Crisis as a Catalyst for Change: How suppliers can drive performance and returns on investment in the transition to EVs

The automotive industry is at crossroads as it navigates what is forecast to be a decades- long transformation from being an industry that builds, sells and maintains vehicles powered by internal-combustion engines to one that increasingly includes a rich portfolio of vehicles powered by electricity.

The transition to electric vehicles (EVs) has clearly begun. However, the road to building the capabilities that can sustain an end-to-end global EV value chain is filled with potholes and unexpected turns that could prevent some companies from maximizing performance and returns on their 
investments.

In part one of this three-part series, our team at FTI presented the business case for why companies across the automotive value chain — battery manufacturers, automakers and suppliers, and service providers — need to already be working to harness the growth opportunities of an EV value chain that we forecast could reach $1.2 trillion annually by 2025.

In part two, we surveyed hundreds of Automotive News subscribers representing automakers and suppliers to understand what they were doing to develop their EV supply chains, how they were managing those activities and the activities surrounding their internal-combustion supply chains, and the complexities they were encountering.

In this final installment, we focus on the questions that we believe executives working in electrification should be asking, as well as recommendations on how those companies ought to be working to answer them. Questions like:

• Do we have the right portfolio of products or services to support vehicles powered by different powertrain technologies?
• Do we have the right tools and technologies to manage and mitigate risk up and down two different supply chains?
• Do we have the right customer portfolio, and is it diverse enough to help weather market downturns?
• Are we focused on the right market or position in the value chain to maximize growth for the business?
• Do we have the right partnerships to supplement our own capabilities to provide a compelling value proposition?
• Do we have access to capital to invest in innovation, capabilities and talent to drive long- term growth?

Before recommending how we believe companies should tackle these questions, it’s important to understand strategies and business models that automakers might adopt and understand what break-even levels are required for these business models to deliver adequate returns.

We have identified four major strategies and associated business models that automakers building EVs should consider: new vertically integrated, traditional, new asset light and new niche.

New vertically integrated: Focused on being first to market to capture the first wave of purchases among early adopters. By vertically integrating, OEMs are able to control supply, quality and cost. Expected margins should be about 20% per vehicle sold, with selling, general and administrative (SG&A), R&D and financing totaling 3-12% of revenue. Growth is driven by lowering component and battery pricing and continued investment in R&D. This strategy does require significant upfront investment, and missteps by company leaders should not be surprising. Break-even is expected about 10 years after the first vehicle demonstration at a volume of 400,000 to 450,000 units annually.

Traditional: Focused on transitioning from building vehicles with internal-combustion engines. Initial margins should total 5-10% per vehicle sold, growing to 12-15% as component and selling costs improve. The strategy leverages existing internal capital to drive growth into EVs, while the existing business in internal-combustion engines serves as a “cash cow” funding electrification. Like vertical integration, growth is driven by lower pricing for components and batteries. But cost discipline, leveraging existing scale and continued investment in R&D is also a must. Because of existing scale SG&A, R&D and financing costs average 1-5% of revenue. Break-even should be expected between seven and 10 years, based on an annual volume of 250,000 to 300,000 units.

New asset light: Focused on design and final assembly, this strategy requires little vertical integration and moderate investment. This strategy gives up some control of the supply chain and cost of supply, which in some ways helps focus operations on making vehicles more efficiently. Growth is driven by establishing partnerships to keep costs low and securing cheap capital for long-term investment. Expected margins, SG&A, R&D and financing costs are like vertical integration, but break-even can be achieved sooner and at much lower volumes—five to seven years at 75,000 to 100,000 units annually.

New niche: This strategy focuses exclusively on design and branding and relies on third- party contractors for components, manufacturing, assembly and services. Companies adopting this strategy are often focused on niche markets and/or specific services or view EVs as a commodity to support broader mobility business models. Growth is driven by partnerships that keep R&D and SG&A costs low because of limited connections with end customers. However, R&D and financing costs could total 25-50% of revenue. While margins are likely 5-7% per vehicle sold, break-even can be achieved in as little as five years and an annual volume of 40,000 to 60,000 units.
 

A variety of OEM EV-related business models are emerging, in terms of strategy and operating-model choices that OEMs make to build their value chain. Not all OEMs are taking the traditional linear automotive value chain for granted. Factors driving growth and competitiveness for each will depend on how these business models are built up and executed. For the automotive supply base and companies working along the value chain, it is not only critical to understand the 
OEM’s EV-related business model and factors driving growth but also each OEM’s value creation and integration strategy.

For suppliers, it is critical to link and align their EV growth strategy with the differing OEM models and follow a five-step roadmap to define where they want to play and how they want to win.

1.Assess your product and process competencies in EVs and other future vehicles

2.Assess which tier you play in the EV supply chain and what are the key customer-partner relationships

3.Find the “portfolio of winners” to bet on (OEMs, next-tier companies, partners) based on business analysis

4.Invest in R&D to help solve OEMs’ EV issues (safety, technology, quality and cost), especially if they are new to the industry

5.Establish partnerships, especially in product development, design and new technology capabilities

While there are regular challenges and crises to navigate, the underlying automotive business model had largely remained unchanged for a century. For the past decade, however, the industry has undergone massive transformation as technology has emerged that affects everything from how vehicles are designed and built to how people shop for and operate their vehicles. The push to electrification is the next transformation that has the potential to create crisis and serve as a catalyst for change. Our hope is that this series has helped offer perspective on what mass scaling of EVs means for the industry and various business models and offered recommendations for how suppliers and manufacturers can navigate the curves ahead.

For more about FTI Consulting’s analysis of the electric-vehicle value chain, contact Neal Ganguli, senior managing director, at [email protected] or Todd Eddy, managing director, at [email protected].