeated for centuries, but it is getting more severe with compressed innovation cycles, particularly as we’ve seen in the last 10 years.

Innovation is not an awesome, single, magic improvement that solves everything all at once. It’s a process that creates an idea or coincidence that often starts out overhyped but not functional for the masses, followed by a series of constant improvements that lead to what is later called a disruption. This pattern repeats with all technology disruptions. It is doing so today with battery technology as well as autonomous driving.

The more you are advanced in that innovation, the more you innovate. With that, your lead takes shape. To give another example:

Most people, in particular in the US, if you ask who invented the telephone, will tell you that it was Alexander Graham Bell, the famous inventor who transferred the first words “Mr. Watson, come here, I want you.” The truth is that he was someone making important improvements to an existing device and was very successfully marketing it but the true invention, the step change, was made by the German Philipp Reiss, who transmitted — about 10 years before Bell filed the patent — the first ever wired words: “a horse does not eat cucumber Salat.” But he never filed a patent. Finally, the third inventor of the telephone was Antonio Meucci, who also invented a talking device before Bell did but did not have the money to file a patent. Instead, he sent the construction drawings to Western Union Telegraph, where they supposedly got lost and by coincidence the company worked later with Bell after he improved the device.

Invention is a process, not a single event, and at the end of the day, Reis, Meucci, and Bell each had an important part in history helping to start something that we today have in our hands like Captain Kirk in the Starship Enterprise did. It does not matter for humanity who did something first or who filed a patent, but the end result does. It was completely impossible in my childhood to imagine it would come true one day, but it happened faster than expected.

Another important note is that one step change is not enough — you need to be able to develop a product that you can produce in high volume. You need something that is technologically ready and that you can bring to market and sell. All of that sounds kind of boring, but that’s part of effective invention. If you think about all the “break throughs” you heard about with solid-state batteries, for instance, you can see the point. The real breakthrough is usually after the official breakthrough is announced, and that’s why in 99% of “breakthrough” cases, you don’t hear about them again.

A BEV driving 500+ miles (805+ km) on one charge is feasible today, but if you cannot build one that you can mass produce for at a reasonable cost, it’s not very valuable. The same is true for the Tesla Cybertruck. If you listen carefully to Elon Musk, the hard nut to crack was not to develop and show the prototype, but to build the production technology to make it applicable for the masses. The exoskeleton of the vehicle might look like the true innovation, but the production technology is the hard part.

It sounds like a contradiction, but politics and lawmakers can easily stop innovation even while trying to support it, especially when they listen to what the industry is asking them for. Managers in the industry are interested in profits and market share, but prefer to avoid innovation until they are forced to. In a disruption like the one we are in, where the move from ICE to BEV is going much faster than anybody thought, the reaction time between the moment you are forced to do something to the moment in which you make profit again is shrinking exponentially with every day of delay, and that’s the issue.

The exponential of that shrinking time is the final nail in the coffin for companies that believe they can win a battle today with weapons from the past.

The demise of the global ICE auto industry is not caused by the inability of technology innovation, but by the ill designed combination of interest between politicians and managers, both incentivized to do something that in the end results in a reduced pace of innovation for those companies. Unfortunately, it also effectively accelerates climate change.

All photos by CleanTechnica