Excellent article
On Sat, Oct 31, 2020, 12:10 PM Gary Bulmer <gpbulmer@xxxxxxxxx> wrote:
---------- Forwarded message ---------
From: Vitaliy Katsenelson <writeus@xxxxxxxxxxxxxxxxxx>
Date: Sat, Oct 31, 2020, 11:54 AM
Subject: Why The Survival Of Traditional Carmakers Is Far From Certain
To: Reader <gpbulmer@xxxxxxxxx>
Dear Reader, I hope you enjoy this article. -Vitaliy
Painting is by my father, Naum Katsenelson
Why The Survival Of Traditional Carmakers Is Far From Certain
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*This article is a small part of a 11-part analysis of Tesla, Elon Musk,
and the EV industry by value investor Vitaliy Katsenelson. You can get
complete analysis as an email series with one click here
<https://ima142.acemlnb.com/lt.php?s=1190a308a6d49424c52fa8c1fbf19013&i=5020A5084A36A73579>.*
Let’s go back to June 2008, when Apple introduced the iPhone 3G and Nokia
was still the world’s largest phone maker. What we did not know at the time
was that Nokia was actually the largest dumb phone maker and that Apple was
about to become the largest smartphone maker — a crucially important nuance.
*Technological Change vs Domain Shift*
In 2004, Nokia missed the flip phone boom and lost market share to
Motorola, which came out with the slick Razr flip phone. Nokia had a few
quarters of disappointing sales, the stock declined, and we bought it. But
then Nokia came out with its own flip phone and the status quo was
restored: The company was again the king of the dumb phone castle. The flip
phone was a technological change, but it was still in Nokia’s domain of
core competency. We sold the stock and made money.
The mistake many investors made, including yours truly, was missing the
fact that the iPhone was not a technological change like the flip phone,
but shift into a very different domain with a very different ecosystem. It
was not a phone, but a portable computer that also made phone calls. Nokia
should’ve thanked Apple for showing the future of the phone and developed
its own smartphone, but it didn’t. So Apple did not dethrone Nokia; Nokia
did it to itself.
Which brings us to Tesla and traditional carmakers. In theory, nobody
knows more about making cars than the traditional
internal-combustion-engine (ICE) carmakers, and so EVs made by these
companies should be the ones busying our streets a decade from now. But the
transition from ICE cars to EVs is not just a technological shift within a
domain, like the transition from two-wheel-drive sedans to four-wheel-drive
SUVs. This is a radical shift into a new domain and the success of ICE car
manufacturers in this new domain is anything but guaranteed.
ICE cars are dumb phones; Tesla’s Model 3 is an iPhone 3G. Cars last about
12 years and phones two to three, so this transition will happen slowly.
*Why Domain Shifts Are Tricky Business*
In domain shifts, assets turn into liabilities. Nokia in 2008 was a master
of hardware, but not software or user interface. It tried to respond to the
iPhone by remolding its dumb-phone Symbian OS into a smartphone OS. That
attempt failed miserably.
That’s because when you are in the middle of a transition from one domain
to another, your knowledge of the past domain may cloud your vision. You’ll
be seeing through the lenses you’re used to wearing.
Established companies also need the capacity and ability to suffer (lose
money) to survive a domain shift. In 1997, Barnes & Noble sold more books
in a day than Amazon did in months. But to snuff out Amazon, B&N would’ve
had to lower its prices and hurt its very profitable business. We all know
how that story ended.
Another example: Walmart. As it’s trying to catch up to Amazon in online
sales, Walmart needs to invest – and invest a lot. To do just that, the
company is currently losing $1 billion (a tiny fraction of its profits) on
online sales, but the company’s board and CEO Greg Foran are not very happy
about these losses. This is a company that never lost money before. Losses
are not in its DNA, but they are Jeff Bezos’ middle name. To make things
more complicated, Foran’s bonus is tied to profits of both online and
offline stores.
You can see how difficult it is even for a company as dominant and
successful as Walmart to adapt to a shift in domain.
*Nokia or Samsung?*
Nokia wasn’t the only dumb phone maker at the time of iPhone’s release.
There was also Samsung. Unlike Nokia, it successfully transitioned into one
of the biggest smartphone makers today. So, established companies can and
do transition during a domain shift.
But what about ICE carmakers? Are they going to go the way of Nokia, or
the way of Samsung?
Tesla created its cars by entirely breaking out of the domain of existing
auto manufacturers (well, except for the original Roadster). Because it
created the EV industry, Tesla had the advantage of acting from first
principles. It could start with a blank piece of paper. As Musk once told
an interviewer: “I tend to approach things from a physics framework …
physics teaches you to reason from first principles rather than by analogy.”
This first-principles approach allowed Tesla to build EVs that are free
from the limitations of gasoline-car thinking. No gears, a skateboard
chassis, two engines, a “frunk,” a credit-card key, a mobile app that works
as a key and controls the car, and no start button, among others. Tesla
applied first-principles thinking to how its cars would be sold and
serviced.
Today’s ICE auto manufacturers are basically wholesalers of their cars to
auto dealers that are their franchisees. This business model is a Great
Depression relic that went basically unchallenged until Tesla came along.
Tesla decided that the traditional business model was not appropriate for
the new EV domain. Instead, it borrowed from Apple, which controls the full
customer experience, from buying a phone to servicing it to upgrading to a
new one.
Consider: My purchase of a $51,000 Model 3 was as easy as my purchase of a
$900 iPhone. I test drove the car. A few days later, I called the Tesla
store and told the salesperson I wanted to buy it. My information was
already in the system. A few days later, I got an email confirming the
delivery date and asking me to schedule a pickup time. One morning this
past June, I showed up for my car at 9:30 a.m. — 10 minutes later I was
driving home. It was that simple.
Tesla changed how a car is serviced, too. A few weeks after I bought the
Model 3, its speakerphone stopped working. I went into the Tesla iPhone app
and requested service. I was given a choice between bringing my car to the
Tesla service center or having a service technician come to me. I chose the
latter. Two days later, the technician showed up at my office. I gave him
my car key and went back to work. An hour later my car was fixed. Tesla’s
technician had simply restarted my computer. In hindsight, I could have
called Tesla and my speakerphone issue could have been fixed remotely.
Now compare this experience with buying and servicing an ICE car. It is
difficult for traditional car companies to adapt first-principles thinking,
as it requires them to unlearn what made them successful in the old domain.
They are going to have to retool their factories and go through a
significant and painful change of their workforce. Their current employees
have a different skill set and look at the world through petrochemical
lenses (one reason perhaps why General Motors’s initial foray into EVs was
the Chevrolet Volt, an electric car with a gasoline engine).
Auto dealers, an asset to car companies today, are tomorrow’s liabilities,
as Tesla’s direct distribution and service model should provide a cost
advantage once it gets to scale. Tesla’s model is more customer-friendly
and efficient, allowing the company to capture the profit that ICE
carmakers share with their dealers. Because a good number of Tesla’s cars
are built to order, the company doesn’t need massive inventory sitting on
parking lots. Moreover, ICE manufacturers may not be able to replicate
Tesla’s direct-sales business model because they are stuck with the
franchise agreements they signed with their dealers.
But while it won’t be easy for ICE carmakers to adapt first-principles
thinking to their EVs, they may not need to: they can just copy Tesla, as
Nokia should have done with Apple. William Durant, who turned struggling
Buick into General Motors, originally made his millions on horse-drawn
carriages. Samsung did a great job of copying the iPhone with Google’s
help; instead of developing its own operating system, Samsung used Google’s
Android.
Given the enormity of the needed investment, carmakers are creating
alliances. Ford and Volkswagen, for instance, are working together on
artificial intelligence (AI) and skateboard chassis for EVs. Historically,
such alliances in the auto industry have had mixed success.
Traditional car companies do have strengths in designing, assembling, and
marketing cars. They use legions of suppliers to make the parts that go
into their cars. They can do the same thing when it comes to EVs. They can
outsource the battery to LG or Samsung. They can outsource software design
to the likes of Cognizant and DXC (we own both of these stocks in our
portfolios). They can use Waymo self-driving software and Nvidia’s
self-driving hardware. Plus, traditional automakers are in their best
financial shape in decades and have capital to finance the EV adventure.
They can afford to make an enormous investment in EV and absorb the losses
that come with them. But will they?
To some degree, their job is more difficult than Tesla’s. They have to
keep innovating as they make ICE cars because ICE cars pay their bills. At
the same time, they have to focus on the future and invest enormous amounts
of time and capital into EVs.
For ICE automakers to succeed in electric vehicles, they should set up
separate EV units with management reporting to the board of directors. The
EV management team should be given a blank check, equity in the new
company, and the ability to hire people from inside and, most important,
outside of the company. The existing ICE business should be run with a
focus not on growth but on maximizing cash flows.
It is easy for me to write this, but it will be very difficult to do,
considering that these companies will need to introduce new, exciting cars
every four years and entice consumers to buy them, just to keep financing
their losses on EVs.
*Want more Tesla & EV industry analysis? This is just one part of a value
investor’s 11-part analysis of Tesla, Elon Musk, and the EV industry. Get
the rest in your inbox with one click here
<https://ima142.acemlnb.com/lt.php?s=1190a308a6d49424c52fa8c1fbf19013&i=5020A5084A36A73579>.*
Drawing is by my brother, Alex Katsenelson
<https://ima142.acemlnb.com/lt.php?s=1190a308a6d49424c52fa8c1fbf19013&i=5020A5084A36A73582>.
Prints available on ArtistUSA.com
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.
Johanna d’Arc
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Today I’d love to share with you *Johanna d’Arc*, a symphony in four
movements that has smitten me over the last few months. It was written by
German composer Moritz Moszcowski, who was of Jewish-Polish descent
(1854-1925). I’ve written before about his terrific Piano Concerto in E
<https://ima142.acemlnb.com/lt.php?s=1190a308a6d49424c52fa8c1fbf19013&i=5020A5084A36A73584>
(I promise, it is one of the greatest).
At first, when I listened to *Johanna d’Arc* it fell completely flat for
me – which is typical of new classical music, at least for me. However, I
stuck with it, as love of Moszkowski’s piano concerto and a few glimpses of
greatness in the second movement kept me listening to it. After half a
dozen times I finally understood it. My advice to you: Start in the middle
of second movement and listen to it a few times, and then relisten to the
whole piece. When I listen to *Johanna d’Arc* I hear occasional bits of
Mahler (in the violins and in Jewish melodies), Elgar (in the cellos),
Saint-Saens (in melodies), and Bruckner (in grandness).
Click here to listen
<https://ima142.acemlnb.com/lt.php?s=1190a308a6d49424c52fa8c1fbf19013&i=5020A5084A36A73583>
*Vitaliy Katsenelson, CFA*
Student of Life
*I am the CEO at IMA, which is anything but your average investment firm.
(Why? Get our company brochure here
<https://ima142.acemlnb.com/lt.php?s=1190a308a6d49424c52fa8c1fbf19013&i=5020A5084A36A73580>,
or simply visit our website
<https://ima142.acemlnb.com/lt.php?s=1190a308a6d49424c52fa8c1fbf19013&i=5020A5084A36A73585>).In
a brief moment of senility, Forbes magazine called me “the new Benjamin
Graham.” I’ve written two books
<https://ima142.acemlnb.com/lt.php?s=1190a308a6d49424c52fa8c1fbf19013&i=5020A5084A36A73586>
on investing, which were published by John Wiley & Sons and have been
translated into eight languages. (I’m working on a third - you can read a
chapter from it, titled “The 6 Commandments of Value Investing” here
<https://ima142.acemlnb.com/lt.php?s=1190a308a6d49424c52fa8c1fbf19013&i=5020A5084A36A74918>).And
if you prefer listening, audio versions of my articles are published weekly
at investor.fm
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