What Can Detroit Learn from the Silicon Valley?

Will the new GM innovate?

Will we catch up with China in new car technology and electric battery design?

According to Intel's former CEO Andy Grove, Detroit can learn that capital intensive, vertically integrated production is a thing of the past.

Will the auto industry's new overseers catch on?

Some clues are offer by the creative destruction of the capital-intensive mainframe computer business which was replaced by the high growth PC industry where the Silicon Valley, U.S.A. still enjoys strategic advantages.

Our government has made heavy investments in the U.S. automobile industry. How should it use its influence? It is a difficult question to answer because it appears that the automobile industry is in the middle of a fundamental transformation. There is a lot of information available on how companies have dealt with major changes in their business environments, but little is known about the transformation of entire industries.

History shows that most companies do not deal well with transformation. One reason has to do with senior managers. They usually "don't get it." They have a difficult time accepting that the future will be vastly different from the present because they rose to power in the old business environment. They excelled in the old environment and didn't acquire skills necessary to operate in the new.

It is also hard for managers to distinguish between an erosion in a company's competitive position and a change in the fundamental nature of an industry. Knowing the difference is one of the most difficult things to do, even though it is among the most important.

The transformation of an entire industry does not happen very often. It only occurs when a number of factors align, such as a change in consumer demand, a shift of parts of the major supply chain from one country to another, and the emergence of key technological changes.

This is what happened in the computer industry in the 1980s and '90s. Previously, each company produced its own mainframe computers using proprietary hardware and software. The company's sales force then sold these complex and expensive products.

The PC changed this. In a period of just a few years, the industry was pulled apart and reassembled. The entire industry began to rely on common hardware elements (microprocessors) and packaged software; selling was handed off to third parties. In business we call this moving from a "vertical" structure (where a company handles its own development, manufacturing and distribution) to a "horizontal" structure (where some companies specialize in building components while others integrate them and handle distribution tasks).

The result was that the computer industry became more dynamic as old participants (such as Burroughs and Digital Equipment) faded away and new types of companies (such as Compaq and Dell) emerged.

Typically, a single company cannot call the shots that transform an industry. But when a government gets as involved as ours has in the U.S. automobile industry, it can end up making transformational decisions.

Imagine if in the middle of the computer transformation the Reagan administration worried about the upheaval and tried to rescue this vital industry by making huge investments in leading mainframe companies. The purpose of such investments would have been to protect the viability of these companies. The effect, however, would have been to put the brakes on transformation and all but ensure that the U.S. would lose its leadership role.

The government's investment in General Motors might be directly helpful if the auto industry only had the recession to contend with. But that is not the case. The industry faces the confluence of a world-wide recession, rising fuel prices, environmental demands, globalization of manufacturing, and, most importantly, technological change involving the very nature of the automobile.

Electric cars have become viable and will likely only become more capable in the future. Components critical to their performance -- batteries and electronic control systems -- are on a rapidly rising technology curve. These technologies are new and therefore capable of improving quickly with incremental investments. By contrast, technologies that have been around a long time, such as the internal combustion engine and the fuel and drive systems built around it, have enjoyed the benefits of decades of development and have limited potential for further improvement.

The result is that there are several factors aligning to bring about a change in the structure of the automobile industry. Electric cars may match the needs of our time better and become more desirable than cars relying on the internal combustion engine. The car industry today is as vertical as the computer industry was before the PC. However, the simplicity of the electric car combined with the standardization of certain components may cause the automobile industry to shift to a horizontal structure. The Internet is already emerging as a key marketing medium for automobiles and is easily adaptable to a horizontal structure.

If such a shift occurs, the success of a producer will depend on how well it takes advantage of the new structure -- whether it can use the mass-producibility and falling cost of batteries and other components better than its competitors.

The U.S. government is investing in the automobile industry with the intention of preventing jobs from being lost. This may improve GM's ability to operate within today's structure. But there is no comparably large investment being made to develop the capabilities that could serve the company in a new era of electric cars.

China appears to be making a different bet. It's not clear precisely how the Chinese government influences industrial strategy. But China is putting a great deal of effort into developing and manufacturing batteries. Essentially, it is betting that it can take the lead in creating the foundation technology of what will likely be the new structure of the auto industry.

Which is the better investment strategy? It is too early to say. In the short term, the U.S. strategy will likely save jobs. The long term is much more problematic. We do not yet know when and if the automobile industry will shift into a horizontal structure. The stakes, however, are very high. The strategic bets being placed by each country may determine which one will end up as the world's leader in automotive technology and manufacturing.

Edited from 7-13-09 WSJ by Andy Grove is the former CEO of Intel Corp.