Rethinking the Luxury Auto Business Model

RETHINKING THE LUXURY AUTO BUSINESS MODEL

IN BRIEF

We propose 3 strategies luxury auto makers can use to reduce waste and improve profitability, all while helping conserve the environment.

As a mature, high-cost industry, luxury auto makers stand to enjoy considerable gains from these strategies.

STRATEGIES FOR A CIRCULAR ECONOMY IN THIS REPORT Rethinking the Luxury Auto Executive Summary...... 1

Business Model by Mark Esposito, Jonathan Xu What is a Circular Economy?...... 2

Current state of the luxury auto Executive summary In the illustrative case of Mercedes Benz, industry...... 2 implementing these strategies could The automotive industry can benefit from increase profits by up to nine times within Current business models…………...... 3 a radically different business model, one five years. that involves less waste, higher customer Opportunities for a Circular Economy loyalty, and significantly improved profits. What is a Circular Economy? Strategy...... 4 In this report, we propose strategies luxury automobile makers can implement that A circular economy is an economic system Strategy 1: Engage in more closed- can revolutionize their business. Instead of where companies keep resources in use for loop recycling……...... 4 selling cars for a one-time profit, as long as possible, extract the maximum manufacturers should switch to a service- value from them whilst in use, then recover Strategy 2: ‘Rent instead of sell’ based long-term lease business model. and regenerate products and materials at business model….……...... …….4 1 Instead of losing touch with customers the end of each service life . This means after the initial sale, manufacturers should that firms design and manufacture their Strategy 3: Lengthen product collect back used vehicles years later to be products in a way that is recyclable and usability...... 7 remanufactured into new vehicles. These remanufacturable into new products. For are examples of Circular Economy example, instead of discarding a Significantly increased profits with the new business model...... 7 strategies (explained in the next section), smartphone after four years of use, it is whereby manufacturers efficiently recycle returned to the manufacturer, Implementing a Circular Economy and remanufacture their products without disassembled, and made into a new model. Strategy: Final Considerations...... 8 sacrificing quality. Ultimately, this leads to According to the World Economic Forum, a more sustainable business model and a smartphone made this way could enjoy Conclusions...... 9 environment. Circular Economy strategies could help firms dramatically increase A circular economy enables Appendix...... 10 profits while conserving environmental the decoupling of growth resources. from resource constraints RETHINKING THE LUXURY AUTO BUSINESS MODEL 2

50% lower production costs per device 2. A increases per-unit profits while reducing The positive news is that, at an industry circular economy enables the decoupling the need for firms to continually increase level, approximately 95% of a vehicle’s of growth from resource constraints, partly manufacturing and sales force capacities. material content currently is recycled, by insulating firms’ cost structures from reused or used for energy recovery, volatile commodity prices. Current state of the luxury according to the Automotive Recyclers Association 13. This is done in what is 3 auto industry Businesses can follow three approaches typically described as the open-loop to implement a Circular Economy strategy: The global luxury auto industry generates recycling method where end-of-life vehicles are professionally processed by 1. Practice more closed-loop recycling. approximately US$200 billion a year in 7 recycling firms. Each year, the steel This means adopting self-sufficient annual sales , and is often characterized industry recycles more than 18 million tons recycling processes and using recyclable by four brands, namely Mercedes Benz, of steel from cars that are no longer fit for materials that maintain their quality BMW, Audi, and Lexus. Collectively, these the road. This is equivalent to nearly 18 throughout recycling processes. Closed- brands account for more than half of million new cars. Greenhouse gas loop recycling is more preferable because luxury vehicle production and sales, emissions are reduced by over 30 million allows a product to be recycled back into producing approximately 5 million vehicles metric tons per year. Every ton of new steel itself. In contrast, open-loop recycling per year for combined sales of almost 8 made from scrap steel conserves 2,500 indicates that it can be recycled into other US$160 billion . Traditionally, the industry pounds of iron ore, 1,400 pounds of coal, types of products, and is commonly has focused its efforts on quality and 120 pounds of limestone 14. referred to as downcycling. Whenever manufacturing and prestige marketing, Manufacturers build new tires with 10% economically feasible, closed-loop two effective levers that have helped justify recycled tire rubber material. Recycled tire recycling is always more preferable to the higher retail prices that these vehicles 4 command. However, as the industry rubber is also used in brake pedals or floor open-loop recycling . 15 continues to be challenged by rising raw mats . Metals such as steel or copper material prices, net profit margins have from old cars are melted down and reused Closed-loop recycling does been eroded under difficult operating for new consumer products, building not imply a degradation of conditions 9. construction, or put back into the product quality. production of new vehicles. According to the New York Times, the estimated average lifespan of a car is 13 2. Rent, instead of sell, products. This years 10. Drivers, however, keep a new car On average, a car lasts 13 means that business charge customers a on average for only 6 years, according to years. Drivers, however, keep fee to use their products and services. In Autotrader, the largest online marketplace a new car for only 6 years. return, customers enjoy greater peace of for US car transactions 11. mind and convenience, while businesses reap improved profit margins. Such an Among BMW, Mercedes, and Audi cars arrangement significantly reduces listed on Autotrader, only 30% of them Typically vehicles in North America are unnecessary consumer waste, and were 6 years or older 12. This potentially composed of approximately 20% post- promotes product longevity 5. suggests that older luxury vehicles are consumer recycled material by weight. either not being resold frequently or are Everything from old carpet to blue jeans 3. Offer ways to lengthen and widen the being prematurely retired by their drivers. may end up in a new vehicle 16. Auto use of products. For example, recyclers remove parts such as engines, manufacturers can establish product transmissions, doors and bumpers for recycling, refurbishment, and replacement reuse in other vehicles. Other parts that programs which engage with customers can also be remanufactured include directly. By increasing the points of starters, alternators and water pumps. customer contact, firms have more Batteries, catalytic converters, tires and opportunities to improve customer some plastics are removed and their engagement, brand loyalty, and the profit materials are recycled into new products 17. margins. In Europe, governments have typically If manufacturers promote excessive been highly supportive of environmental longevity of their products, does this protection laws. In 2015, the legally always entail a reduction in profits over the required recycling rate for end-of-life long-run? Not necessarily: by vehicles, components and materials was implementing the ‘‘rent instead of sell’’ raised to 95 % overall recovery (85 % reuse business model, manufacturers can and recycling of materials) 18. mitigate reduced product turnover with Based on research from American Recyclers increased customer loyalty and higher per- Association unit profit margins 6. This revenue model RETHINKING THE LUXURY AUTO BUSINESS MODEL 3

Current business models 22. The key raw materials used in luxury BMW is in a similar position when it comes automobiles are metals (~75%) and to incorporating circular strategies into The luxury automotive industry is a mature plastics (~10%) 23. Both of these material their production and recycling processes. industry that has traditionally focused on types are highly recyclable, with metals at Most of BMW’s recycling is in the form of high quality design and manufacturing, as 95%, and plastics at 80% 24. open-loop recycling. BMW has established well as prestige marketing. Its above- recovery systems in over 30 countries for average Cost of Sales component (on Remanufacturing key vehicle component is end-of-life vehicles to be recycled, average, 80% of revenue) indicates an important step in both cost savings and presumably by third parties 29. Currently, lucrative cost-saving opportunities 19. Net sustainability. In remanufacturing a most BMW vehicle components are profit margins in this century-old industry component, it no longer needs to be recycled as raw materials as opposed to have also been gradually compressed, and recreated from scratch, but instead is remanufactured. However, improving 25 currently average at less than 7%. The created from an existing old component . vehicle component re-manufacturability industry’s high material and labor costs Most luxury automakers are currently has been identified as one of the firm’s represent a high potential for gross margin developing their remanufacturing long-term goals in enhancing improvements via a Circular Economy capabilities. Leading the way in this field is sustainability 30. strategy. Daimler, which is already able to remanufacture many key components of Audi’s progress on these fronts closely its Mercedes Benz vehicles. This includes approaches those of Mercedes and BMW. Among the used cars sold, as parts of the engine, transmission, and It currently recycles based on a partially many as 98% are vehicles <5 steering unit 26. Remanufacturing saves closed-loop model, with parts of its metals years of age. energy and production costs, but requires production being closed-loop. Some of careful planning during initial design. Audi’s vehicle components are designed Daimler states that all Mercedes-Benz with circular design in mind, which Luxury automakers, like all car models are 85% recyclable and 95% facilitates efficient material recycling 31. manufacturers, purchase parts from recoverable. This includes the major Audi, however, has not yet invested heavily suppliers, manufacture vehicle components such as engines, in the area of component re- components, assemble them into vehicles transmissions, and axle housings, as well as manufacturability. It has instead focused and sell them, via dealers, to retail mechanical components such as its efforts more on moving towards a customers. The luxury automakers own turbochargers, brake parts, and steering close-loop recycling model. some of these dealers (i.e. corporate units. The firm has 350 specialists for stores), while others are independent. replacement engines (in Germany). Currently, luxury dealers are mostly Globally, it employs 2,100 workers involved A notably lacking feature focused on selling new vehicles: an 27 in remanufacturing activities . among all luxury automakers estimated 80% of vehicle sales are new cars and only 20% are used cars 20. Among However, Daimler notes that certain is the ‘rent instead of sell’ the used cars sold in the US, as many as limitations do still exist when it comes to revenue model. 98% are vehicles <5 years of age 21. Note remanufacturing. Notably, it is still unable

that the average vehicle lifespan is actually to entirely remanufacture or recycle its A notably lacking feature among all luxury 13 years. engines, due to difficulties with removing automakers is the ‘rent instead of sell’ magnets from old engines, as well as revenue model. The ‘rent instead of sell’ Therefore, it is evident that luxury auto challenges with repairing electric motors approach is a true hallmark of a Circular manufacturers generate most of their within the engine 28. In addition, its reliance Economy strategy. Not only is it income from new vehicle sales. However, on open-loop recycling allows for only sustainable, it can boost per-unit profits there are numerous constraints to this generic recycling processes. In contrast, and net margins significantly. In such a business model: new vehicles are with closed-loop recycling, the materials of model, the luxury automakers rent their expensive to manufacture, and net an old product are almost fully reused to cars instead of selling them outright. margins are low (averaging at less than manufacture a new product. Closed-loop Currently, among almost all luxury car 7%). Selling new vehicles once also recycling does not imply a degradation of makers, the closest available form is the establishes a low ceiling on the profitability product quality. In fact, if design and vehicle leasing option. This does not of each car. Constantly supplying large manufacturing processes were initially exactly constitute a ‘rent instead of sell’ numbers of new vehicles also requires devised with remanufacturing in mind, revenue model, because the vehicle is sustaining high labor, material, and parts should be easily be disassembled and ultimately sold to another consumer after overhead costs to support large reconstructed without material the initial lease period ends. However, the manufacturing capacities and employee downgrades to quality. The end user, after demonstrated popularity of leasing is an headcounts. In an age of volatile all, is not willing to compromise on the indication of the potential profitability that commodity prices, the business will be quality of the product that they are a ‘rent instead of sell’ model could bring to highly susceptible to fluctuations in receiving. material costs, while not necessarily being luxury automakers. able to pass on those costs to consumers RETHINKING THE LUXURY AUTO BUSINESS MODEL 4

Opportunities for a Circular also ensures that automakers do not lose In the luxury auto industry’s case, instead track of most of these vehicles after the of just selling cars to customers, they Economy Strategy initial sale, and captures the full potential should establish a Long-term Lease value of these vehicles since their useful program. This program will be different If the auto industry has already achieved a life is on average 13 years. Today, although from a traditional vehicle leasing 95% recycling and recovery rate, what 95% of a car’s materials are recyclable, arrangement. more can be done? In fact, probably quite there are still many “gaps” in the circular a lot. By today’s standards, the major loop. As the firms move closer to a closed- In a traditional leasing arrangement, the luxury automakers are already well- loop recycling system, purer inputs (i.e. dealer leases a vehicle to a customer for a positioned in terms of sustainability. Yet uncontaminated material) are obtained as fixed period (typically several years) at the much can still be done to fully adopt a a result of this collection and redistribution end of which the vehicle is returned and Circular Economy strategy. Not only is this efficiency. This enables the efficient resold to another customer as a used good for the environment it is also equally refurbishment and remanufacturing vehicle. Thereafter, the automaker has good for business. More recently, BMW, processes that can generate a cost almost no obligation (and revenue Audi, and Mercedes have all started their advantage for automakers that leverage opportunity) with respect to this vehicle. own versions of short-term (by the such methods. minute/day) car rental programs. While these pilot programs are commendable steps towards efficient resource allocation, In the Long-term Lease program, the they are still distant from an ideal ‘rent Strategy 2: ‘Rent instead of automaker charges customers a instead of sell’ business model. sell’ business model monthly fee for driving the vehicle. Instead of actually selling the vehicle As is applicable to almost all industries, A core tenet of a Circular Economy strategy outright, the automaker retains luxury automakers should: is that firms sell their products as ongoing ownership of it, and provides it with a services, as opposed to solitary products. lifetime warranty. During the vehicle’s 1. Engage in more closed-loop Consider Spotify’s successful model of lifetime (eg. 13 years), the automaker recycling selling music as a service for a regular covers all warranty-eligible repairs at no 2. Move to a ‘rent instead of sell’ monthly fee, and Netflix’s model of selling extra charge. In exchange the customer business model movies as a monthly subscription. It was pays a fixed monthly fee for the entire 3. Lengthen product usability not long ago that music was sold as CDs duration. and movies, as DVDs. These industries Strategy 1: Engage in more have already successfully transformed to a closed-loop recycling ‘rent instead of sell’ model. Both firms and The automaker can even offer periodic consumers win in this model – firms upgrades to the engine, transmission, and Luxury automakers can establish programs receive more predictable revenue streams, vehicle cosmetics at an extra charge if the that more proactively collect end-of-life and consumers receive ongoing support customer desires a car that can be vehicles directly from end users. Although and updates while paying less upfront continually updated. such programs do exist today (eg. BMW’s), costs. Typically, the more complex the At the end of the Long-term Lease period, the onus is usually on the customer to product, and the more ongoing the vehicle has also reached the end of its contact and locate the collection center, maintenance it needs, the greater the life. The automaker collects the vehicle and thereby creating customer inconvenience. potential for selling it as a service. Ideally, firms should establish greater recycles/remanufactures its major incentives for customers to return the their components into a brand new car. end-of-life vehicles to them directly so that materials eligible for closed-loop recycling can be directly extracted and remanufactured into new vehicle components.

Examples: The steel, aluminum, upholstery, and glass from an old Audi A4 vehicle can be recycled for use in a new Audi A4 vehicle.

Strategic Benefits:

This type of recycling reduces energy use by as much as 75%, according to the World Economic Forum 32. This translates into cost savings in manufacturing processes. It RETHINKING THE LUXURY AUTO BUSINESS MODEL 5

The customer pays the automaker a flat The customer returns the vehicle at the are perfectly satisfied with the car they monthly fee during this Long-term Lease end of vehicle life, but also has the option have been driving. They also no longer period, in exchange for an entirely-taken- to return it prior to that, at a time-weighted need to worry about “selling” the vehicle care-of driving experience. penalty. The penalty will be significant when it is out of warranty and in need of enough to deter most customers from repairs. The automaker will repair the returning it. However, the customer can vehicle for free, and recycle it when it transfer the Long-term Lease obligation to reaches the end of its useful life. Moreover, another person for a nominal regular maintenance and upgrades to the administrative fee. vehicle help prolong its useful life. Customers are also free to make non- How customers benefit from this warranty nullifying modifications to the program: vehicle, or incur minor cosmetic damages to the vehicle without being fined. This is Customers will enjoy unlimited driving in contrast to traditional leasing programs mileages and very few restrictions, as if which impose heavy penalties on they own the vehicle. They no longer need customers for even minor scratches or to worry about expensive out-of-warranty damages. repairs after 4 years (when traditional warranties expire). Customers anticipate that this will save him/her money, time, A 13 year-old Mercedes Benz C-class vehicle and trouble in the long run. (2003 model). This vehicle continues to drive well. Monthly payments under the Long-term The customer pays US$450 Lease are stable and predictable, and lower An example of ‘rent instead of sell’: per month for the life of the than any other financing method vehicle. In comparison, a Using a tangible example, consider a (traditional lease, or financing). Long-term traditional 3-year lease customer signing up for a Long-term Lease Lease monthly payments are also tax- for a new 2016 Mercedes C-class sedan. deductible (as a business expense). currently costs US$550 a From this customer’s perspective, it is as if month, and a 5-year finance Customers avoid having to unnecessarily he has leased the vehicle indefinitely, with switch cars every 3 or 4 years because their purchase costs US$754. all extraordinary expenses covered. lease term has ‘expired’. Many customers The customer pays US$450 per month

Based on research from Edmunds.com

throughout the life of the vehicle (estimated at 13 years). In comparison, a traditional 3-year lease currently costs US$580 a month, and a 5-year finance purchase costs US$754 33.

In return, Mercedes covers all non- accident-related repairs for the entire duration. RETHINKING THE LUXURY AUTO BUSINESS MODEL 6

Why will this business model attract sufficient resale interest. Moreover, when corporate valuations (hence a higher stock more customers? they are abandoned, they are rarely price). The automaker can reduce vehicle returned to the original manufacturer, but production costs while retaining market According to Edmunds, a top automobile instead sent to junk yards where they are share and increasing profitability per review resource, 4 of the top 6 reasons for crushed and not fully recycled or vehicle (because vehicles are no longer not buying a used luxury vehicle have to remanufactured. These activities result in a unnecessarily abandoned by customers). do with the manufacturer providing no product and material waste in the The stability and predictability of the all- 34 warranty or support for the car . Car economy. When products are not used up buyers desire luxury cars for their prestige, to their full life expectancy, it is akin to Today, 4 of the 6 main design, and driving dynamics; yet they fear drinking half a cup of coffee and reasons for not buying a used the unpredictable repair costs and discarding the entire cup. In this regard, maintenance hassles once the standard 4- global “waste” due to premature luxury car have to do with 35 year basic warranty period elapses . This automobile abandonment is estimated to lack of manufacturer support is one of the main reasons why almost half be approximately US$20 billion 38. of BMW and Mercedes Benz customers encompassing monthly payment will lease their vehicles in the United States 36. Why should the ‘rent instead of sell’ attract new customers who desire the Car review websites and forums often warn revenue model only apply to luxury prestige of ownership, but not its car buyers about the risks associated with automakers? unpredictable troubles. By servicing and buying a used luxury car after the standard engaging the customer over a much warranty period has run out. Horror stories Theoretically, the ‘rent instead of sell’ longer horizon (eg. 13 years), stronger with regards to $5000 electronics repairs revenue model can apply to any car customer relationships can be built, and and $3000 parts replacements abound 37. manufacturer. However, the largest impact will likely be seen with luxury automakers customer loyalty will be improved. By for the following reasons: collecting the end-of-life vehicles, the The all-encompassing automaker will be able to manufacture  Luxury automakers (especially new vehicles much more efficiently and monthly payment appeals to European brands) are known for cost-effectively via the recycling or customers who desire the expensive repair and maintenance remanufacturing of key parts. By prestige of ownership, but not costs after warranty expiration. A ‘rent manufacturing fewer new vehicles and its unpredictable troubles. instead of sell’ model will allay augmenting the profitability of existing customer fears about unpredictable ones, cost savings can be rapidly achieved costs due to lower inventories, less raw

 Luxury vehicles are more expensive materials, and reduced direct labor Yet, because few people truly know the than regular vehicles. The lower expenses. probability and costs associated with these monthly payment under a Long-term Overall, this revenue model will enable the potentially expensive repairs (and not Lease plan (which generates short- firm to increase brand recognition, and be many are willing to be guinea pigs to find term savings) are more apparent for recognized as an innovative, sustainable, out), there is a general revulsion among luxury vehicles. and environment-friendly company. The consumers when it comes to buying a  Luxury vehicles are driven for a shorter long-term benefits in terms of brand second-hand luxury vehicle. number of years compared to regular vehicles. This could be due to a variety loyalty and customer satisfaction are A consumer in the market for a used of reasons, including expensive repair undeniable. vehicle is much more likely to buy a used costs, customer desire for newer Toyota or Honda (which are considered models, etc. Therefore, promoting a more reliable over the long run), as ‘rent instead of sell’ business model will opposed to a Mercedes, BMW, or Audi. As discourage unnecessary waste in the a result, most used luxury vehicles beyond economy. the 6-year mark are typically not actively bought, sold, or maintained. There is not Strategic benefits of this strategy: much of an active market for these This proposed strategy represents a major vehicles, and some of them are destroyed shift towards a ‘rent instead of sell’ due to “early retirement”. In most cases, business model as opposed to a these vehicles, if properly maintained, manufacturing one. As a service-based would have a much longer lifespan business model, it typically benefits from (probably equal to or greater than the higher margins, greater differentiation average lifespan of 13 years). potential, as well as improved customer Unfortunately, they are frequently loyalty. Service-based revenues are also prematurely abandoned due to their more stable and predictable. This leads to expensive servicing costs and the lack of Based on research from Edmunds.com less earnings volatility and improved RETHINKING THE LUXURY AUTO BUSINESS MODEL 7

Strategy 3: Lengthen product Significantly increased profits volumes, luxury automakers can focus their resources on service quality and customer usability with the ‘rent instead of sell’ satisfaction, as opposed to volume business model manufacturing. This strategy focuses on designing vehicle components to be recyclable, reusable, To demonstrate the tangible improvement “Selling” one car under this and remanufacturable from the outset. to profitability under the ‘rent instead of new business model is Integrating these concepts into product sell’ model, we can study a representative design and initial manufacturing is critical example – the Mercedes Benz C-class, a equivalent to selling 2.17 to reducing remanufacturing costs later on compact luxury sedan. Consider the cars under the old model in the product cycle. Although it does profitability of a selling this vehicle in the require additional R&D investment today, US market. There are three potential it will reap benefits in the future in the form Based on these scenarios, it becomes revenue models: the traditional leasing possible to estimate the consolidated of lower production costs. Lengthening program, the traditional financing product usability after a ‘rent instead of financial impact that the aforementioned program, as well as the new Long-term Circular Economy strategies could have on sell’ model has been implemented will Lease program. serve to improve firm profitability even luxury automakers. further – as vehicle repair expenses The first thing to notice is that the When applied to the example of Daimler, decrease in the face of constant recurring customer’s monthly payment under the the following financial impacts are revenue streams paid by customers. Long-term Lease model is actually 40% forecasted: lower than it would be in a traditional Remanufacturing a part is preferable to Finance purchase, given today’s interest recycling because it builds upon an rate environment. Lower monthly already-manufactured component, as payments are attractive for cash flow opposed to re-creating it from raw conscious customers, which tend to be the materials. Remanufacturing components younger clientele. Incidentally, recent avoids the need to repurchase raw studies have shown that an increasing materials from suppliers (thereby reducing number of younger-aged drivers are incremental costs). leaning towards purchasing Mercedes and BMW cars. Although certain luxury automakers, such as Daimler, are already able to In the Long-term Lease program, although remanufacture many of its vehicles’ the payment term is much longer, components, there is still room for customers enjoy a hassle-free driving improvement. experience throughout the duration. They are likely aware that, on an aggregate Opportunities for improving material basis, they will be paying more in the Long- usability include: term Lease program, but many customers  Ensuring that the materials used are may come to terms with this if they value adequately suitable for a closed-loop peace-of-mind and certainty more than manufacturing system (avoid materials pure cost-savings. After all, driving a luxury that degrade significantly post- car in itself is not a frugal activity. recycling) Under this new business model, Mercedes  Investing in R&D to further improve on Benz’s net income per vehicle is actually the recyclability of engines, including 217% of what it was under the traditional the removal of magnets from the old finance purchase. This means that “selling” engines, repairing of electric motors, one car under this new business model is and the recycling of magnet materials equivalent to selling 2.17 cars under the and rare earth metals old model.  Leveraging new 3D printing technologies when producing smaller- Net income margin has also increased batch niche components that benefit significantly by 72% over what it would be from additive manufacturing. This with a traditional finance purchase. could save up to 90% of raw materials, according to successes that firms like Naturally, automakers will sell less vehicles Boeing have already had 39. under the new Long-term Lease program, but the profit per unit would increase dramatically in a way that mitigates the reduced sales volume. With lower sales RETHINKING THE LUXURY AUTO BUSINESS MODEL 8

Implementing a Circular Economy Strategy: Final Considerations

In adopting a Circular Economy strategy, the following factors should likely be considered. They will affect both the feasibility and results of strategy implementation.

Feasibility of technological improvements

Improving remanufacturability requires technological improvements and/or redesigning of certain components. This may prove to be capital intensive in the short run with financial benefits only visible after 3 to 7 years. Firms need to have a long-term perspective before investing in such capabilities. Not all components can be economically remanufactured immediately. For example, if remanufacturing a part is 20% more expensive than manufacturing from scratch, few firms would choose the former. Thus investing in closed-loop design and production processes is a necessary precursor to a feasible to remanufacturing plan.

Long term revenue streams

Adopting the ‘rent instead of sell’ model requires companies to forsake large cash flows in the short-run (i.e. vehicle sales) in exchange for steady revenue streams in the long-run (i.e. fee income). Firms must be ready for such a long-term view. If a publicly-traded company is singularly focused on the next quarter’s earnings, it may be disappointed when a long-term strategy fails to reap financial rewards right away. An effective and profitable ‘rent instead of sell’ revenue model requires companies to focus more on customer service as opposed to just quality manufacturing. Customer loyalty stems directly from him/her having received stellar service in every interaction. Traditional manufacturing-focused firms competitors gradually all enter the space, annual sales. Therefore, firms will need to need to pay special attention to customers’ margins will collectively shrink. This alone find a balance between immediate and needs and desires to succeed in this should present an incentive for luxury future revenue streams. One way to do this environment. automakers to begin adopting circular is to focus on the “rent instead of buy” economy strategies as soon as possible. business model whereby regular fees are Competitive Pressures paid for product usage. This reduces the Circular strategies tend to extend and need to constantly increase production, The first mover has an advantage if promote longevity of the firm’s products. and instead focuses on increasing per-unit adopting circular strategies early. As However, excessive longevity may hurt profit margins. RETHINKING THE LUXURY AUTO BUSINESS MODEL 9

Conclusions

To conclude, there are a couple of key Quick Refresher s takeaways from this report:

The luxury auto industry stands to “

greatly profit from Circular Economy A circular economy enables the decoupling of growth from resource constraints strategies Closed-loop recycling does not imply a degradation of product quality.

Although luxury automakers have already On average, a car lasts 13 years. Drivers, however, keep a new car for only 6 years. made steady progress in the area of sustainability, they can do more. Among the used cars sold, as many as 98% are vehicles <5 years of age. Note that the Specifically, they can: average vehicle lifespan is actually 13 years.

A notably lacking feature among all luxury automakers is the ‘rent instead of sell’ (i) Engage in more closed-loop recycling revenue model. (ii) Move to a ‘rent instead of sell’ model (iii) Lengthen product usability As is applicable to almost all industries, luxury automakers should: Doing so will result in significant margin 1. Engage in more closed-loop recycling

improvements and stock price increases. 2. ‘Rent instead of sell’, and

There is a compelling business case for 3. Lengthen product usability adopting these Circular Economy strategies Under the ‘rent instead of sell’ model, the all-encompassing monthly payment will attract new customers who desire the prestige of ownership, but not its Full adoption of the circular strategy not unpredictable troubles. only conserves resources, but in doing so The customer pays US$450 per month for the life of the vehicle. In comparison, a helps raise businesses’ net profit margins traditional 3-year lease currently costs US$550 a month, and a 5-year finance and earnings dramatically, as purchase costs US$754. demonstrated in this case study. In an industry as mature as the luxury auto

industry, business model innovation ” becomes even more important in fostering continued growth and development. When earnings and sustainability can be achieved simultaneously, all stakeholders are happy.

RETHINKING THE LUXURY AUTO BUSINESS MODEL 10

Appendix: Sample firm (Daimler) | Financial performance forecast with implementation of Circular Economy Strategy

Common Size (as % of Revenue) 2013 2014 2015 2016 2017 2018 2019 2020 Revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Cost of sales 78.7% 78.3% 78.7% 78.7% 75.9% 70.6% 65.1% 59.5% Gross profit 21.3% 21.7% 21.3% 21.3% 24.1% 29.4% 34.9% 40.5%

Selling expenses 9.4% 8.9% 8.1% 8.0% 7.4% 6.8% 6.2% 5.6% General administrative expenses 2.7% 2.6% 2.5% 2.3% 2.3% 2.2% 2.1% 2.0% Research and non-capitalized 3.6% 3.5% 3.2% 3.3% 3.4% 3.5% 3.5% 3.5% development costs Other operating income 1.3% 1.4% 1.4% 1.3% 1.1% 1.0% 0.9% 0.8% Other operating expense 0.3% 0.9% 0.4% 0.3% 0.3% 0.3% 0.2% 0.2% Profit/loss on equity method investments, net 2.8% 0.7% 0.3% 0.3% 0.2% 0.2% 0.2% 0.2% Other financial income/expense, net 0.3% 0.4% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Interest income 0.2% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% Interest expense 0.7% 0.6% 0.4% 0.4% 0.3% 0.3% 0.3% 0.2% Profit before income taxes 8.6% 7.8% 8.5% 8.6% 11.9% 17.7% 23.8% 30.0%

Income taxes 1.2% 2.2% 2.7% 2.6% 2.3% 2.1% 1.9% 1.6% Net profit 7.4% 5.6% 5.8% 6.0% 9.5% 15.6% 21.9% 28.3%

RETHINKING THE LUXURY AUTO BUSINESS MODEL 11

References

1 The Waste and Resources Action Programme, June 2016. WRAP and the circular economy Retrieved from: http://www.wrap.org.uk/about-us/about/wrap-and-circular-economy

2 World Economic Forum, January 2014. Towards the Circular Economy: Accelerating the scale-up across global supply chains Retrieved from: http://www3.weforum.org/docs/WEF_ENV_TowardsCircularEconomy_Report_2014.pdf

3, 4 Tse, T., Esposito, M., and Soufani, K. How Businesses Can Support a Circular Economy, February 2016, Harvard Business Review.

5 US Environmental Protection Agency, June 2016. Reducing and Reusing Basics. Retrieved from: https://www.epa.gov/recycle/reducing-and-reusing-basics

6 Refer to section “Significantly increased profits with the new business model” of this article.

7 Based on research of Daimler, BMW, and Audi company data, VFACTS, and Scotiabank Global Banking and Markets research.

8 Statistica data, 2016.

9 Based on research of Daimler, BMW, and Audi company data

10 New York Times, March 2012. As Cars Are Kept Longer, 200,000 Is New 100,000 Retrieved from: http://www.nytimes.com/2012/03/18/automobiles/as­cars­are­kept­longer­200000­is­new­100000.html?_r=2&ref=business& pagewanted=all&

11 Autotrader, May 2016. Buying a Car: How Long Can You Expect a Car to Last? Retrieved from: http://www.autotrader.com/car­shopping/buying­a­car­how­long­can­you­expect­a­car­to­last­240725

11 Based on research conducted via filtered search of used US-based vehicles on Autotrader.com, conducted May 2016.

13 Automotive Recyclers Association, 2011. Automotive Recycling Industry - Environmentally Friendly, Market Driven, and Sustainable. Retrieved from: http://www.a-r-a.org/files/pdfs/ARA_Recycling_Brochure.pdf

14 Steel Recycling Institute, 2014. Steel: Driving Auto Recycling Success. Retrieved from: http://www.recycle-steel.org/steel-markets/automotive.aspx

15, 16, 17 Automotive Recyclers Association, 2011. Automotive Recycling Industry - Environmentally Friendly, Market Driven, and Sustainable Retrieved from: http://www.a-r-a.org/files/pdfs/ARA_Recycling_Brochure.pdf

18 BMW Group, 2014. Sustainable Value Report 2014. Retrieved from: https://www.bmwgroup.com/content/dam/bmw-group- websites/bmwgroup_com/responsibility/downloads/en/2014/BMW_Group_SVR2014_EN.pdf

19 Based on research of Daimler, BMW, and Audi company data

20 Based on primary research of Mercedes and BMW dealers in various major cities across North America RETHINKING THE LUXURY AUTO BUSINESS MODEL 12

21 Based on research conducted via filtered search of used US-based vehicles on Autotrader.com, conducted May 2016.

22 World Economic Forum, January 2014. Towards the Circular Economy: Accelerating the scale-up across global supply chains Retrieved from: http://www3.weforum.org/docs/WEF_ENV_TowardsCircularEconomy_Report_2014.pdf

23 BMW Group, 2014. Sustainable Value Report 2014. Retrieved from: https://www.bmwgroup.com/content/dam/bmw-group- websites/bmwgroup_com/responsibility/downloads/en/2014/BMW_Group_SVR2014_EN.pdf

24 Automotive Recyclers Association, 2011. Automotive Recycling Industry - Environmentally Friendly, Market Driven, and Sustainable Retrieved from: http://www.a-r-a.org/files/pdfs/ARA_Recycling_Brochure.pdf

25, 26, 27, 28 Daimler, 2014. Daimler Sustainability report 2014. Retrieved from: http://sustainability.daimler.com/dai_nachhaltigkeit2014/static/export/docs/Daimler- Sustainability2014_Sustainability%20Report_product-responsibility.pdf

29 BMW Group, 2016. BMW Recycling. Retrieved from: http://www.bmw.de/de/topics/service-zubehoer/bmw-service/recycling.html

30 BMW Group, 2015. Sustainable Value Report 2015. Retrieved from: https://www.bmwgroup.com/content/dam/bmw-group- websites/bmwgroup_com/responsibility/downloads/en/2015/BMW_SVR_2015_RZ_EN.pdf

31 Audi AG, 2015. Corporate Responsibility Report 2014. Retrieved from: http://www.audi.com/content/dam/com/EN/corporate-responsibility/audi_cr_report_2014_en.pdf

32 World Economic Forum, January 2014. Towards the Circular Economy: Accelerating the scale-up across global supply chains Retrieved from: http://www3.weforum.org/docs/WEF_ENV_TowardsCircularEconomy_Report_2014.pdf

33 Based on indicative calculations from Mercedes Benz USA website, May 2016. Assumes $0 downpayment. Retrieved from: https://www.mbusa.com/mercedes/portfolio/payment_estimators

34, 35 Edmunds, September 2014. Should I Buy a New Car or a Used Luxury Car? Retrieved from: http://www.edmunds.com/car-buying/should-i-buy-a-new-car-or-a-used-luxury-car.html

36 NADA, 2012. 2012 Special Analysis: Luxury Brand Trends and Used Price Forecast Retrieved from: http://www.nada.com/b2b/Portals/0/assets/news/NADA_whitepaper_LuxuryBrands_12-NA-0170.pdf

37 DrivenAudio, 2016. Mercedes-Benz COMAND Radio Replacement Retrieved from: http://www.drivenaudio.ca/mercedes-benz-comand-radio-replacement-command-upgrades/

38 Based on an estimate that premature abandonment is equal to approximately 10% of the value of global annual new luxury vehicle sales.

39 World Economic Forum, January 2014. Towards the Circular Economy: Accelerating the scale-up across global supply chains Retrieved from: http://www3.weforum.org/docs/WEF_ENV_TowardsCircularEconomy_Report_2014.pdf