How auto suppliers can navigate EV technology disruption in four steps

Capital allocation and business structure decisions taken now are critical to the success of automotive suppliers undergoing change.

Fueled by a global commitment to developing sustainable energy solutions and decarbonization imperatives being demanded by customers, structural shifts in the automotive industry are emerging at a faster pace than many previously anticipated. The US has set a goal that by 2030, half of the vehicles sold in the US will be battery electric, fuel-cell electric or plug-in hybrid.¹ Other parts of the world are also well ahead on their transition to electric vehicles (EVs), as evidenced by original equipment manufacturer (OEM) offerings, government legislation and consumer incentives. Some OEMs recently agreed to new goals during the recent 26th UN Climate Change Conference of Parties (COP26).²

Safer, “greener,” connected and autonomous cars increase the share of software value and require distinct strategies within the vehicle’s electrical and electronic (E/E) architecture, while some traditional hardware components are either becoming obsolete or are at the verge of becoming largely commoditized. 

EY researchers recently conducted interviews with more than a dozen senior executives from automotive suppliers across the globe to discuss industry changes. Most participants felt that companies must begin to plan for change now or risk losing out to competitors in the future.

“The electrification train has left the station. It has picked up so much speed that it becomes nearly impossible to jump on it if you are not already riding it,” said a CEO of a European diversified automotive parts supplier in a recent interview with EY researchers.³

Table of contents

• EV migration offers new opportunities for auto suppliers but requires careful planning
• High-level technology assumptions for 2030
• Four steps companies can take to foster their strategic transformation
• Strategic options: Evaluation framework and key considerations
• Conclusion

The additional value from electrifying a mass-market compact car, either through new components, modules and systems, or through needed modification and upgrades, will outweigh losses by two times. EY research analysis indicates that until 2030, roughly 40% of this value increase may be compensated for — mainly due to a significant reduction in battery costs.⁵

In fact, it is important to note that engines might not be the heart of the car anymore, but rather the central processing unit driven by various software applications. Vehicle autonomy can boost the software value by roughly five to six times. EY research analysis further indicates that these disruptive changes to the vehicle’s architecture will likely lead to shifting value and profit pools through 2030,⁶ requiring both OEMs and suppliers to review their overall business models based on the evaluation of different realistic future scenarios.

Predicting the future is highly complex as the relevant drivers of change are manifold, diverging by region and often either accelerating or contracting each other. EY has developed several future scenarios for technological disruption.

High-level technology assumptions for 2030

One scenario that EY views as very likely assumes relative robust economic growth for the global economy, e.g., the gross domestic product growth remains relatively stable and the trend in urbanization and population growth persists — with perpetuated differences on a regional level.

In this predictive scenario, EVs will become more prominent as more governments introduce measures to decarbonize fleets, especially in the developed countries and China. Customers may also drive the uptake of EVs due to the combination of being more environmentally conscious, dropping battery costs and the reduced total cost of ownership. It should be noted that these assumptions are based upon current EV-related subsidies and government programs which are subject to cancellation or modification.

Some additional connected car features with higher customer value and monetization options will be introduced in the market because of customers’ increased willingness to share basic data for advanced analytics offerings and the associated simulation of data, as well as the fact that OEMs increasingly recognize the importance of partnerships with third-party vendors.

Autonomous driving will remain a niche product mostly limited to conditional and highly automated features in selective, marked-off areas. Regional differences will remain significant. For shared mobility, the positive momentum will continue across the globe. Penetration of different concepts (e.g., ride hailing versus car sharing) differ by region. However, despite increasing popularity, the associated effect on new vehicle registrations remains small. Purpose-built vehicles based on existing platforms will gain importance until 2030.

Roughly 25% of today’s profits are generated from legacy ICE assets that will be the most adversely impacted by 2030, resulting in a 50% decrease from current levels. Disruption will require a nimble and well-coordinated strategic response, along with favorable policy changes by local authorities.

Automotive OEMs and suppliers alike have understood the significant impact on the future car architecture and invested heavily into new growth areas. Some players have already started to streamline their ICE-related portfolios, while others have disconnected them and are now managing the business separately. Various capital allocation choices are emerging, including investment in captive capacity, acquisitions, spin-offs and joint ventures (JVs), among others. Examples include:

• A European supplier invested in a hydrogen storage system manufacturer, another acquired a battery maker, while yet another global player plans to invest over €1b in fuel cell technologies in the next four years alone.
• A global tier 1 supplier recently acquired an advanced driver assistance system specialist for trucks and trailers.
• A large US automotive supplier spun off its turbocharger division, while another US peer split into two separate entities — one with a focus on electronics and one focused on powertrain solutions. Yet another European peer separated its powertrain business and is currently planning for its initial public offering (IPO).

Four steps companies can take to foster their strategic evolution

While peak ICE vehicle sales may be a thing of the past, long-term value can still be generated in traditional value pools — if the business model, organization and operations are designed accordingly.

Suppliers must perform a balancing act and simultaneously manage components and systems that are dedicated to ICE vehicles, while increasing their investments in new EV-related components and various other new key technologies, such as software. Timing and aggressiveness will dictate success. Companies can begin their journey by:

• Defining the strategic target picture
  
• Determining future business and product portfolios
• Defining target operating models
• Executing strategic options

Step 1: Defining the strategic target picture

It is crucial to evaluate if there is only one strategy or several parallel strategies to effectively fulfill diverging portfolio requirements and subsequently solve for both “new” business avenues, as well as any legacy or wind-down businesses. Developing a robust target picture requires the holistic and unbiased (“no sacred cows”) assessment of two perspectives:

• External — expectations of the automotive sector and segment growth trends and their variability, market attractiveness, competition and new technologies
• Internal — how capable and flexible the organization is in terms of workforce, know-how, resource availability and financial stability to achieve target aspirations

Step 2: Determining future business and product portfolios

After the strategic guardrails are clear, the range of options and associated feasibility for the future organization must be defined at a more detailed level. Questions, such as the following, should be looked at on several levels, from assessing individual products, business units and the overall enterprise:

• Where do I want to play?
• How do I want to play?
• How long do I want to play?
• With whom should I partner?

To determine the optimal future business portfolio, new segments should be identified and evaluated by their adjacency to the current business, the implementation complexity, the future right to win, and any potential barriers to entry or exit. It is important to determine which customer segment of the ecosystem should be in focus, such as off-highway, passenger car and trucks, and to align regional strategies to public versus private sector investments. For a well-structured portfolio, it is also vital to streamline existing offerings. A differentiation between future core versus non-core capabilities, along with targeted wind-down businesses, can release capital for better investment avenues. Scenario planning and iterative refinement of the road map play a prominent role in this process.

In contrast to a full carve-out, a fallback on the existing support function structure avoids high additional costs for a stand-alone unit. But a word of caution: in many cases, a company and its TOM cannot be structured freely. There may be inherent inhibitors to the envisioned structure, such as the level of entanglement with the core business. The operational complexity could be extremely high, along with associated costs, making it only worthwhile in case of a potential opportunity. It is important to remember that SBGs are only built for strategically important units with a certain need for flexibility.

SBGs are more common in Europe as their ownership structure and government support allows for more operational flexibility. In contrast, US companies, which are largely influenced by capital markets and public company shareholders, are more likely to create spin-off entities.

In the end, the organizational design and resource allocation generally must enable the envisioned strategy, letting the vision reverberate culturally throughout the organization while keeping execution options in mind. A company that is set up for partnering is designed differently than a company where growth initiatives are planned to be developed in-house or a company that is envisioned for an asset-light setup. An SBG alleviates these problems to some extent, as it offers maximum flexibility and can be altered at a faster rate.

Step 4: Executing strategic options

Whether it is regarding the legacy product portfolio or potential new business segments, future strategic measures can take a variety of forms and face unique hurdles. The future road map depends upon:

• Defining a radical vision and managing change for the organization to achieve the TOM
• Ability of the legacy business model and organization to “flex” and adapt
• Making appropriate investment decisions to reallocate capital for future growth bets
• Opportunity to cost effectively fund the envisioned strategy
• Retraining talent to develop new capabilities and support the TOM
• Ability to secure a robust supply chain
• Growth within the specific market or product segment or the expected wind down cycle of legacy products and business areas

EY framework for evaluating strategic options

EY has developed a proprietary framework to evaluate the strategic measures, including the legacy portfolio, new revenue opportunities and associated capital allocation choices.

2. Wind down

In the case of segments at risk of obsolescence, particularly ICE-related, some suppliers could claim to be the last person standing. This would require a unique strategy on a long-term streamlining effort, as described above, and the proactive implementation of relevant ramp-down processes. However, internal hurdles, such as staff inflexibility and the adoption of new ways of working, can disincentive employees and impact morale. Cost leadership and strong market positioning within an increasingly oligopolistic market may become the most prominent mantra. The overall focus will shift from product to process innovation and from efficiency gains to securing the supply chain, while production capacity needs to be managed continuously based on smart production volume bundling — all of which are part of an effective stranded (manufacturing) asset exit strategy.

A robust aftermarket strategy becomes a key pillar for success, too. Refinancing options may become more and more difficult over time. Therefore, suppliers need to have strong and transparent collaboration with their investors and financiers.

3. Streamline operations, resource allocation and portfolios

Streamline operations, resource allocation and portfolios to reduce the overall complexity, increase efficiency, and optimize the capacity and footprint. Compared with other rationalization efforts, this option appears less radical and mostly creates comparable marginal improvements to the legacy portfolio, while still consuming relatively high capital. Therefore, the company needs to evaluate the return on the future potential of the investments vs. new revenue opportunities, especially when the capital is limited.

4. Ecosystem innovation

Ecosystem innovation is another strategy many companies are considering. Asset-light strategies and business models, which involve transferring assets to “better owners” to enable companies to transition from fixed costs to variable costs, are increasingly gaining traction across sectors as companies seek to deliver profitable growth while managing capital prudently. These assets can include hard assets, such as property, plant and equipment, as well as soft assets such as product development, channel plays, information technology and customer loyalty programs.

5. Consolidating or a merger

Consolidating or merging with equals, even historic competitors, could be an option in a stable market environment where scale will be important. This can drive capacity and revenue synergies for future innovations. Merging with complementary product companies can help diversify the product portfolio and increase the value chain depth of the combined company to enable profitability. Also, merging real estate and factories provides the opportunity to repurpose factories or sell off less productive assets when prices are high. Importantly, consolidation will also be an instrument for ramping down to gain necessary market power to dictate prices, while creating the needed scale effects to reduce costs.

One potential scenario emerging, more prominently in the US, is a private equity (PE) buyer-focused “roll-up” strategy with the goal to consolidate legacy assets. PE entities can use their pronounced value creation capabilities and specialized leadership talent with automotive experience to pursue such strategy. This can become a viable strategy when the targets’ core technologies can also be transferred to adjacent markets, or if the portfolio contains further valuable technologies. This may vary globally as PE activity is still very nascent in the European region due to regulatory differences, particularly labor laws. These are critical decision variables, especially in case of potential restructuring and capacity consolidation decisions, resulting in plant shutdowns and exits.