How Volvo Is Normalizing Electrification

SMITH BRAIN TRUST – In what was heralded as an encouraging step, Volvo last week announced that the margins on its electric vehicles are set to match those of combustion engines by 2025.

But, was it really a milestone in the electric car evolution? The Chinese-owned Swedish automaker’s announcement does hint at a light at the end of the tunnel, says Maryland Smith’s David A. Kirsch, as global automakers continue to pour billions of dollars into electric vehicle technology development.

“But should we be surprised by this news now, when we are about 10 years into the new electric era?” he asks.

It’s been a decade since Tesla introduced its electric Roadster (2008) and almost that long since Nissan unveiled its Leaf (2010) electric vehicle. “Since then, we’ve been watching these cars trickle onto the market,” says Kirsch, associate professor of management and organization at the University of Maryland’s Robert H. Smith School of Business. “The recent announcement from Volvo strikes me as an acknowledgement that electrification is becoming normalized, at least for Volvo. In effect, the new Polestar 2, Volvo’s first fully electric vehicle, will be treated like their other, non-electric offerings.”

Volvo isn’t necessarily the brand that immediately springs to mind when you think of electric vehicles. In fact, prior to the Polestar 2, Volvo’s “electrified” vehicles have been plug-in hybrids. No, the brand with electric name recognition is Tesla.

But Tesla has its problems, Kirsch is quick to point out. His recent book, “Bubbles and Crashes: The Boom and Bust of Technological Innovation,” co-authored with Maryland Smith’s Brent Goldfarb, explores Tesla’s stunning rise and potential risks at some length.

The all-electric Tesla has reported “very high gross margins,” in excess of 20 percent, since its Model S was introduced in 2012. But those are non-GAAP numbers, Kirsch cautions, using the acronym for Generally Accepted Accounting Principles.

Tesla, he notes, has still been consuming billions of dollars a year, as it grapples with working capital needs and the expenses associated with research and development and building out factories. Tesla’s response has been that they could be profitable at any point in time (and have produced small profits in the last two quarters of 2018), but have chosen to prioritize growth over profitability, thus the need to resort to the non-GAAP numbers.

Incumbent global automakers have faced those costs as well. Most have committed to big investments in electric vehicle technology and have repeatedly cautioned that higher component costs and relatively limited consumer interest would continue to weigh on margins.

“If you are Mercedes Benz or General Motors, you don’t have the luxury of trying to fool the market with a non-GAAP statement of your margin. People look at your actual income statement, and scrutinize it,” he notes.

The global automobile industry has long struggled with over-capacity, leading to relatively low profit margins, Kirsch says. GM’s gross profit margin is around 5.4 percent. Volvo’s profit margin is only around 8 percent.

“If a company like General Motors or Volvo can make any money, any real margin – not a fake, sort of gimmicky margin, selling electric cars or hybrid electric cars – they are probably going to do it and be very happy about that, because it’s a lot better than losing money,” Kirsch says.

Volvo has committed to making all models available with an electrified option (i.e., the all-electric Polestar line or plug-in versions of its other offerings). . And that approach could push the automaker out in front of some of rivals, says Kirsch.

“If Volvo can make money regardless of the powertrain of the car that it’s selling, that tells us that it really is a watershed moment for the incumbent industry’s adoption of electrification” he says. “Because it says that the incumbent company doesn’t have to fight against electric vehicles anymore, nor does it have to pretend to be in the vanguard. It means Volvo can normalize electrification.”

And that’s a shift, for the industry and for the consumer.

“It means Volvo can say, ‘You can have your XC90 either with a regularly configured internal combustion vehicle or as a plug-in hybrid, and we’ll make money either way.’ It’s just an option now.”