I think a good place to begin would be for you to give us just a bit of background and context to your experience. How did you enter the auto space?

I entered the auto space about 27 years ago with Daimler. My first years were in aftermarket and in product management. Later on, I moved into Booz Allen Hamiltonwhere I was active on the commercial vehicle space, helping the merger of Volvo and Renault V.I.trucks. Then I spent the last almost 18-19 years in suppliers. I worked for Bosch, first in diesel and then in India in auto-electrics and electro mobility - starters, automators and small motors. Then in Continental and in Volvo, I was head of purchasing, working mainly with suppliers. I sourced the current SPA [Scalable Product Architecture] platform, including the SPA electrics, so everything that is in the 60s and 90s series today in the market. The last 5 years I was in Valeo as head of sales for all products, all customers, all regions. In this context, again, electrification was a key element, not only because Valeo is probably number 1 or 2 for alternators worldwide, but also because Valeo is really keen on the 48V system. Later on, we did the joint venture Valeo Siemens, which is one of the larger providers of electric architectures now in production or in development of major OEMs from Volkswagen to Volvo to Jaguar to Peugeot in various applications.

How is the culture different at a Tier 1 versus an OEM in your experience?

I think that's an important question. I really appreciate working for suppliers because there is one big difference, working for suppliers you only have a few customers. And the work is much more focussed on how to make sure the customer is happy. I've worked in two different OEMs, Volvo cars and Daimler. There, the customers have to be far away because you have a three tiered sales structure: you are in headquarters and you sell to the regional or national importer, and then they sell to dealers, then comes the customer. So the customer voice is really hard to hear and this makes space for a lot of politics. The other reason for a lot of politics in an OEM versus a supplier, is that nobody knows what will be the tastes three years down the road. So once you decide on a vehicle, the design, the options, the features, the capabilities, you don't know whether this will fly three years down the road. It's about guessing and the guessing is again power gaming between different fractions, more cost or more engineering, more of this or more of that, more halogen or more LED, more electric or more conventional. Whereas, as a supplier, you are much closer to this business. The key for suppliers is to win the business for engineering.

Once you are in production at an OEM, the pure sales are relatively far away, as you have these three years of co-engineering. So the challenge here is to get close to the customer, to work with him, to find the right design and the win the award, whether it's an option or whether it's a classic RFQ. Then you have this intense co-engineering work until the car goes into production. Then, finally, there's the sales, in terms of the money, the cash flow for you as a supplier manager is very far away, and you're already looking for the next vehicle to be launched.

Do you think the culture at OEMs will make it difficult for them to adapt to an electric industry?

Again, I worked in trucks and passenger cars. So trucks are obviously a B2B business, where you have many businesses, so it's somewhere in the middle. We can keep that to the side for a moment.

For an OEM, this culture of self definition and trying to predict the future where it's uncertain also means you also need to predict customer demand. Well, demand is switching fast now. Demand is not linear, there's exponential growth, like the electric vehicles now coming in. It's very hard to project a nonlinear development. Will it explode in 3 years, in 5 years, in 10 years? Will we still have diesel cars in 2030 or not?

Therefore, there is room for discussion. But, of course, the classic engineers are very proud of their ability to have the most efficient combustion system. It's very hard to convince them that they might not need to do that because there won't be the same demand that there has been in the last 100 years in the next 10 years. That's why it's culturally very hard for an OEM to be far away from the customer, to just follow the intuition of Bloomberg and forecast institutes, when the customer is still buying diesel cars every day.

You mentioned earlier about Valeo being a strong alternator business, which has then led to the 48V system. Can you elaborate on the engineering basis of the alternators and how that led to the 48 volt system?

For a long time, cars have been supplied by 12V solutions. It was 6V in the 50s. Trucks in Europe and Japan have 24V systems, though not in the US. Obviously trucks have a higher voltage because the energy consumption is much higher in a truck.

Now putting this on a 12 volt solution, with many more features coming in, soon you'll realise that for a Mercedes-Benz S-Class, an Audi A8, for a BMW 7 series, your 12-volt system has its limitations. You want it to be autonomous, you want to have calculations, you want to have rear-seat entertainment, that's lots of electric consumption on top of the already available demands. This has taken the 12V system to its limits for a while.  In around 2000, they tried to use 42V, but this failed because suddenly innovation came and 12V was happy again to run for another two decades. Now, 48V is a mathematical calculation of 12. Because you have 3 phases and 6 phases, it's logical to have 12, 24, 48 and not 42V. But this is a way to increase your electric power in an existing vehicle, without passing 60V.

60V is important in electricity because it's the border between low and medium voltage. And you're meeting the requirements for mechanics as everybody's usages are different. From 60V onward, it endangers life if you connect the two poles with your fingers and you are not attentive. Therefore, we wanted to stay below 60V. Now, 48V was the natural choice and the big hype came when we thought "Oh, we have our diesel and gasoline cars, when we move towards some electrification, a mild hybridization, with a little bit of electric power we can actually make our gas and diesel engines live much longer." So we planned for 48V, then we said "Ah, diesel is under pressure now in the UK, in Germany, in Paris, all over Europe." The 48V system gives big savings. You cut off the highest consumption areas of the engine, you can help on the start and suddenly you have mild hybridised vehicle where the gasoline consumes like diesel.

This is great when you continue on combustion engine thinking. We now see that the world will move to electric, even in China and the US also, and with the legislation in Europe, suddenly a 48V enhancement of a combustion engine becomes more questionable. It's the choice between enhancing your old style, let's say, steam locomotive, the old style typewriter or passing straight into modern future-proof technology, in this case meaning electric vehicles.

Yes. New legislation that the European Commision now performed in light of having cities with health problems caused by too much pollution on the main roads, surpassing microdust, microparticles as well as NOx. This lead to regulation that now requires that from 2021 average emission levels of a new car should be equivalent to 95 grams of CO2. From 95 it will go down about 37.5%, this leads mathematically to 60 grams of CO2. Now, in December 2018, we have 120 grams. This means from now to 2030, you want to reduce it by 50%, one half. That is unprecedented. It's never happened before that legislation requires you to half consumption in a period of 11 years. At the moment, the only choice is to have a significant amount of electric vehicles in your product mix to fulfill this requirement.

Now, this comes back to your OEM situation. You sit there in your executive team, you have x amount of resources and the resource of engineering, typically 5-6% of your sales. There is a lot of engineering that needs to be done, autonomous vehicles, connected vehicles, you want to have nice displays everywhere in the car, LED lights and all this fancy stuff. And on top of that you need to decide "I do either 48V and my latest emission norms on my diesel and gas or I go for straight electric cars." And suddenly resources get tight and priorities get difficult.  You have to decide, and it's likely that's what will happen now, to cut off the combustion engine where it stands and to put all the resources into electric to catch up with Tesla and to catch up with China and really make an accelerated run for electric vehicles. Then the money for combustion engines and 48V is limited or non-existent.

So what are the major components of a 48V system, in terms of the price per component?

Actually the 48V that I mentioned was done by suppliers like Valeo, Bosch, Denso and others now because they said "Hey, I have an alternator that makes 12V and I have the same alternator that makes 24V. I have lines producing millions of the same alternators in different sizes, now I basically change the electronics and then the alternator makes 48V. So basically, I have no capex requirements, except the electronics. And I have an electric motor that does around 12-15 kilowatts."

Now, when you put this in the classic position at the front of the engine then when you drive electrically and you have an idling engine, you have to also pull and this costs a lot of energy. Or you change the alternator position and put it on the rear side of the engine, next to the transmission, then you can decouple the engineand make your own differenttransmission.And that's why you have these different architectures, P0 or P1, P2, P3. But, ultimately, you say "Hey, I can put it on the rear-wheel as well, 15 kilowatt on the rear-wheel makes it an electric 4x4." Not for high-speed driving on the racetrack but to pull your car out of the snow or to help you start, these are all nice things. Then, suddenly, you have P4 architecture, but at the end it's always the same, it's the alternator converted to an electric motor that is easy to realise. So this is about a cost of maybe €200 in total, alternator plus the electronics.

Now, when we have 48V, you need to also balance between 48 and 12 volt in your interior and your compartment, so you need to have a DC-DC that is balancing the two voltages. You might want to charge it from the outside and you might have a charger that is a battery. These things that are then part of a 48V architecture, depending on how much electric drive you actually want to realise.

So you've got a DC-DC converter, typically how much does that cost?

48V to 12V is easiest, maybe €150. €200 would be on the high side.

Now, the inverter is more challenging. The inverter is the intelligence of the electric motor. You need it to make your electric motor drive like a motor, not like an alternator. So this is now the electronics I mentioned, before, to scale it up. It was maybe €100. Nowwhen you want an inverter for rear-electric drive you add another €100: you put on the alternator, you have a seperate device and it's more like €200-250, sometimes €300 when you go into higher voltage areas. But for 48 volt, maybe €200 on an inverter.

And this inverter is made up of computer software?

And power electronics. The power electronics drive the price, the software is also needed but the price is the power electronics. That's why high voltage, meaning electric car, inverters are in the €300 range, whereas a 48V is probably nearer €200. Because the elements to control the high voltage and the high currents are much more expensive on a 300-400V than on a 48V solution. But it's essentially the same. And what is an inverter doing? Just for your understanding. The battery produces direct current and the motor likes to have alternating currents. Not alternating like you get out of the plug at home, which would be a sine curve, but a curve in which the phases are designed. So it's a specific design of alternating current to make a motor behave in a smooth and comfortable way. All the intelligence in an electric car is to have an inverter that makes the electric motor drive like you want to have a car driving. It's a pulse and phase shaping type of electronics and that's the intelligence that's hidden in there in terms of software and hardware. It's a pulse with modulation. You have modulation on your radio, it's why it plays music and not just noise. So there's a lot of power in modulating your waves in the height and the width and cutting them off, and this is exactly what you do in this case

So how does the componentry compare when you move to full EV from 48V systems? Does the inverter become more expensive and more powerful and sourced from different companies. How does the componentry change?

The componentry from an electrical engineering perspective is the same. It's the same elements you need. It's just a question of higher voltage and much higher currents because an electric car on 400V typically has 100-150 kilowatts and on a 48V you have 15 kilowatts. That's a 1 to 10 ratio. This means all your power electronics that control the electric waves need to be much more robust and much heavier and you need cooling and temperature control otherwise they get too hot. So basically, the functioning is the same and the actuation is the same but the implementation needs high voltage semiconductors that are a very special breed of design, they're much more expensive on a 400V than on a 48V.

It seems like a lot of the value-add actually comes from the inverter, which is manufactured by Infineon or any other semiconductor business.

Infineon would make the chips that have these modulation files.  Then you need to have enough higher-end output units that are able to control the higher voltage and the higher currents compared to the 48V, where the power units are smaller in size. Infineon makes the chip that control it and the power units that give the right output, and these are expensive. The chip gets into the €100 range. A few chips from Infineon are really expensive and these are the best ones. And why Infineon is so important compared to others? There are many sources, but as you move up in the voltage, the losses become really important. When you have 1% less efficiency on a 48V then you create some heat, but if you have a 1% loss of efficiency on the 400V then you can do the mathematics yourself, you immediately come into kilowatt ranges of heat that you need to dissipate and you need a thermal system to take it out, to protect the electronic components.

So just from the content per vehicle lens, if you look at Delphi's recent results, they're saying that content per vehicle roughly is $450 for a 48V mild hybrid system and it goes right up to full hybrid $1200, plug-in hybrid $1500, electric vehicle $1500. Does the inverter make up the major cost in that?

Yes. The calculation of $400 to $1500, $1600 is basically as you said, the plug-in hybrid on a 48V and a plug-in hybrid on a full electric vehicle, this is on the basis of the electronic components needing to be more robust for the higher voltage. This jump from $400 to $1200 comes because as an enhanced combustion engine, you would have less components, you would basically have a simplified inverter, basic electronics, and a cheap motor. On a plug-in hybrid you want to actually drive, then you need a motor that is made for driving and the an inverter that is made for driving and the DC-DC to have a more constant charge, and this all blows up the cost, that's why it goes higher. And then in a plug-in hybrid, you also have the charger to connect to the outside world, which is not part of the basic 48V, that's another $100-200, $250 sometimes.

Do you think there's enough raw material capacity and assembly capacity for pure electric vehicles? In terms of the inverters and assembly of the batteries required for the OEMs to meet the new regulations?

I think regulation is not the problem. The problem is that the new technology needs to be ramped up, so everybody is investing in capex. We haven't got much experience so the first capacities are ultimately not the best ones, that will come after 10 years of production. We are learning, we'll scale up and then over time we'll learn to become more efficient and more cheap. At the moment, everybody's investing and trying to get a big share of the cake, of something that did not exist 3 years ago.

That leads us on to the question about the changes in the value chain, which I think is important. Maybe you can share some insight and a bit of context into the percentage change of components that are outsourced from OEMs over the last say 10 years.

Historically, most of the OEMs have produced their own engines. Transmissions a little bit less, they have a mix, some are bought, some are done in-house but the large OEMs tend to have transmissions in-house. So you have big factories that are basically doing the mechanics, the engines, and transmissions. Those will be ending.

And now on this electric device, you have two items that are key. One is the electric architecture, with the inverter, the motor and the elements we just discussed, the other one is the battery. Now, surprise, surprise, the battery is much more costly than before, when it did not exist. Whereas the powertrain gets a bit cheaper, so the electric architecture as such is not necessarily more expensive than the motor and definitely less than the motor plus transmission but electric architecture plus battery is a huge add-on cost. That's why the cars are so much more expensive, and even then, not profitable yet.

OEMs are trying to make some things in-house to employ their workforce. But, on the other hand, we all know that the electric motors make a difference in terms of carbon. Would you buy a BMW for their electric motor? Probably less likely. So many OEMs find that it might just be smarter to buy from a supplier who can then allocate the engineering costs, not on the basis of a single customer. If you do it in-house you will only do it for yourself and the capex for only one. But, if you go to a supplier, you would have a large scale production for many OEMs of something that is not necessarily considered as a USP in your branding . That's why the value chain is now moving strongly, with a few exceptions, from an OEM who did in-house engines to giving this to suppliers who in some cases deliver the whole electric architecture and in others, the whole battery and all mixes in between. So some, like Daimler, want to produce the battery in-house, others even source the battery like Tesla and others, like BMW, want to do the motor in-house. So everybody is trying to find out where to position themself in this conflict of 'here is my workforce that I have to employ and here are the costs', and that it's probably cheaper to buy from Valeo Siemens, Bosch, Conti, Denso, Delphi than doing it all in my own installations.

Roughly what percentage to date is outsourced in the EV vehicle versus ICEs?

Back in 2012, we had about two thirds of costs at suppliers. Now, recently, with the move towards the other big ticket items, autonomous, connected vehicles, it moved straight into 70-75%. I would imagine that now when we have a fully electrified vehicle you would go way beyond 80% that is sourced from suppliers, and you as an OEM come back to basically being an assembler, that assembles the technologies and that puts it in the car. Then, the cost - not the price of the car but the cost - would probably come down to 15% only and all the rest you source from suppliers.

So how do you look at the role of the OEM in this new value chain? You said it's just an assembler, when you look at the actual value-add of it, is it just purely the brand and then the leasing capabilities in some kind of mobility customer relationship?

There could be some extreme cases, in which an OEM says "Okay, I'm just doing design, brand, buy and sell." While this could be dangerous on one view, we also see that there's an extremely strong move towards software and software becomes a clear differentiation factor. Now, when you think about smartphones in general, a Samsung to an Apple to a Chinese phone, you see that while the device is basically the same, the difference is in the software environment, the operating system.

The OEM's haven't got the capabilities for that?

That's absolutely right, they don't have it yet. They see that the point of differentiation will become much more a case of a good design, the space, and a good ability to have software to customise the vehicle in the way the customer likes it. Rather than having halfware, meaning capex invested USP for your brand image. With this move the risk is not so dangerous. Once you control the software and you control the specifications, you can actually make this move in a positive way.

If they can get the capabilities to build this in-house?

Exactly, if they have the capability of the software as a differentiating factor and the design, this of course becomes key then.

Which parts can they manufacture or design in-house? You mentioned that BMV are looking to do the motor. Out of the legacy OEMs, what are the different strategies?

All kinds. Some, like Peugeot, set up joint ventures with Nidec because they want to have some control. Others, like Volkswagen, asked suppliers for the statotr and the rotor and then they assemble the motor on a short line to claim that they still produce the motor themselves, or you assemble the inverter and then make the packaging, or they buy the cells and makes the battery packaging. All these different models exist and it's not yet clear what the ultimate solution is, but it's clear that BMW understands more in depth what it takes, and therefore, interestingly it's taken a different approach to others. Daimler just announced that it's going to expand its battery manufacturing, if this is the right thing to do, I don't know. Look at how Tesla makes it, Tesla gets the battery, the motor and everything else from outside, but it still manages to have a fancy holistic brand image and a car that is unique to Tesla. So I think the brands will work very hard now to find a new way of differentiating themselves, and for this they need capability they don't have.

How do you look at Tesla's position, in terms of their vertically integrated manufacturing with Panasonic?

For me, it's a Panasonic factory. Now, you have a Panasonic factory in Nevada, you have several in Japan, you will have some in Europe and you will have Northvolt, which is basically Panasonic design implemented in a new type of style out in Northern Sweden. So for me, actually Tesla is an example of how you can define the content of the battery without producing it yourself, and this is very much a role model. They designed it, they have the specifications. And that's what BMW is also doing. They also want to keep this concept.

Do you think they have a significant advantage over legacy OEMs in being vertically integrated?

In this dimension they would have a huge advantage, because they have a design and they have experienced challenges and they have now finally made a car that was profitable. They have found a way to come forward with the electric architecture that now tends to take traction. I see the problems of Tesla in a different way, but from this perspective, they have a huge advantage.

The problems we saw in the press was this production hell that they had. Elon Musk had the idea to make everything different by designing it. It's a good choice to design it, but sometimes they were forced to make it different because classic suppliers did not want to take the bet. You go to Fremont to see the seats that are produced in-house by a not very well known supplier who took the risk to engage with Tesla. The current players in the world did not engage with them. Because of this Tesla had to take unique approaches. Now, when they took these unique approaches, they learnt a lot of things. But, now he also wants to take a unique approach to manufacturing, this almost made Tesla collapse, because to scale this up into a large scale manufacturing you needed classical know-how and they took too long to accept this. It took a while, but now they have finally come to a relevant level of mass production.

Were suppliers not willing to work with Tesla then?

I myself had this challenge. How much do we engage and when we do engage? How much of the plan do we believe in? How much capacity would you build up to believe in Tesla versus what happens if they go bust? Take Faraday, take thousands of others, who just disappeared. And others will disappear, not all of these startups actually really take off. Tesla finally managed to take off but he remained a little too long on his own ideas regarding manufacturing, not in design. In design he made the right bets and it paid off. On the manufacturing side, I think the same logic made him take too high bets that almost made him collapse.

Just on Tesla's design capabilities, do they only design the battery, or do they also design the inverter and the system around the inverter and the motor and converter as well?

To my understanding, Tesla tried to design everything, because they made some huge bets on the battery, on the battery thermal system, on the way the whole architecture is built. They took huge bets in terms of making it happen, as I mentioned, some worked out, some others were challenging to manufacture, and some others will be challenging in the near future. Because when you take this bet to reinvent, you also have to make some compromises. My personal view is that Tesla did not dare to jump far enough from a platform or 'skateboard' concept that is now only becoming visible in some players in the world. To take electric mobility one step further, you would no longer have a classic vehicle as Tesla still is. You would go one step beyond and have a 'skateboard' approach, where you then create flexible body structures on a 3D print in a decentralised location, rather than having a mass production facility in Fremont. But this is only now becoming more clear, this was not clear when Tesla started.

Could you elaborate slightly on this skateboard concept? How far away are we from this and what does it look like?

I think today the first skateboards still have to come to life. Volkswagen have come in with a very skateboard-ised approach. One platform can become many cars, many body shapes out of the same platform, which is not necessarily the case in Tesla. You have a Model S, a Model X, they have a Model 3, which is relatively different already. Basically they do not have this platform thinking - many cars out of the same base - but more like every car is vertically integrated in design and manufacture, which is exactly the down side they will be facing when taking the next steps.

What makes it a platform? What's the engineering behind that?

We got back to childhood, I played with Lego, these Danish coloured bricks. Similarly, with a platform you take the same base, you put the wheels on, and afterwards your body shape can be as creative as you want to be. The platform having the battery, the four wheels, and the steering is self-contained. It's enough to have the vehicle running, and all the rest is then a creative design.

They could have done it but it's a different approach. An approach where you have a platform that is in itself already self-sufficient in terms of rolling, driving, crash-testing, breaking. The whole functionality in 4-5 metre long, 30 cm high box where the battery, the wheels, the motors, the steering, everything is already contained and all the rest is then fancy, creative and made on the spot. More like a structure but applied to electric passenger vehicles.

You mentioned how the OEMs are moving towards being more of an assembler. How do you think that will affect their cost base, with all the employees they have, all the capacity they have? So you think we'll see consolidation in the OEMS, or huge restructurings?

There will be a major impact. This is now beyond 2030, but over the next 20 years, when we think about electric automated mobility-as-a-service vehicles, whatever you call them, then the differentiation will no longer function in the way that it does today, and so you would not need everything that the big OEMs have invested in factories. This will be replaced by more creative flexible solutions. There, the OEM actually has a legacy problem, because it will need to justify its experience in bricks and mortar that will no longer be needed.

Is the Tier 1s' position in this EV world stronger? They own more of the design process, more value-add.

My personal view is that the Tier 1s are benefiting from this by and large because, whether it's a Waymo, whether it's Evelozcity or Volkswagen EV or ProfessorSchuh or whether it's a classic car. You always have a part of your supplier in it, so this is why you have to be flexible for this revolution. You can adapt and you can supply the parts in all kinds of vehicle. So long as it's a vehicle, you can supply.

Whereas the OEM is the one who has made these big investments and this needs to be justified. It might actually be a legacy rather than an advantage, at a given moment in time, when we think beyond electrification now into skateboards and what's coming.

The OEMs are outsourcing more to the Tier 1s. Do you think they could increase the EBIT margin? For example, Delphi is around 10% currently. Or do you think the OEMs still have the power in that relationship?

Good question. I think the contents will increase or suppliers will have more value and will grow further, but will they be much more profitable? As long as there's competition in this market, I wouldn't think they were going to be much more profitable. The first period will actually be less attractive because this transition from doing fuel injectors on Delphi and also doing electric architecture, takes a lot of investment in terms of engineering and new design, and capex. For the first few years, it will take a time until we come back to normal margins, only with electric architectures in the same way that they enjoy combustion engine parts today. This is going to be the next 3, 4, 5 years. Over time they will grow, but as long as there's competition among those 5 or 6 big players that we know today, then I would not see that their margins will explode in a situation where the OEM still assembles the vehicle and has the branding and the marketing power towards the end customer, when they would be under huge pressure. So at least today, the model is - and I would say that it will stay this was even if the players may change - that the one who is at the customer front makes sure that his own margins are not significantly lower than the margins of his key suppliers. And when it happens, you'll find ways to squeeze down the supplier and play competition, so that you get it back to a balanced margin.

Is it likely that we could see consolidation in Tier 1?

No, I wouldn't necessarily see consolidation.

Do you think there's space for all of them then?

Of course, there is consolidation. The big ticket names, the top 10 or top 20, have all understood the shift. Delphi, Conti, Bosch, Denso, ZF, and so on, they've all understood this now. But the smaller ones, the 20 to 100, they are often still stuck in pistons and crankshafts, in classic elements.

If you take the powertrain ones, you've got Denso, you've got Conti, Bosch. Is there enough space for all of these?

Yes, definitely, for those 5 or 6. Because the market will hugely grow and they will benefit from it. But the smaller suppliers will either be consolidated, disappear or go out of business. And the strong suppliers now will they be able to command more margin? They will be healthy but I cannot see that they will ultimately command much higher margins still when their customers, meaning the vehicle assemblers, the builders, the brand owners who sell the vehicles to the end customers, if those make no margin then I think the competition will make sure that the balance comes back. So there should be reasonable, not identical, similar levels of margins.

So how do you look at the challenge of managing the legacy gas and diesel injection business with this new power electronics business?

I think this is probably the biggest challenge that now Delphi and Bosch face, and to some extent Continental as well, because you still have some challenges to keep up your manufacturing, to get the tolerances is right, to meet the next emissions levels here and there. The engineering effort is irrelevant to the volume, so you still have to put some power, some force, some money into keeping it, whilst at the same time you would need the money to actually invest in electric architecture. So it's going to be a difficult balance for them to play, to get the right priorities on wrapping up fast enough. Not to forget the cash cows that we have. This is a special challenge of the business in managing to keep this balance right. Also, compared to the consumer electronics, meaning autonomous connected driving, where you have these laser scanners and the Ubers and Waymos coming in, I do not see side entrance on the performance electronics. On the electric architecture, I don't see so many people coming from the outside, because the barriers of entry are not negligible. You're doing electric motors, small motors you can do for €5 or €10, this is not a problem, but big motors, performance motors, drive Motors, propulsion, this is something where there are some but there isn't a newcomer around the corner every day.

The difference is that on the electronics side, electronics gets miniaturized and software takes a big share, though on the consumer electronics side, less and less electronic hardware, more and more software. And this allows new entrants to come in. On the high-performance electronics, it's actually a much more classical hardware, it's not mechanic but it's electrico-mechanics. So you need to understand electromagnetism, you need to understand how the waves make this motor turn, how the friction, how the control is happening. This is an area where you need really solid know-how. There are existing players who have it, and some who are investing in it, but, unlike software, not everybody can do it. There's no Google and Waymo doing electric motors or inverters.

And the OEMs can't do it because they've been outsourcing this for years.

Exactly. Except BMW who have now invested heavily. The others don't have this experience and suddenly players who did like Siemens and Hitachi, have come into play.

Which is why you see the growth in Valeo Siemens lately?

Exactly. It was a huge step forward with Siemens because Valeo had no idea what electric motors do. We did alternators but that's a different area. It was an alternator, not an electric motor, and this is not what you need to have an electric vehicle. And Siemens really brought this with the joint venture.

Why can't the likes of Siemens or Panasonic or the core electric players partner with the OEMs directly? Why do they partner with the Tier 1s?

That's what Siemens has now done. Of course, the electric motor for a big machine or a big streetcar or a train is not the same as a car, so some adaptation is needed. A car is specific in this automotive grade as we call it. But of course you have a good prerequisite and some people are trying this now Nidec has gone from small motors into propulsion motors jointly with Peugeot.

But indeed Peugeot made a joint venture to get there and if you are coming from the outside, from the world of software, then you are just not equipped with this know-how so you have a few who are trying to partner in joint ventures, like Nidec Peugeot, others like Valeo and Siemens. And there are some other solutions, Delphi want to do a lot on their own. But, at the end, there is not a high number of new entrants coming in, which, now coming back to your margins, might promise for those who actually take the challenge and invest, that they can also have a good margin and a good market.

Just looking at the valuations of Tier 1s, they're trading so cheaply right now, I think Valeo and Delphi is on two three four times EBIT multiple, which is the lowest in the last decade or so. It seems to be,  if  you look at the diesel business, there's only a couple of players that can earn pretty decent margins. You mentioned they can run the gas and the diesel business for cash for the next few years, investing in power electronics. Do you not think there is more value here than the market is estimating?

Yeah, I would even say it's an over correction. There was a lot of hype in the idea that we will all drive autonomous and electric vehicles in the few years to come, then suddenly the market realised that it takes a lot of time until the cash comes to the door. And the more we find out about electric, the autonomous story gets rather delayed, it will take much longer for any return to come back. Suddenly you realise, that's a lot of capex, a lot of R&D costs, and that the future takes some years to come. Now they have corrected it down to a record low level, but it has to come back to a reasonable amount of valuation that is equivalent to the potential that those Tier 1s have in this field.

For a private equity sponsor would it be attractive to break up these in businesses?

I think a lot of things are happening at the moment. I think there will be more to come. Delphi was badly spinning separating as Aptiv from the diesel and gas side. So I think there will be more of these deconsolidations.

Interestingly enough, both Conti and Delphi have kept the electric propulsion jointly with the diesel. Now, why? Because it's electro-mechanics, it's not software and devices. It's much more hardcore and this is where there are the entry barriers, and where the business dynamics will be different, not negatively, they will just be different from these high fancy electronic type of autonomous work.

How do you compare the positions of the likes of Delphi, Conti, Valeo, in terms of the legacy business? You mentioned earlier how Valeo had a strong alternator and 12V business that allowed them to scale to 48V, but I guess they've spent a lot of capex on this business, so if we do see a shift to full EV, how would that affect them?

I think there are other reasons why Valeo is under pressure. That is one of them. It was a decision that's been taken. But, today, I also see why Bosch spun off their 12V alternator business and gave it to a Chinese investor, and focuses solely on electric vehicle motors and it works. Conti actually does the same. Conti has no 12V business at all, and we always thought "Conti will never make it." But Conti somehow makes this work. What Conti and Bosch are doing selling the alternators, is combining the 48V with high-voltage electronics, so they're doing exactly what I said earlier. The architecture on an inverter on 48V and an inverter on 400V is the same. Whereas, there's a big difference between what you do on an alternator plus on 48V, compared to a P4 architecture where you actually want to drive a car where the alternator function does not exist anymore but you really want to have an electric motor inverter, plug-in charging and you have a full electric system. Therefore, the decision of Conti and Bosch is actually quite interesting to observe and it might be a challenge for Valeo.

Delphi is not doing any 12V business, at least not significantly. But they have the electric architecture. They are a little smaller than the others, but they're also smart. I'm actually quite impressed by what they have in the market. The question is will they be strong enough to manage both. On the other hand, you mentioned that the diesel business might well turn out to be different.

I like the example of bearings and turbochargers. We have duopolies in these markets. In turbochargers it's obviously Honeywell and BorgWarner. They have sky-high margins because nobody else can move into turbochargers. Nobody has managed to get in, to a sizeable degree. It's the same in bearings, you have two Japanese, two American and two European suppliers. All six have sky-high margins because nobody else can enter this business from the side. It might well be that when Conti is struggling with diesel, you'll have only two players left. You'll have Delphi and Bosch. Delphi and Bosch both have significant truck businesses in diesel that Conti doesn't have. So both might well be in a good position to milk the cash cow for quite some years, and there will be little competition for them.

Tier-1 versus OEM: Powertrain Dynamics

Senior Vice President of Sales and Business Development, Valeo SA

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Axel Joachim Maschka

Senior Vice President of Sales and Business Development, Valeo SA

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Tier-1 versus OEM: Powertrain Dynamics(October 9, 2019)

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