When the winds of change blow, some people build walls and others build windmills ~ Chinese Proverb

Most prior seismic shifts in technology over the past 50 years have been precipitated by the commoditization of what were uniquely hardware-oriented products toward software-oriented solutions. The pace of change during these shifts feels glacial, then sudden. Their potential feats trivial, then limitless. Incumbents fight the imminent change until that tipping point where it becomes apparent, then rush to catch up. The future is always obvious in hindsight.

Electric vehicles (EV) are the future. “Electric,” however, is just an enabling technology and can be seen as commoditizing the hardware cost of transport. We believe the winners in the EV revolution will be “smart” and defined by software in much the same way we have seen in prior historical analogues. China has the opportunity to be a leader in not only the design and production of the next generation of vehicles, but also to leverage the power of software and big data to reimagine the entire automobile industry.

Hardware was king because it was expensive, software was a necessary accessory

To better understand this perspective, we just need to look at two of the prior seismic shifts in technology – the invention of the personal computer and the smartphone. The incumbents in the 1970s during the rise of the PC were premier electronics engineering companies such as Digital and Hewlett Packard. Similarly, telecommunications equipment vendors including Motorola and Nokia dominated the handset industry in the early 2000s. Today the automotive original equipment manufacturers (OEM) are the premier mechanical engineering companies. What made these companies special was their relentless innovation to solve distinctly physical problems. The winners in the race to reduce hardware costs historically won the marginal profit pool. Years ago, and similarly, the Digital Equipment PDP-11/70 minicomputer could be configured with up to a “full meg” of RAM. The cost of that memory board was about a million dollars, so memory-intensive software was simply not an option. The value they brought was in the hardware.

During these shifts, however, we see software completely redefine what the hardware can do. When the cost-per-bit of compute power fell far enough, it gave way to the rise of Microsoft’s Windows. When the same happened with bandwidth, we saw the rise of Apple’s iPhone. In much the same vein, we believe EVs are not special because they are electric, but because of what electric can enable.

Mentality of incrementality vs. exponentiality

It was the culture of incrementality that made these companies great. Automotive engineering focuses on a traditional hardware-centric approach. The OEMs take their starting point, “A,” as a given, and work forward to “B.” There are physical limitations on the power that can be extracted from combusting gasoline inside a cylinder and small changes to the engineering of these components could yield improvements in fuel efficiency over competitors. Their cultures have been built on constant innovation at the edge of these physical limitations. As recently as five years ago almost every automotive company in the world was dismissive of electric as too costly versus the present internal combustion engines. They poured billions of dollars into diesel, turbochargers and hybrid solutions to meet increasingly stringent fuel-efficiency requirements.

Technology, however, deals in exponents. Software companies architect their cultures from a solutions-oriented mindset. They begin with the vision of the end goal, “Z,” work backward to the present, “A,” and assume the hardware cost convergence as a given. With the exponential improvement in battery costs, these two do not meet in the middle. When it becomes apparent that the hardware has been sufficiently commoditized, the incumbents find themselves caught out along that continuum, say at “D” or “E” where the software companies find themselves somewhere closer to the end goal, say “S” or “T.”

China wins in manufacturing

One of the most important results from an emerging markets perspective stemming from these seismic shifts was the geographic move in manufacturing from West to East. As software began to define the value add of the personal computer, both assembly and component manufacturing shifted to Asia, primarily China. Automotive production has historically come from developed markets given the national importance of industry employment, union presence and intellectual property in manufacturing. However, the number of moving parts within the engine in an EV shrinks by orders of magnitude, from 2,000 to just 20. What was once a marvel of engineering is quickly becoming obsolete. Put simply, it is much easier to build an electric car than an internal combustion one. It is perhaps for this reason that we see so many EV start-ups coming out of China. China has the unique capability of being able to leverage their low-cost manufacturing base and support innovative start-ups to focus on a software architecture from the outset.

A software defined experience

Perhaps the most important aspects of EVs are that they offer a better value proposition to the end user. The Chinese start-ups like Nio, Xpeng, and Lixiang have designed their vehicles with a unified software architecture that is capable of being dynamically updated over-the-air down to the firmware and component level. As noted by a predominant executive of a major legacy automotive manufacturer, “mechanical engineering has a cycle time of two to five years. Now when it comes to software, we are talking two years to two weeks.” Incumbents’ products are built upon hundreds of outsourced vendors using broadly incompatible software code. By developing a unified software stack these innovators can continually improve the vehicle after the initial sale. This fundamental shift has the potential to turn industry economics upside down and slow the natural depreciation of their vehicles. Consumers now have access to the most modern technology for longer and are embracing “smart” electric vehicles much faster than expected.