What German Automotive Suppliers Should Do

Automotive Industry in Europe

Western Europe is one of the three largest automotive markets in the world. The passenger car

sector is recovering in the region thanks to the improvement of the economy and to the resulting

pent-up demand accumulated in the years of the financial crisis. In 2016, new vehicle sales increased

by 5%, to 13.9m vehicles. However, Western Europe is still quite a way from the registration

numbers of the pre-crisis years. The perspective for 2017 is stable, with figures similar to those of

2016. In Eastern Europe results were also positive. However, it remains at a low level of demand:

there are 315 registered cars per 1,000 inhabitants, whereas in Western Europe this figure is 529.

The coming months will show the extent to which the Brexit will affect the market. The UK produced

nearly 1.72m cars in 2016; about 1.35m were exported, and the EU was its largest market, receiving

roughly 760,000 vehicles (56%). In return, the UK is the most important market for German car

exports, with a 20% share of total vehicles manufactured for this market.

Automotive Industry in Germany

Germany is the largest European market in both production and sales of cars. In 2016, production

amounted to around 5.8m units and there were nearly 3.4m new registrations. About 4.4m units

(75% of total production) were exported. Western Europe is the most important market for German

automakers, with over 50% of total exports.

The almost 3.4m new registrations of 2016 (5% more than in 2015) are the best result so far in this

decade. One of the reasons for this is the healthy state of the economy, with high employment rates,

a good level of consumer income, and favorable financing conditions. It is expected that in 2017 the

market volume will be similar to that of 2016.

Germany has a lower proportion of electric cars than other European countries, including the UK,

France, Italy and Spain. The federal government has created a €1bn package of direct support,

investment in charging infrastructure and a public procurement initiative to become a leading

market for electric vehicles. Under the direct support, buyers of purely electric vehicles receive a

rebate of €4,000, and buyers of plug-in hybrids receive €3,000. The government will contribute half

of it, supplemented by the carmakers.

A Change in the Industry Paradigm

The high-tech sector has high cash reserves and large market caps. This has driven companies to

seek growth through business opportunities outside of their core activities. As cars are increasingly

connected, the automotive industry has become attractive to the high-tech sector. Top players are

looking forward to have a dominant role in the development of car-related software in the following

years.

The high-tech sector will likely transform the vertically-integrated value chain of the automotive

industry, with automakers currently in full control of their supplier networks. However, as the

newcomers penetrate the market, innovations are expected in both hardware (advanced user

interfaces, modular bodies, etc.) and software (autonomous driving, data analytics, and so on).

The disruptive approach of tech companies will lead to a complex horizontal value chain. Only a few

will be able to invest the resources necessary to reach scale and lead the software-focused parts.

For the automakers and tech companies, success in tomorrow’s mobility sector will depend on how

well they build on their natural advantages. Automakers have them over tech companies when it

comes to hardware, but in software the tech players enjoy significant advantages over automakers,

including leading-edge capabilities, agile operating models, and the financial muscle required to

aggressively pursue exploratory investments. Their risk-taking, innovation-rewarding organizational

cultures, as well as the positive perception of customers, are other conditions in their favor.

Tech players have several options to enter the sector in a horizontal way, such as becoming a

supplier focused on new high-tech products, and then evolving into a dominant platform player by

acquiring all relevant competitors. For mass-market automakers, the emerging strategy is to build

additional scale. They will have to develop and produce market-leading hardware. In low-margin

areas, scale is needed to generate substantial profits. Premium manufacturers should provide

extensive personalization and focus their development efforts on a single new area, while securing

partnerships to exploit other disruptive technologies and focus on maintaining their brand strength.

The Landscape for Suppliers

The arrival of non-traditional competitors, as well as the growing influence of emerging markets,

presents suppliers with three main challenges. First, to rethink their strategies and locations as more

than two-thirds of sales volume growth in the next years will come from emerging markets. Second,

to help automakers to rapidly develop cost-effective emissions control and alternative powertrain

technologies. Finally, to expand their line of products to incorporate equipment and software to

enhance driver enjoyment and safety. As competition from newcomers will be fierce, suppliers will

have to learn how to differentiate themselves. Thinking well ahead of the next vehicle generation,

scenario planning and an innovative approach to product development will be crucial success

factors. An example of this is Eaton Corporation: it divested its transmission and engine control

products and invested into its underperforming electrical business. In 2012, it made several

acquisitions to strengthen its electrical capabilities and product portfolio. In part due to this

strategy, the compound annual growth rate during the period 2012-15 was 8.5% for sales and 13%

for the EBIT.

M&A is expected to grow in relevance for suppliers to permit them to gain the technological edge

much needed in the years to come. Acquisitions are often a desirable option because they offer a

shortcut to a potentially long process of developing capabilities. When speed-to-market is crucial,

companies should focus on gaining capabilities via partnerships. If control of capabilities is essential,

companies should move rapidly to acquire the necessary skills.

Suppliers must actively reexamine their portfolios as the profitability of many product categories

will change significantly. The future value creation of product sectors will largely be a function of

their innovation potential. Suppliers must address whether the required capabilities for the

segments and markets they decide to remain in can be developed organically or not.

Trends in the Automotive Market

Electric Vehicles

The regulatory pressure in key markets and the publicity generated by Tesla Motors or even BMW

are some of the reasons why pure battery electric vehicles have entered consumers’ mindsets. This

segment is not yet fully developed because of the lack of user-friendly charging infrastructure, which

has prevented most consumers to embrace this type of cars. Moreover, recharging times of electric

batteries are significantly longer than refilling a conventional fuel tank. Reducing recharging times

and making significant investments into a dense, user-friendly charging infrastructure is crucial to

mass acceptance of electric vehicles. The German government is already taking action on this

matter, as it will spend €300m from 2017-2020 to foster the expansion of the charging

infrastructure.

The increase in demand and, consequently, of the production of electric vehicles could accelerate

innovation and reduce the cost of batteries, with prices already on a downward trend: for instance,

the cost of a lithium-ion battery pack fell 65% from 2010 (US$1,000 per Kw/hour) to 2015 ($350)

and it is likely to keep declining, expected to drop below $100 per Kw/hour over the next decade.

Connected Cars

Within the field of connected mobility, car-to-X communication (C2X; both car-to-car and car-to-

infrastructure) enables vehicles to collect information and to process it immediately, and informs

the driver about hazardous situations and congestion along the route, even if they are not yet visible

from the vehicle. Under adverse environmental conditions, information that cannot be collected in

full by the vehicle’s sensors can be supplemented with information arriving via C2X.

It is likely that in the following years the main source of revenue for automakers will shift away from

the car itself to the data streams generated within the car (upstream) and those that the customers

bring into the car (downstream). Modern vehicles already need and produce a variety of data, and

this trend will keep going as motor vehicles incorporate information technology equipment,

allowing for fully connected cloud processing and data feeds for manufacturers. Data security

should be a top priority for automakers, especially in an autonomous driving scenario where hackers

could manipulate cars and even modify its routes. It will also be a key criterion for clients.

Automation

Several high-tech players are developing autonomous-driving systems that are quite likely to merge

into an operating system, moving from advanced driver-assistance systems to fully autonomous

driving as the technology matures. Driverless cars have already gone from low-speed and test

environments to limited use on public roads and highways. Safety and production issues need to be

addressed before widespread adoption can occur.

Automated systems may eliminate the need for the driver to check the vehicle continually. This

presents an opportunity not only for developers of apps and infotainment, but for established

mobile platforms (iOS, Android) as well.

Car Sharing and Ride Sharing

In car sharing services, vehicles may be available at fixed stations located around a city or on a free-

floating basis. This trend is taking hold in large urban areas in both the developed and the developing

world, and could lead manufacturers to rethink its business models, substituting a stream of fee

income for sales revenues, or providing vehicles to consumers on an as-needed basis.

Although car sharing will expand quickly and widely, its effect on new-car sales will be muted,

because most drivers will not forgo car ownership entirely and because some share of lost sales will

be offset by sales into car-sharing fleets in large urban areas. It is expected that a growing number

of drivers will stop using cars, but their conversion will proceed at a manageable pace.

Ride sharing is generally more expensive than car sharing, but it offers considerable benefits over

car sharing in cities with serious parking constraints. Some of the most important players of this

industry are Uber and Lyft. The former has ambitious plans of expansion into new territories and

across regions it already serves, but it has faced popular resistance in several European countries.

An increase in the demand for car sharing and ride sharing services could boost electric-vehicle sales

since shared vehicles are used more intensively, improving the economics of ownership.

Automotive Industry and Private Equity

2016 underperformed versus 2015 in terms of deal value and deal volume. However, 2015 was

extraordinary: its megadeals (such as the acquisition of TRW Automotive Holdings Corporate by ZF

Friedrichshafen AG for $12.5bn) drove overall deal value to highs not seen in the last 15 years.

Disclosed transaction value was of $41bn, down 34% from 2015. Volume of deals (583 in total) was

down 1.4%. Deal volume in the second half of 2016 outpaced that of 2015, providing a strong

foundation to continued activity for 2017. M&A activity should increase, as manufacturers expand

into software and services, and as mobility solutions and strategies likely drive an increased number

of start-ups.

The investments of top players will redefine the future of personal mobility, by exploring new

technologies, services and business models. Autonomous driving is already driving M&A strategies

today, although the arrival of fully autonomous vehicles to the market is unclear. Another important

source of innovation are partnerships, ventures and alliances among most automakers and car-

sharing or ride-sharing companies, as manufacturers explore ways to engage with millennials.

Transaction multiples

Disclosed transaction multiples (both in terms of revenue and EBITDA) decreased from 2015. The

implied EV/revenue multiples for automotive transactions announced during 2016 decreased

relative to 2015, from 1.3x to 1.1x. In the same regard, the implied earnings (EBITDA) multiples

declined, from 13.6x in 2015 to 8.8x in 2016. Lower multiples can be partially explained by

decreasing deal activity and also by the extraordinary nature of 2015.

Changes in the regulatory landscape

Development of national and international legislation is necessary to keep up with the automation

trends of the industry. The automotive industry needs a secure legal framework – both at national

and global levels. The right conditions should be put in place so that vehicles can assume tasks that

today only the vehicle’s driver is allowed to perform.

From the point of view of the German automobile industry, the introduction of highly automated

driving functions for specific application cases should take place incrementally. The regulation of

highly automated driving functions can initially be expected for Autobahn travel or traffic jams.

Technological progress and the integration of additional information sources such as V2X (vehicle

to everything) technology will gradually permit the expansion of the field of activity of highly

automated driving functions.

The interaction between traditional players and high-tech newcomers will reshape the future of car-

making. Survival will be unlikely for those who fail to react to the new trends. At this point, the

competitive space remains fluid, but that could change quickly as incumbents position themselves

or the future challenges.

February 2017

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Germany

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