THE “REAL” PARADIGM SHIFT: A re-examination of Porter’s Forces as Applied to the Disruptive Force…

THE “REAL” PARADIGM SHIFT: A re-examination of Porter’s Forces as Applied to the Disruptive Force of Digital Transformation on the EV Industry.

Introduction

The electric vehicle (EV) automobile industry has been characterized by high growth until recently. The Canadian and the US EV markets are expected to experience a slower growth of 26.8 per cent in 2024 due to a lower global demand secondary to a reduction in state subsidies

(Kachwala, 2024). Tesla, once considered the only first mover in the EV industry, must now face strong competition from new Chinese EV automakers in a race to the bottom line (Hoskins & Sherman, 2024). Nevertheless, in the past couple of years, digital transformation as characterised by Industry 4.0, which includes artificial intelligence (AI), internet of things (IoT), blockchain and cloud technology, in addition to additive manufacturing, has played a central role in accelerating growth in the industry (McKinsey, 2022). This will continue well into the future, Tesla’s CEO predicted, given the unprecedented pace at which AI technology has grown recently (Musk, 2023). In this essay, the impact of the digital revolution on the EV industry will be examined in light of Porter’s (2008) five (or six) forces to determine the sources of profitability and competition within the industry (Figure 1). It can be argued that digitalisation has such a disruptive effect on the other six forces, as to mandate the inclusion of the seventh force in Michael Porter’s framework, that is, the rate of innovation (Larry et al., 2014, as cited in Kohnová & Salajová, 2023). It is through this seventh force that AI exerts its influence on the competitive landscape of not only the EV industry but also most industries in the near future. For this essay, the scope of analysis will be limited to the EV industry, versus the greater automobile industry, since the size of the EV market now merits it to be considered as a separate industry in its own right.

From an industrial organization (I/O) perspective, the three strongest Porter’s forces affecting the EV industry were traditionally high barriers of entry, moderate threat of substitutes, and low rivalry between firms, which once upon a time made it a moderately attractive industry for other automakers to get into (Figure 1; Shu, 2022). High barriers to entry were due to the high capital costs needed for R&D, limited access to suppliers and distribution channels, incumbents’ strong branding particularly Tesla, and low demands for EVs (Kim, 2014; Shu, 2022). Few US luxury automaker incumbents were eager to jump onto the bandwagon with Tesla in mass producing EVs because the steep part of the learning curve (or by proxy, the experience curve) (Porter, 2008) was not particularly easy to climb (Figure 2). Technological know-how comes at a high cost, and pursuing innovation means foregoing other cost-reduction strategies (Abernathy & Wayne, 1974). Innovation was once said to be the enemy of efficiency. Even Tesla’s CEO, Elon Musk (2022), recognized that the main challenge that EV firms must face was to “achieve [scale] without going bankrupt”. As such, these factors became major deterrents for EV-maker wannabes so that threats posed by new entrants and subsequently, substitute products, e.g. hybrid cars, were low even as late as a couple of years ago (Kim, 2014).

Figure 1. Porter’s Five Forces (Porter, 2008).

Figure 2. The Basic Sigmoid Curve (S-Curve) is what usually typifies a learning curve for an industry (Fordyce, 2020).

On the other hand, the EV competitive landscape has undergone a radical change (and will do so in the next few years) due to the widespread digital transformation brought about by Industry 4.0. Industry 4.0 (also known as the Fourth Industrial Revolution) is the next step in the digitalisation of the manufacturing sector “driven by disruptive trends including the rise of data and connectivity, analytics, human-machine interaction, and improvements in robotics” (McKinsey, 2022). According to one research, the effect of Industry 4.0 is mainly to change the rate at which new substitutes appear, the so-called “content changes” (Figure 3; Kohnová & Salajová, 2023). Although the study has some limitations, basing their findings on a handful of Slovakian firms, their argument has been corroborated by recent trends of new players entering the market such as the Chinese EV automakers (Hoskins & Sherman, 2024) in addition to the rising number of complementary products associated with EVs, which include Over-the-Air (OTA) technology and charging stations (Bhargava et al., 2021; Shen, 2023). In particular, the effect of AI, one aspect of Industry 4.0, is largely to increase the rate of innovation at minimal cost because it is a “technology that enables computers and machines to simulate human intelligence [and therefore, self-learning] and problem-solving capabilities” (Vazquez & Goodwin, 2024). AI will result in innovation taking place at an unprecedented rate, touted Musk, when he warned others about the dangers of AI (Musk, 2023). Tesla, for example, has managed to upgrade its Full Self-Driving (FSD) feature within less than a year (Loveday, 2024). This means that the learning curve becomes a lot steeper and the peaks and troughs cycles take place much faster, making old curves obsolete very quickly. AI may, in fact, nullify the paradigm of innovation at the expense of efficiency by finding ways to bypass certain parts of the learning curves altogether. Therefore, there may be multiple, infinite even, numbers of learning curves appearing at the same time, in other words, the so-called rapid “content changes" or the appearance of new differentiated products (i.e., substitutes) (Kohnová & Salajová, 2023). Ultimately, this can also mean that EV automakers will be able to pursue both cost-reduction strategies while maintaining high levels of innovation simultaneously, as recently done by Tesla. The latter pursues both cost-cutting measures by achieving near full automation of its production process (Lambert, 2023; Lang et al., 2021) while continuing to innovate on its complementary products using AI (Dickens, 2023; Sumanasena et al., 2023).

Figure 3. Effects of Industry 4.0 on the Porter’s Five Forces in increasing buyer demand through content change (Kohnová & Salajová, 2023).

Elsewhere in the literature, Johnson et al. (2014) also suggest that the “level” or rate of innovation, made possible by the advent of AI, can be considered an additional force in Porter’s framework due to their widespread effects on the other forces, particularly in shortening the product and design life cycle. AI can subsequently make Porter’s five forces model obsolete where bargaining powers of suppliers and buyers are concerned. The latter two’s importance will take a backseat to the threat of substitutes since AI tech-owning companies like Tesla, will have the ultimate power over innovation. These companies will not only possess the ability to produce highly differentiated products within a short period, but they can easily integrate forward or backward. This seems to be the approach that Tesla is taking when it decides to collaborate with CATL, its battery supplier, to create its own battery assembly line (Bloomberg News, 2024). The downside to this is what is termed “a mass extinction event” for many companies that cannot keep up with the pace of technological change (Siebel, 2017). Digital transformation has served to lower the barriers to entry for new entrants in many industries, the EV industry notwithstanding, which would lead to more intense rivalry between existing firms and new entrants in many, if not all, industries. This may also mean that firms will reach the flat or downward slope of the S-curve a lot faster. No one company can be profitable in the long run or gain a lasting competitive advantage in any single learning curve. A firm in the EV industry should thus not craft its strategies based on a single learning (or experience) curve anymore.

Implications for Firm Strategy

A question that probably plagues new entrants is: does industry analysis point to the EV industry as an unattractive industry to get into? In terms of Return on Invested Capital (ROIC), an often-neglected component in many CEOs’ agendas (Trainer, 2018), the ROICs for BYD (a new entrant) and Tesla (an incumbent) are 10 per cent and 28 per cent respectively (Appendix A; Alpha Spread, 2024). Although these figures look promising, industry analysis indicates that the situation will not last long. It would be a matter of time before another firm comes along with a new, superior product that can serve as a substitute for Tesla’s self-driving cars or BYD’s swimming cars and turns the tables on these two giant corporations. As an example, Toyota is already set to produce longer-lasting solid-state batteries, which can render lithium or lithium iron phosphate (LFP) batteries that are currently used in most EVs redundant (Dreibelbis, 2023). Therefore, a more pertinent question in IO analysis may instead be, where does the source of profitability lie in terms of the EV industry in three to five years’ time? The answer may rest elsewhere in the power of complements (often known as Porter’s sixth force) (Froeb et al., 2017), which has gained momentum recently no less because of Elon Musk. The Tesla’s CEO quite possibly set off a trend towards adopting a platform strategy for the next generation of EV automakers upon realizing the “platform value” of EVs (Li, 2022; Wolff et al., 2022). The role of complementary products is mainly to reduce or stall the threats coming from substitute products. The greater the power of complementary products, the longer EV makers can maintain profitability in the industry.

Conclusion

In summary, from an IO perspective, the EV industry was characterized by high barriers of entry, moderate threat of substitutes, and moderate rivalry between industry incumbents. However, this has changed secondary to sweeping reforms brought about by digital transformation. The greatest threat for industry incumbents now comes from new entrants who bring with them a multitude of substitute products, leading to intense rivalry between industry players. Out of the four components of Industry 4.0, AI has created the largest effect as it has resulted in a paradigm shift in Porter's five forces operating in many industries, EV industry notwithstanding, by affecting the rate of innovation thereby lowering entry barriers. In the long run, no single EV maker is expected to come out on top due to the much-shortened learning curves. Nevertheless, the message for CEOs in many industries is clear: get on the right side of technological change. It is insufficient to simply dabble in digitalisation, but the current market situation will force every CEO to become the driver of digital transformation in their respective companies eventually (Siebel, 2017).

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