How Attractive Is the North American Automobile Industry for New Entrants?
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How attractive is the North American automobile industry for new entrants?For a potential new entrant to the North American automobile market, the landscape is highly unattractive. There are three main reasons why this is the case: competition amongst existing players is fierce, barriers to entry are high, and the profit margins on sales are extremely low. After analyzing the industry, it is clear that for new entrants utilizing traditional industry technology, it would be (and has been) nearly impossible to create, capture, and sustain economic value. As Warren Buffet said, “When an industry with a reputation for difficult economics meets a manager with a reputation for excellence, it is usually the industry that keeps its reputation intact.”[1] Indeed, the North American automobile industry has a knack for difficult economics. Currently, the market is extremely concentrated, with 49% of market share being dominated by the three largest companies. As evidence of how difficult it is to compete in this space, even two of these top three companies filed for bankruptcy in 2009, and there have been no successful new entrants with a mass-produced car since WWII. As a measure of how tenaciously firms compete in this industry, large players spend roughly $4 billion annually (GM and Ford spent $4.2 billion and $3.9 billion respectively) on marketing. While the case does not explicitly state GM’s market capitalization, it does note that Ford’s is $8 billion, which means that they spend roughly 50% of their total value (not their revenue, their total value!) on marketing alone. If the level of competition between existing competitors were not enough to deter a new entrant, the high costs of entry likely would be. A normal automobile manufacturing plant costs roughly $1 billion dollars to build, and between $1 billion and $6 billion are required to engineer and design a new car over a 4-5 year period. In fact, the manufacturing costs themselves typically make up 80% of the car’s final MSRP. Even once the factory and car design have been secured, the minimum efficient scale required for the average car company is between 100,000 and 250,000 units, a daunting demand level for a new entrant. Combine these costs with high defect rates and a considerable learning curve, and the barriers to entry and required IRR to achieve profitability are considerable.  Furthermore, the industry overall has extremely low margins from sales. Automobile manufacturers typically source parts for the powertrain and chassis from over one thousand suppliers, which have a cumulative cost burden. Within the factories themselves, worker errors are costly and have residual effects down the assembly line. As a result, 10% of the average factory floor has to be reserved for repairs, limiting the space that can be used for valuable production capacity. Plants that produce multiple models also frequently encounter imbalances along the line, meaning that some assembly stations of significantly more work than others. To combat this, flexible production systems can be installed, but these reduce volume and thus economies of scale. The compound effect of all of these factors is an extremely squeezed industry, with an average gross sales margin of 5%.[2] Rather, automobile companies rely on services and maintenance for revenue, posing an inherent conflict of interest; they are at once supposed to sell a top quality car and yet at the same time rely on repairs (most frequently on the powertrain) for revenue.

How did Tesla Chose to Compete?Tesla successfully entered the North American automobile market and was able to compete by thinking not only of how they could capture and sustain value in a very competitive environment, but also how to create new value in the industry altogether.[3] In particular, they were able to drastically reduce barriers to entry and cut costs while developing an innovative product that increased willingness to pay. They accomplished this by focusing intently on five key realms, which included market entry strategy, manufacturing, capital investments, technology, and customer interaction (comprised of sales, distribution, and service). Tesla chose to enter the market with a high-end luxury product.[4] By coming in with such an elite offering, Tesla and their Roadster competed on many fronts with the best cars available, but also debunked much of the conventional wisdom surrounding electronic vehicles. From a performance perspective, the Roadster accelerated faster than a Ferrari Testarossa and was described by enthusiasts as a “jaw dropper” and “head turner.” Simultaneously, the vehicle soothed concerns about the efficacy of electronic vehicles, including apprehensions regarding range, resale value, longevity, charging time, and safety. Additionally, by releasing the vehicle in limited supply, they were able create scarcity and allure for subsequent products to follow. Initially, this drew in the most affluent consumers with high willingness-to-pay, but later models would target lower price point segments with the brand equity that the Roadster established.In establishing their manufacturing capabilities, Tesla made extremely prudent choices about how they would compete with existing producers. From the outset, they assembled a team of both technology and auto experts to push boundaries. By combining some of the best minds from Silicon Valley with experienced automobile industry veterans, they limited the biases and anchors that could stifle innovation. Tesla also paid careful attention to how they would get down the learning curve to reduce costs as they developed their capabilities. Essentially, production of the Roadster allowed them to benefit from experience and learning prior to building scale. For this first vehicle, they partnered with Panasonic for battery production and Lotus Elise for help building the chassis. These partnerships allowed them to leverage expertise in battery design, safety, and engineering that they could then apply themselves for future models. Another critical component of Tesla’s manufacturing efficiency was that they were extremely efficient with their capital. Tesla bought the NUMMI plant at a discount price of $42 million, and received capital injection of $50 million from Toyota as part of a broader cooperation. They bought equipment from struggling car manufacturers at steep discounts, like the hydraulic stamping press that was worth $50 million that Tesla procured for $6 million, and brought the manufacture of 90% of their requisite components in-house. In total, Tesla spent less than $300 million to get the factory operational, roughly 30% of the typical costs to do so. They also designed and engineered the Model S completely in-house at cost of only $500 million (refer to $1 billion- $6 billion average mentioned earlier), and sold powertrains and design services to other manufacturers, the estimated revenues from which total $400 million. This not only contributes to overall profitability, but keeps competitors at bay and moves Tesla down the experience/learning curves by selling and manufacturing at higher volumes, while constructing additional barriers to entry for competitors who won’t be able to get down experience curve to compete with them on price. Overall, the cumulative effect of these capital efficiencies was a reduced minimum efficient scale at between roughly one-fifth and one-tenth of the typical output levels required for an automobile manufacturer and the foundation of a dominant market position.

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Tesla Chose And North American Automobile Industry. (June 13, 2021). Retrieved from https://www.freeessays.education/tesla-chose-and-north-american-automobile-industry-essay/