Part II: The incumbent’s perspective

Last week I wrote about why customers don’t appreciate the rate of change in disruptive technology until they experience it.  But it doesn’t stop there. Like their customers, established companies under threat from disruption tend to miss it too. And this feeds into the mainstream media, who are naturally attracted by the fallacious appeal to authority of the established brand names…. Surely if anyone knows, [insert established brand] would know!?

Despite the rapid advance of EVs in relative cost and performance terms, internal combustion engine (ICE) manufacturers still see electric vehicles (EV) as a small market, with negative margins which most of their customers don’t want. Why?

Clayton Christensen observed this behaviour repeatedly in his study of why great businesses with excellent managers fail to adapt to disruptive technologies. And just like their customers, it’s not because they’re idiots!

“It is in disruptive innovations, where we know least about the market, that there are such strong first-mover advantages. This is the innovator’s dilemma. Companies whose investment processes demand quantification of market sizes and financial returns before they can enter a market get paralyzed or make serious mistakes when faced with disruptive technologies. They demand market data when none exists and make judgments based upon financial projections when neither revenues or costs can, in fact, be known…Discovering markets for emerging technologies inherently involves failure, and most individual decision makers [within established bureaucracies] find it very difficult to risk backing a project that might fail because the market is not there.” – Clayton Christensen

Given the news last week that Telsa will build their European manufacturing facility ‘Gigafactory 4’ in Berlin, recent statements from BMW executives are extra ironic. I suspect that those who laugh at EVs and Elon Musk now will look back and laugh at ICE companies and Klaus Frölich in a few years. For now, such comments are usually taken as evidence that EV adoption will be slow. In a disruptive context however, dismissive comments like this are entirely predictable. Indeed, when viewed against the recent EV unit growth in all markets (1) and the fact the Tesla has not spent a single dollar on traditional advertising to date, I think they are a very positive contrarian signal. The quote below was sourced from a Forbes article in June 2019:

“There are no customer requests for [EVs]. None,” BMW’s director of development, Klaus Frölich, told a shocked round-table… “Europeans won’t buy these things… From what we see, [EVs] are for China and California and everywhere else is better off with plug-in Hybrid Electric Vehicles with good EV range.”

I believe the chart below is insightful when assessing the prospects of EVs. It tells me two things. 1) The demand is very high because people are willing to spend more than normal to purchase the item and 2) The addressable market is much bigger than most people think.

So it won’t surprise you to learn that I think Frölich is missing the biggest disruptive shift in automotive history, but I also believe he is overstating the role of hybrids in the transition. Why? Whilst it’s natural to cling onto the technology you know, pure EV costs will inevitably be lower than hybrids over time due to predictable cost reductions. These are reductions which can’t be achieved when combining both technologies, due to the complexity of doing so and the compromises needed. ‘Inevitable!?’ I hear you say ‘That’s a bold statement!’ Perhaps so, but in the context of history, I don’t think it’s that bold.

Source: SS Savannah 1819 (The first hybrid “steam ship” to cross the Atlantic).

Next week I will explain why EV costs will keep falling and performance will keep improving in the part III, the final act in the Trilogy of the Silent Disruption.

Source: European EV growth rates
https://insideevs.com/news/373420/august-2019-plugin-ev-car-sales-europe/
https://insideevs.com/news/373278/plugin-car-sales-europe-h1-2019/
Tesla surveys
https://www.bloomberg.com/graphics/2019-tesla-model-3-survey/market-evolution.html#intro

 

About the author

Craig Bonthron is an investment manager in the Equities team, responsible for actively co-managing high conviction global equities portfolios. He focuses on analysing disruptive and sustainable investment trends within the technology, healthcare, industrial and consumer sectors in order to identify high conviction stock specific investment ideas.  He joined us in 2014 from SWIP, where he was an investment director in global equities. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors. Craig has a 1st Class honours degree in Building Surveying and an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 18 years’ industry experience. *As at 30 April 2019.

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