The Connected Car Market has “Arrived”

GM just paid $1B+ to acquire 40-person self-driving technology vendor Cruise Automation; last year Continental AG paid $700m for Elektrobit’s automotive software business unit (full disclosure: Magister has advised Elektrobit). For comparison GM’s entire market value, with 250,000 employees, was only $7B less than 10 years ago.

These deals are a watershed. A $1 trillion+ industry operating the same way for the last 100 years is being forced to rethink product development, opening enormous opportunities for technology vendors to deliver faster, better software to this market. While the future of the auto industry is certainly uncertain, the drivers of that future are now clear:

• The end market is growing, from 90m vehicles annually today to a projected 100m+ vehicles by 2018. This rapid growth is driven by the faster growing economies, but vehicle use is rising everywhere.
• Electronics will soon exceed 50% of vehicle value –across the industry, electronics have risen from 20% of total vehicle value to 30%+ today, and are expected to hit 50% by 2030. Premium brands, such as Audi Lexus and BMW will see electronics exceed 50% of vehicle value much earlier, likely by 2020.
• Car makers and their Tier 1 suppliers just cannot develop software – A big reason for the Cruise and Elektrobit deals is the dearth of software skills and tools in the auto industry. Car-makers are used to buying “sub-systems” built around hardware from vendors such as Bosch, Continental, Magna and TRW. These suppliers meanwhile are industrial, not technology companies. The concept of a car as a software driven network on wheels is totally alien to this whole eco-system. Which is why Tesla has differentiated itself so much with its approach.
• Tesla is not the “enemy,” Apple and Google are – Tesla has captured the worldwide imagination while never advertising. Its effect on consumers’ perception of how “sophisticated” a car should be can’t be overestimated. However, Tesla’s 90,000 car output makes it a niche player unlikely ever to become a million+ vehicle manufacturer. Apple and Google are far greater threats; they already operate at scale, and have the resources to offer car makers a complete tech platform. In essence they can shift the whole market from industrial to technological. But the cost to car-makers is most comparable to the IBM/Microsoft relationship decades ago. Microsoft “helped” IBM sell many more boxes until it established control and brought all PC makers (including its former partner IBM) to their knees. A car industry “powered by Google” is IBM “powered” by Microsoft; to many auto CEO’s any other option is preferable.
• Consumer expectations are high and rising – Tesla’s “software with wheels” has shown what cars can evolve into; post-Tesla its hard to put the genie back in the bottle. Also, the upswing in interest in both green and autonomous technology is defining consumer demand; a quarter of consumers in a recent US poll indicated interest in buying an electric autonomous driving car. Car makers know the first mass producer of a complete software-driven autonomous driving line of vehicles will gain major market share.

How will these market drivers shape financings and acquisitions in the market?

• Hardware will be designed to accommodate software, not the other way around –For the next 100+ years, driving vehicles will be built around consumer requirements and, crucially, software components and applications. Hardware will have to accommodate software. In addition, cars will evolve into small networks in motion, tethered to a broader network of millions of other vehicles.
• The centers for car technology will be Germany and California – We do not see Detroit, or any Asian market, emerging as a focal point for connected car technology. The centers will be where there is a critical mass of capable software engineers, close enough to leading-edge auto makers. Germany benefits from having a disproportionate share of the world’s premium-brand, early-adopting car makers (BMW, Audi, Mercedes etc.), while Silicon Valley has woken up to adapting its software resources to this huge legacy industry.
• Financings so far have been small bets, but funding will grow significantly – Magister counts just over $100m invested in two dozen connected car startups in recent years, with the focus on autonomous driving and dongles that can activate apps. This excludes the near $200m invested in Tesla pre-IPO, but the numbers are still quite small. We view the last 3 years as the “experimentation stage” for the sector.
• $1B will be invested in connected car technology companies in the next 4 years – Now that two larger deals have validated the value of technology, and both involved incumbent legacy players paying up to secure their futures, we expect $1B+ of investment to flow into the space over the next 4 years to fuel the technology arms race. The auto industry now is in many ways like the financial services industry during de-regulation; a change in the market, with risks from potential disruptors, fuel unprecedented investment in next generation technology to create or maintain an edge in the market.
• Selling to the auto industry will remain challenging – Despite unprecedented investment, many VC’s are shy about automotive investing for 2 reasons. First, the number of ultimate end customers is often very small, perhaps 10-20 at most. Second, the sales cycles are years not months, and depend on the evolution of car platforms. As a result, auto tech vendors can and do spend years positioning themselves with a small group of potential customers. The difference today is these customers have no choice but to listen, and buy.

The auto industry will be based around vehicles as mini, integrated, software-driven networks, connected when possible to a wide-area network for remote services. Sensors will take over from electronic control units (ECU’s) as the main source of functionality. Billions will be invested to transition at warp speed to this brave new world.

As Marc Andreessen has said, Software is eating the world. Nowhere more so these days than the auto industry.

Posted by Victor Basta @MaExits