Tesla Is Turning Cars Into Phones. Other Car Makers Better Catch On.

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Cars are slowly becoming less about hardware and more about software. That shift has the power to change the automotive industry as much as any other trend, including vehicle electrification and autonomous driving. Automotive investors should start paying more attention to software.

If a “software defined vehicle,” as the industry calls it, is difficult to grasp, all consumers need to do is look at their phones. Then, perhaps, visit their grandparents.

Phones used to be all about hardware. A rotary phone from Ma Bell didn’t have a lot of features constantly updating. Innovations were push-button numbers and extra long cords. But a new iPhone from

Apple

(AAPL) regularly has new apps and operating systems making it go a little bit better day by day.

Cars are still in the rotary phone stage—or perhaps the flip phone stage. But that is changing.

Tesla

(TSLA) pioneered over-the-air updates, and now more auto makers are doing the same, connecting their vehicles to the web.

Ford Motor

(F) announced this past week a plan to set up a new business around connecting its commercial vehicles. .

Investors loved the news. Ford stock rose 9% this past week, to $14.53. The

S&P 500

and

Dow Jones Industrial Average

both rose roughly 1%.

Software-related changes aren’t always perceived as positive, however. On Friday, the Tesla Model 3 lost a Consumer Reports top pick rating. The rating change came down to safety features and Tesla’s decision to use vision-only perceptions—optical cameras—when other auto makers have radars and cameras.

 “According to NHTSA, Model 3 and Model Y vehicles built on or after April 27, 2021, will no longer receive the agency’s check mark for [next to several safety features],” the Consumer Reports article said. “NHTSA told CR that it rescinded the check marks after Tesla briefed the agency on production changes due to the transition to Tesla Vision from radar.”

Essentially, Tesla is taking sensors off the car and relying more on software. Traditional auto makers are adding software, but they don’t tend to remove sensors and hardware. Tesla stock reacted to the news by dropping about 0.9% on Friday, to $625.22. The

Nasdaq Composite

rose 0.1%.

Transitions aren’t without growing pains. AndTesla isn’t likely to backtrack on its decision. In fact, more auto makers are likely to pursue a Tesla-like approach. As the transition to more software-centric vehicles takes place, it has many implications for the way cars are designed and sold.

“Tesla has never really focused on model years,” Tesla power electronics supplier

Aptiv

(APTV) CEO Kevin Clark tells Barron’s. Tesla can improve power output with software. EV range enhancements can be made with software. In-car entertainment enhancements? Yes, software.

That approach has yielded real benefits. Tesla’s gross profit margins are better than

BMW

‘s (

BMW.

Germany), despite being about 30% of BMW’s size. Tesla also saves on tooling. Tesla spends less on capital, adjusted for size, than does BMW.

The software-defined vehicle trend is still in the early innings, Clark says. It has a long way to run, but the end of the game for cars might not look exactly like the phone business.

There are a couple of key differences between the industries. Manufacturing cars so teenagers can use them without injuring pedestrians isn’t a trivial matter. Also, the regulatory complex, including crash testing and emissions regulations for automobiles, isn’t comparable to phones either. And a new car costs, on average, $40,000 and is expected to last a decade or more. A phone costs $1,000 and lasts until it is dropped one too many times.

Still, attention needs to be paid. At minimum, investors can start tracking how many software engineers auto makers and suppliers have. (Clark says Aptiv has thousands). The winning automotive maker of the future won’t be those with the coolest looking car. It will be the ones with the best software for entertainment, safety, and reliability.

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