Why So Many EV Companies Fail

The electric vehicle revolution has offered entrepreneurs the opportunity to make history and, sometimes, lots of money. Elon Musk's wealth soars thanks to the rise in Tesla shares. So he introduced them to the Cybertruck. But in this race to seize the moment,

many

contenders are faltering. Several high-profile

companies

have

fail

ed, gone bankrupt, or struggled in fight after fight. Even established players in other industries with automotive dreams have thrown in the towel. In recent years, more than 30

companies

have filed for bankruptcy or are at risk of bankruptcy. The total addressable EV market is huge. Tesla, which controlled more than 50% in the United States in 2023, sold more than 650,000 vehicles in the country and collected more than $82 billion in vehicle sales and leasing income worldwide.

And electric vehicles accounted for just 8% of new car sales in the United States that year. They are expected to be 46% by 2030. That's almost 8 million vehicles. But the business is not for the faint of heart. Billions and billions are needed. Applicants have routinely underestimated those capital costs. A company has to put together a complex supply chain, build factories, design vehicles, comply with regulations and get them to customers through a distribution and service network. So why is it so difficult to start an EV company and why do so

many

fail

? To be sure, despite talk of a sales slowdown, forecasts continue to show a boom in EV adoption around the world, from 2.4% of new cars sold in 2019 to 61% in 2035.

Startups, by definition, love the vast markets they can address. This is a venture capital speech. You know, slide number one. And, by the way, these are not only light vehicles, but also buses, trucks and motorcycles. And on, you know, airplanes from the even more distant future. Investment commitments in electric vehicles have doubled in value in just two years, reaching $616 billion through 2027. Enthusiasm like this is what allowed the creation and success of Tesla, basically the first major electric vehicle manufacturer. outside Asia. Market growth is partly supported by favorable government policies. Countries eager to decarbonize offer a variety of incentives, subsidies and other benefits to help defray the cost of getting started.

Since 2021, Tesla has earned more than $5 billion in credits for zero-emission vehicles. Those are credits that other automakers have to buy from Tesla or other electric vehicles, or hook up manufacturers every time they want to sell a fuel-burning vehicle. In some states. You know, China has had the fastest growth in electric vehicles than anywhere else. And that is also supported by many government policies. So, you know, in some of the places where there is a proliferation of startups, you could say that with the help of the government, some of them are the entrepreneurs who want to take advantage of the opportunity of this shift in dominant design to electric. .

But this time of tremendous growth and opportunity has also coincided with several high-profile failures. Apple, one of the largest companies in the world by market value, closed its car project, known within the company as Titan. Dyson, the privately held British company best known for its bagless vacuum cleaners, abandoned its electric car plans after deciding it couldn't make money from them. I mean, those are two businesses that come from very high profitability and very high return on capital. I agree with them. If you're going into automotive, you better come with some important innovation. Indifference. Bringing a car to market requires a combination of engineering and design talent and execution ability, actually securing manufacturing space and suppliers, dealing with strict and complex regulations, and actually bringing something new to the table.

Even if you start with an advantage, you have the blank slate of opportunities that startups have. You have to learn all these really difficult things that the big automakers do. You know, you have to learn how to design and you have to learn how to build a supply chain. You have to learn to manufacture. You have to learn how to sell and deal with repair, maintenance and after-sales service and all that. But, above all, capital is needed. Just look at returns on capital, not stock prices. Real returns on capital are not very attractive. It is a highly competitive and intensely capitalized industry.

Returns on invested capital for established automakers like Ford and GM have been in the single and double digits for 11 of their 15 years as a public company. Tesla's returns on invested capital were negative. Plain and simple. Companies simply run out of money. Fisker experienced an old-fashioned liquidity crisis. Some of that was inherent to the capital intensity required to become an automaker, but some of it was also due to mistakes the company made. Running out of capital is the biggest problem an automaker has. This might seem obvious. Of course, it's the problem every business faces, but the capital costs involved in starting an automaker are enormous.

Yes, you are missing two billion to get your first vehicle. Not everyone has $2 billion to play with. And frankly, even if there are 2 billion available, that is no guarantee of success. Actually, that's just the beginning. You need to be like a shark where you are always moving or you will die if you stay still. So there needs to be the ability to raise the next 2 billion and the next 2 billion after that. Take Rivian and Lucid for example. Both have gutted $10 billion. It's very interesting to see these other small startups raising a billion or two billion. And they think that's enough.

It's not even close. This was a problem faced by many of the startups that went public using special purpose acquisition companies, or SPACs. A Spac is a public shell company that merges with a private company, in this case an electric vehicle company. And through that merger, the private company becomes public. There isn't a venture capital firm on the planet writing billion-dollar checks for an electric vehicle startup. So to raise that amount of money, the only realistic scenario is to become a public company. For electric vehicle startups, a SPACE had some advantages over the traditional IPO. For example, you could go public using projected revenues instead of actual revenues.

The promise of SPACs, at least, was that these companies could turn to the markets for the financing they would need to grow. It really hasn't been the story. It's not like retail investors have poured a ton of money into Tesla. This is like Daimler and others who put in money when needed, and then debts and other things. You know, companies that are before generating revenue, normally they shouldn't be public companies. It's very difficult for a pre-revenue company to stay ahead and have people interested in investing and putting billions more dollars into a startup. So what will all those billions of dollars in the initial budget go to?

About 500 million to 1 billion to build a plant and equip it, then about 200 million to 500 million more in supplier tools, and another 250 to 500,000,000 in product development costs. There are certain fixed costs associated with building and operating a factory and its tools. Once you've built and equipped a factory, you need to produce a certain number of vehicles to absorb those fixed costs. The person selling the parts will say, well, look, I have a big fixed cost. I spent 50 million dollars to be able to manufacture 200,000 vehicles. You're only asking for 20,000 vehicles. I need my money and then I say, well, sorry, we don't have anything.

Okay, well, sorry, you don't get parts. So you need between 100 and 200 million dollars a year just to keep everything running while you wait for the vehicles to be launched. Once you launch, you need to invest more growth capital into the business to fund the second vehicle and possibly the second plant to build that vehicle. Companies choose different approaches. Vertical integration is basically doing everything yourself, or at least as much as possible. Another way to do things is to outsource some or most of the work. Some start with what's called a donor vehicle, basically a reused vehicle or a set of components from an existing manufacturer, such as a chassis or powertrain.

Lordstown started with a donated body for its Endurance pickup truck. Elms started with a Chinese van. This can save you the hassle of having to build something from scratch, but it can have disadvantages, such as the degree to which you can change the vehicle and customize it is somewhat limited. There is also the asset-light approach favored by companies like Fisker that use outsiders, such as suppliers or contract manufacturers, to make the vehicles you design. It might seem like a company is saving a lot of money by paying an experienced outside company to build the car in an already-built factory, but the costs add up.

Mark Wakefield of Alixpartners says that taking a vehicle model from design to rolling reality can take 2 to 4 times more hours than expected. You never design it once and that's fine. Electric vehicles escape the burden of emissions regulations, but there are still a number of other rules they must comply with, perhaps most notably the Federal Motor Vehicle Safety Standards, or Fmvss for short. The barriers to entry in things like Fmvss are aggressive, they are tough, and they are tough because they are things that can kill people and kill them immediately. But a car also has to be refined enough to drive comfortably.

And there are all these complex interdependencies around vibration and, you know, things that are important to drivers. Macduffie is referring to a concept called noise, vibration and harshness. A car manufacturer must ensure that all components of a car fit together perfectly. If not, you will get intolerable levels of all three. Every automaker that has ever been successful is constantly making many of these fine adjustments. Tesla will probably make a little less and some people will complain about that. You know, the fit and finish isn't that great. The gaps aren't as clear, things seem a bit shoddy and so far people haven't cared because they love power.

They love the big screen, they love the software. There has to be a reason to buy this vehicle. And a lot of the new companies were trying to be the first to act, so there wasn't a huge amount of innovation to really make the consumer feel more stylistically different. Some of them had challenges due to delays in reaching the market. At that time, there were also other vehicles on the market, which were very similar, and now they were not the first to move nor the only ones in the city. This is a huge source of tension.

Perhaps the fundamental problem any electric vehicle or automobile startup will face. I have this dichotomy that you need to change things and be different, but there are a lot of tried and true things in existing vehicle designs, approaches, and validation methods that indicate you run risks when you don't do those things. I mean, the less innovative you are, the lower the bill can be, but the less innovative you are and different you are, the less reason there is for anyone to really care about your product and value you on anything. There is no exact recipe for success.

US data shows that demand for electric vehicles is stagnating. Tesla missed even the most bearish delivery targets for the first quarter of 2024. Shares have fallen nearly 35% since the beginning of the year. On the other hand, rival Rivian's first-quarter deliveries were better than expected. In some ways, today is a lot like the early days of the automotive industry. At the time, there were hundreds of small businesses, mostly clustered around Detroit, the center of the business. But in a very short time, about a decade, the vast majority of them disappeared and only a few survived. They are more or less the same big three that exist today: GM, Ford and the remains of Chrysler Corporation, which has merged with the Fiat and Peugeot empires to form Stellantis.

Part of that consolidation came as automakers moved toward achieving economies of scale.for final vehicle manufacturing, but there was also a lot of vertical integration that brought suppliers inland. General Motors is known for consolidating several brands such as Chevrolet, Cadillac, Buick and the now-defunct Oldsmobile and Pontiac, but it also brought many third-party suppliers in-house. GM's legendary CEO Alfred Sloan even came to the company through a supplier acquisition and then rose through the ranks. But in the second half of the 20th century, automakers began expanding their supplier businesses in an effort to become more efficient and focus simply on making the final product.

Today, that trend appears to be reversing. Tesla and BYD are two of the most vertically integrated companies in the world. They are deciding that it is much better. You get a lot more control, you get a lot more parts suitable to fit into a complete vehicle. If you do it yourself. You generally have more flexibility if you do it yourself. But it costs a huge amount of money up front. They could be repeating a pattern the industry saw before, and both their market share and ability to survive so far suggest their chances of still being around in another decade, when many of their potential rivals have bitten the dust.

Even if there is a rush of startups and a postponement of them right now, history would tell us that it won't last.