Winning the Hardware Software Game Winning the Hardware-Software Game - 2nd Edition

Using Game Theory to Optimize the Pace of New Technology Adoption
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The Players: Incentives and Potential Actions

Regulators

Users

Automobile Manufacturers

Emissions Testers

Gasoline vs. Diesel vs. Hybrid Automobiles

US vs. European Automobile Standards and Procedures

Standards

Approval Process

 

The VW emissions scandal has brought the issue of automobile emissions to the forefront of discussions. Recent scrutiny of industry practices has led to further revelations about behaviors of industry players. In particular, auto manufacturers have been gaming the emissions testing system by increasing amounts over time, while regulators – particularly those in Europe – have been lax in establishing/enforcing appropriate standards. Taken together, the actions taken by auto manufacturers and regulators have led to real-world levels of pollutant emissions from automobiles that significantly exceed healthy limits.

This analysis examines the evolution of incentives and actions taken by each set of automobile industry players (Regulators, Users, Manufactures, and Emissions Testers), together with the actual outcomes that have occurred, as well as the potential alternative outcomes that might have occurred under alternative scenarios.

A copy of the full analysis can be downloaded by clicking on the link at the bottom of this blog entry.

The Players: Incentives and Potential Actions

This section provides descriptions of the incentives and actions available to each set of players. The Auto Emissions Game is depicted in Figure 1.

Figure 1

Regulators

Regulators play active roles in the industries of most (all?) nations that produce automobiles. The timeframe that Regulators generally consider when choosing which standards to set is roughly five to fifteen years. Achieving new standards requires Auto Manufacturers to rework their technologies, which takes time. As such, new standards are generally rolled out over several years into the future.

(Theoretically) Regulators choose standards and policies so as to maximize social welfare. More specifically, Regulators choose standards and policies to maximize the value of the automobile industry, while minimizing the social costs associated with the transportation services achieved by Users. 

Safety Standards

Due to the informational advantages Auto Manufacturers have over Users regarding the safety of manufactured automobiles, Regulators establish safety standards, which force Manufacturers to attain minimum levels of safety. As technology improves over time, Regulators increase the minimum standards for safety. From the National Highway Traffic Safety Administration,

The National Highway Traffic Safety Administration has a legislative mandate under Title 49 of the United States Code, Chapter 301, Motor Vehicle Safety, to issue Federal Motor Vehicle Safety Standards (FMVSS) and Regulations to which manufacturers of motor vehicle and equipment items must conform and certify compliance. FMVSS 209 was the first standard to become effective on March 1, 1967. A number of FMVSS became effective for vehicles manufactured on and after January 1, 1968. Subsequently, other FMVSS have been issued. New standards and amendments to existing standards are published in the Federal Register.

These Federal safety standards are regulations written in terms of minimum safety performance requirements for motor vehicles or items of motor vehicle equipment. These requirements are specified in such a manner "that the public is protected against unreasonable risk of crashes occurring as a result of the design, construction, or performance of motor vehicles and is also protected against unreasonable risk of death or injury in the event crashes do occur."

Emissions Standards

Due the pollution externalities associated with Users’ use of automobiles, Regulators establish emissions standards, which force Manufacturers to achieve maximum levels of pollutant emissions. . As technology improves over time, Regulators decrease the maximum levels of permissible emissions. From the EPA,

The Office of Transportation and Air Quality's (OTAQ) mission is to protect human health and the environment by:

  • Reducing air pollution and greenhouse gas emissions from mobile sources and the fuels that power them.
  • Advancing clean fuels and technology.
  • Encouraging business practices and travel choices that minimize emissions.
OTAQ's programs address emissions from the range of mobile sources: cars and light trucks, large trucks and buses, farm and construction equipment, lawn and garden equipment, nonroad recreational vehicles (e.g., dirt bikes and snowmobiles), marine engines, aircraft, and locomotives. 

OTAQ's primary activities include:

  • Assessing mobile source-related air quality problems and developing sophisticated modeling tools to develop solutions, measure results, and support emission inventories.
  • Establishing national standards to reduce emissions from on-road and nonroad mobile sources of pollution.
  • Implementing national mobile source standards through certification processes and in-use monitoring strategies.
  • Developing fuel efficiency programs and technologies to reduce the emission of greenhouse gases from the transportation sector.
Researching, evaluating, and developing advanced technologies for controlling emissions, as well as developing new strategies for improving fuel efficiency. 

Mileage Standards

In an attempt to minimize national dependence on foreign supplies of fossil fuels, Regulators establish mileage standards, which force Manufacturers to attain minimum levels of vehicle fuel efficiency. As technology improves over time, Regulators increase the minimum mileage standards. From Wikipedia:

The Corporate Average Fuel Economy (CAFE) standards are regulations in the United States, first enacted by the U.S. Congress in 1975, in the wake of the Arab Oil Embargo, to improve the average fuel economy of cars and light trucks (trucks, vans and sport utility vehicles) produced for sale in the United States.

From the National Highway Traffic Safety Administration (NHTSA)

Corporate Average Fuel Economy (CAFE)

First enacted by Congress in 1975, the purpose of CAFE is to reduce energy consumption by increasing the fuel economy of cars and light trucks. NHTSA has recently set standards to increase CAFE levels rapidly over the next several years, which will improve our nation’s energy security and save consumers money at the pump.

Support Industry

Global automobile production is relatively concentrated within a few countries (see Figure 2). And in the countries that host the largest Auto Manufacturers, the associated manufacturing, sales, and services sectors employ significant portions of the total national populations.

In the US, the auto manufacturing, sales, and services sectors employed almost four million people in 2014, accounting for $144 billion in payroll.

In Germany,

The automotive industry is the largest industry sector in Germany. In 2014, the auto sector recorded turnover of EUR 384 billion – around 20 percent of total German industry revenue. The automobile industry is one of the largest employers in Germany, with a workforce of around 775,000 in 2014.

In Japan, the auto manufacturing, sales, and services sectors employed 2,655,000 in 2014, accounting for over four percent of the national workforce.

Because the auto industry employs so many people and accounts for such a large portion of the economy, it is natural for government to support these industries.

Figure 2

Regulators choose standards and policies for Automobile Manufacturers to (i) maximize industry value and (ii) minimize the social costs (safety, emissions, dependence on foreign oil) associated with Users' use of Manufacturers' vehicles.

Users

Users choose which vehicles to buy to maximize utility, primarily based on a combination of

    • The total price associated with generating transportation services from the vehicle.

        • This includes the price of the vehicle, and

      • The price of fuel associated with operating the vehicle (i.e., vehicle mileage).
    • The quantity of emissions generated by operating the vehicle.

 

  • The driving performance of the vehicle.

Different Users have different relative values (i.e. weights) for each of these three components.

The timeframe that Users generally consider when choosing which vehicle to buy is the expected life of the car.

Automobile Manufacturers

Automobile Manufacturers choose the types of automobiles to develop (gas, diesel, electric/hybrid), given the standards set by Regulators and the preferences of Users, so as to maximize profits. So then Auto Manufacturers Choose

  • The price of the vehicle.
  • The levels of

      • Safety,

      • Emissions, and

    • Mileage

   to be achieved, given the mandatory minimum requirements established by Regulators

  • The driving performance of the vehicle, such as maximum speed, horsepower, and acceleration.

The timeframe that Auto Manufacturers generally consider when choosing which vehicle to manufacture is, say, five to ten years. Automobile Manufacturers spend significant amounts of resources (time and money) on research, development, and manufacturing of automobile technology. According to PWC, “The 2014 Global Innovation 1000: Automotive industry findings”, the Auto Manufacturing industry is third in innovation spending only to computer electronics and healthcare (see Figures 3 and 4).

Figure 3

Source: PWC, “The 2014 Global Innovation 1000: Automotive industry findings”

Figure 4

Source: PWC, “The 2014 Global Innovation 1000: Automotive industry findings”

The development of different classes of automobiles (by technology: gasoline, diesel, electric/hybrid; and by vehicle type: compact, sedan, SUV, truck) requires very large investments in technology, know-how, supplier relationships, etc. What this means is that there is a large component of path dependence in (long-term commitment to) each particular class of vehicle. That is, Auto Manufacturers cannot easily switch production from, say diesel to hybrid. Rather, such a switch would take many years and much investment in resources.

The large size of the automobile industry (in terms of employment and contribution to the economy) affords Auto Manufactures substantial leverage when lobbying Regulators regarding industry standards and policies.

Of course, once an Auto Manufacturer has committed to a certain class of vehicles, it will be in the Auto Manufacturer’s best interest to lobbying Regulators to impose standards and policies that support the path he has chosen.

Emissions Testers

In Europe, there is a single-pronged testing approach, where Emissions Testers are paid by Auto Manufacturers to test pre-production models for emissions and certify that the standards have been met. In the US, the EPA (Regulators) oversees a three-tiered process involving pre-production, production, and post-production models. (See section below “US vs. European Automobile Standards and Procedures: Approval Process” for more details.)

 

Gasoline vs. Diesel vs. Hybrid Automobiles

Understanding the incentives and potential actions faced by players in the Automobile Emissions Game requires a basic understanding of the differences in price, emissions, and performance between gas, diesel and (gas) hybrid vehicles.

According to EPA, “Greenhouse Gas Emissions from a Typical Passenger Vehicle,” diesel engines create more CO2 emissions per gallon of fuel than gasoline engines do, but diesel engines tend to get better mileage, especially on highways, than gas engines.

Diesel engines emit more nitrous oxide (NOx) and particulate matter (PM) emissions than gasoline engines, but NOx and PM emissions are generally small relative to CO2 emissions; however NOx and PM emissions have higher global warming potential (GWP) than CO2.

Mike Hudson in “Diesel, Gas or Hybrid?” provides a nice summary comparison:

Here is a quick overview of the strengths and drawbacks of systems that are on the market:

Gasoline: Gas engines are relatively cheap and powerful. But they tend to be the least efficient type of engine and produce higher emissions.

Diesel: Diesel engines are powerful and efficient. Diesel fuel is easier and cheaper to refine from crude oil. But diesels are more costly by $1,000 or more because of the advanced technology to make these engines accelerate more quickly.

Gasoline hybrid: Hybrids like the Toyota Prius are on the road today. They get great gas mileage in the city by running partially on electricity. But they are more expensive than traditional engines by about 20 percent.

Gas hybrids have made a tremendous splash with big successes like the Toyota Prius and the Ford Escape hybrid. But many owners notice that when they get on the highway, the gains in fuel-efficiency are less impressive.

In “Gas, Hybrid, Diesel, Electric: What Do They Cost Over 5 Yrs?” Antony Ingram compared the 5-year costs associated with gas, diesel, and hybrid cars. I summarized the results of his analysis in Figures 5A and 5B, where the difference between the two figures is whether rated or actual fuel mileage is considered.

Figure 5A

Figure 5B

Ingram’s comparisons show that using actual fuel costs, the total price of buying and using a vehicle is pretty much “a wash” across the difference types of vehicles. However, as Peter Braun notes in “Diesel Versus Hybrid: The Battle for Eco- Friendly Supremacy”

While cost might be a wash, performance isn’t. Hybrids have come a long way in the last decade. If you want efficiency without having to sacrifice performance and fun, diesel is still far ahead.

After doing the research for this analysis, my sense is that this distinction is perhaps one of the most important contributors to the actions the Auto Manufacturers have chosen to take regarding gaming the emissions tests.

Finally, Bill Howard in “Gas vs. diesel vs. hybrid: Which car engine is best for you and the environment?” provides a very succinct summary of how the three types of vehicles compare with one another.

Here’s the broad answer: Go with gasoline if you’re a low-mileage driver, hybrid for city driving, and diesel for high-mileage (mostly highway) driving.

The mainstream gasoline engine is best if you drive less than 7500 miles a year because the savings on fuel won’t match the premium you’re likely to pay for a hybrid or diesel car. Hybrid is the winner if you cover a lot of miles in stop and go city driving or on clogged expressways, where braking recharges the battery that powers the electric motor. It helps if you’re easy on the throttle and brake early and smoothly in a hybrid.

If you drive a lot of highway miles, diesel cars — like the 2014 Chevy Cruze diesel— are right choice for cost per mile driven, and most diesel vehicles have higher trade-in values than gasoline-powered cars. The case for diesel is clearer in the premium/sporty segment where the gasoline engine uses premium fuel, so the diesel price disadvantage per gallon of fuel is less than 10%.

 

US vs. European Automobile Standards and Procedures

Standards

The differences between American and European automobile testing standards and procedures are laid out in Bill Canis and Richard K. Lattanzio, “U.S. and EU Motor Vehicle Standards: Issues for Transatlantic Trade Negotiations”.

…[M]otor vehicle regulatory regimes … govern three distinct aspects of vehicle manufacturing and involve a number of U.S. and EU agencies.

Safety. U.S. automakers self-certify that they are meeting U.S. vehicle standards. In Europe, vehicles must obtain “type approval” from a government before an automaker can bring out a new model.

Emissions. U.S. and EU emissions regulations are administered by the U.S. Environmental Protection Agency (EPA) and the European Commission (EC), respectively. While U.S. and EC rules address a similar range of pollutants, including carbon monoxide, nitrogen oxide, and non-methane organic oxides, allowable emissions levels in the EU are different from those in the United States—and they are stricter in more than a dozen U.S. states than in the other states. The United States and the EU have similar “type approval” systems for new engine models.

Fuel Efficiency. Auto manufacturers selling in the United States must meet the Corporate Average Fuel Economy (CAFE) standards enforced by the National Highway Traffic Safety Administration (NHTSA). Under the Obama Administration, greenhouse gases (GHG) in vehicle emissions are being regulated for the first time, making fuel economy standard-setting a joint venture between NHTSA and EPA. The EU does not directly set fuel economy standards, but it effectively does so by regulating greenhouse gas emissions of new vehicles.

Figure 6, taken from Canis and Lattanzio provides a comparison of US and EU differences in automobile regulations.

Figure 6

Source: Bill Canis and Richard K. Lattanzio, “U.S. and EU Motor Vehicle Standards: Issues for Transatlantic Trade Negotiations”

Note that US emissions standards are “fuel-type neutral,” that is, the same for gas and diesel vehicles, whereas European emissions standards differ by fuel type. In particular, in Europe, diesel vehicles have higher NOx emissions limits than do gasoline vehicles. From Wikipedia (emphasis mine):

Since the Euro 2 stage, EU regulations introduce different emission limits for diesel and petrol vehicles. Diesels have more stringent CO standards but are allowed higher NOx emissions. Petrol-powered vehicles are exempted from particulate matter (PM) standards through to the Euro 4 stage, but vehicles with direct injection engines are subject to a limit of 0.005 g/km for Euro 5 and Euro 6. A particulate number standard (P) or (PN) has been introduced in 2011 with Euro 5b for diesel engines and in 2014 with Euro 6 for petrol engines.

From Delphi, “Worldwide Emissions Standards: Passenger Cars and Light Duty Vehicles” (emphasis mine):

US FEDERAL TIER 2 STANDARDS

- Tier 2 standards were phased in from 2004-2009

- Same standards applicable to cars and trucks up to 8.500 Ibs GVWR (most sport utility vehicles, pick up trucks and vans)

- Emissions limits are fuel neutral, i.e. applicable to gasoline, diesel and all other fuels

As it relates to the analysis of the Auto Emissions Game, an essential distinction between European and US emissions standards is that Europe has different standards for gasoline and diesel vehicles (allowing greater amounts of NOx emissions for diesel vehicles than gas vehicles), whereas in the US the emissions standards are “fuel-type neutral”.

Approval Process

Canis and Lattanzio describe the EU and US Approval Processes. The EU process entails having Auto Manufacturers submit new model vehicles to Emissions Testers for testing. Once the models have passed the tests, Emissions Testers grant Auto Manufacturers certification, and the Auto Manufacturers attests that all other manufactured vehicles conform to the certified test models.

The EU Approval Process

Since 1970, the EU has used the Whole Vehicle Type Approval system, under which production samples of new model cars must be approved by national government authorities prior to the vehicle entering the market. An automaker must submit the “type” of vehicle it intends to manufacture and sell to the proper authority in any country that is a signatory to the 1958 UNECE agreement.



Nearly every EU country has either a government agency or designated privately-owned test houses that conduct testing to ensure new models will meet all standards. Once formal approval is obtained, the automaker then issues a “certificate of conformity” for each vehicle manufactured, attesting that it conforms to the approved type. Once an EU member state approves a new vehicle, it can be marketed throughout the EU.

In contrast to the single-phase certification for the EU approval process, the US process entails a more rigorous, three-stage approach, consisting of pre-production, production, and post-production evaluations. From Canis and Lattanzio:

U.S. Certification and Test Procedures

Once EPA sets emission standards for a particular engine and/or vehicle category, manufacturers must produce engines that meet those standards by a specified date. Conformity is determined under test procedures specified by EPA. The most common testing procedure used by EPA is the Federal Test Procedure, as mandated by the Energy Tax Act of 1978. Tests are based on the Urban Dynamometer Driving Schedule to reflect typical driving patterns (e.g., city, highway, aggressive, and use of air conditioning). Currently, EPA uses a three-tiered compliance strategy for light-duty vehicles: (1) pre-production evaluation to certify vehicles prior to sale; (2) a production evaluation on the assembly line for early evaluation of production vehicles, and (3) a final clearance applied to verify that properly maintained vehicles continue to meet the standards after several years of use.

The information from Canis and Lattanzio thus indicates that emissions testing procedures in Europe are more lax than they are in the US. Once vehicles have passed emissions inspections and been certified by Emissions Testers in Europe, there are no further testing requirements, and there is no authority empowered with the ability to “to perform spot checks that can catch abuse.” Also, emissions testing in Europe takes place in laboratories under conditions that diverge significantly from real-world driving. So even vehicles that have passed the emissions tests and been certified as legal may produce (and, in fact, have produced) excessive levels of emissions when driven on the road. Jason Chow, Ruth Bender, and David Gauthier-Villars provide more detail about these issues in “Europe’s Auto Makers Keep Test Firms Close” (emphasis mine)

The scramble to tighten rules on emissions tests following Volkswagen AG ’s diesel-engine scandal is laying bare a system in which car makers pay the very firms that test and certify their vehicles.

That system relies on the use of so-called “golden vehicles,” stripped down prototypes that car makers send to testing firms for inspection. The practice, which officials for car makers and testing firms say is widespread, allows car models to undergo tests before they are fitted with everything from back seats to wheels with heavier tread, boosting fuel efficiency and lowering emissions.



Industry and environmental watchdogs say the commercial ties between car makers and testing firms allow them to wield too much influence over test results.

“A car maker is free to choose who does the test, and the testing houses are commercial companies who rely on the car makers,” said Jos Dings, director of the Brussels-based environmental group Transport & Environment. “There is no incentive to be tough on car makers,” he added.

The rules for testing emissions across the Continent are set by the European Union, but the economic bloc doesn’t have an authority like the U.S.’s Environmental Protection Agency to perform spot checks that can catch abuse.



Because enforcement is handled by national governments, the implementation of EU rules varies from country to country, fostering testing standards that analysts say are lax and easy to manipulate. Cars approved in one country also can be sold throughout the EU.

More on these same issues from Matthew Dalton in “Volkswagen Scandal Puts Spotlight on Europe’s Dirty Air”:

U.S. testing procedures of NOx emissions from cars are also much stricter than EU tests, because they more accurately model aggressive acceleration and other aspects of real-world driving…

In Europe, independent tests of cars in normal driving conditions have shown that emissions from even new diesel models with the latest pollution-control technology are four to five times the advertised levels.



Regulations could also play a role in the discrepancy between lab and road tests: Industry experts say European law allows companies to prep vehicles sent for emissions tests in laboratories so they perform better, for example by testing the cars with a fully charged battery so the engine doesn’t have to work harder to charge the battery as it would on the road.

 

Go to Part 2

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