Climate Change - The Automotive Industry’s 100-Year Storm

Ernst & Young

For one of the world's most durable and influential industries, the far-ranging impacts of climate change are beginning to spur a global transformation that will continue to accelerate. Nearly 100 years ago Henry Ford revolutionized the world with the moving assembly line, and over time the automotive industry has grown to a global enterprise that produces nearly 75 million passenger cars, light trucks and commercial vehicles every year. Even as automotive consumption continues to grow and developing markets increase their pace of motorization, climate change and a wide array of other significant challenges have the potential to dramatically alter the automotive industry in the coming years.

"As for CO2 reduction, we cannot be too lofty in our goal because the issue of climate change is so serious that a half-way correction would not be acceptable."

 
The automotive industry is already being buffeted by an array of economic challenges that show little sign of abating. Costs of major vehicle-making materials - steel, aluminum, copper, resins and rubber - have been particularly volatile, partly because of increasing demand in emerging markets. Oil prices have fluctuated drastically, resulting in rapid shifts in consumer demand and vehicle usage, as well as heightening governmental concerns about energy security. Industry growth continues to transition to new markets dominated by new players on the global stage, while regional trade barriers and market dynamics restrict the ability of automakers to optimize their production globally.

The response to climate change may have a greater impact on the automotive industry than all the other factors mentioned, as a confluence of pressures that would have been unimaginable just a decade ago are now converging to create new opportunities and risks. Federal, state, provincial and local governments are beginning to take action to combat climate change, implementing both incentives and penalties that can have substantial impacts on the operation of automotive companies.

It's not just the regulators that stand to transform this industry going forward. Investors are favoring companies making the necessary technological investments to create the desirable "green" vehicles. Consumers and businesses are demanding more efficient, less costly products. Innovators are looking for partners to implement their ideas and have the greatest leverage on reducing the environmental impact of the automobile.

All of these influences are resulting in a period of rapid transformation for the automotive industry unlike anything seen since the early part of the 20th century.

The actions by governments, customers, investors and innovators in response to concerns about climate change are most visibly influencing the industry by altering the design and production decisions that vehicle and component manufacturers make as they develop the vehicles of tomorrow. However, climate change's impact on the automotive industry extends far beyond the product; it is creating a business response that will touch every aspect of the global industry.

The automotive industry responds

Climate change activities are impacting the enterprises comprising the global automotive industry at every point along the industry value stream, with differing but important levels of activity, risk and opportunity. The automotive industry value stream can be viewed in seven different areas of business activity and we will examine the response to climate change as it impacts each of the following areas:

▪	Research, design and engineering
▪	Manufacturing and assembly
▪	Sales, distribution and marketing
▪	Finance and retailing
▪	Vehicle use, maintenance and aftermarket products
▪	Recycling and disposal
▪	Overall corporate strategy

 

"The reduction of CO2 emissions is absolutely and unequivocally the most crucial issue [for the automotive industry]."

 
Research, design and engineering

Today's automobiles are one of the most complex mass-produced consumer products available on the planet.

Intense global competition has already pushed automakers to accelerate their research and design activities to bring products to market faster, typically 18-24 months from design to production. Automakers are challenged with creating a vehicle portfolio for each region that balances the evolving consumer demands of those markets while meeting current and future regulations developed in response to climate change, many of which will target vehicle exhaust emissions.

"Environmental advertising is not a box to check. It's organic to the brand."

 
Fostering additional innovation to minimize emissions and embedding it into the vehicle design process will be more crucial than ever. Leaders at the 2008 G8 Summit pledged to cut global greenhouse gas (GHG) emissions in half by 2050, which will require reductions of approximately 70% in the larger, more developed economies. Even with this extended timeframe, the magnitude of such a reduction in the face of growing energy demands will require dramatic societal changes and a reliance on technological solutions that have yet to be invented.

Vehicle emission reductions will come from incremental improvements in the current designs of internal combustion engines, plus an expanding array of alternatives to the engine, transmissions, fuels and materials in use today. The focus on development of alternative powertrains (engine, transmission and driveline components) has broadened over time to include electric drive vehicles, hybrids, plug-in hybrids and fuel cell vehicles, which convert hydrogen into electrical power.

Mass production of plug-in hybrids and electric drive vehicles using advanced battery technologies is expected to commence in the next few years. Producer and consumer incentives for advanced power trains are becoming quite common around the world, especially for vehicles using hybrids and clean diesel technologies.

The incentive and development picture is even more complicated when considering the fuels to power future vehicles. Alternative fuels such as ethanol, bio-fuels, natural gas, coal-to-liquid, hydrogen and even compressed air all will likely have some place in the automotive fueling future, with the pace of development influenced by the various tax and incentive regimes that may be put in place.

In addition to developing alternative power trains and fuels, material substitution is another way for automakers to reduce fuel consumption and lessen the impact of the automotive industry on the environment. Lightweight materials are increasingly replacing steel body components, and even renewable materials such as biodegradable plastics made from corn and soy-based foams are being utilised for an increasing number of interior applications.

Automotive research activity into clean technologies is not limited to the vehicle manufacturers, component suppliers and energy companies. Dozens of smaller companies, many not traditionally associated with the automotive industry, have made and are pursuing further innovations that are moving alternative fuels and technologies to the point where they can be mass produced economically. Business relationships with clean technology companies will continue to increase and be available for automotive companies that are willing to look outside their own walls for breakthrough ideas. Expanding business relationships and investments also represent risk to an automotive enterprise, requiring appropriate diligence to decrease risk and maximize potential investment returns.

One significant unknown relative to the speed of technological change in the automotive industry is the pace of infrastructure development that will need to occur in different geographies to support these new types of vehicles and fuels. In most cases a substantial governmental investment will be necessary to begin the development of new refueling infrastructures, with a distinct possibility that different countries may choose different technology and fuel "winners" based on the needs of their particular market.

Changes in the regulatory environment as well as consumer demand shifts for more fuel-efficient vehicles are two of the primary drivers of the climate change impact on the research, design and engineering aspect of the automotive industry. The balancing of regulatory and consumer influences on design decisions and research investment makes evaluating the future risk and reward environment challenging. Creating the proper global vehicle portfolio, in such a way that maintains profitability and other organizational imperatives, is a complex undertaking.

Manufacturing and Assembly

With approximately 700 vehicle assembly plants operating around the world, collectively producing two vehicles every second of every day, vehicle assembly and the associated manufacturing activities represent a highly resource intensive part of the industry. From the mining of the raw materials, to the manufacturing and shipping of component parts around the world, to the energy and chemicals used in the assembly itself, the carbon footprint related to vehicle production is considerable.

Implementation of ISO 14001-compliant Environmental Management Systems has been commonplace in the industry for years; most large automakers have required it of their Tier 1 suppliers since 2003 or earlier. Companies working toward this standard or another environmental certification have benefited from significant reductions in water usage, decreased electricity use, greater recycling of excess paint and other waste and increased packaging efficiency.

Just-in-time manufacturing, with its emphasis on lean production methods and eliminating unnecessary inventories, has contributed to an automotive industry culture dedicated to driving out waste and incrementally improving the efficiency of the activities on the plant floor. More precise materials forecasting and quicker and more transparent information flow throughout the supply chain are fostering additional production improvements at existing facilities.

To stimulate investment in facilities and manufacturing processes that are more environmentally friendly, credits and incentives are available in many jurisdictions, which offset some of the initial cost of the process changes needed for many environmental upgrades. Taken together, the incentives and the facility improvements often pay for themselves over relatively short timeframes. Companies also have access to incentives for developing efficient manufacturing operations at green-field or brown-field manufacturing facilities. In 2006 the first automotive factory, a new vehicle assembly plant, was recognized for achieving Leadership in Energy and Environmental Design (LEED) certification. This was also the largest facility in the world to receive such certification.

"The world has changed tremendously in three areas: in social and climatic environments, in technological progress and in the way we do business."

 
Clean technologies are also allowing automotive companies to utilize their manufacturing assets in ways never imagined at the time of original investment. Case in point is a vehicle assembly plant in Spain that has been in operation for over 25 years. The automaker that owns the factory initiated a project that resulted in the recent installation of the world's largest rooftop solar panel array. Revenue is generated for the automaker by its leasing of the roof space to a joint venture that will distribute the energy created, enough to supply the average demand of 4,500 local households. Several automakers are now utilizing solar arrays at locations around the world to offset the energy needed to operate warehouse facilities in sunnier climates, a trend that appears to be accelerating.

Sales, Distribution and Marketing

Getting a vehicle from the dealership lot to a buyer's driveway or a fleet garage has always been the industry's preeminent sales challenge. However, it just represents the final step in a process that began with moving the vehicle from factory to dealer and creating the brand and product awareness that makes the sale possible. Improvements to the fuel efficiency of vehicles used for distribution, whether by truck, rail or boat are targets for cost savings and reducing emissions, while branding and outreach efforts can help turn environmental initiatives into incremental revenue.

Higher fuel taxes around the world have long made fuel economy an issue at the forefront of most buyers' and marketers' minds outside the US. Vehicle fuel economy has become much more important to US drivers since gasoline prices began climbing sharply in 2005. Manufacturers and dealers with fuel-efficient vehicles have shifted their marketing messages to be responsive to changing customer values regarding increased fuel economy. An increasing number of automotive television advertisements are devoting time to green messages, either about the efficiency of a particularly model or increasingly about the environmental friendliness of the manufacturing facilities or automaker as a whole. For the first time in 2008, a "Green Award" was among the presentations at the Automotive Advertising Awards held during the New York International Auto Show.

Creating market recognition 'of the environmental credentials of an individual model in the marketplace may be as simple as citing fuel economy test results, but extending that halo to an entire brand or corporation is a much larger challenge. Care must be exercised as well; as regulators are increasingly targeting companies that make unsubstantiated or overstated environmental claims about their products. Consumers may quickly become skeptical of many of the industry's environmental claims in advertising if this type of "green washing" behavior becomes associated with the automotive industry.

Corporate branding in the green space is an area that has the potential for significant returns on investment that the automotive industry has not capitalized on despite their corporate commitment. In terms of automotive green branding, perception can quickly become reality in the marketplace, and focused outreach is crucial. Those manufacturers that were early to market with hybrid offerings have been perceived as the most environmentally-friendly in the US, even as they concurrently sold a wide range of trucks and SUVs along side their more economical offerings.

For years, the Detroit-based automakers have been responding to climate change by making flexible-fuel vehicles capable of operating on either gasoline or the E85 blend (85% ethanol, 15% gasoline). Such vehicles are gaining increasing traction among consumers as rising gas prices makes E85 more attractive.

Finance and Retailing

The image and branding benefits of being perceived as green are starting to make their way to the retail space of the industry as well. While vehicle price and financing terms, fuel economy and features remain the primary concerns for new car buyers; there is a growing market of buyers who are taking environmental stewardship into account. In a recent survey, 58% of shoppers polled by CNW Marketing Research favored a "green" dealer over a competitor without an environmental program, even if the vehicle price was slightly higher.

Some of the ways retailers are making their operations more environmentally-friendly include roof-mounted solar panels, rooftop parking to lower land use, higher efficiency carwashes, using rainwater runoff to irrigate landscaping, "paperless" purchase documentation and implementing other building improvements to meet LEED certification standards.

The move to position dealerships as eco-friendly compared to the competition may become more beneficial in the future, as vehicle purchase options diversify further and new engine and battery technologies become mainstream. Environmentally conscious buyers have been proven to be more likely to purchase those cutting-edge vehicles from dealers they trust to share their views related to the environment, and can be influential advocates via word-of-mouth advertising.

Vehicle Use, Maintenance and Aftermarket Products

Getting back to the current environment, increasing economic distress is resulting in a shift of spending in this area, as some drivers' delay needed maintenance. Others seek out proper maintenance and aftermarket products in order to improve their vehicle's fuel efficiency. Retail gasoline prices, which have nearly tripled in the US over the last three years, have contributed to the first reduction in annual vehicle miles driven of the total US fleet in 40 years, decreasing the fleet-wide need for vehicle maintenance and demand for the aftermarket products and replacement parts.

The ability for proper vehicle maintenance to improve fuel efficiency and help the environment has even been elevated to an issue in presidential politics. Both of the major US presidential candidates reminded voters of the energy-saving benefits of such efforts during their campaign speeches in the summer of 2008, reinforcing the messages consumers had voiced in "Be Car Care Aware" programs and other education campaigns that the aftermarket industry has conducted for the past several years.

Auto parts retailers have an opportunity to playa growing role in the environmental stewardship of the industry, beyond providing products that can increase fuel efficiency. Retailers in many jurisdictions have been required to recycle exchanged automotive batteries for many years, and many have extended that type of service to the free collection and recycling of used automotive fluids, something most vehicle repair shops might consider.

Recycling and Disposal

The environmental impact of a vehicle continues even after it has reached the end of its time on the road; fortunately, the automotive industry has become more aggressive in re-using the components that go into making a vehicle. Eighty-five per cent of the material used in passenger vehicles is typically recycled during scrap page operations, and that percentage continues to rise as manufacturers increasingly plan for recycling and disposal during product design. Regulatory oversight, particularly in Europe, has driven manufacturers to improve vehicle recyclability, but it is quickly becoming good business to do so regardless.

Plastics have accounted for the majority of residual automotive waste, but as the price of the petroleum used to create virgin plastic resins has increased, so have the industry's efforts to recoup more of the plastic previously discarded as waste. Plastic performance degrades with recycling, so for most automotive applications recycled material can at best be mixed in with new plastic. Certain components like bumpers and instrument panels are increasingly seeing 20% or more of the plastic used coming from recycled material. Efforts to improve the recyclability of vehicles and the completeness of disposal are paying off in multiple ways: benefiting the environment and the bottom line.

Incentives, regulations and customer behaviour are all constantly changing and need to be continuously evaluated when deciding between strategic options.

 
Overall Corporate Strategy

Society's response to climate change is impacting the automotive industry through the actions being taken by governments, individual and fleet vehicle purchasers, competitors and other stakeholders throughout the industry value stream. We've seen how the industry's response to these factors is affecting the various aspects of the automotive business, and highlighted some of the risks and opportunities specific to those functional areas.

Climate change initiatives should be evaluated and integrated across the enterprise as part of the overall corporate strategy. Altering business models, evaluating partnership opportunities and deciding to invest in property and equipment are some of the strategic areas where automotive organizations need to consider the full range of implications and enterprise benefits when responding to climate change drivers.

A holistic approach towards environmental initiatives will enable sufficient consideration of the risks and rewards of the separate actions underway at a particular time. Incentives, regulations and customer behavior are all constantly changing and need to be continuously evaluated when deciding between strategic options.

Each day there are seemingly several developments from around the world related to climate change that automotive companies have to consider when planning their corporate strategy. One week in September 2008 brought news of plans to install tens of thousands of electrical charging stations in several urban areas in China, a California proposal to link vehicle insurance rates to actual miles driven and carbon emitted and the announcement of a forthcoming electric vehicle by a Dutch company new to the automotive industry. Evaluating the implications of these and thousands of other similar developments influenced by climate change is a job that is growing in importance.

Climate change responses in automotive businesses will often be in line with broader sustainability efforts occurring in the organization. Many automotive companies have named corporate level executives to be accountable for these sustainability activities. The number of corporate social responsibility reports from automotive companies is rising, and they are increasingly being independently reviewed and assured to be in accordance with the Global Reporting Initiative (GRI) sustainability reporting guidelines.

Increasingly, corporate organizations are focused on measurement systems to track and monitor an organization's progress toward goals developed in response to climate change. Improvement will be fairly straightforward to measure in some areas (i.e., energy savings from factory improvements) and not so easy in others (i.e., sales increases due to improved brand perception), so internal and external measurements systems will continue to evolve over time in order to best quantify the progress derived at local, national and international levels.

 
Enhancing existing sustainability efforts and being a responsible corporate citizen is just one of many drivers of automotive response to climate change. When asked their main concern behind the industrial emphasis on all things green, 41% of respondents on Ernst & Young's recent Business Response to Climate Change web cast cited cost reduction as the primary driver. In the automotive industry's traditional mature markets, slowing economic growth and the resulting declines in new vehicle sales and profits have made cost reduction even more crucial in order to remain competitive.

Cost reduction may be top of mind, but several other drivers are also behind the need for a coordinated corporate strategy related to climate change. Revenue generation, regulatory factors and stakeholder expectations are the other key considerations making dealing with this issue vital for all automotive companies. The most visible clean tech efforts in the automotive industry, to date have been expensive technology developments such as hybrid and clean diesel propulsion systems. The time needed to realize returns on those investments is lengthy, but by looking for green opportunities throughout the entire industry value stream and not just in product design, automotive companies can reduce costs or even generate revenues.

Top 10 climate change considerations for an automotive business

For automotive companies, being environmentally friendly and responding to concerns about climate change means more than improving vehicle fuel economy or manufacturing cars and trucks with greater efficiency. It encompasses a commitment to looking for better solutions and improvements in all seven areas of the industry value stream. In future reports, Ernst & Young will explore the implications for the automotive industry in these specific areas.

Climate change and the possibility of drastic action to reduce carbon emissions may impact the automotive industry in the coming decades more than any of the other competitive, resource or business pressures currently shaping the industry. A global commitment by society to drastically reduce GHG emissions would reshape the way that the world works, plays and drives. Automotive companies that are prepared to address the challenges and risks head on will be in the best position to reap the potential rewards that this transformation will bring to light.

The top 10 questions that automotive executives should ask when integrating climate change initiatives into their overall business strategy:

▪	Do we have a comprehensive strategy in place to respond holistically to climate change developments?
▪	Does a commitment to "be green" in my organization come from the top, and is it strong enough to withstand short-term pressures in order to achieve long-term strategic gains?
▪	Are we taking advantage all of the national, state and local incentives for the research and deployment of new green technologies, and for "greening" our facilities?
▪	What is the best way to measure our performance against our environmental improvement goals, and to communicate results to stakeholders?
▪	How can we partner with other entities to take advantage of clean tech opportunities?
▪	Are there new ways to utilise existing capital assets to benefit the environment and improve our enterprise's green credentials?
▪	How can we highlight our green initiatives in external marketing and branding efforts?
▪	How can we foster innovative climate change activity in our supply chain partners, and are we being receptive to the resulting green ideas?
▪	Should we encourage governments to support fueling infrastructure improvements and other forms of green transportation subsidies, and if so how?
▪	How can we create a portfolio of products consisting of internally-developed as well as licensed technologies to best minimize risk?