Electric vehicles and vertical integration
Electric vehicles and vertical integration
Are Chinese electric car companies better off being vertically integrated?
(1) It is not clear whether a vertically integrated approach conveys any sort of business advantage in the car business.
Tesla has famously used a highly vertically integrated approach and achieved some success. However, it is not yet clear to me whether vertical integration contributed more to its success than other factors such as minimal use of paid marketing, the novel idea of using an existing battery format (18650), first-mover advantage, the sheer tenacity of Elon Musk, etc.
Moreover, it is probably still too early to definitively conclude that Tesla is an unqualified success, at least in the sense that its vertically integrated business model is the one to copy. Indeed, very few (if any) car companies have tried to mimic its highly vertically integrated approach. While this may very well be driven by incumbent inertia, the fact remains that dozens of car companies have had ample time to consider shifting to a more vertically integrated approach and universally decided that it wasn’t the right approach. Before we can declare Tesla an unqualified success, I think we need to see the level of sustained profitability it can achieve in the face of market competition.
The critical question here is whether the benefits of vertical integration (rapid time-to-market, greater control over product quality etc.) outweigh the negatives (far greater complexity, higher capital needs, lower benefit from specialization and scale, etc.). In some cases such as the smartphone industry, Apple’s vertically integrated approach has clearly proven to be the right approach. But it is unclear at this point whether the smartphone industry is the right analogy for the automobile industry.
(2) Some Chinese car companies are actually quite vertically integrated.
A good example is BYD, which got its start in the rechargeable battery business (primarily for consumer devices) and then became an automobile company later. Today, like Tesla it designs and manufacturers its own electric vehicles as well as the battery packs and also retains tight control over its retail dealer network. It has also made forays into electric buses.
The Chinese car market is also at a very different stage than the U.S. car market. The industry is more fragmented and there is a lot less incumbency inertia at play. So even if vertical integration did provide some degree of sustainable long-term advantage in the U.S. market, it still may not necessarily be applicable to the China market.
It may not even be possible or make sense for car companies in China to integrate certain elements of the value chain; for example, Tesla has built out its proprietary Supercharger network while Chinese regulators are looking to take on that role and implement a public charging standard.
Lastly, my observation is that Chinese car companies are willing to try a variety of different approaches, including being more or less vertically integrated. In the long run, the “invisible hand” will determine winners and losers.
(3) The Chinese electric car industry is likely to be quite successful over the long run … but for reasons that have nothing to do with vertical integration.
First, the Chinese automobile market is by far the largest in the world and has the scale to drive product innovation going forward. Sales of electric and plug-in hybrids in China comprise more than half of global sales and this percentage is rising. Scale Matters.
Second, electric vehicle technology is relatively new (as opposed to combustion engine technology) and Chinese automakers have much less of a technology gap to bridge vs. experienced foreign automakers. Indeed, at this point one could argue that Chinese companies have taken the lead in certain aspects of electric vehicle technology.
Third, the electric vehicle industry enjoys tremendous policy support in China. It is a cornerstone of its Made in China 2025 plan and dovetails nicely with other policy initiatives such as the build-out of the country’s solar and renewable energy infrastructure. China has generally been much more aggressive enacting policy to accelerate the shift from combustion vehicles to electric vehicles — for example, Shenzhen has mandated a complete shift to electric taxis over the next two years.
This was originally published on Quora in June 2018.