Industry Insights
When the basis of competition shifts, companies optimized for the old game face a painful choice: rebuild their cost structures or watch them become anchors. Right now, some of the world's most sophisticated manufacturers are living through this transition.
Consider Volkswagen. For decades, German automotive engineering represented the pinnacle of mechanical precision. Cost structures, supply chains, and engineering organizations were refined to optimize every aspect of internal combustion vehicles. Then the rules changed, software became the differentiator. Vertical integration in electronics created new advantages. And suddenly, the infrastructure built to win at mechanical engineering became a liability.
In November 2025, the crisis deepened: Volkswagen's board delayed approving an €11 billion investment plan, leaving nearly 100 factories worldwide waiting to learn their future. By December, sources confirmed the planning round wouldn't conclude in 2025, the second year in a row. The underlying crisis: plans to close three German plants and eliminate 35,000 positions by 2030, factory costs 25% to 50% above targets, operating margins collapsed to 2.3%, less than half the target.
Dr. Andreas Cornet, who spent over 30 years at McKinsey advising automotive manufacturers, sees this as more than an industry-specific crisis. In a recent Beyond Cost podcast conversation, he explained: "Germany and Europe were very good in things you can touch. Like the injection pump, the gearbox, the electric motor, the suspension. And now differentiation of the car is software, defined vehicle...they're not that much touchable anymore."
The pattern extends beyond automotive. When value creation fundamentally shifts, whether to software, digital services, or AI capabilities, cost structures built for physical products become disadvantages. For cost engineers, the German automotive crisis offers a case study in recognizing that shift before it's too late.
The Success That Became a Trap
For three decades, Germany held steady as the world's third-largest economy. Automotive grew predictably, single-digit percentage gains year after year. That stability masked a dangerous pattern.
The numbers looked stable. The underlying rules of competition were shifting beneath the surface.
Between 2015 and 2025, software content in vehicles exploded. Average lines of code per vehicle jumped from 100 million to 650 million. The automotive software market grew at four times the rate of vehicle sales. Domain control units went from less than 1% of the ECU market in 2019 to an expected 43% by 2030.
German manufacturers perfected mechanical precision while value creation moved to software integration.
Things You Can Touch vs. Things You Can't
Andreas Cornet offers a vivid illustration of how Germany's competitive edge eroded:
This shift goes deeper than technology catching up. It involves business models, speed, and organizational agility.
German manufacturers excelled at perfecting physical products through incremental engineering improvements. When value creation shifted to software, user experience, and rapid iteration, the old playbook stopped working.
The Cost Structure Mismatch
German automotive engineering organizations were built to optimize mechanical complexity. Cost engineering teams developed deep expertise in machining tolerances, material properties, and assembly processes. Supplier bases specialized in precision components.
That entire infrastructure became misaligned when vehicle differentiation moved to software architecture, over-the-air updates, and digital services.
Volkswagen's software division, Cariad, struggled for years to deliver the digital architecture that modern vehicles require. After burning billions, VW announced 1,600 layoffs at Cariad and partnerships with Rivian and Chinese firms to source software capabilities. That decision represents an admission: German automotive engineering excellence couldn't be redirected fast enough to master software-defined vehicles.
Cost structures followed the same pattern. German cost engineering processes excelled at optimizing stamping dies, reducing machining time, and negotiating component costs. Those capabilities still matter, but they're no longer sufficient when a vehicle's bill of materials shifts toward electronics and software.
What Success Looks Like
While German manufacturers struggle to adapt, competitors who built for the new game from the start show what's possible.
Chinese manufacturer BYD, which began as a battery maker before moving into vehicles, has achieved a sustainable 25% cost advantage over legacy competitors according to UBS teardown analysis. The advantage comes from vertical integration optimized for electronics and software rather than mechanical systems. Where legacy European OEMs outsource major systems to suppliers (typically achieving about 30% vertical integration), BYD makes battery cells, powertrains, and electronics modules in-house.
At last year's EV seminar in Japan, attendees tore down a BYD vehicle and asked: "How can it be produced at such a low cost?" The answer: fewer parts, integrated modules combining multiple functions, and engineering simplicity optimized for the new value drivers.
The lesson isn't about copying China. It's about recognizing that when value creation fundamentally shifts, cost structures optimized for the old game become structural disadvantages that can't be fixed with incremental improvements.
Beyond Automotive: The Pattern Repeats
This pattern extends across manufacturing. In industrial equipment, value is migrating from mechanical systems to IoT connectivity and predictive maintenance algorithms. Medical device makers find differentiation shifting from precision manufacturing to software-enabled diagnostics and remote monitoring. Aerospace companies see performance advantages increasingly coming from flight management software and autonomous systems rather than materials and aerodynamics.
The challenge is universal: cost structures, skills, and organizational focus optimized for one form of value creation struggle to pivot when value migrates.
What Cost Engineers Should Do About It
The German automotive crisis offers pragmatic lessons for cost engineers in any industry facing similar shifts:
1. Audit Where Value Is Actually Created
If your should-cost models focus on mechanical tolerances and material costs while your product's value increasingly comes from software and integration, you're measuring the wrong things.
Are your cost breakdowns aligned with how customers perceive and pay for differentiation? When BYD integrates batteries, powertrains, and electronics in-house, they're not just reducing supplier margins, they're optimizing across system boundaries that legacy OEMs can't cross without restructuring their entire supply base.
Question whether your make-vs-buy decisions were made for an architecture that no longer exists. The integration points that matter may have shifted.
2. Rebalance Your Technical Depth
This doesn't mean abandoning mechanical engineering expertise. It means ensuring your cost engineering team has comparable depth in the technologies that now drive differentiation.
If software represents 40% of your product's value but your cost engineering team spends 5% of their time on software costs, you have a mismatch. German cost engineers developed world-class expertise in costing injection-molded parts, cast components, and machined assemblies. That expertise matters less when vehicle differentiation comes from software architecture and electronics integration.
How many cost engineers on your team can accurately model software development costs? Cloud infrastructure? AI model training? If those are becoming major cost drivers in your products, skill gaps become strategic vulnerabilities.
3. Challenge Your Benchmarks
Many should-cost models are built on historical benchmarks. If your product architecture has fundamentally changed, those benchmarks may anchor you to the wrong comparisons.
Ask: Are we comparing our costs to competitors with similar architectures, or to competitors who've already made the transition we're attempting?
4. Learn from Adjacent Industries
Consumer electronics made the hardware-to-software transition decades ago. What cost management practices do they use that manufacturing hasn't adopted?
Andreas Cornet suggests a "best-of benchmark" approach: identify solutions that work in other contexts and adapt them. The same logic applies to cost engineering. If software cost estimation methods work in tech companies, why can't they work in manufacturing? The answer is often: they can, but organizational inertia prevents adoption.
Conclusion
The German automotive crisis is a warning signal, not just for Germany, but for any industry where value creation is migrating faster than cost structures can adapt. The manufacturers and cost engineers who recognize this pattern early and act decisively will gain competitive advantages that persist for decades. Those who wait for the crisis to become undeniable may find they've already lost.
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