Always quick off the mark, electric-vehicle (EV) sales have recently seen a surge. In many industries, the COVID-19 pandemic delayed momentum. But the electrification of vehicles accelerated—with EV sales between 2020 and 2022 growing by more than 90 percent in both the United States and Europe and by more than 300 percent in China.
This report, on the heels of McKinsey’s 2019 investigation of the trends surrounding powertrain electrification (see sidebar “Electrification: A changing of the guard”), reviews the latest electric powertrain (e-powertrain) market developments. Our research reveals a significant structural shift is occurring: roughly 70 percent of automotive suppliers expect the industry to consolidate over the next three to five years. Simultaneously, tier-one suppliers are feeling squeezed, facing pressure from tier-two-plus suppliers (for example, raw materials and electronic manufacturing services), as well as major internal cost increases. While OEMs can pass costs onto consumers via price increases, tier-one powertrain suppliers have few pass-along options, which is reflected in the 2022 average higher margins for OEMs over their suppliers.
In this article, we address the implications for automotive suppliers and suggest moves they could make to emerge on top.
Over the past three years, several key shifts have occurred in the powertrain component market. Those relevant to this article include the following:
- Electrification consistently accelerates faster than expected. EV sales have surged since the pandemic, and increased action on climate change (via government policy, company pledges, and consumers behavior) is driving sales.
- OEMs clarify their electrification make-versus-buy strategies. With the move toward the electrification of vehicles accelerating faster than expected, automotive OEMs are increasingly deciding to insource e-powertrain systems and components.
- Legacy components are becoming a transition consideration for OEMs. The EV speedup has made legacy powertrain components for internal-combustion engines (ICEs) a key consideration for OEMs. Demand is projected to grow through mid-decade before declining, which may enable increased supplier pricing power.
- Carve-outs become more common in the powertrain business. Increased efforts to separate ICEs from EV businesses for both OEMs and suppliers to generate short-term cash can help finance the transition in the short term and clarify the true opportunity for capital markets.
Electrification accelerates
The journey toward widespread vehicle electrification has reached a crucial turning point because of a confluence of factors, including stringent regulatory pressures, consumer demand, technology advancements, and the commitment of automakers in key global markets to an electric future.
Today to 2035: China, Europe, and the United States
Europe’s path to growth
The latter half of the decade could be a significant step forward in Europe’s electrification journey, propelled by the commanding influence of small and medium-size vehicle segments (known as B and C automotive segments in Europe and subcompact and compact vehicle classes, respectively, in the United States). Our analysis suggests that by 2035, small and medium-size vehicles will account for more than three-quarters of the European BEV market (exhibit).
Chinese BEV manufacturers, in particular, are prioritizing these segments as they seek to compete in the increasingly crowded European market. Indeed, many new models are set to launch in the coming years with more-competitive pricing, extended range, and enhanced charging capabilities, making BEVs increasingly attractive to broader segments of consumers.
Spurred by consumer demand, China has surged ahead in battery-electric-vehicle (BEV) penetration, overtaking Europe’s sales volume in 2021 and 2022 (Exhibit 1). But according to our projections, Europe will bridge the gap in BEV penetration before the end of the current decade. (See sidebar “Europe’s path to growth” for more information.) This momentum will propel the transition to Europe’s electrification targets by 2035, when the European Union’s ban on the sale of new gasoline and diesel vehicles takes effect; that year, annual BEV sales in Europe could reach 14 million units.
In the United States, the momentum toward electrification has been less rapid—though the tides are shifting. Recent legislative moves, such as the Inflation Reduction Act and the implementation of stricter emissions targets under the current administration, are catalyzing the drive toward electrification.
To highlight the economic impact of accelerating electrification, we reexamined market size and growth forecasts for electric powertrain components (Exhibit 2). The components analyzed include the following:
- Electric drive unit (EDU): a subassembly comprised of a traction motor, reducer, and inverter
- Battery pack: the battery housing (including structural elements and connectors) cells, and battery management system
- Power electronics: the onboard charger (OBC) and DC/DC converter
- Thermal management system: the system that maintains powertrain component temperatures within operational limits
Most of these components have large markets (greater than $1 billion) that will likely increase rapidly by 40 percent or more annually over the next five years.
Following the sustained dip in car sales since the start of the pandemic, growth in overall vehicle production will likely resume. This momentum, combined with e-powertrain cost reductions driven by market competition and manufacturing scaling effects, will support EV growth through 2035 and beyond, posing an unprecedented challenge to existing value chains.
According to the Status of the Automotive Supplier Industry, a joint survey by the European Association of Automotive Suppliers (CLEPA) and McKinsey in the spring of 2022, several factors will help increase consolidation among suppliers. These include the shift in technology from ICEs to EVs, the repositioning of value pools within the powertrain industry (as powertrains will have a larger overall share of vehicle costs for BEVs), and the make-versus-buy decisions by OEMs.
OEMs clarify their electrification strategies
As a result of ambitious electrification targets and plans to divest ICE powertrain manufacturing assets, automotive OEMs continue to invest significantly in BEV production. Announced investments by OEMs exceed $500 billion for general electrification by 2025. The actual figures are likely to be much larger, since many OEMs aggregate their investment announcements.
EDU make-versus-buy implications
As OEMs’ BEV platform strategies have emerged, electrified-component assembly plans have matured. No single preferred solution exists, but by mid-decade we expect many large traditional OEMs to assemble e-drive units and battery packs in-house and to outsource battery cells and selected power electronic systems, such as DC/DC converters and onboard chargers.
The key drivers of e-powertrain insourcing include cost savings, workforce retention, and competitive differentiation (see sidebar “Making e-powertrain components core”). At high volumes—for example, 100,000 units of annual capacity for an e-drive system—insourcing powertrain components can provide significant cost savings. Some OEMs may also choose to retain legacy ICE component plant employees through insourcing to satisfy powerful regional unions. Furthermore, e-powertrain components exert a high influence over the performance of vehicle drives, with battery packs and EDUs being the two largest differentiators of BEV performance.
These sourcing decisions have cascading implications across an OEM’s manufacturing footprint, including existing facility planning. They can have a significant impact on the tier-one and tier-two automotive supply base. For instance, many suppliers are managing e-drive market pressures knowing that, between 2015 and 2020, more than 20 global tier-ones announced more than $11 billion of EDU investments. These investments have helped suppliers to build capabilities to support the current BEV market. Now OEMs are making major EDU investments to build their in-house capabilities. Given the fragmented nature of the EDU supplier market and the tendency of OEMs to insource—at least on the system and assembly levels—we expect a major consolidation of this nascent supplier market.
OEM e-powertrain sourcing strategies could follow five potential paths (Exhibit 3):
In-house. Some EV disrupters are insourcing components across the e-powertrain value chain. These players work with suppliers on subcomponents and lead the design and final assembly stages of powertrain components. They control virtually all systems-related work as part of their core competency. We expect that any outsourcing to suppliers will be small, reaching about 5 percent of the addressable market in 2030.
Cost focused and leaning toward insourcing. These players, typically mainstream incumbents, will likely limit systems sourcing to about a quarter of the available total, in part to stay current with the latest system-level breakthroughs from the supplier community. Based on expert interviews, we believe that by 2030 they will represent 20 to 40 percent of the outsourced EDU market to suppliers.
Performance focused. Primarily luxury performance OEMs, these players seek to control the performance-related differentiating aspects of an e-powertrain. By 2030, their sourced system share (such as the share of completely purchased EDU systems versus single components) is expected to reach 50 percent, and they will likely represent 20 to 50 percent of the addressable EDU market to suppliers in 2030.
Cost focused and leaning toward outsourcing. These companies will include a mix of new entrants and niche players that have a high focus on short-term profitability. In 2030, they will probably represent 60 to 80 percent of the addressable EDU market to suppliers, with a fully outsourced systems share of 75 percent.
Buy. OEMs that primarily buy their EV powertrain solutions from suppliers will mostly be electrification followers without the resources or expertise to develop their own e-powertrains. By 2030, we expect them to represent 75 to 95 percent of the addressable market for EDU suppliers and have a sourced systems share of about 90 percent.
For their 2025–30 strategies, individual OEMs will vary their approaches within each archetype. For example, for EDUs, we expect OEMs to build 70 percent of all e-motors from scratch. They will likely source the remaining 30 percent from the tier-ones, with most of that demand consisting of completely assembled EDUs versus subassemblies. Many larger OEMs plan to pursue dual strategies: sourcing EDUs from tier-ones for selected platforms or trims while deciding to make them for others. We also expect tier-one suppliers to provide about 75 percent of traction inverters by 2030.
Full-system EDU suppliers are likely to experience continued margin pressure, although experts may disagree on this point. Some view EDUs as commodities, while others consider them a key performance differentiator. Nevertheless, most OEMs seek aggressive annual price reductions and remain hesitant to include raw-material indexes in supply contracts. This will lead to a consolidation of the fragmented EDU supplier market, which now has over 20 suppliers offering EDU systems.
The shift of ICE-related portfolios toward e-mobility will allow new suppliers to emerge in the EDU space. Together with OEM insourcing strategies, this development will increase competition and put pressure on suppliers to sustain their market positions. That should in turn cause suppliers to fine-tune their offering(s) for addressable markets. While some will focus on manufacturing excellence for high production efficiency and low costs, others will seek niche markets, such as high-performance EDUs.
Legacy components emerge as a transition challenge for OEMs
OEMs face component production capacity challenges through the midterm. We expect net ICE production to increase moderately through mid-decade due to the continued growth in demand for hybrid vehicles, before dropping precipitously by 2030. OEMs, which are reluctant to build out additional internal capacity for “sunset” ICE components, will likely shift low-volume ICE engine and transmission programs to tier-one suppliers to free internal plant space for BEV components such as e-motor assemblies.
We believe the ramp-down of ICE volumes carries both mid- and long-term risks for OEMs. Declining ICE component volumes present two major challenges. The first involves “diseconomies” of scale. Substantial lifetime value is at stake because of the likely increase of component prices due to reduced economies of scale and “last man standing” supplier pricing flexibility. The second involves the risk of recalls, which OEMs must manage for existing ICE vehicles. This will require capabilities to provide adequate solutions. Unless banned outright, the durable and enduring ICE car parc1 will likely create shortages for aftermarket components in the years beyond 2030. Our article, “ICE businesses: Navigating the energy-transition trend within mobility,” presents some ideas on how ICE suppliers can create value while advancing sustainability.
Separating ICE and EV functions
The continued production of ICE components could generate cash, and industry players have taken actions to capitalize on this by separating business units or creating stand-alone entities. Some other reasons for making such moves include creating a distinct proposition for capital markets, helping management focus on critical challenges (for example, growth versus operational performance), and driving strategic repositioning. ICE suppliers that can endure the transition could expect to experience increased pricing flexibility. OEMs Ford, Geely, Renault, and Volvo announced last year that they would form distinct auto units based on powertrain type.
Implications for suppliers: Becoming an electrification winner
Our previous report recommended that suppliers take several initial actions to prepare for electrification.2 We have updated these recommendations to reflect the current trends.
- Update company strategy to include a detailed implementation approach. Our research and experience suggest that many suppliers have already completed this step. The resulting updated strategy and transition vision will help such players successfully navigate the waves of expected industry consolidation activities. Another strategic imperative is to target the right customers. As OEMs evolve their make-versus-buy strategies, suppliers need to develop an ongoing understanding of the OEMs’ cycle plans and timing. When do they intend to bring e-powertrain capabilities in-house, and what product features do they plan to offer? With this knowledge, suppliers can target specific OEM programs to lock in long-term agreements and support OEMs in their transition away from legacy ICE components. Cash generated from these efforts can help finance the transition.
- Emphasize a performance focus with a ‘culture of accountability.’ The CLEPA pulse check indicated that tier-one suppliers feel increasingly prepared for the changes from the Aftermarket Catalog Exchange Standard (ACES) trends (autonomous driving, connectivity, electrification, and shared mobility). At this point, suppliers should have moved to implementation, using unified company-wide approaches to position themselves for growth based on clearly defined capabilities. Suppliers should have already prioritized transitional actions, recognizing the need to systematically steer their relevant ICE components, and updated their strategies for which areas to emphasize as last-man-standing components rather than consider divesting early. The C-suite should lead this transition, with a strong, empowered performance office that steers overall performance and manages compliance within the clearly defined strategy. A key element of this performance involves improving e-powertrain component profitability via a mix of procurement and engineering actions while managing the profitability of ICE components with reduced R&D support and rationalizing the production footprint. Tier-one suppliers should harness their advanced expertise to develop more integrated offerings across systems. Doing so will allow them to address complexities with a lower cost base than those of the OEMs. Likewise, vertical integration can improve the margin profile on EDU systems and components while creative sourcing partnerships can enable suppliers to scale market demand to capture greater savings.
- Brush up M&A skills. A company’s merger-and-acquisition (M&A) capabilities become increasingly important for industries in which one market is declining while another is booming and many players fight for market share. All the issues surrounding scarce talent and tight capital markets come into play, as does the need for strong postmerger-management skills. M&A activities are relevant on both the ICE side, where growth is only possible through share of wallet growth, and on the EV side, where some markets are very fragmented (for example, e-motors and inverters). Strategic M&A actions can bring together the right mix of skill sets and competencies, critical mass, and scarce capital to weather the current disruptions.
- Allocate resources through an ‘old world versus new world’ lens. Many suppliers will have carved out their initial electrification resource requirements. These will be allocated in a defined product development budget based on electrification trends and other indicators. R&D efforts should focus on future markets, while backbone and legacy markets ought to follow a low-investment and cash-out logic. Suppliers, OEMs, and public-sector players should cooperate to bundle research efforts and to ensure competitive, viable, and promising solutions for the future of powertrain technology. It also makes sense to review long-term capacity planning based on the confirmed order book, upcoming programs, OEM mix, and other indicators. Suppliers need to know the forward plans of their targeted OEMs in terms of insourcing and outsourcing almost as well as the automakers do themselves: are these plans changing, and do they still match the supplier’s development program? Tier-one suppliers are already developing electric drivetrains targeted to specific OEM archetypes by defining product road maps that complement likely OEM strategies.
- Keep supply chain resilience as a priority. Staying ahead of supply chain challenges will remain a challenge for some time. Tier-ones should seek to maintain the resilience muscle developed through the pandemic by diversifying their tier-two-plus base, continuing investments in infrastructure and analytics, and collaborating with OEMs and other suppliers on topics such as tracing for sustainability measures. They should also anticipate changes in regulations that could differ widely by region. By diversifying the supply, powertrain suppliers can reduce supply chain risks and improve flexibility. Investing in analytics can help them anticipate macroeconomic and market shifts, providing them more time to react. Collaboration with OEMs and other suppliers can improve supply chain efficiency through improved transparency, which is especially critical for achieving sustainability targets.
Given electrification’s rapidly changing competitive environment, suppliers should maintain an active portfolio road map. They should ask themselves if they can bolster future offerings, how they can tap into innovative practices they already use, and whether they should think about M&A. McKinsey research suggests that 70 percent of suppliers already expect more M&As soon—a sign that the industry is likely to consolidate. Once a supplier develops its product road map, it needs to become specific: which nameplates, models, and services will it offer, and to whom?
A fundamental shift is taking place across the automotive value chain, and it’s happening faster than many in the industry anticipated. The impact of the current surge in vehicle electrification has fallen heaviest on the shoulders of the supply base, which faces high levels of uncertainty, shifting customer plans, and the need to secure investment capital. To win, suppliers should position themselves as indispensable partners of targeted OEMs for critical components and systems and back up their claims with industry-leading competence.
