- Martin Fridson, CFA and Michael Livian, CFA
The Auto Industry's Game-Changing Announcement
On January 28, 2021, General Motors made the historic announcement that its vehicle production would be entirely zero-emission by 2035. Investors barely noticed the auto industry's game-changing announcement. They were too busy focusing on the ticker symbol GME (GameStop) instead of GM (General Motors). General Motor is the world's 4th largest automaker. Its decision to go completely electric demonstrates that the changes towards a green economy are irreversible and are gaining wide acceptance by governments, the public, and businesses. Investors should take note.
GM’s planned full switchover to electric-powered, and possibly some hydrogen-powered vehicles, represents a revolution for a company historically dependent on high-emission “gas guzzlers” for its biggest profits. The announcement forced even skeptics about the environmental benefits of electric vehicles (EVs) to acknowledge that the global passenger car fleet's conversion to electrical propulsion is accelerating. Declining battery costs, savings on fuel costs relative to gasoline-powered cars, and lower repair costs promise to make the total cost of ownership (TCO) lower for EVs than for internal combustion engine (ICE) vehicles, even after government incentives disappear.
Other countries are far ahead of the U.S. in the transition to electric propulsion. For example, 54% of new vehicles sold in Norway are now electric because of that government’s early offering of incentives for EV ownership and prodigious construction of charging infrastructure.
Implications for Investments and the Economy
Tesla’s 743% gain was last year’s most spectacular stock market response to electric vehicles' increasing popularity. Many solid investment opportunities are sure to arise, however, from the profound change underway in the manufacturing of automobiles.
Substantial innovations can be expected in battery technology.
Demand will continue to rise for various EV components, including semiconductor chips, of which there is currently a shortage.
A less obvious impact of converting the passenger car fleet to EVs is that consumers and businesses will pay lower prices for non-transportation-related electricity. In order to ensure that it can always satisfy peak demand, the U.S. power system currently operates at less than 50% of its capacity, on average. For the rest of the U.S. industrial base, the comparable figure is around 80%. Because fixed costs represent most of the cost of generating and distributing electricity, filling a significant portion of the unutilized capacity with new demand from EVs can greatly reduce power companies’ cost per kilowatt-hour. Utility companies have pricing mechanisms that enable them to channel that new demand into off-peak hours. Regulatory rate-makers will pass much of the savings on to the utilities’ customers, but their revenues will grow, and their profit margins will consequently improve.
The EV revolution’s impact on employment and wages raises some concerns. Industry experts estimate that producing an EV requires about 30% less labor than building an ICE-powered vehicle. EVs have many fewer moving parts; they need no pistons, fuel injection systems, radiators, exhaust systems, or complex transmissions. As EV production displaces traditional production, employment will shrink in the most labor-intensive part of the operation, namely, making the powertrain. Furthermore, auto companies will have a greater incentive than in the past to outsource the production of major parts to nonunionized suppliers. A clause in the United Auto Workers’ current contract bars the automakers from outsourcing EV and autonomous vehicle production, but that contract will expire in four years. The companies are likely to take a tougher stance as EVs’ share of production and profits increases.
The history of dynamic new businesses is that the number of startups vastly exceeds the number of companies that attain a long-lived competitive position. For example, in the early 1900s more than 485 companies entered the US car manufacturing business. By 1929, the number of competitors was down to 44, and eventually the Big Three (GM, Ford, and Chrysler) accounted for the vast majority of US production.
The major automakers have absorbed the lesson of Theodore Levitt’s 1960 Harvard Business Review article. Levitt argued that the railroads fell into decline because they failed to understand that they were in the transportation business, not the railroad business. They consequently left their passenger business vulnerable to disruption by the rise of the airlines. Today’s automakers recognize that they are in the car business, not the business of producing cars powered by internal combustion engines.
Tesla and perhaps a few others may achieve sustainable—perhaps even dominant—shares of the EV market. Similarly, some newcomers may successfully challenge incumbent parts suppliers. Investors who hope to profit from the coming changes will need to look beyond fads and fanfare. In these early days, dazzling product introductions and visionary CEOs may generate lofty valuations. However, to retain investors’ favor over an extended period, the highfliers will have to translate the excitement into substantial, high-quality earnings.