Why Remaking the Auto Industry Makes No Sense

There are two competing theories on how to reset the auto industry. One is that entrepreneurs can create auto companies from scratch by outsourcing major component systems and abandoning traditional dealers. The other is that five or six giant companies should rule in a globally consolidated auto industry.

Neither theory makes sense.

The Entrepreneurs

First, take the entrepreneurs—people such as co-founders Elon Musk and Marc Tarpenning of electric car maker Tesla Motors. The theory is that entrepreneurs can quickly integrate new technologies (mostly electric propulsion systems) and cobble together cars from outsourced design and components. But assembling cars this way cannot reach the scale necessary for mass volume. Small production volumes result in high prices that can't compete with those of the large auto companies. Although they might be late in adopting a technology, they will have the advantage of scale.

The San Carlos (Calif.)-based Tesla Motors sells the only electric vehicle legal for highway use. But the price of the current model, the Tesla Roadster, is $101,500. That's in the range of the ultra-luxury Porsche Carrera. Despite the high price, Tesla probably loses money on each Roadster it sells. Fisker Automotive, based in Irvine, Calif., prices its Karma model, which uses a hybrid drivetrain, at $87,900. Deliveries will begin next year, but at that price Fisker, owned by former BMW and Aston Martin designer Henrik Fisker, is unlikely to sell many of these imported vehicles assembled in Finland.

Entrepreneurs focus on building a car, but that's half the challenge of success in the auto industry. Car developers often ignore the reality of how mass-market cars are sold, financed, and repaired, and they forget how important resale values are to establish a brand permanently in the market. Cars stay on the road for 10 to 15 years, and owners expect a car to have a predictable value throughout its lifetime. That means the supporting infrastructure is as important to the broad base of consumers beyond the elite collector, who is impressed when Tesla sends a technician to his home to fix a part.

The Consolidators

On the other end of the spectrum from the entrepreneurial approach is Sergio Marchionne's vision of a globally consolidated automotive industry. Marchionne, the CEO of FIAT (FIA.MI) and Chrysler, believes that eventually there will be only five or six large global automobile companies serving the mass market.

The consolidation theory has its roots in the mid-1970s, when the Arab oil embargo resulted in a global recession. Under the theory, excess production capacity, which today approaches 30 million units annually, would be eliminated through the thinning of vulnerable companies and the closing of uncompetitive assembly plants. Production would shift from high-cost locations to low-cost areas as part of this global restructuring, increasing the efficiency of the enterprises.