How Software Will Dominate the Automotive Industry

Once a concept confined to science fiction, autonomous vehicles are well on their way to becoming reality. Tech companies, soon followed by traditional auto manufacturers, have been betting big on the space.  In this article, Toptal Insights shares industry-shifting trends and recommended strategies to help incumbents adapt.

Technology companies initiated the transformation.  Uber acquired Otto, the self-driving trucking company, for $680m, while expanding upon a $300m partnership with Volvo, focusing on vehicle development and production. Tesla committed to equip vehicles with fully-autonomous functionality, and Google spun out its self-driving unit, Waymo.

In response, automakers have not been sitting idle. General Motors acquired Cruise Automation, a startup developing self-driving technology, for a whopping $1 billion while also partnering with Lyft to test self-driving taxis.  Ford proclaimed it would mass produce fully-autonomous self-driving vehicles by 2021.

A profound shift is under way in the automotive industry.  AT Kearney estimates that the connected mobility market value will skyrocket to over $550bn by 2035, while BCG estimates that autonomous or semi-autonomous vehicle sales penetration could reach 25% by the same year.

A Radical Shift in Consumer Behavior

Rapidly changing consumer behavior will alter the revenue model and value chain of the automotive industry. While multifaceted, these changes can be summarized in two key trends.

More Time Spent in Vehicles, Less Time Driving

The first major trend highlights time spent in vehicles. We already spend an enormous amount of time driving: the AAA Foundation estimates that US drivers spend more than 290 hours each year – or roughly 6-7 hours per week - behind the wheel.  Autonomous vehicles will increase this number.  Two separate academic studies concluded that autonomous vehicles could increase vehicle miles travelled (VMT) by up to 20%.

Drivers will also spend more idle time in vehicles.  As cars become self-driving, people will have more time to do other things while travelling.  AT Kearney estimates that self-driving technology could free up 1.9 trillion minutes of idle time for passengers by 2030.

The Rise of Mobility-as-a-service

Mobility-as-a-service (MAAS) refers to the shift from personally-owned to on-demand vehicles.  The last decade has already seen a shift in consumer preference for utility over status symbol. Car ownership has been waning for several years, likely driven by changing sentiments among younger demographics.

Even in the absence of transformative technology, US citizens aged 16-24 holding a driving license declined from 76% in 2000 to 71% in 2013.

The rapid growth of on-demand ride services and car-sharing services such as Uber and Zipcar will accelerate this trend.  Membership in car clubs, for instance, is growing at more than 30% per year, and should hit 26m globally by 2020.  Recognizing these trends, traditional OEMs such as Daimler and BMW have entered this space via investment in Car2Go and Drive Now.

A New Value Chain

The automotive industry will evolve from an OEM-dominated value chain towards a “technology stack,” comparable to the PC industry and comprised of three categories.

At the bottom, hardware companies will produce vehicles and their components. Atop hardware, the software layer will provide intelligence that runs cars, as well as connectivity and fleet management functionality. Presiding over the stack, the application layer will leverage the two lower parts to provide services and content that enhance the transportation experience.

Industry evolution will shift value creation. Today, the majority of value in car manufacturing resides in hardware - the chassis, powertrain, and interior - but the new paradigm means that differentiation and profits will migrate towards higher parts of the stack. Morgan Stanley estimates that software and applications will collectively account for 60% of the value of a future self-driving car.

The implications of these developments are clear: to stay relevant, industry incumbents must intentionally position themselves in the evolving landscape.

Pivot for the Future

Faced with the prospect of decline, OEMs who enter new segments of the value chain (software and/or applications) will flourish.  Two strategies seem viable: own the entire chain or focus either on the operating system or hardware, while partnering with companies specializing in complementary segments.

Building a fully integrated car will likely revolve around the operating system, which current technology giants are best positioned to produce. Accordingly, OEMs should continue to optimize hardware, while simultaneously developing applications, either through in-house development or partnership with technology leaders and startups.

Regardless of the strategy chosen, success will depend on effective talent sourcing and management. The companies that attract the best talent and structure their organizations to maximize innovation will be the winners in this space.

About the author:  Toby Clarence-Smith is Lead Editor of the Toptal Finance Blog, overseeing the publication's strategy and direction. His career has spanned various areas of finance, from investment banking to social impact investing, and more recently venture capital. He also cofounded an omnichannel retailer in Mexico which raised multiple rounds of funding with institutional investors and is now one of the category's leading companies. He has a BSc in Economic History from the London School of Economics and an MBA from Wharton Business School.