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Explained: How the billion-dollar automobile industry is changing, courtesy Covid-19

Automakers are moving away from outsourcing towards internalizing most of the production. What catapulted this change? What are automobile companies doing? Is 'Teslafication' the way out?

Cars on the manufacturing floor of a Tesla facility in Austin, Texas. (Jay Janner/Austin American-Statesman via AP, File)

The automobile industry, encompassing thousands of companies, millions of workers and billions in sunk costs, is undergoing a once-in-a-century change. Besides shifting from regular internal combustion engines towards electric vehicles, it is also going through another epochal change while trying to tackle the global supply chain issues.

Having outsourced much of the manufacturing process in the past half-century to focus on design, supplier management and parts assembly, the big automobile firms now want greater control over their value chain — from the metals that go into EV batteries to the software those EVs run on and the shops in which they are sold. In turn, what they want to do is to turn their EV arms into technological start-ups.

However, in order to understand how automakers are moving away from outsourcing towards internalizing most of the production, we need to first understand what catapulted this enormous, and of course expensive, change.

How the supply chain crisis unfolded

Ships stuck at sea, warehouses overflowing, trucks without drivers: the highly intricate and interconnected global supply chain was in an upheaval as the Covid-19 pandemic struck. The turmoil has revealed how the need to ship surgical masks to West Africa from China can have a cascading effect on Ford’s ability to put back-up cameras on its cars at factories in Ohio and delay the arrival of Amazon Prime orders in Florida.

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For every car or truck that does not roll off an assembly line in Detroit, Stuttgart, Shanghai or Manesar, jobs are in jeopardy. They may be miners digging ore for steel in Finland, workers molding tires in Thailand, or Maruti Suzuki employees in India installing instrument panels — the livelihoods of billions of people are at the mercy of supply shortages and shipping chokeholds that forced factories to curtail production.

The auto industry accounts for about 3 per cent of global economic output, and in carmaking countries like Germany, Mexico, Japan and South Korea, the percentage is much higher. The shock waves from the semiconductor crisis, which forced virtually all carmakers to eliminate shifts or temporarily shut down assembly lines, could be strong enough to push some countries into recession. In Japan, home of Toyota and Nissan, parts shortages caused exports to fall by 46 per cent in September 2021 compared with a year earlier — a potent demonstration of the car industry’s importance to the economy.

Industry experts had said that automakers were having trouble getting all manner of parts and raw materials for a variety of reasons, including Covid-related plant shutdowns by suppliers, logistical problems involving shortages of ships, shipping containers and truck drivers, and difficulty that some suppliers are having filling jobs. Industry consultant AlixPartners stated that supply chain problems caused automakers to build 7.7 million fewer vehicles globally than they would have if they could get all the parts and raw materials they need.

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As the shortage of semiconductors wreaked havoc and as carmakers take the electric route and refashion their supply chains, doing everything under one roof seems to be the way ahead. And it is here that the term ‘Teslafication’ came into being.

Tesla’s industrial system is all about internalising all aspects of production, and therefore, all the profits. Elon Musk has claimed that his company was “absurdly vertically integrated” by any standard, not just the car industry’s. And the bigger automobile companies want to emulate what Tesla, the undisputed EV champion of the world, has done.

So, what does Tesla do? The EV giant has struck recent deals with lithium miners and graphite suppliers, and in May 2022 confirmed a deal with Vale, a Brazilian mining giant, to purchase nickel. The plan is to acquire most of its lithium, over half its cobalt and around one-third of its nickel directly from nine mining companies. It will use those minerals in its gigafactories, the first of which started making batteries in 2017 in Nevada in partnership with Panasonic of Japan. It plans to make more cells on its own at its three other gigafactories around the world. Tesla has also pulled other bits of the powertrain in-house. It makes its own motors and a lot of its own electronics, giving it more control over costs as well as over the technology.

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To add to this, Tesla also designs its own semiconductors, a move that has helped it weather the global chip shortage better than the rivals. Tesla’s software engineers have also created a centralised computing architecture to run on those chips, ensuring smooth integration with the hardware. Elon Musk has even ditched the dealership-based sales model, instead opening his own Tesla stores.

And what is the result of this? A whopping market value of $724 billion, which is almost as much as the next nine big carmakers combined.

What are other automakers doing?

The big players in the game are doing what has been an age-old practice —tailgating a rival that tries something that works.

According to the bank UBS, “integration represents a strong competitive edge in an environment of structurally tight supply chains.” For years, car manufacturers have been outsourcing to big suppliers such as Bosch, Continental and Denso in order to concentrate on managing supply chains, integrating separate parts, design and marketing. Suppliers sold similar components to many customers using scale to keep prices low. This freed up capital for carmakers but put technological innovation at one step removed. Mercedes Benz estimates its value-added split at 70-30 in favour of suppliers.

However, hit by the global supply chain crisis, they want to do what Tesla does, i.e., bring down this ratio to 50-50 (the figure is according to an estimate by Jefferies, an investment bank) rising in favour of in-house.

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BMW said in 2021 that it had put $334 million into an Argentine lithium project. Last year, Stellantis and Renault each signed deals with Vulcan Energy Resources, and GM revealed a “multimillion-dollar investment” in Controlled Thermal Resources, in each case for lithium. In April, Ford inked a deal with Lake Resources for the same mineral, while Stellantis and Mercedes entered an arrangement with Umicore, a Belgian chemicals giant, to supply cathode materials for ACC, the two carmakers’ battery joint venture. A month earlier BYD, a more Tesla-like Chinese firm, announced a nearly $500 million investment in a Chinese lithium miner. It is said to have bought six mines in Africa.

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Efforts to emulate Tesla’s battery gigafactories are also starting. Volkswagen is creating some in-house battery-making capacity and has earmarked $2.1 billion for its German factory, and says it will build six battery factories in Europe by 2030. Ford and SK Innovations of South Korea will stump up $7 billion and $4.4 billion, respectively, for three joint gigafactories in America. Last year, GM unveiled an investment of $2.3 billion for a battery plant in Tennessee built with LG, another South Korean firm.

Buying off-the-shelf electric motors is also falling out of favour. Hyundai and the Renault-Nissan-Mitsubishi alliance are mostly going it alone. BMW, Ford, GM, Mercedes and Volkswagen are planning to make more motors in their own factories. The 7.7 million cars in lost production last year as a result of the global semiconductor shortage has made the industry forge closer links with chip designers such as Qualcomm and Nvidia, which would once have sold chips to firms far down the carmakers’ supply chain.

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Is there any precedence to this?

What Tesla is doing now, Henry Ford did decades ago. He often sourced raw materials, like rubber for tyres and steel for chassis, from plantations and blast furnaces owned by his firm. His River Rouge factory in Detroit was powered by coal from Ford mines. He was consumed with stockpiling enough materials to ensure that his assembly lines could continue operating without debilitating shortages.

With internalising supplies rather than outsourcing, it would definitely amount to losses for suppliers and more headaches for car bosses and even though this change will provoke backlashes from governments, Teslafication seems to be the way ahead.

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First published on: 25-06-2022 at 09:41:33 am
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