Navigating the hardware-to-software transition in cars

Navigating the hardware-to-software transition in cars:

How automakers bring clarity to the true value of their software–defined vehicle (SDV) transformation and why it matters

by Marek Jersak, Jan Frederik Sieper, Karsten Hoffmeister, Daniel Hodapp

In short:

# SDVs have attracted a lot of attention in the automotive industry and automakers are investing heavily in transforming from hardware- to software-defined vehicles.

# The value of this transformation for OEMs and suppliers is often ambiguous and means different things to different stakeholders. This leads to uncertainty about the scope of the transformation program, the organizational changes required and the investments needed.

# Our SDV Value Pyramid is a straightforward discussion tool that helps OEMs and suppliers plan, size and manage SDV transformation programs by linking and integrating the different SDV value perspectives.

Automakers around the world see the software-defined vehicle (SDV) as essential to accelerate the pace of innovation and bring new software-enabled features — such as connected services, personalization, and autonomous driving — to vehicles more quickly. To deliver on the high expectations, automakers have formed technology ecosystems with suppliers and partners of all sizes and backgrounds to drive vehicle software forward. However, we observe that the actual value that results from transforming a hardware- into a software-defined vehicle is very ambiguous and means different things to different automotive stakeholders.

To provide guidance on right sizing and structuring of SDV programs and investments, it is crucial to understand that the value of SDV transformation is driven by two factors:

1. SDVs can unlock new potential in the form of software and services revenues throughout the vehicle lifetime, creating novel monetization opportunities such as subscriptions

2. A stronger focus on SDVs can reduce cost through leaner architectures, faster processes and more resilient supply chains in all vehicle areas and, more generally, modernize the automotive legacy culture

So, it’s important to keep both value dimensions in mind. This helps avoid disjointed SDV strategies that don’t span an entire company or supply-chain and in some cases can even lead to the pursuit of conflicting goals.

To better understand said key factors, together with our partner EY we introduce what we call the SDV Value Pyramid – Figure 1, which links different value perspectives and provides a basis for integrated discussion and steering.

• At the most basic level (A), SDV transformation enables OEMs and their suppliers to comply with an evolving regulatory environment and to continue bringing cars to the road in different geographies

• The left side of the SDV Value Pyramid shows the savings and efficiencies (B) that can be achieved

when the SDV transformation is done right: Reduced complexity, increased ability to deliver software-heavy vehicles on time, and increased software quality of the operating fleets

• On the right side (C), the SDV Value Pyramid shows the potential that SDV transformation can unlock in terms of new software and services revenue, increased customer lifetime value and higher valuation levels

To tap into the three SDV value dimensions, automotive players must establish a north star strategy that guides the long-term transformation process.

OEMs and suppliers must adjust to constantly evolving regulatory requirements

Tightening global regulations — particularly in the areas of safety, cybersecurity and CO2 reduction — are forcing automakers to re-architect their vehicles. Many of these regulations are evolving, but at different speeds and with different restrictions in different jurisdictions. As a result, the complexity of today’s vehicles is increasing at an accelerating pace, coupled with uncertainty about what exactly is needed when and where. Moreover, none of these aspects can be addressed in isolation — a system-level transformation is required.

Take cybersecurity, for example: If there was very limited remote access to vehicles, all would be well. But, the desire for more SW content brings risks which are being addressed by new regulations for Cyber-Security Management Systems (CSMS) and Software Update Management Systems (SUMS). Remote access can penetrate much deeper into the vehicle – at this point, nothing can be securely patched up as an afterthought. A modernized vehicle architecture is required considering cybersecurity from scratch, and it needs to be software-defined to be adaptable to the evolution of requirements in different regions and to deal with other uncertainties (including novel types of attacks for example).

Beyond evolving regulations, OEMs and suppliers want the ability to quickly respond to emerging technologies, changing customer expectations and new, faster market entrants eating into the money pie. Consequently, companies need to carefully consider the benefits of SDV transformation, analyze associated risks, and derive measured strategies that avoid over-reacting on one hand, but (more importantly) avoid underestimating the challenge or doing too little, too late. Let’s take a closer look.

Savings and efficiency gains through SDV transformation for carmakers

By moving from hardware- to software-defined vehicles, automakers realize savings and efficiencies, particularly in terms of reduced complexity, increased deliverability of software-intensive vehicles and enhanced software quality across their fleets.

Address increasing complexity through a rigorous review of the status quo and a long-term software platform and architecture roadmap

A key challenge for established automotive companies is their long history of vehicle evolution creating a wide variety of software-enhanced subsystems; from advanced driver-assistance systems (ADAS) to infotainment. These subsystems are all complex in their own right, have historically been provided by different vendors and are increasingly difficult to get to function as a cohesive whole. Traditionally, more than 100 million lines of code and more than 100 electronic control units (ECUs) are required. This complexity often exceeds the capabilities of OEMs, while adding engineering resources only increases costs and fails to accelerate development.

To escape the complexity trap, OEMs need to take a step back and consider where the allocation of additional development resources might lead to progress and where a fresh start and a ‘blank slate’ approach might make more sense. The basis for this is a consistent platform architecture subdivided into hardware, software and middleware. This layered architecture needs to enable flexible software deployment and updates. In parallel, it’s critical to address organizational legacy, complexity and lack of SW experience and establish a systematic cultural and organizational shift towards a software-centric approach. The amount of time and effort all this takes cannot be underestimated. Adding to the challenge, the relationship between OEMs and suppliers needs to shift from project-based development to scalable platforms (including open-source components) that can be reused across different makes and models. To guide this paradigm shift, OEMs and suppliers must have a stable and long-term architecture roadmap. The roadmap must focus on differentiating functions, software and system integration, as well as integration of open-source solutions for the non-differentiating parts of the SDV.

An end-to-end hardware and software decoupling strategy is the basis for OEMs and suppliers to deliver software-centric features and vehicles on time

When we look at today’s SDV efforts at different OEMs, we find that vehicle launches are delayed due to software issues or mismatches between platform maturity and planned start of production (SOP). SOP delays cause serious financial and reputation damage to OEMs. Therefore, it’s of utmost importance to focus on a reliable and robust ability to deliver software-centric vehicles on time. Challenges we observe include over-emphasizing feature-first thinking, late testing, little virtualization and automation, and under-estimating interdependencies.

OEMs need to strictly decouple hardware and software across the SDV stack and make this part of the top management agenda and portfolio steering processes (no new services without platform compliance). Hardware-related functions must have high stability to be future-proof. Independent upgrade cycles and speeds must be possible, even after SOP. This means that it’s better to bring a well-functioning, well-tested vehicle to market on time and on budget, even if some features are not available yet (or limited) at the time of SOP, knowing that those features can be reliably added or improved later through software updates.

Updateability across the entire SDV stack is crucial to maintaining fleet quality

The transition to SDVs offers OEMs the opportunity to improve the quality of their fleets — this means fewer recalls, complaints and rework. A look at today’s recalls shows that in Germany alone, more than 8.5 million cars were recalled between 2018 and 2022. Over 40 percent of these recalls were partially or fully due to software problems.1 This imposes significant costs on OEMs and their suppliers. Furthermore, the corresponding reputation damage leads to dropping sales and profit margins.

Establishing a permanent connection from the fleet to development teams — the ability to collect data on the use of features, KPIs, etc. — allows OEMs to respond much faster to quality issues, functional update needs, and to enhance the user experience. Customer-facing features — usually complex end-to-end chains of many system parts — can be improved faster over time and be visible to the end user, while updates ‘under-the-hood’ can happen more quietly. Therefore, OEMs and their suppliers need to focus on setting up clear DevSecOps processes in parallel to a clean hardware/software architecture that enables both remote monitor and remote updates.

1 EY Analysis

New upside and business potential for automakers through the SDV transformation

OEMs and suppliers have a unique opportunity to create value with SDVs, particularly through add-on features during vehicle lifetimes, new digital services, and deeper customer engagement in their digital ecosystem. The most successful companies will likely achieve significantly higher valuation levels by being more attractive to investors.

OEMs and suppliers unlock new software and service incomes through SDVs, enabling more scalable and recurring revenues

A key factor in an OEM’s SDV effort is the potential service revenue it can generate from its vehicles in the future. The latest EY studies for SDVs forecast revenues of over €100 billion by 20302. However, at present many content-related services are being monetized in the mobile ecosystem with its app stores and payment infrastructures. In addition, there are currently no proven business models for monetizing in-vehicle services — this deters third-party service providers. One possible path for OEMs is to identify the high-value services and develop and offer them as the core of their service ecosystem.

Beyond that, OEMs need to facilitate the development of services by third parties, focusing on their in-vehicle infotainment (IVI) operating system. This means they need to create the best conditions for service development (e.g., through a full CI/CD setup, seamless integration of existing best practices) and, most importantly, offer strong monetization incentives.

Ultimately, OEMs need to differentiate the vehicle-centric SW ecosystem from established mobile offerings. A common tenor in the market is that an SDV functions more like a home than a smartphone, which also makes it substantially different from the mobile ecosystem. Crucially, to deliver a home-like experience, SDVs need to integrate a range of technology ecosystems (deeply embedded functions,

mobility-specific content, entertainment and gaming, social networking, etc.).

Through an immersive in-vehicle digital service ecosystem, OEMs in particular gain deeper customer lock-in and increased customer lifetime value

A key imperative for OEMs is to move away from the car as the sole sales activity and focus on recurring service revenue throughout the lifecycle of the car. The transition to SDVs is paving the way for this. Through a rich ecosystem of digital services, OEMs can increase customer engagement as the vehicle becomes the heart of user interaction, enabling an immersive customer experience. To make that happen, OEMs need to level up and establish the vehicle as a ‘third living space’, in which users interact on a massive scale. Currently, the interactions that generate relevant data do not take place via the vehicle user interface, but largely via the smartphone. Consequently, they are not accessible for OEMs to improve their services.

In addition, users are already deeply integrated into competing technology ecosystems, making it difficult to shift to a vehicle-centric ecosystem. To tap the potential here, OEMs must ensure that the necessary services are available in a native form for the vehicles and integrate seamlessly into the vehicle’s user interface and overall user experience. To achieve this, many OEMs are opening-up their user interfaces to tech players, bringing in their IVI platform and app ecosystem, or driving their app ecosystems through dedicated third-party programs. Ultimately, whoever knows the users and their preferences best and whoever can translate this knowledge into user-centric experiences and services will win the race for screen time in the car and therefore create recurring revenue.

Lower scaling costs and recurring revenues make OEMs more attractive to investors, increasing valuations and facilitating access to capital

With the transition to SDVs, OEMs are perceived more as software companies for which tech-like growth rates are expected. From an investor’s point of view, the shift to SDVs and the associated digital services business with low scaling costs is an extremely interesting growth opportunity. This is important for OEMs, as higher valuation improves access to capital, thus helping to fund technological transformation in EVs, AD, chips, SDVs, etc., and thereby fostering innovation and competitiveness. Looking at current OEM market cap growth, it appears that aside from Tesla (74% CAGR of market cap) and BYD (23% CAGR of market cap), the

software revolution has yet to translate into improved capital access for traditional OEMs (CAGR of market cap mostly amounts to 3-7%)3

As a result, investors don’t yet see expanded growth opportunities among traditional OEMs and are reluctant to make large scale capital commitments. To be considered a software company, OEMs must master both dimensions of the SDV value pyramid, i.e., they must offer digital services that show growth while reducing the cost and complexity of software development. This process can be embedded in a more tech-oriented investor story that focuses, for example, on reporting revenue and growth from digital services, the number of developers involved, passenger screen time in the vehicle and third-party purchases enabled.

3 Market Cap CAGR is calculated from 2010 to end of 2021

Table 1: Details on SDV value dimensions

A clear and measurable north star strategy that drives SDV transformation is key to long-term success

The transition from software to hardware doesn’t happen overnight, but is a marathon project for automakers and suppliers that takes years to complete. To avoid getting bogged down, companies need to both; develop a clear SDV strategy and keep track of the scope and effectiveness of SDV transition programs through an appropriate governance framework. To help achieve this, we have compiled five key actions:

Set clear, measurable targets for the SDV transition program, such as new software revenue, increased CLV, reduced complexity and increased ability to deliver – for today, tomorrow, and beyond

Right-size the SDV transformation program in terms of talent, organizational change, technology, intellectual property, partnerships and investment needs to fit the objectives

Prepare for the long-term hardware-software transition (10 years plus), but keep things manageable by establishing well-defined monitoring and governance frameworks

Ensure sufficient funding for the SDV transition to maintain pace and momentum, especially as risk factors often require rapid and unpredictable capital deployment

Stay on top of your talent sourcing and safeguarding, not only in technical areas, but also across the management function, as people are the heart of the SDV transition

About the authors

Marek Jersak

linkedin.com/in/marekjersak

Dr Marek Jersak leads Luxoft’s Automotive Advisory solution portfolio, applying our expertise in automated, connected, hyper-personalized software, data, processes and architectures. He combines an outstanding engineering education with deep insights into semiconductor and software industries.

As VP of Automotive Advisory, he strives to combine his experience and the strengths of a super talented, agile and growing advisory team to help clients create capabilities akin to tech and software companies, and to monetize on software and data.

Karsten Hoffmeister

linkedin.com/in/karsten-hoffmeister

Karsten is Luxoft’s head of Autonomous Driving. Previously, as the chief technologist for the same sector, he helped key clients in their transformation to develop software-defined vehicles. He has over 20 years’ experience in the automotive and software industries, this including more than 14 years in technical management positions at world-class companies. He has published many technical papers and was also a key speaker at TechAD 2022.

Jan Frederik Sieper

linkedin.com/in/jfsieper

Jan is a director in EY’s Strategy and Transaction practice, focusing on automotive strategy and new mobility. He has over 15 years of automotive industry and consulting experience and advises international clients –OEMs, suppliers and technology companies – on software-defined vehicles, digital and sales transformation programs, new business models, platform and ecosystem strategies, e-Mobility, autonomous driving and mobility services.

Daniel Hodapp

linkedin.com/in/dr-daniel-hodapp

Daniel is a senior consultant in EY’s Strategy and Transactions practice. Daniel has more than 5 years of experience in the automotive industry, including leading Tier 1 suppliers, in the areas of vehicle software strategy, digital ecosystem building, platform strategies, and vehicle data monetization. Daniel supports OEMs and suppliers in their transformation toward software-defined vehicles.

About Luxoft

Luxoft, a DXC Technology Company delivers digital advantage for software-defined organizations, leveraging domain knowledge and software engineering capabilities. We use our industry-specific expertise and extensive partnership network to engineer innovative products and services that generate value and shape the future of industries. Luxoft and EY joint publish insights around the future of mobility, and collaborate in the provision of services to clients.

For more information, please visit luxoft.com