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As car companies struggle to appeal to fickle millennial consumers, the modern connected car raises a bigger question: are cars becoming a winner-take-all market?

As car companies struggle to appeal to fickle millennial consumers, the modern connected car raises a bigger question: are cars becoming a winner-take-all market?

This article will argue that cars are likely to become a winner-take-most market in the near future. From this perspective, the huge investments traditional car companies have been making in high risk, high tech ventures are not a preemptive gamble for resurrection but are instead rational investments in their long term viability.

Network Effects

History

Before we can discuss the future of transportation, we need to revisit the past. Ever since Ford invented the Model T, network effects have played a role in the success of automobiles. Ford’s Model T relied entirely on interchangeable parts, which was the first step in creating a standardized aftermarket for parts and services. In standard economist parlance (i.e., nerd jargon), this would be called an indirect network effect – a benefit realized by consumers because of the increased value in complementary products and services. As time went on, these systems became less integrated and more modular. Most auto shops can now handle most cars, standards developed regarding individual parts, and the network effects weakened.

Getting back to the modern era, these indirect network effects are part of the reason it is cheaper to repair a Ford F-150 Truck than it is to repair a Morgan 4/4 (costs and willingness to pay are others). Nevertheless, these indirect network effects wouldn’t result in a winner-take-all marketplace. There exist enough drivers, repair shops, auto mechanics, and so on to support a huge variety of cars.

Connected Cars

Newfound car connectivity, however, entirely changes this equation. As cars are more able to communicate with one another, inter-car communication could play a huge role in reducing traffic and collisions. This is a big deal because the value to consumers of more effective and efficient transportation is huge; if cars only communicate with other cars from the same manufacturer, then there’s a huge incentive to buy a Toyota over a Mitsubishi. This is called a direct network effect; it is the benefit you directly receive from your neighbor buying the same type of car as you.

Connected cars can also make better use of indirect network effects. As Tesla has shown with their electric plutocrat mobile (aka the Model S), the connected car allows your car to learn from others that had issues. This is very similar to a car maker issuing a recall, but is actually much more powerful because it can be done frequently and in near real time.

This same logic is sure to be applied to autonomous vehicles, where the manufacturer can learn from failures and immediately improve all the others. Here the application would be far more powerful because it would allow the car to get better at its core functionality based on what other cars are on the road. It’s as though your car gets faster and more fuel efficient based on what your neighbor is driving.

Other Aspects

There are a number of characteristics of the car market that lend themselves to a winner-take-most model already. Unlike social networks or messaging apps, it is extremely costly to own multiple cars when one would do. This makes multi-homing unlikely.

Cars are already fairly commoditized. Every major car manufacturer already competes across a wide variety of segments and car types. Ford, Toyota, GM, Volkswagen, and most other multinational manufacturers already compete in essentially every car category. While there is a lot of differentiation between cars within a category, they are highly substitutable. For example, a Toyota Camry is a great substitute for a VW Jetta or a Ford Fusion. Therefore, I argue that there’s actually very little differentiation within a category for most consumers, and most car manufacturers can satisfy demand across all meaningful categories, excluding a few extremely poorly defined niche categories, like the “four-door version of a two-door version of a four-door saloon car”.

Future of the Automotive Industry

Given all this, this is now the most important moment in the history of the automotive industry since the introduction of the Ford Model T. As these technologies (the connected car and autonomous vehicles) begin to roll out, they will largely be integrated systems held within individual car companies. Rather than a system of modular components, the connected car communication networks and autonomous algorithms will be closely protected and seen as a huge competitive advantage. The leaders in this field, amongst the large car companies, will be able to build and maintain a competitive advantage, as long as they are a leader in market share and technology early on. A successful entry into this market will help ensure the success of a manufacturer for decades to come.

Clearly the elephant in the room is Tesla. While Tesla is at the cutting edge on the connected car technologies, their product line is too limited and their current prices are far too high for them to have any real chance of being the winner in this marketplace. Even with their upcoming Model 3, Tesla will only be competing in a few small segments of the relatively premium market. Therefore, if a winner emerges in the next decade, Tesla will unlikely be it.

Over the next decade, network effects in the automotive will outweigh the standalone product value, marking a significant shift towards a winner-take-most market. From this perspective, GM seems to be taking the most logical steps forward; they’re buying companies in order to build an edge with autonomous vehicles; they’re responding quickly to customer trends regarding electric and hybrid power systems; they’re introducing new car usage models in order to increase the number of GMs on the road. GM’s likely plan is to introduce a new connected car system that would leverage their then market-share leadership to give them a sustainable leading position. GM’s not the only company taking this strategy; other companies are making investments of a similar magnitude, although largely internally.

In the long run, standards and third party manufacturers will likely disintermediate most of these integrated systems. That is, new and smaller car companies will probably be able to buy modules and rights to communicate with other cars, in much the same way as small car companies can now buy engines and transmissions rather than develop their own from scratch. While this will again break the winner-take-all model, it is likely many years away given the historically glacial pace of the automotive industry. The winner of the automotive market in the early 2020’s will be able to realize significant profits before any of this happens.

 

Image via: catacars

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