The quest for economies of scale is at the heart of many firm’s operational designs. Economies of scale justify everything from big capital investments to sprawling call centers. But just how easy is it to take advantage of economies of scale? That’s essentially the question raised by a recent Wall Street Journal article (High Battery Cost Curbs Electric Cars, Oct 17). The article focuses on the big battery packs necessary for hybrid and fully electric cars. The issue is not just academic. These battery packs are very expensive — by some estimates they account for half the cost of the car — and their cost is seen as one of the stumbling blocks in getting wider market penetration of alternative fueled vehicles. The Department of Energy has set a goal of having the cost of fall by 70% based on a 2009 base by 2014. Where are those cost savings going to come from? Economies of scale. Once Nissan rolls out the Leaf, Chevy the Volt and so on, battery production will increase dramatically and, the logic goes, cost will fall.
But will they?
The article makes a pretty compelling case that the DOE goal may be just wishful thinking. Economies of scale matter when the efficient scale of capital is large. An oil refinery that produces just a gallon a day would be horribly inefficient. The equipment to produce just a gallon is very expensive and could easily be sized to produce way more with little change in cost. Hence, refineries are sized to process hundreds of thousands of barrels of crude per day. Note that capital intensity also implies that labor and input costs while possibly high are not necessarily the dominant concern in how production is organized. (Or put another way, the price of gas moves so much with the cost of crude oil because economies of scale in refineries have minimized the variable cost of transforming crude into gas.) Economies of scale also matter when demand uncertainty across regions or sectors can be effectively pooled. A centralized facility can then run at higher utilization and lower cost then dispersed facilities. It’s not clear that either of these apply in the case of car batteries.
Both the industry and government are betting that a quick takeoff in electric-car sales will drive down the battery prices. But a number of scientists and automotive engineers believe cost reductions will be hard to come by.
Unlike with tires or toasters, battery packs aren’t likely to enjoy traditional economies of scale as their makers ramp up production, the scientists and engineers say. These experts say increased production of batteries means the price of the key metals used in their manufacture will remain steady—or maybe even rise—at least in the short term. They also say the price of the electronic parts used in battery packs as well as the enclosures that house the batteries aren’t likely to decline appreciably.
Experts argue that 30% of the cost of a battery pack comes from the various metals it contains and those prices are expected to stay fairly high.The enclosures for battery packs are expensive and the various electronic components are already manufactured in high volume. On top of that, assembling batteries requires specialized labor trained to work in a “high-voltage environment.” To the extent that demand for electric vehicles will be positively correlated across makes and models (i.e., this market is either going to take off or it’s not), there seems little possibility of gains from statistical pooling. If these estimates are right, it is not clear where gains might come from.
to be fair, there are some out there who believe that serious savings are possible:
Alex Molinaroli, president of Johnson Controls Inc.’s battery division, is confident it can reduce the cost of producing batteries by 50% in the next five years, though the company won’t say what today’s cost is. The cost reduction by one of the world’s biggest car-battery makers will mostly come from efficient factory management, cutting waste and other management-related expenses, not from any fundamental improvement of battery technology, he said.
The assertion from Johnson Control’s would then seem to depend on other assertions being wrong. If the simple costs of materials (i.e., metals and enclosures) really do account for a large part of the cost of a battery, it is not immediately evident that smarter management (while useful) is sure to deliver large savings.