It’s time for car makers to partner with software makers, or risk extinction says McKinsey & Company.

The automotive industry is shifting from a vertically integrated value chain to a horizontally structured ecosystem, according to a new report from the management consultants.

That means traditional OEMs must abandon strategies aiming at total control of vehicles and instead pick and choose how to play by shedding assets, streamlining operations, and embracing digital acquisitions.

“As automotive software is developed, cars are evolving into computers on wheels, a change similar to events in the computer industry 20 years ago and the mobile phone industry 10 years ago,” the authors write.

Vehicles’ hardware and automakers’ brands have traditionally been the drivers of value for consumers, however shifting consumer preferences are threatening incumbents’ position in the market.

According to McKinsey, the four trends challenging incumbents and shaping the new ecosystem are: electric vehicles, autonomous driving, diverse mobility (ie lease to rentals and car sharing) and connectivity with media and IoT infrastructure.

The authors argue the disruption posed by these trends and the entry of new high-tech players into the market will transform vertically integrated automotive value chains into a complex, horizontally structured ecosystem.

“Today’s OEMs and tier-one suppliers must abandon strategies aiming at total control of vehicles and instead pick and choose where and how to play by shedding assets, streamlining operations, and embracing digital acquisitions,” the authors write.

Who are the new players in the ecosystem?

According to McKinsey the new ecosystem will be divided into the following categories:

  • A number of high-tech players are developing autonomous-driving systems that are quite likely to merge into what the computer industry calls an operating system (the central system that makes a unit run).
  • Disruptors from the taxi and ride-sharing industries are developing innovative new business models.
  • Two leading online and technology companies are focusing on in-car entertainment platforms, which they hope will become the standard for applications.

McKinsey auto report

McKinsey does not believe that one single player is likely to dominate the new ecosystem. However, for each part of the ecosystem outlined above here might be room for only a few winners, since few players will be able to invest the resources necessary to reach scale.

McKinsey states OEMs and suppliers face tough competition as they lag behind the tech entrants in the asset base, skills, and resources needed to respond to this new competitive environment.

Incumbents and disruptors have different strengths. McKinsey assessed both groups on five indicators of competitiveness: financial flexibility, the deployment of capital and people, operating models, culture, and customer-centricity.

For example tech players have much more financial flexibility than traditional OEMs, particularly in terms of market capitalisation. Exploratory investments in new disruptive technologies, which might cost as much as 10 per cent of a leading OEM’s market cap, would cost only 1 per cent of the market caps of the largest tech players.

Culture is one interesting area where the two approaches differ. Automotive incumbents operate by a rich legacy of sectoral norms and conventions, that value quality and minimises risk. Tech players on the other hand prefer to fail fast embracing a culture that rewards innovation and risk taking.

Automakers are more likely to dominate hardware-focused areas, whereas in software, the tech players enjoy significant advantages.

McKinsey’s advice for OEMs is similar to the changes undertaken by hardware manufacturers in the mobile-phone industry: Focus strongly on developing and producing market-leading hardware, such as bodies and interiors. Increase margins by embracing digital manufacturing techniques (including 3-D printing and automation), added purchasing power, and the dilution of overhead. And finally, secure partnerships to exploit other disruptive technologies and focus on maintaining their brand strength.

Meanwhile tech players have several options to enter the sector through horizontal plays, for example become a technology supplier focused on new high-tech products eg, infotainment ecosystems or autonomous-driving systems, but then to evolve into a dominant platform player by acquiring all relevant competing assets. These companies would then partner with the OEMs to push their products to market.

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