From electric vehicles (EVs) to artificial intelligence (AI), the auto industry is changing at a rapid pace – and making headlines. On behalf of our next gen newsletter, The Fresh Take, BBH Relationship Associate Holloway Rule sat down with BBH Principal and Senior Equity Analyst Scott Hill to discuss the latest hot topics in the space.

Holloway Rule: Let’s start with the big picture. What is your take on the auto industry from an investment perspective?

Scott Hill: The auto industry is an interesting and important part of the global economy. However, from an investment perspective, it’s extremely challenging: A vast majority of the industry’s available economics are competed away or disproportionately shared with labor and the consumer. Today’s automotive consumers have benefited from enormous gains in added value in terms of utility, safety, functionality, and aesthetics.

The crux of the auto industry’s economic ills is that it suffers from massive overcapacity (there is about an entire continent’s worth of global excess automotive manufacturing capacity), which leads to significant pricing pressure in the industry. Labor dynamics and high fixed costs structurally limit compensating cost reduction efforts. These dynamics make for a difficult investment landscape, with challenging cash flow dynamics and relatively low returns on capital for most industry participants. For a capital-intensive industry, recapitalizing the industry to accommodate the energy transition simply makes matters worse from an economic perspective. The number of vehicles that will ultimately be sold hasn’t materially changed, but the cost to manufacture them, utilizing two fundamentally different sources of propulsion, has structurally increased.

HR: There has been a notable focus on EV production in recent years. While we’ve observed automakers embracing a shift toward EV production, buyers seem more hesitant, despite more choice and lower prices. Why is that?

SH: That is a complex topic with myriad factors driving your observation. To try to simplify the answer, I think it’s largely the result of a disconnect between automakers and consumers as it relates to certain key decision points.

For the auto companies, they are not only responding to future consumer expectations for adoption of EV vehicles, but also government mandates dictating the mix of vehicles they produce. For most consumers, the decision point is a function of the relative comparability of EVs to vehicles powered by traditional internal combustion engines (ICE vehicles) in terms of utility, safety, functionality, aesthetics, and, critically important, cost.

While governments have mandated and incentivized EV production and consumption, EVs are largely more expensive for the consumer than comparable ICE vehicles. We have observed that as government incentive structures roll off, consumer demand for EVs has meaningfully declined in most markets. Regardless of these natural market forces, auto companies have government mandates to produce a certain mix of EV products over defined periods of time, creating an imbalance in the market.

HR: What emerging technologies in the auto industry excite you, and why?

SH: In my view, the two most important and interesting technological automotive capabilities are widespread precision location and sensor capabilities. These capabilities will inform the speed and fullness that society moves toward increasingly driver-assisted or driverless modes of mass automotive transportation.

In our view, while these shifts will likely take far more time than many of the more optimistic forecasts in the public domain, their potential value to society on many fronts – human safety, efficiency, and environmental stewardship – is simply massive. We have made a lot of progress in these two areas, but still have just as far to go in order for the full potential of these important and interesting technologies to be realized.

HR: I recently read more than 95% of used car searches start online. How is the growing popularity of online car buying platforms (such as Carfax and Carvana) influencing the used car buying experience and associated prices?

SH: The “digitization of exploration” for both used and new cars has dramatically changed the auto industry, shifting even more power to the buyer, especially in the used market, where comparable information was historically very constrained to proximity to physical location and local media supporting those markets. These forces favored the relatively insulated seller. Those days are long gone, and the used car buyer has joined its new car buying counterpart as being very firmly in the driver’s seat.   

HR: Gen Z leans toward innovative, tech-savvy, and eco-friendly automotive solutions. Will these priorities redefine the industry’s approach to product development?

SH: In short, yes. In many respects, those priorities have already come to dominate much of the product development landscape. The industry as a whole used to implement a highly transportation-focused value chain, with modest incremental consumer comforts and safety features added over time. The core focus of the product development effort was efficient transportation.

Over time, these priorities have changed – design elements around information systems for consumer enjoyment became integral to the consumer experience and, consequently, the development and design efforts. Digital and software enablement is now at the center of almost all utility, safety, functionality, and aesthetic automotive features. We expect this shift to not only grow but accelerate over time.

HR: Is the increase in cutting-edge technology related to the increase in auto insurance rates consumers have experienced over the past few years?

SH: Yes, but that is only one of myriad factors affecting the cost of auto insurance. A bumper, for example, used to have a relatively modest cost, whether as original equipment or as a replacement part.  Today, the cost of an original or replacement bumper is meaningfully more expensive given the sensing capabilities built into the equipment.

The holy grail of these technological enhancements is that they minimize the frequency of accidents, which reduces the total cost of ownership, including insurance costs, over time. Unfortunately, so far, the data is not fully supportive of that promise. This is one of the reasons developing the technologies we discussed earlier is increasingly important.

HR: Recent studies indicate younger generations may be more interested in forgoing car ownership in favor of a vehicle subscription model – what do you think? Are there any companies in the space you are monitoring?

SH: I will divide the space into two kinds of subscription models. The first is a group of consumers interested in sharing the use of a vehicle. These business models are almost exclusively theoretical at this stage, given the difficulty in aligning a group of individuals around the specifics of the vehicle model and trim level, its maintenance and upkeep, the full cost of ownership, and shared use. In theory, there is an available marketplace for this subscription service; however, the details around its actual implementation are so challenging and nuanced that we haven’t observed any economically successful companies operating at scale.

The second is a recurring fee to rent and use available vehicles within a geographic area for a designated period of time. In our view, this business model has commercial and economic potential, but scale is the issue to get a company to a market capitalization of interest to us. This model works economically for people who only need the vehicle for a short and specific duration. Economically, this consumer may pay more per mile than they would in a traditional leasing agreement, but the specific circumstances around their prescribed use allows total overall lower costs per month or year and some lifestyle advantages related to model choice and frequency of change. My view is the opportunity here is very niche for a new business model to develop on a standalone basis.

HR: Any final thoughts?

SH: I would encourage people to own automobiles, enjoying their growing technological capabilities, functionality, and overall utility, and refrain from owning automotive stocks. As consumers, the value disproportionately accrues to them and is sourced disproportionately from their shareholders – that is to say, you will likely receive more value from owning a car or truck for your personal use and enjoyment than an automotive stock in your portfolio.

HR: Scott, thank you for your time.