Automobiles represent one of the best examples of how rapidly technological change can be adopted as indicated by the above picture that shows how the streets of NYC went from being dominated by horses and carriages to cars over a period of 13 yrs. To set the context for this deep dive into automobiles, it is only fitting to discuss the main technological changes facing the industry today.
Biggest themes in the automobile industry
Clearly, the elephant in the room is the conversion from internal combustion engines (ICE) to electric vehicles (EV). Currently, EVs represent ~3% of vehicles globally and is expected to go to 90+% over the next 30 yrs. Keep in mind that the total demand nor the price for autos is not expected to change markedly going forwards, but instead incremental sales will favour EVs vs ICEs. Championing the move to EVs is Tesla ($TSLA) with ~80% US market share of EVs but only ~1% of the global auto market share (ie., global ICE + EV). More recently, $TSLA has faced competition from both ICE incumbents and from newer EV companies that have ample access to low-cost funding. The supply chain for EVs will also look different from that of ICEs and is expected to be 1) simpler as EVs have ~5x fewer parts than ICEs; 2) be more automated and require less labour; and 3) include a focus on different components like batteries, which are currently supplied by other companies (https://uaw.org/wp-content/uploads/2019/07/190416-EV-White-Paper-REVISED-January-2020-Final.pdf).
Another change in the industry is the emergence of shared mobility innovations by the likes of Uber, Lyft, etc. As a result of this, fewer younger people are now bothered to get a driving license and car ownership is showing signs of saturation in developed countries. This trend has reversed more recently with covid-19 as driving a car provides more personal space than other means of transportation and WFH has also promoted working in more spacious non-urban areas, which also requires more driving. However, this is likely a blip rather than a reversal of the generational trend towards shared mobility and lower levels of car ownership.
An evolution of shared mobility is autonomous driving where the machine drives the car instead of the human. While a great deal of progress has been made on this front, the more likely path forward seems to be an evolution over the next few decades of more technologically advanced cars capable of better safety and more self-driving technology rather than a disruptive adoption to full-blown autonomous driving. The recent investigation into $TSLA’s autopilot system gives a sense of how difficult regulatory approval of autonomous driving will prove to be (https://www.wsj.com/articles/teslas-autopilot-system-to-be-probed-by-u-s-auto-safety-regulator-11629116457).
Used car value chain > new car value chain
The value chains are slightly different between new and used cars and these differences are highlighted below starting first with new cars.
The new car value chain is facing more pressing changes than the old car value chain. For eg., OEMs are competing with new entrants on EVs while at the same time, gearing up themselves to produce more EVs, which requires both incremental R&D and capital. Suppliers as well are transitioning to EV platforms that have fewer parts and require less labour than ICE ones, which may imply lower profitability for them when it comes to EV. These changes present uncertainty in terms of who the winners and losers will be within the new car value chain over the long term.
In contrast, the value chain for used cars is more complex, undergoing less change, and has more stable demand over time. There are more sales channel options for consumers to buy used cars than new cars. For eg., consumers can buy used cars from other individuals, auto dealerships, and from car auctions at salvage yards. The salvage yards in turn are supplied by insurance companies that deem the repair cost of damaged cars to be higher than what they are worth. Used cars are an increasingly attractive value proposition for consumers due to a lower price than new cars and increasing reliability of cars generally as they meet increasing regulatory standards for safety and emissions. During economic recessions, used car demand is more stable than new car demand because consumers are typically more price sensitive in these times.
While there is less pressure to change the used car value chain, there is still some exposure to change in parts of the value chain. For eg., many auto dealerships are adapting to a shifting preference by consumers for e-commerce. E-commerce only dealerships like Carvana ($CVNA) have seen good traction from a relatively low base of ~1% e-commerce penetration of used cars currently (vs ~50% penetration for books). Another example of change is that car auctions are also increasingly moving from physical locations to online and the auction players are improving their toolset to accommodate this shift. However, unlike with new cars, the market dynamics in these areas are more attractive and likely to be less impacted by change.
Market dynamics in used car dealerships and in auction yards
What do I mean by favourable market dynamics within the used car value chain? Auto dealerships, for instance, are highly fragmented with the top 100 used car dealerships accounting for only ~10% market share. This implies an advantage for the largest dealerships in terms of scale and a long runway for them to continue to take share from weaker independent dealerships. Hence, while they may lose some share to online players like $CVNA, the larger players should be able to transition to e-commerce better than smaller ones and as a result should be able to continue to gain share from smaller players. The dynamics are even more favourable for auction yards as this is largely a highly consolidated duopoly with Copart ($CPRT) at ~50% market share and IAA ($IAA) at ~40% market share. While consumer preference is shifting to online auctions, both these players are so far making the transition while largely maintaining their market share.
Join me in the next part as I delve further into the used car auto dealerships players and auction yard players.
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