Automotive Industry Exploration (Part II)
The automotive industry is a huge place, so it is best we tackle it one step at a time. For our first stride, we took a look at the revenues, expenses, and incomes of only a few car manufacturers: GM, Ford, BMW, and Volkswagen. For this next step forward, I have added Daimler, Honda, Toyota, and Nissan to our repertoire of car companies. Let’s take another look at the cost structures of these companies (as compared to each other and Apple), this time with additional companies and a better understanding of the automotive industry. Again, please excuse the slight variations in years, which are due to the different fiscal year end each company uses, and the delay in reporting annual figures.
Now that we’ve introduced additional companies to the mix, we can see that Apple’s impressive annual revenues of $182B in 2014 are actually dwarfed by the revenues of Toyota ($249B in 2014) and Volkswagen ($241B in 2013). The higher revenues of auto manufacturers have very a simple explanation: a car costs a lot more than a consumer technology device. Therefore, I wouldn’t place too much importance on the revenue figures - they are best suited for comparing the car manufactures to each other, rather than to compare them to the revenues of Apple.
I should also point out that the revenues used for our purposes are consolidated revenues. They include revenues from all of the segments each car manufacturer operates in (cars, trucks, motorcycles, financial services, etc). The revenues we used for our selected car manufacturers also include the income from companies they hold an equity interest in (which is usually other car companies). Unlike the relatively simple financials of Apple, the auto companies are full of incestuous relationships that heavily cloud their financial metrics.
Though we now know that revenues are not the end-all-be-all, the same cannot be said about gross profit (which is calculated as revenues - cost of sales). Software companies, for example, tend to command the highest gross profit because the cost of producing an intangible good is tiny compared to what you can charge to sell it (think Windows, or Mac OS X before it went free). On the other hand, a car is as tangible as a good can be, and requires copious amounts of materials and labor to manufacture. As a result, the cost of sales for car companies is proportionately higher to that of software, which results in a lower gross profit. Apple is somewhere in the middle of software and cars. Most of Apple’s revenue and cost of sales comes from the hardware products it sells (iPhone’s, iPad’s, Macs) but Apple also makes some money from intangible services like iCloud and iTunes. That is all to say that if Apple entered the car business, its gross profit would look more like what it is for car manufacturers than what it is for Apple now.
It comes as now surprise then that Apple has the highest gross profit out of all the companies we profiled for this analysis. It costs less to make an iPhone/iPad/Mac than it is to manufacture a car.
Restating gross profit as a percentage gives us even more valuable insights into the manufacturing intensity of Apple vs. the auto companies. To calculate how much each company keeps for every $100 of revenues, just multiply $100 by the percentage in the above chart. For Apple, that would be $100 x 39% = $39. For Honda it would be $100 x 26% = $26. -
You can see that the luxury auto brands have higher gross profit percentages, while the American car companies have the lowest (no wonder many went into bankruptcy!). Tesla has a gross profit percentage of 28%, Daimler (Mercedes) of 22%, BMW of 20%, and Honda of 26% (Honda does have a luxury brand (Acura), but the disproportionally higher gross profit is probably attributable its to operational efficiency).
Apple is well known for its operational efficiency (it has the highest gross profit percentage out of all smartphone manufacturers). But how well would this efficiency transfer to the manufacture of cars? I would venture to say that if Apple made a car, the margins would be slightly higher than those of Tesla, or around 30 - 35%. This would translate to much higher margins than what traditional car manufacturers are used to, but lower than what Apple is used to.
Non-finance people usually despise discussing margins since they have nothing to do with the product itself. Despite my rather traditional accounting background, I also tend to favor looking at the product instead of its profitability. But margins are helpful to understand because no reasonable company would enter an unprofitable business. If Apple’s research labs find that their is little money to be made in cars, it is doubtful we would see any Apple Car released at all. Before billions of dollars are spent on R&D, someone at Apple Finance needs to give the go ahead, which will only happen if there are profit margins to be made. Of course it is possible that Apple will develop a car with shockingly high margins (>40%), but I think it would have to be assembled from thinly cut paper for that to be true.
The mother of all financial metrics is net income, which lets us know how much a company has left over after all expenses, interest charges, taxes, and “extraordinary” items. Net income is the holy grail of business; it is why investors invest, and what a company wants to attain in order to be successful. It can be used to pay dividends to investors, it can be reinvested into the company, or it can simply be stashed into retained earnings. As you can see from the chart above, Apple made around $39B of clean, unadulterated income.
Just to put things in perspective for you, here’s something to ponder about: Apple had a higher net income in 2014 than the combined net income of GM, Ford, BMW, Volkswagen, Daimler, and Honda (I would include Tesla too, but it posted a net loss of -$294M in 2014).
Now, you might ask - why would Apple get into the car industry if there is little profit (by Apple’s standards) to be made? After all, it’s doubtful that Apple would be able to sell as many cars as all of those automakers combined, and even if it could, Apple’s net income from car sales would be lower than its income from technology products. To play devils advocate, you can argue that if Apple were to assemble cars, its operational efficiency would keep margins high and thus allow for a higher net income. This is certainly a plausible scenario, but how many cars would Apple have to sell to reach even $1B in net income? The answer to that question remains a mystery, but hopefully for not much longer, as we will dive into automotive unit sales soon.
Takeaways
Just as with the first automotive industry exploration, we are left with more questions than answers. That doesn’t mean this post wasn’t worth writing, however. We learned that car makers have ballooned income statements; exceptionally high revenues, and exceptionally high costs. We also learned that automotive margins are fairly low, especially for U.S. carmakers. As a result of their cost structures and the nature of the industry, the net income’s of car companies are paltry compared to that of Apple. In order to make money in this industry, you have to be extremely efficient, which, fortunately for Apple, it is known to do.
Undoubtedly, there is a sizable team of finance/accounting/operations employees at Apple that are doing the very same market research as we are here. Their data is likely to be much more comprehensive and detailed, but I can’t imagine the results to be far different from ours. As we continue our exploration, we will learn more about the business of making cars, but for now, it doesn’t look like a great business for Apple to be in. Revenues are high, but profits are low (we should note again, low by Apple’s standards). It is still way to early to have any conclusive thoughts, but who says we can’t have opinions!
What If
You can probably tell from all of the data we have analyzed thus far that the traditional car market isn’t the most appealing business to be in. But what if Apple totally changed the game? The current production system for cars is arduous and expensive - but does it have to be that way forever? What if the margins on cars were dramatically higher? Or what if the use-case for cars were expanded or altered? At the moment, the driving age in most jurisdictions in the United States is 18. But cars are expensive, and most teenagers are forced to use their parents’ car rather than to purchase their own. Suppose, however, that Apple is able to cheaply manufacture tiny cars (work with me here) that cost under $5,000 and take no gas. All you need is a battery charger. How many parents would buy their teens a car now?
To stretch things even further, let’s make these cheap Apple cars self-driving. Instead of having to drop your kids off at school or have them take the bus every morning, you could just pack your child into these small autonomous self-driving vehicles. And if you’re thinking this sounds very sci-fi, you’re on the right track. If we are to believe Apple is making a car, and that automotive profitability is quite low, something else should be going on, and spreadsheets alone won’t help us find it.
In future posts, we will be taking a look at automotive unit sales, break-downs of revenues by brand (Volkswagen vs. Audi, Toyota vs. Lexus), and a much deeper look into the electrically charged darling, Tesla.
If you have anything to add about the automotive industry, or just want to share your meandering thoughts about what we covered, please comment below! I’m also very active on Twitter, so don’t hesitate to @lsukernik me!
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