A focus on software as opposed to hardware could well position China as the leader in electric vehicles, according to Janus Henderson Investors’ Matt Culley.
Culley, an emerging markets assistant portfolio manager, explained that most prior seismic shifts in technology over the past 50 years have been precipitated by the commoditisation of what were uniquely hardware-oriented products toward software-oriented solutions.
“The pace of change during these shifts feels glacial, then sudden,” said Culley.
He said while electric vehicles are no doubt the future, the electric component is just an enabling technology commoditising the hardware cost of transport.
The winners in the electric vehicle space will therefore be defined by software, which is no different from the previous technological revolutions in personal computers and mobile phones.
“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,” he added.
Total estimated EV fleet size
Source: CAAM, CEIC, Morgan Stanley Research
Indeed, the two previous seismic shifts in technology – the personal computer and the smartphone – provide a useful allegory for what is happening in the electric vehicle industry.
Market share went to the companies with expensive hardware and microcomputer memory boards provided the arena in which companies could display their value.
“What made these companies special was their relentless innovation to solve distinctly physical problems,” said Culley. “The winners in the race to reduce hardware costs historically won the marginal profit pool.”
He went on to outline that, during these shifts, software began to completely redefine what the hardware could do.
“When the cost-per-bit of computer power fell far enough, it gave way to the rise of Microsoft’s Windows,” he said. “The same happened with bandwidth and 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.”
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,” Culley added.
Historically, however, automotive production has come from developed markets given how much weight is given to employment in the sector, union presence and intellectual property in manufacturing.
However, the number of parts in an electric vehicle engine is considerably less than its combustion counterpart and this low barrier to entry has given rise to many 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,” he said.
Culley explained that perhaps the most important aspects of electric vehicles are that they offer a better value proposition to the end user.
He added that 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.
“Existing products are built upon hundreds of outsourced vendors using broadly incompatible software code,” he said. “By developing a unified software stack these innovators can continually improve the vehicle after the initial sale.”
This fundamental shift has the potential to slow the natural depreciation of vehicles.
“Consumers now have access to the most modern technology for longer and are embracing smart electric vehicles much faster than expected.”
Expected revenue contribution from software services
Source: CAAM, CEIC, Morgan Stanley Research
With software at the centre of the consumer experience, data emerges as the key.
Culley noted that Chinese start-ups are collecting more data every day and improving their products at an accelerating rate, requiring fewer models and less hardware investment.
“They have built their business from the standpoint of engagement to build the flywheel around data and it is no surprise that the three current listed manufacturers are all backed by the Chinese Internet giants,” he said.
Indeed, Nio is backed by Tencent, Xpeng is backed by Alibaba and Lixiang is backed by Bytedance, owner of TikTok and its Chinese counterpart Douyin.
However, this would not be the first time that China has capitalised on innovation to meet a future trend - becoming a first-mover in 5G technology and adopting digital payments before the West.
The central government also appears to back rapid advancement of electric vehicles as it aligns with its goals of dominating select advanced technologies and achieving carbon neutrality by 2060.
“By providing an accommodative home market, Chinese manufacturers will be able compound these natural data scale advantages and export globally,” he said.
“China has the unique opportunity to win on both the manufacturing and technology fronts and surpass the Western incumbents who have dominated the industry for the last century.”