Automotive industry: Subsidised in order not to change

Posted by Christian Pfäffli on

This article is about a questionable business that I have deliberately not written about for years, a business that polarizes people, families and friends until they are no longer. This article is about politics and its impact on the transformation of a large global industry on which the world has built its wealth in the last century.

Every nation in the world will rightly do its best to protect its industry for the benefit of the country and its people. Politicians are elected to ensure that the industry and jobs are doing well, to stabilize incomes and reduce risk. There is absolutely nothing wrong with this protection, but unfortunately, by trying to support their industry to the best of their ability, politicians can destroy it without even realising it. This has happened several times before, and there is a great risk that it will happen again today in the largest car-producing countries, such as Germany, Japan and the USA.

Germany closer to the abyss than previously thought

Since I live in Germany, I take the German automotive industry and politics as an example, but similar processes naturally take place in other countries in different variations. I believe that in Germany for some time now there has been an unintended destruction of the most important industry, driven by the belief that one is doing something good when in reality one is doing something bad, and this article would like to shed light on the deadly combination of protectionism and its result, the demise of an industry.

Some may call what I describe a conspiracy, but I don't like these theories, which are often based on a lot of wild, unproven speculation, which has a clear definition of good and evil, as in a well-drawn comic strip we read when we were 10 years old. Many people divide the world and its actors and politicians into two opposite poles, pretending to sort a confusing world with many shades of grey into an order of black and white that in reality does not exist and never has. They create an enticing and superficial order that makes decisions and actions easier, but they never solve the real challenges and problems of this world, and therefore such theories are counterproductive rather than helpful. The real world we live in is a mixture of shades of grey, in which black or white is a concept rather than a real thing.

In many of my articles, I have questioned, challenged and maybe even attacked the German automotive industry, sometimes harshly saying that the obvious is not understood, that managers are arrogant and greedy and risk-minimizing themselves in a significant way, but today I will explain why what the leaders of the German automotive industry consider to be their friends are a kind of enemies. I will try to explain why all the chaos we see through a constant stream of profit warnings and layoff notices is largely a side effect of governments trying to do good in cooperation with the car manufacturers and inadvertently doing bad in the process.

"For children, not everything they ask for is good for them, no matter how much children try to influence their parents, they will act in their best interest and often say no. Good parents know that in many cases it would be against their responsibility and love, and therefore against the physical and mental health of their children if they would do everything your child asks them to do".

Industries are like children who ask for the delicious sweets every day and avoid doing homework and sports, but instead of being good parents, our governments act like parents who assume that their children know better than they do what is good for them. Instead of educating, nurturing and helping an industry to grow, they give them lots of candy and wonder why their teeth fall out very soon and they can't eat properly and their health and growth is at risk.

Comparison to the banking industry is obvious

We have seen this in the banking industry, where the mantra was "too big to fail" or "systemic risk", a blueprint and carte blanche for them to do anything without having to take responsibility for their actions. In the end, it led the world into a severe financial crisis, which could only be solved by rescuing the banks with hundreds of billions of euros in an internationally coordinated action to avoid a global collapse and depression-like the one in 1929

In Germany, however, the proportion of politicians who have never worked in the industry or have worked outside the civil service is growing considerably, making it difficult for them to understand what makes a company, industry and the economy. Without this understanding, politicians are called upon to support the economy and its companies with rules and regulations, which is one reason why most laws and regulations today are no longer written by the government, but by industry and its lobby groups. This is an astonishing fact because to follow the earlier analogy, it leads to children writing the rules for themselves. We all know where this could lead and the car industry has managed to dictate effectively to politicians what they want, especially when we talk about battery electric vehicles and the internal combustion engine.

This is similarly happening in many other industries and the aviation industry is another good example of this with Boeing and its software development which has led to several tragic crashes. While human lives are lost there, jobs are lost in the automotive industry.

"We are in times where a well thought out the balance to maintain the health of industry and jobs is failing. Such times are often called downturns or recessions. This article is not a prediction that there will be a recession, the recession in the automotive industry is already happening today."

The automotive industry has entered a recession and must react

The list of companies announcing insolvencies, layoffs and profit warnings at Tier 1 and Tier 2 suppliers in the German automotive business is getting longer and longer and is gaining speed, while many are already either introducing short-time work, asking their employees for salary cuts or even laying them off altogether.

If politics and industry were to work well together, the German automotive industry, which is the backbone of our nation, would be the strongest in the world with the best products in the world, but anyone who claims this is either full of illusions or poorly informed. The reality is that if you give your child everything it wants, you limit its ability to succeed in life, and the German government has done just that.

The German car industry has done a good job of getting politicians to give incentives to keep the internal combustion engine industry going, and there is nothing wrong with that interest. Ultimately, you want to protect jobs and the economy because that is what you were elected to do, but if the laws, regulations and the framework that the politicians have defined are actually against the good of the economy and jobs, you would expect the voters and the industry lobby groups to argue against it, but in reality, they do not.

The car industry is slow in its pace of innovation, it is like a child doing only as much as it is asked to do to get what it wants. For a century the arrangement has worked well. When internal combustion engine sales are good, the pressure to innovate is low, and when the pressure is high, the rate of innovation increases. This system makes sense as long as the innovation cycle remains constant in its pace, but what we see today is a dramatically accelerated pace of innovation that changes everything.

With the improvements in battery technology that Tesla has continuously implemented, one would expect the established car manufacturers to increase their innovation efforts, but in reality, they have not done so and are still not doing so sufficiently today. If they did, we would have heard about a "Battery Day", as we hear Tesla say, to proudly present the next breakthrough in technology with decreasing costs and increasing energy density at the April event, but we haven't heard about such a day in Germany, have we?

Shareholders before innovation

Instead, most of the capital of the incumbent carmakers go into securing profits and not into research and development, because that is what will make the voters of managers, the shareholders, vote for them again at the next general meeting. A shareholder is only interested in high profits and returns in a certain period and most cases not in long-term sustainability. This is why a manager of a car manufacturer is induced to ensure that profits continue to flow in the short term, and they do so by threatening politicians to lay off workers unless they receive subsidies that reduce their profits or losses when sales of the old technology are not as good as they used to be.

By receiving subsidies, the pressure to innovate decreases as the next profits are secure and the urgency for the organization to change decreases. The time gained through government subsidies, which satisfy shareholders in the short term and which the established car manufacturers have bought with incentives, has passed quickly, while the promised innovation needed to support demand with great products and increase the available supply capacity is lagging behind even more than before. The threat of having to lay people off is now more real than ever, as the issue becomes increasingly important with Tesla leading the way in innovation and cost pressure is increasing.

"The automotive industry will therefore once again call on politicians to provide further subsidies. The industry is caught in a vicious circle of demanding more and delivering less, and politicians because they demand more but receive less. The gap between the expectations of both sides is widening."

A good and current example of this is not only the additional subsidies but also the recent delays in the current German electric car premium, which was announced to be implemented as a handsome subsidy of an additional 50% from 4,000 to 6,000 euros for pure electric cars with a base price below 60 thousand euros, at the end of 2019. An additional €2,000 when buying an electric car is a lot of money for most people. The increase in the subsidy went through all media at the end of 2019 but was applied for significantly late in Brussels. The argumentation of the German Minister of Transport that the inclusion of "alternative vehicles" should be examined sounds extremely questionable and dubious. While Brussels claimed the application had not been received, the Ministry of Transport said it had been submitted. In the meantime, the premium was approved in February 2020, months late. All buyers who wanted to buy an electric car in 2019 were holding back the purchase for understandable reasons and the benefit of the German manufacturers, as I will explain in more detail in a moment.

German car manufacturers benefit from the delayed environmental bonus

All this is happening at a time when the following announcements have been made:

  • Daimler will reduce production for the EQC from 70 thousand to 40 thousand units due to bottlenecks in battery supply - meanwhile refuted by Daimler.
  • Audi is switching its e-Tron production to short-time work due to battery supply problems and missing parts.
  • VW sources announce delays in the ID.3 launch.
  • BMW will not deliver the next generation of electric cars before 2021.

Attractive electric cars that are not made by German manufacturers such as Renault, Hyundai or Tesla run a high risk of a drop in demand if subsidies are held in front of the face like a carrot but then delayed while German manufacturers cannot or will not deliver. Delaying subsidies damages their demand and sales much more than German producers who want to have more time to better organize their supply chain, work on production capacities and develop around a sufficient product offer.

The first two, Renault and Hyundai, have in the meantime announced, following numerous complaints to the German Government, that they will compensate buyers to the same extent and besides as if the incentives had been implemented. Tesla, on the other hand, has probably not announced any comparable measures at all, partly because of the high demand in Europe.

All this may, of course, be pure coincidence and have nothing to do with each other, but the delays are a welcome gift to any German manufacturer who has problems with either supply, production or demand because it gives them time to adjust, maintains profits and limits the ability of competitors to take away market share.

"If you listen carefully, you will not hear a single complaint from the German automotive industry about the delay in the Bafa premium, and that is very suspicious, to say the least. In politics, if you want to better understand what is happening, you should not only listen to what is said but also to what is not said. The same goes for the industry."

To believe that this is a conspiracy theory is a fair claim, but the result, whether or not this claim is correct, is to the advantage of German manufacturers. Although it is certainly not true in all cases, in the past it was good advice to "follow the money" if you want to understand why what is happening to happen.

Tesla strengthens the mental presence of e-cars in Germany

Since the location of the Tesla factory here in Germany was announced, electric cars are more and more present in the consciousness of German consumers, and people looking for a vehicle will consider the company and its products today more than yesterday, because the factory creates jobs, is more often present with positive articles in the media, the share price development shows the confidence of investors and finally soon a product Made in Germany with German employees will be available. Once people start earning their living at Tesla Brandenburg or Berlin, as CEO Elon Musk prefers to call it, pay their taxes here in Germany and understand that most of the working conditions and pay discussed in the media about Tesla are simply wrong, the mood will continue to shift in Tesla's favour.

Delays in subsidies are a minor problem so why am I writing about it at all? My answer: what looks like a small problem is a big problem. Not only because consumer demand for the much-needed zero-emission vehicles on our roads could be negatively affected, but because the consequence of this politically motivated measure is reduced pressure on the industry to become more innovative. Instead of supporting the pace of innovation, the incentives to do so will be removed.

The delays are a relief for the industry, but not because they will be able to devote more energy to them, but because they will focus less on innovation. Car manufacturers will optimise their ability to make short-term profits because they will be rewarded for short-term profits. Short-term profits are something beautiful and there is nothing negative about them unless you pay for them with your future.

Since subsidies are a minor issue and they have only been temporarily delayed, I would like to point out that the politically motivated measures to reduce the pressure on the automotive industry to innovate are many. It is a systematic problem that arises in many ways.

Hybrid vehicles: no solution to the problem

A good example of this is the hybrid vehicles, which account for 75% of a pure electric car and which are prompting car manufacturers to further develop and produce internal combustion engines, while the battery itself, as various studies have impressively shown, is used only very rarely, if at all. The increased weight caused by the battery leads to higher fuel consumption.

In other words, in 2019 high handsome subsidies of 3,000 euros were paid for a car that emits not less but more climate-damaging pollutants because, among other effects, it is simply heavier. While the UK has abolished the subsidies because of this fact, Germany will increase them by another 50% in 2020. Subsidies for hybrids are not consistent with the reduction of greenhouse gases because they promote them. The fact that this still exists today, contrary to all studies and scientific evidence, shows that the climate targets and therefore our environment are only of secondary importance to the German government.

Regardless of whether an owner ever uses the battery in the life of the vehicle, he receives €4500 on the purchase price while he pollutes the environment just like his previous combustion engine and counteracts the climate goals of the German government. It's a mockery when these vehicles also have an "E" for electric on the license plate, but they pollute the environment more than a normal combustion engine. How can it be that studies by the government in London are being taken as an opportunity to ban these hybrids completely in the future, while Germany is instead of promoting them more strongly?

Exemption for CO2 limits

Another measure is the reduction of CO2 targets in 2015 when the car industry lobby groups renegotiated the rules with EU regulators in Brussels to introduce exemptions such as removing 5% of the most polluting vehicles from the fine list. This now allows them to sell more heavy and popular SUVs with the highest profit margin, thereby offsetting the damage from fines on the remaining burners sold that do not meet targets. The 5% rule is doubly counterproductive because it means that more SUVs are sold than before.

It can also be found in unimplemented regulations of vehicles on German roads that are on the road with 8 times the permitted nitrogen (NOx) emissions, e.g. Audi A8, which they are allowed to have by law. The Federal Motor Transport Authority has been "closing both eyes" on this matter for years, and it is therefore not surprising that manufacturers feel no urge to change and improve.

The fines for failing to meet CO2 targets introduced in 2020, while announcing increased subsidies for buying an e-car in 2019 but then delaying them to 2020 has caused many buyers to hold back their purchase in 2019 and then to carry it out in 2020. Who do you think will benefit most if an electric car is sold in 2020 
instead of 2019?

German automotive industry as beneficiaries of the shift in CO2 limits

German car manufacturers are, because every electric car sold in 2020 is much more valuable to them than in 2019, as it will only reduce the penalties payable to EU regulators from 2020 onwards. Politics and industry have worked well together, regardless of the additional CO2 emissions their actions have caused and continue to cause. Climate targets did not play a role, only the profits of the car industry.

I could go on with many more examples that all have in common that they benefit the personal interests of politicians and industry managers who leave the world with a more polluted environment and Germany with a slower pace of innovation in the automotive industry. To need more time for innovation is exactly what managers tell politicians, but the last 10 years have proven that innovation goes slower when you reduce the pressure, not faster.

"Reducing pressure is exactly what politicians everywhere are doing, and they still wonder why car manufacturers are lagging in innovation compared to Tesla?!

The speed of innovation increases like an S-curve, where the forerunner moves away from the pursuers faster than at the beginning of the innovation cycle. This exponential advantage is very difficult to catch up on. The starting area, where innovation progresses more slowly, must be lived through by all subsequent car manufacturers whether they like it or not, and because of this effect, the disadvantage increases exponentially when innovation is delayed by ensuring that short-term profits are made with obsolete products, whether through subsidies or other measures.

Another way to describe this effect is that the short-term profit you make from selling an obsolete product at the end of its life cycle is only a fraction of the profit you would make if you invested all your assets and energy in trying to accelerate research and development of the new products. The problem is that managers have no incentive to catch up, but one to make profits today and now. This has been repeating itself for decades but is becoming much more acute and precarious with the compressed innovation cycles and rising S-curves of current innovations, as we have seen especially in the last 10 years.

Innovation is not the one awe-inspiring and magical improvement step that achieves everything at once, and when you have achieved it, everything is perfect. Instead, it is often born out of a crazy idea or a coincidence, the effect of which is often overrated at the beginning but is usually not functional for mass use. It is followed by a series of constant improvements, which also leads to what is sometimes later called the disruption of an industry. This pattern is repeated with all technological breakthroughs and we see this pattern today in both vehicle battery technology and autonomous driving.

"The more you advance in this innovation, the more innovative you become and the more you get ahead of your successors."

An example of the progress of innovation

Most people, especially in the US, will tell you when you ask who invented the telephone: "It was Alexander Graham Bell", the famous inventor who transmitted the first words "Mr Watson, come here, I need you". The truth is that he was the one who made important improvements to an existing device and marketed it very successfully, but the real invention was probably more likely to have been made by the German Philipp Reiss, who, about 10 years before Bell, transmitted the very first words "a horse does not eat cucumber salad", but Mr Reiss never applied for a patent. Finally, the third inventor of the telephone is Antonio Meucci, who also invented a talking device long before Bell, but did not have the money to apply for a patent. Instead, he sent the construction drawings to the Western Union Telegraph, where they were allegedly lost and the company later "quite by chance" worked with Bell when he improved and patented the device.

"Invention is a process, not an event, and at the end of the day Reis, Meucci and Bell all had their whole important elementary part in the development of a product that started something that we hold in our hands today, as Captain Kirk did in the Starship Enterprise. It doesn't matter who did something first or who filed a patent, but the result that matters."

The hard work is not one step towards change, but the long-term development of a product that you can mass-produce, that is technologically mature and that you can bring to market and sell. All this sounds kind of boring, but that's the way it is with an invention. The "eureka" moment may be nice, but it's often disappointed by "wait a minute" shortly after.

If you think of all the "breakthroughs" you've heard about, for example in solid-state batteries, then that's exactly what I'm talking about here. The real breakthrough usually comes a long time after the first breakthrough, and that's why in 99% of all cases you never hear of them again because most of them never make it to commercialization. Be it the 3-D printer, solid-state batteries or a cable made of a carbon-based cable that enables a lift into space, they all need a lot of time and money to become economically and technically feasible.

A uniquely produced electric vehicle with a range of 800 km is already feasible today, but if such a vehicle, which is needed in large quantities at a reasonable cost, cannot be mass-produced, then it is an impressive invention but one that will never reach the broad market.

The same applies to Tesla's Cyber-Truck, where, if you listen carefully to Elon Musk, the hard nut to crack is not to develop and show the prototype but to create the production technology to make it available to the masses. The exoskeleton of the car may look like real innovation, but the production technology is "the hard nut to crack".

Politics stops progress through subsidies

It sounds like a contradiction, but politicians and legislators can easily stop innovation by trying to support it, especially if they listen to the demands of the industry. Managers in the industry are interested in profits and market share but prefer to avoid innovation until they are forced to.

In a disruption like the one we are currently experiencing, in which the switch from internal combustion engines to electric vehicles is happening much faster than everyone thought, the reaction time between the moment when you are forced to do something and the moment when you are supposedly making a profit again shrinks exponentially with every day of delay, and this is an underestimated problem of the German automotive industry.

The exponential nature of this shrinking time is the last nail in the coffin of companies who believe that they can win a battle today with weapons from the past.

"The decline of the globally established automotive industry is not caused by the inability to innovate technologically, but by the ill-conceived combination and regulation of interests between politicians and managers, both of which have an incentive to do something that ultimately reduces the pace of innovation and increases CO2 emissions.

The key to success for the German automotive industry, therefore, lies in overcoming previous incentive systems which, in their current state, do not allow a successful transition to manufacturers of the world's best electric cars. The difference to past crises lies in the lack of time for companies to adapt to new circumstances quickly enough.

In nature, species that experience rapid environmental change and cannot adapt in time are disappearing, and the automotive industry is no different.

This article was published in February 2020 on the US website and was adapted in the current German version with up-to-date figures, content and information and translated into English. The translation has been done by Christian Pfäffli


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