the circuitous path to electrification of china's automotive industry
TRANSCRIPT
Perspective
The Circuitous Path to Electrification of China’s Automotive Industry
John JullensBill RussoHuchu Xu
Booz & Company
Contact Information
Beijing
Bill RussoSenior Advisor [email protected]
Shanghai Huchu [email protected]
John [email protected]
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EXECUTIVE SUMMARY
As the balance of world market and economic power shifts from West to East, China will emerge as the key location in the battle for dominance of the 21st century’s global auto industry. Due to increasing pressure from air pollution, oil consumption and urban congestion, the focus of the country’s auto industry will increasingly switch from internal combustion driven vehicles to alternative propulsion technologies, particularly those powered by electricity. Already many observers believe that the government’s ambitious series of programs and policies designed to accelerate the development of new energy vehicles run over the last decade will lead to the emergence of China as the key location for a global “green” mobility revolution. As this happens, the eventual electrification of the automotive powertrain will transform the automotive industry, and even society itself.
However, we also believe that these efforts to reinvent transportation will take longer than widely anticipated. Efforts to leapfrog internal combustion engine technologies or to otherwise short-cycle the development of new and advanced mobility technologies will fall short in the short to medium term. Instead, China’s automotive industry will take a longer, more circuitous route towards its objective of finding new energy replacements for gasoline. The government will be a key player in this through its decisions on where resources and research efforts should be directed, what standards should
be mandated, and what subsidies and incentives such as tax breaks should be offered. Transformation will occur in stages, with commercial vehicles such as taxi fleets, delivery companies and bus services being the first major users. As this happens, the industry will see the emergence of new business “ecosystems”—ones that bring together a different range of companies from those traditionally involved in the auto sector. These new forms of collaborative partnerships will in turn lead to new business models, very different from those formed in the era of the internal combustion engine.
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InTRodUCTIon For global automakers, Asia Pacific, and above all China, represents the greatest opportunity for growth in the 21st century. In 2009, China surpassed the US as the world’s largest market by volume. But with it just entering the accelerated growth phase typical of emerging markets, its car industry will continue to grow strongly for the foreseeable future. Over the coming decades, therefore, China will be the main battleground for dominance of the global auto industry (see Exhibit 1 and 2).
However, this battle will not be fought over traditional territory. The eventual electrification of the automotive powertrain will transform
the automotive industry—and, given the importance of cars and mobility to cities and our ways of life, to society itself.
The impact of the electrification of the powertrain on the automotive industry’s value chain will be hugely significant. The supplier landscape will call for new companies—many of them from the technology and IT sectors rather than the engineering and metal businesses which have dominated the industry until now—to develop and make very different components—from the electric motors and the batteries needed to drive them, through belt-driven alternator starters and regenerative
Exhibit 1 For the Global Auto Market, Asia Pacific Represents the Greatest Opportunity for Growth
Source: Global Insight
Area Reflects Size Of 2010 Actual PV Sales
Area Reflects Size Of 2020 Forecasted PV Sales
Market 2010 PV 2015 PV 2020 PV
Asia Pacific 22,212 30,350 34,838
NAFTA 11,545 16,877 17,073
Western Europe 12,776 14,133 14,302
Eastern Europe 3,261 5,035 6,095
Latin America 4,030 5,570 6,929
Africa/Middle East 2,946 3,783 4,211
In Thousand Units
Asia PacificGrowth thru 2020: 12,626KCAGR (2010-2020): 5%
Eastern EuropeGrowth thru 2020: 2,835KCAGR (2010-2020): 6%
Africa/Middle EastGrowth thru 2020: 2,899KCAGR (2010-2020): 6%
Western EuropeGrowth thru 2020: 1,527KCAGR (2010-2020):1%NAFTA
Growth thru 2020: 5,528KCAGR (2010-2020):4%
Latin AmericaGrowth thru 2020: 2,899KCAGR (2010-2020): 6%
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Note: ASEAN figures include top 5 ASEAN member countries, including Thailand, Malaysia, Indonesia, Singapore, and Philippines; Rest of Asia-Pacific includes Hong Kong and PakistanSource: Global Insight
Exhibit 2 Within Asia Pacific, the Greatest Growth Opportunity Is China
braking systems to electrically-driven ancillaries and intelligent controls—along with all the electronic components needed for such vehicles.
An even larger challenge, though will be the transformation of society itself. Cities and highways which now have their streets clogged with internal-combustion driven cars, vans and trucks, will instead find themselves filled with zero-emission
vehicles. These will almost inevitably be much smaller, quieter and lighter than current autos. They will be made from recycled materials, and incorporate smart features such as sensing technologies and telematics that allow them to drive and navigate with little or no driver assistance.
Vehicles will rely for their power on smart grids that combine electricity provision with features such as
electronic parking with dynamic pricing determined by availability and usage and meters that double up as recharge stations; power generation will be distributed widely, incorporate storage and be friendlier to wind and solar sources. Their designers will find themselves with greater freedom to test and experiment—much as the traditional joystick is no longer needed in fly-by-wire passenger aircraft, so even steering wheels could
China:Growth thru 2020: 8,653KCAGR (2010-2020): 6%India:
Growth thru 2020: 2,621KCAGR (2010-2020): 8%
Japan:Growth thru 2020: -457K CAGR (2010-2020): -1%
ASEAN:Growth thru 2020: 1,074KCAGR (2010-2020): 5%
South Korea:Growth thru 2020: 110KCAGR (2010-2020): 1%
Taiwan:Growth thru 2020: 79KCAGR (2010-2020): 2%
Australia:Growth thru 2020: 310KCAGR (2010-2020): 3%
Area Reflects Size Of 2010 Actual PV Sales
Area Reflects Size Of 2020 Forecasted PV Sales
In Thousand Units
Market 2010 PV 2015 PV 2020 PV
China 11,462 17,296 20,115
Japan 4,254 4,075 3,797
India 2,240 3,700 4,862
ASEAN 1,634 2,185 2,709
South Korea 1,302 1,407 1,412
Australia 807 1,020 1,117
Taiwan 299 337 378
New Zealand 63 82 87
Rest of Asia Pacific 152 247 328
Total 22,212 30,350 34,838
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vanish in the electric car of the future. MIT’s CityCar and GM’s P.U.M.A concept are early prototypes of what such USVs might look like (see Exhibit 3).
Revolutionary as such visions are, China is uniquely positioned to assume a leading role in the reworking of the automotive value chain that would be required to make them a reality. Despite it short history of car-making—just two decades ago, it was producing less than 1 million vehicles a year—it has three key reasons for driving change.
First, it views the automotive sector as a strategic industry for its economic development in general. While its efforts have led to the establishment of a massive Chinese auto industry, domestic companies have not displaced the traditional international giants of the US, Japan and Europe. But a focus on future technologies could allow Chinese companies to leapfrog their Western competitors. The precedent for this is telecoms equipment, where Shenzhen-based Huawei Technologies largely skipped fixed-line technology and went straight to manufacturing mobile network infrastructure,
so enabling itself to become the equipment-making world leader it is today.
Second, its remarkable economic rise has led to staggering levels of pollution and congestion in its densely populated cities. Vehicle pollution and other environmental impacts are a major threat to health. In addition, growing demand for fuel has simultaneously made energy security and cost a major concern. China already imports two-thirds of its oil needs, and its ever-increasing thirst can only put further huge pressure on global prices. Alternative vehicle fuels and powertrains that can simultaneously reduce pollution levels, congestion and reliance on overseas energy resources have enormous appeal.
Third, it has the capacity to make the massive investments in new battery and related automotive technology as well as in complementary industries, such as utilities that a transition from internal combustion engines to electric vehicles will require. Its state-directed breed of capitalism is uniquely able to direct such investments and provide—even compel—the required cross-industry coordination.
Gasoline Alternatives
Numerous technological innovations that can be brought to bear on the challenge of alternative propulsion:
Hydrogen fuel-cell vehicles • (FCVs) oxidize hydrogen stored in a tank to generate electricity.Liquid petroleum (LPG)/• compressed natural gas (CNG) vehicles offer vehicles with lower emissions than gasoline-fueled vehicles.Gasoline hybrid electric • vehicles (HEVs) use batteries to supplement regular internal combustion engines; their batteries are recharged as the vehicle is driven.Plug-in hybrid electric • vehicles (PHEVs) have batteries that are recharged from an external electric power source.Battery electric vehicles • (BEVs) rely solely on electricity for power. Diesel vehicles have long • been more efficient than gasoline vehicles, with about 50 percent greater fuel economy; “clean” diesel engines have lower emissions of most gases and particulates than their gasoline counterparts. Diesel hybrids are • theoretically possible, but despite work on prototypes, no auto company has put one into regular production.
Exhibit 3 CityCar (MIT) and P.U.M.A (GM)
Source: MIT, General Motors
CityCar (MIT)
P.U.M.A (GM)
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ThE SEARCh foR AlTERnATIVES
Already, the government has spent heavily on research into alternative automotive propulsion technology. Over a decade ago, the Chinese government became the driving force in the development of New Energy Vehicles (NEV) with a stronger focus.
Its first target, from 1999-2002, was compressed natural gas (CNG), liquid petroleum gas (LPG) and other combustion alternative fuel vehicles (CAFVs), in a program called the Clean Auto Auction. In a second phase, running from 2002-06 (coinciding with the Tenth Five Year Plan) introduced the goal to commercialize and industrialize electric vehicles. The National 863 Program targeted the Electric Vehicle Project and identified the FCV, EV and HEV as the priorities for the development of alternative propulsion technologies. Through this initiative, officials committed Rmb800 million (then the equivalent of $97 million) from the State High Tech Development Plan, the government’s
leading advanced technology development program.
Spending was further upped in a third phase, from 2006, to Rmb1.1 billion ($138 million), and again in a fourth phase, since 2009, with the range of power sources under investigation broadening to include batteries, fuel cells and hybrid technologies.
Under the 12th Five Year Plan, covering the 2011-15 period, electric vehicles are singled out as one of seven emerging industries to be given special support. An alternative-energy vehicles development plan for 2011-20 provides for investment of Rmb100 billion ($15.15bn) in research and development with the goal of having between 5 million and 10 million electric vehicles on the road by the end of this decade—roughly 20% of the private passenger vehicle total. Meeting this target will require annual production capacity of 1 million electric vehicles by 2020.
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AChIEVAblE? At first glance, this target looks achievable. More and more people believe alternative sources of auto power are approaching the threshold of commercial viability. China with both its fast-growing market and low-cost production strengths would appear the right location to base production, not least because the world’s biggest rechargeable battery manufacturers are all already present with large-scale capacity in place to serve the cell phone and lap-top computer industries.
Consumer acceptance for electric vehicles also looks unlikely to be an issue. With per capita passenger car ownership still low and preferences still for the most part unformed due to the country’s short driving history, electric vehicles face fewer purchasing obstacles than in the mature auto markets of north America, Europe and Japan.
Additionally, a successful entrance into the electric vehicle market would give China’s domestic vehicle makers
a great opportunity to gain a position of technological advantage relative to the major international carmakers and potentially leapfrog into a leadership position in the world automotive industry. Given its already sizable EV research commitment, market scale, and the near certainty that demand for passenger cars will continue to grow, China is apparently in a strong position to drive the standards and architecture of future automotive technology.
Unfortunately, efforts to “leapfrog” or short-cycle the development of advanced technology are likely to fail. One obstacle is that while consumers have no objection to electric cars per se, their extra cost will remain a major hurdle to purchase. While maintenance and fuel charges are considerably lower for electric vehicles than gasoline-powered ones, the upfront cost is around one-and-a-half times as much. Even spread over five years, the total cost of ownership for a mid-sized electric vehicle is around 75-80% higher (see Exhibit 4).
Source: Booz & Company
Exhibit 4 Total Cost of Ownership Comparison—2010
30
20
10
0
21.1
3.0
4.9
Diesel
28.1
18.8
3.4
5.9
Gas
27.4
BEV 100
3.4
50 48.6
44.9
2.01.7
PHEV 40
36.1
31.4
2.21.5
1.0
Hybrid
29.0
6.5
40
17.5
2010 TOTAL COST OF OWNERSHIPIN USD THOUSANDS
Electricity cost
Fuel cost represents mix of vehicle efficiency, driving patterns and fuel prices
Maintenance cost includes oil, filters, brake pads, and other wear items replaced at regular intervals
Fixed cost (net of depreciation) includes initial purchase price minus the residual value of the vehicle at end of life
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By 2020, this gap will have closed considerably, with electric vehicles costing just under 20% more to run over five years, but in a price sensitive market such as China’s this remains a major barrier (see Exhibit 5).
Also problematic are technological and business challenges. Despite its investment in research, Chinese automakers are still very inexperienced at the vehicle development and synthesis process which is critical to the development
of alternative propulsion systems. An automobile is a complex engineered system requiring advanced R&D capabilities in order to test and validate the achievement of benchmark targets in the areas of performance, fuel economy, safety and quality. It is in this area that Chinese firms lack experience.
Furthermore, any transition in propulsion technology will almost certainly be accompanied by a need for major innovations in auto
design—being able to produce just the elements of an electric vehicle, even the most important ones such as the battery, may prove of less importance than the ability to construct entire new value chains that in turn require very different business models.
Thus, despite the efforts of the past decade and more, it now seems evident that it will take longer than anticipated to achieve a genuine “mobility revolution.”
Source: Booz & Company
Exhibit 5 Total Cost of Ownership Comparison—2020 (Estimated)
3.4
5.9
1.7
PHEV 40
30.8
26.2
2.21.4
1.0
Hybrid
28.0
20.4
3.0
4.5
Gas
27.9
19.2
3.4
5.3
50
40
30
20
10
0
BEV 100
32.0
28.3
2.027.2
17.9
Diesel
Maintenance
Fixed Cost (net of depreciation)
Fuel
Electricity
2020 TOTAL COST OF OWNERSHIPIN USD THOUSANDS
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and other incentives, and support for test schemes. Of course, this does not mean official choices will necessarily be the ones that are eventually adopted by the market, but its policies will be one of the most powerful forces deciding which directions are explored or ignored.
But most revolutionary will be changes in the automotive value chain. The electric vehicles will require an entirely new range of manufacturing skills. The step-by-step reduction of gasoline and diesel powertrain manufacturing capacity will be replaced with the ramping up of alternative powertrain production facilities.
AlTERnATIVE CIRCUIT
However, we believe it is possible to discern some of the important features determining the form of the automotive industry that will emerge in China as new forms of propulsion replace internal combustion. What we see happening is the emergence of a new “ecosystem” of collaborative partnerships bringing together organizations along three dimensions—regulatory, technical and business (see Exhibit 6).
As has been the case over the last ten years, the government will play a vital role in setting the direction of the industry through its funding of research and infrastructure, setting of standards, subsidies, tax breaks
Source: Booz & Company
Exhibit 6 Three Dimensions of the New Eco-system
Regulatory Innovation Frontier(Government)
Business Innovation Frontier(Cross Industry/Value Chain)
Technical Innovation Frontier(Auto Industry)
- Partnerships among key players to deliver deep, scalable solutions for future green transportation
- New policies (including subsidy policy) to support the commercialization of green transportation technologies
- Partnerships between other industries and auto makers/suppliers to develop new business model for future green cars
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Along the technical dimension, tie-ups between automakers and new types of electric vehicle suppliers will be required to discover the new mobility technologies, particularly for powertrain and new lightweight material technologies, that will be needed to find viable, cost-effective replacements to internal combustion engines.
The automotive production footprint will be transformed in the process. Metal bashing is replaced with production using different, lightweight materials. New production sites will emerge, using different manufacturing technologies and so configured very differently from the auto plants of today.
Sales and after-sales services will also call for new types of business model. Vehicle maintenance will require very different skills and expertise. For sure, mechanical knowledge will remain important, but as electric vehicles have few moving parts, much of the after-sales repair business—vital for dealers’ profitability now—would disappear. The spare parts business will therefore have to be reorganized, and with it warehousing
and inventory control.Maintenance skills will also have to be married to information technology and software expertise, and home or work-based maintenance may replace visits to garages. The ability to integrate vehicles with other electronic devices such as smartphones and tablets will almost certainly become important.
Companies will need to establish partnerships along the length of the value chain between auto makers, utility companies, distributors, infrastructure developers, leasing firms, and other service providers to develop new business models—many of which will involve businesses and industries from outside the traditional automotive sector.
Success, therefore, will call for collaboration both within and across these three dimensions. Take the effect of changing vehicle powertrains—the location of the biggest “discontinuity” in the technology migration from the internal combustion engine to electric vehicles. This is not a simple matter of replacing one kind of engine with another; rather it will call for a reworking of the entire vehicle.
Electric vehicles need lighter and stronger materials to replace the heavy metal body of conventional vehicles. The cost of currently available technologies remains high; thus a second key challenge is developing economical vehicle body materials.
As both the powertrain and body material elements of electric vehicles bear little resemblance to those used in internal combustion driven vehicles, opportunities will emerge for suppliers from outside the traditional automotive sector to enter the supply chain.
Finally, developing new technologies and building vehicles will not be enough without adequate infrastructure to support recharging and maintenance and alignment with wider government policies on the development of urban transport systems that dovetail with China’s planning needs as hundreds of millions of country dwellers move to cities in the next two decades.
In short, innovations in both technology and business models will be needed to achieve large-scale electrification of transportation.
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TowARd A nEw ECoSYSTEM of CollAboRATIVE PARTnERShIPS
Some of the possibilities can be discerned in a handful of electric vehicle ventures with ties to China that are experimenting with new approaches. Coda, a privately owned US company which aims to sell electric vehicles in the United States, has developed a new business model for collaborative electric vehicle development via a network of partnerships. For its powertrain, Coda uses motor technology from UQM, a US-based manufacturer of electric motors, generators and controllers, but its other major partners are all Chinese. Current electric vehicle models sold in the US are based on a vehicle platform from Hafei Motor, a subsidiary of stated-owned Changan Group, China’s fourth largest auto group. It also has launched a joint venture with Lishen Power Battery, Lio Energy Systems, to develop battery systems exclusively for its use. To unlock the scale advantages of participating in the Chinese market, Coda has signed a letter of intent with Great Wall Motor, a fast-growing automaker from Hebei province, to supply advanced electric powertrains and jointly develop battery electric vehicles.
Better Place, a start-up based in Palo Alto, California, is another company exploring innovative ways of spreading its electric vehicle technology. Its business model is based around the idea of leasing the batteries of an electric car—its single most expensive element—separately from the rest of the vehicle. Instead of charging for them upfront, their cost is recouped through monthly payments that also include electricity and maintenance. To handle both the
sales and service end of its business, it also involves itself in developing the location of recharge infrastructure.
While most of Better Place’s efforts have focused on the two relatively small markets of Denmark and Israel, in the last two years it has signed agreements to develop electric vehicles with Chery Auto, a leading independent Chinese auto firm, to set up an experimental battery station and education center in Guangzhou, the capital of Guangdong province, with China Southern Power Grid Company. This center is a showcase for technology supplied by Better Place. Under the Better Place business model, customers not only recharge their electric cars but also periodically stop at an electric filling station to swap their nearly depleted batteries for freshly charged ones. The power company and Better Place are in talks to sell electric cars to the Guangzhou municipal government and to taxi fleets.
Hertz Global is another company experimenting with a cooperation model. It is teaming up with GE Energy and Shenzhen-based BYD Auto to expand its electric vehicle leasing business into China. The intention is to capitalize on China’s still nascent electric vehicle market, though high cost and weak infrastructure remain the biggest hurdles to popularizing the technology. Hertz will offer leasing to consumers and companies in Shanghai, Shenzhen and Beijing, initially using BYD’s E6 electric crossover model, with GE helping to build up an initial network of 770 charging stations.
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ConClUSIon Nonetheless, despite such promising starts, we believe that the transition from the internal combustion engine towards electrification of the automotive powertrain will prove far more difficult than originally expected, even with the full backing of the Chinese government.
Potential electric vehicles stakeholders will have to develop their strategies and make potentially very significant investments under conditions of considerable uncertainty. Standards will be unknown, and could quite possibly be set to suit the needs of specific state-backed companies. Investment in charging infrastructure will likely be made by local governments or power utilities with no automotive background, with priorities very different from those of the oil companies which dominate the fuel supplies of the today’s road transport industry
They will have to be clear about the range of possible scenarios, and how to adjust depending on what actually unfolds. Just as important will be thinking long and hard about which investments should be made now,
and which should be deferred, and whether it will be possible to advance alone or with a partner.
In general, therefore, we believe that most future collaborations will involve broad mixes of players from both within and outside the traditional auto sector. Companies will need to pool competences and share investment requirements and risk. State-owned enterprises and officially backed research bodies will be crucial for the roll out of infrastructure, setting of standards and testing of experimental projects. But private sector collaboration will be the most important source of new business models as companies figure out just what kind of technical and service partners they need to put together viable operations.
China’s economic resilience, with its financial system is less exposed to turmoil in other parts of the world and GDP growth still heavily driven by fixed investment, will ensure that investment continues into new energy vehicles and the infrastructure needed to support their uptake. (State Grid Corporation of China, the country’s
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largest power transmission company, has announced plans to build a nationwide network of more than 2,350 recharging stations with a total of 220,000 charging points by 2016.)
But with demand for conventional, internal combustion driven vehicles likely to remain robust, China’s route to the widespread adoption of electric vehicles will be circuitous. It is likely that the first major users of electric vehicles will be commercial
vehicles—taxi, bus and delivery companies. Particularly important will be businesses owned by the government—as both purchasers and promoters. The scale of Chinese demand will count further down the road—once a new ecosystem has taken place, then allowing scale to be built at a hyper-rapid pace.
For now, therefore, companies which want to play a leading role in the location where the global automotive
industry will be rebuilt for the 21st century, should turn their attention to figuring out what collaborative partnerships they can form with multinational companies, utility firms, research bodies and officials that will allow them to be among the businesses that drive China—and likely the world’s—mobility revolution.
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About the Authors
Huchu Xu is a partner with Booz & Company and leads the firm’s automotive practice in Greater China. He has over ten years of experience in management consulting, with extensive experience in serving both multinational and Chinese clients along the whole automotive industry chain, from large OEM groups to JV companies and auto parts suppliers.
John Jullens is a director with Booz & Company based in Shanghai. He specializes in demand-side transformation, including revenue growth strategies, brand management, customer retention, and retail channel effectiveness for B2C and B2B clients in North America, Europe, and Asia.
Bill Russo is a senior advisor with Booz & Company as well as the Founder and President of Synergistics Limited. He lives in Beijing and has more than 20 years of experience in the automotive industry, most recently serving as Vice President of Chrysler’s business in North East Asia.
Printed in Greater China©2012 Booz & Company Inc.
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