The latest obsession in the automotive industry is “functions as a service.” While there are numerous forces pushing and pulling on the industry, this one sits at the center of many of the changes occurring today.
Put simply, automakers want to offer capabilities, which traditionally have been built-in hardware features, as a piece of software that can be downloaded or streamed into a vehicle. The function can be as banal as interior lighting changes or as complex as Tesla’s autonomous-driving system.
The ability to update and upgrade a vehicle through software has finally moved from the theoretical to the actual as car companies build their products and organizations around the idea of a software-defined vehicle.
There has never really been a doubt that it could be done technically. After all, over-the-air software updates are two decades old. And, despite the talent shortage at automakers, even the software development is coming along—albeit slowly.
The largest and most prominent hurdle today is how car companies will change their business models to adjust to selling digital products and services. This same challenge isn’t unique to car companies. Manufacturers of all kinds have been venturing into so-called product servitization.
A servitized product for an industrial equipment maker might take information streamed from machines, then offer recommendations about maintenance and repair, or energy consumption—for a fee. In automotive, as-a-service functions are being rolled out like pricey smartphone apps.
Automakers have made a lot of proclamations about revenue and profit from these proposed services. General Motors predicts its services business will generate $80 billion in revenue by 2030, while Stellantis aims to generate €20 billion ($21.55 billion) of additional service revenue by that time. Likewise, BMW, Honda, Mercedes-Benz and Volkswagen all have said software and services will be key to their future business models.
However, consumer response to such services has been lukewarm at best. In my view, the issue is simple: Customers get nothing except higher bills and an uncanny feeling that they don’t actually own the product they just bought.
In fact, just 16% of consumers indicated they would consider paying subscriptions for new features and functions, according to a Gartner survey conducted last year. In the same survey, 42% said they would pay extra for cars that had the latest technology features included with the vehicle.
Car companies likely looked at services such as Netflix and Spotify and assumed car buyers also will pay a monthly fee for something that they used to buy a physical copy of. But they are missing a few key points. Netflix massively increased the supply of media, lowered the cost and reduced the hassle of getting it. This made the transition easy for consumers.
With a car, there is a substantially higher up-front cost, and an expectation that the high price comes with a set of features that will be used for many years. The idea of paying more for additional features, which previously would have been just part of the price, rubs people the wrong way. It’s akin to buying a song from a streaming platform and then paying extra to hear a line in the song.
It’s easy to see why car companies want to pursue this path—they want to replicate the success of tech companies. While revenue from services are considerably smaller than hardware-related ones, services are far more profitable.
For example, Apple’s 2023 fiscal first quarter saw overall revenues decline 5% to $117 billion, but its services revenue rose 6.4% to $20.77 billion. Apple’s gross margins on hardware are pretty impressive at about 35% but its margins on services are an astonishing 70%.
To date, car companies haven’t learned how to replicate this model. The key lesson in my view is that first, most of the digital elements of Apple products are free. They are just part of the product.
Apple regularly updates its products with new software features and fixes at no charge. There really is no compelling reason to add any Apple services.
Instead, Apple entices people into using its services through friction reduction. Apple’s normal applications are largely free and they keep getting better. That’s part of the deal. If you want to buy a non-Apple application, you can get it from their store where they take a nice cut of the price.
If automakers want to be “tech companies” they need to act like them and understand that the car is a digital product that needs to be supported. Revenues and profits will follow through services and applications after the effort is made to make the car better through digitalization and not before.
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