The current wave of auto innovation has emerged with remarkable speed: new safety features, connectivity gadgets, and real progress toward bringing autonomous vehicles onto the road. But more noteworthy than the pace of this innovation is its breadth — and the danger it poses to some automakers.

Consider the car’s interior, until recently a relatively stable component in terms of engineering and value to the automobile. The surfaces around driver and passengers are potential real estate for ambitious safety and entertainment enhancements. New technologies such as 3D laminated glass, haptic sensors (which pick up touch pressure and motion), and augmented reality heads-up displays — which offer drivers alerts, safety aids, and warnings on readouts embedded in the windshield — have entered the vocabulary of traditional suppliers. Large navigation and entertainment display screens, either in the dashboard or visible through rear-projection to passengers, offer web-based information and media as well as the promise of data arrays picked up from networked roads and other cars.

Little wonder, then, that vehicle electronics account for a good chunk of the cost of a car, and that amount is only expected to rise. Meanwhile, beneath the shiny exterior, when the industry gets a thorough under-the-hood inspection, a bleaker reality is evident. In essence, some automakers may be innovating themselves out of business.

On some dimensions, auto industry performance seems strong. The sector continues to climb out of the cyclical slump it fell into in 2008. Worldwide auto sales reached a record 88 million in 2016, up 4.8 percent from a year earlier, and profit margins for suppliers and automakers (also known as original equipment manufacturers, or OEMs) were at a 10-year high in 2016.

But that isn’t the full picture. Altering the basic contours and features of the traditional automobile amplifies the difficulty and cost of manufacturing cars. Ubiquitous electronics, varied arrays of digital services, and alternative powertrains and connectivity systems are hastening the need for expensive new parts, components, and functions. For OEMs, the price tag is high. Add to that increasing requirements for investment and innovation from regulations, consumer demands, and intensified competition with new entrants. Many of today’s automakers, perhaps a majority, will not see a reasonable return on their invested capital.

Automakers are unlikely to recoup the new costs of innovation from higher prices or from other sources. The cost of capital is already low and is unlikely to drop further. At the same time, there are other cracks in the financial picture. For example, over the past five years, shareholder returns in the auto industry have averaged 5.5 percent, far less than half of the equivalent figure for the S&P 500 (14.8 percent). Further, in 2016, the top 10 OEMs’ return on invested capital was an anemic and unsustainable 4 percent, which is below their cost of capital. As such, the OEM part of the industry value chain was actually destroying shareholder value. In short, OEMs are paying more to borrow capital than they are earning in returns. The leading 100 suppliers have done a little better, just beating their costs of capital to enjoy a small net positive return, after many years of negative net returns. At best, this picture suggests the auto sector is less viable for investment than many other industries; at worst, it represents a sector that, while relatively rosy on the surface, is in fact in crisis.


Read more: https://www.strategy-business.com/blog/The-Automakers-Dilemma-Getting-More-Impact-from-Innovation-Capital 

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