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The Conundrum of the North American Lithium-Ion Battery Supply Chain

Electricity unattached to the grid will power the technologies that shape the 21st Century.  Unless and until fuel cells, green hydrogen and other electricity micro-generation technologies mature, advanced batteries, and in particular lithium-ion batteries, are likely to be the source of much of that power.

Where those batteries are made and who makes them matters.  Ensuring adequate supplies of lithium-ion batteries will be an important national security issue.  Lithium-ion batteries are also an important tool in the fight to reduce greenhouse gas emissions.  But most importantly, lithium-ion batteries and the technologies they enable are likely to create substantial wealth and many jobs in the 21st Century.  Nations around the world are already competing to see which can best capture this important economic development opportunity.

The importance of developing a lithium-ion supply chain in North America is widely acknowledged.  But what that actually means is a bit unclear.  For example, a bill of materials for a completed automotive lithium-ion battery pack would list thousands of items.  Few would argue that all those items need to be made in North America.  Instead, the North American supply chain discussion should focus on those elements of the supply chain that are strategic.

But what does it mean to be a strategic part of the North American lithium-ion battery supply chain?  The answer lies what we want a domestic lithium-ion supply chain to do.  While energy security and environmental responsibility are important reasons to develop a domestic source of lithium-ion battery supply, the principal reason for building up a domestic supply chain is economic.  It is a way to generate new wealth and new jobs.  It is also necessary to preserve jobs in existing industries, such as the automobile industry, that may well be lost to foreign competition in the absence of domestic lithium-ion battery expertise.

So the measure of something being strategic in the lithium-ion battery supply chain is whether that something is an important driver of wealth and job creation.  Unfortunately, identifying those strategic elements is complicated in the lithium-ion world.

In 1992 Stan Shih, the founder of Acer Inc., proposed something called the “smile curve” as a way of explaining where value is created across different stages of product development.  According to Mr. Shih, the highest values are created in the first stages (technology creation) and last stages (consumer branding) of the product cycle, while the middle stage (fabrication) creates the least.  It is called a “smile curve” because if you plot these stages of development on a graph against value created, you get a smile.

Apple is an example of a business based on the smile cure.  Apple tightly controls the development of the technology that goes into its iPhones and the branding and sale of those phones to consumers.  But Apple does no manufacturing.  It happily outsources the less valuable middle stage of its product development--fabrication--to companies such as Foxconn and its low-wage workforce.  If you wonder how this strategy is working for Apple, just take a look at its stock price.

At first blush, the lithium-ion automotive battery business would seem to have a lot in common with the cell phone business.  Creating new lithium-based technologies and their spin-off products can be quite profitable.  At the other end of the product development cycle, controlling the customer is also highly lucrative. Tesla and its stock price vividly illustrate the value of using a lithium-ion battery-based product to control consumer sentiment and loyalty.

But the middle part of the product development cycle in batteries--the fabrication of battery cells--is a lousy business.  It involves huge capital investment, razor thin margins and extraordinary risk.  Every major U.S. corporation that has considered getting into the business of manufacturing lithium-ion automotive batteries at scale has taken a pass.  Even the most enthusiastic supporters of domestic lithium-ion supply chain development must grudgingly admit that every one of those corporations made a good business decision.

Based on the smile curve and the lack of North American corporate interest in large scale lithium-ion battery production, it is tempting to conclude that lithium-ion battery cell fabrication is not strategic, that it can safely be offshored much as Apple has offshored the manufacture of its iPhones.  But that conclusion would be wrong.  In fact, the lousy business of fabricating lithium-ion battery cells that no major North American corporation wants to do is the key to controlling the entire supply chain.  That is the great conundrum of the lithium-ion battery business.

The lithium-ion business is not the cell phone business.  Unlike makers of cell phones, lithium-ion battery makers do not have a direct nexus with customers that battery makers can leverage and turn into value.  Few consumers know or care who makes the battery that powers their electric car.  Fabricating battery cells is the last step in the lithium-ion battery supply chain.  There is no branding opportunity or consumer contact.  As a result, in Stan Shih’s model the lithium-ion battery product development cycle looks more like a half smile than a full one.

But the fact that a battery cell maker cannot extract a lot of value from the fabrication itself does not mean that fabrication is without value.  In fact, it is the lithium-ion battery cell maker that controls the supply chain, including the much higher value processes towards the early part of the development cycle.  Cell makers determine what R&D will be commercialized, what manufacturing machinery will be used, and what cathode, anode and separator materials will be employed in the cell.  Car manufacturers may provide cell makers with specifications that the cells must meet.  But how the cell maker meets those specifications is up to the cell maker.  It is that discretion which gives cell makers their inordinate power in the supply chain.

Even more important is the possible ability of cell makers to move downstream. It will always be tempting for cell makers to move downstream, into assembly of the applications their batteries power.  Selling those applications, rather than battery cells, is where the highly valuable nexus with consumers lies.  In electric vehicles the battery accounts for nearly half the cost and most of the complexity of the vehicle.  It would not be overly complicated for a cell maker to try to get into the business of assembling the rest of the automobile in order to capture the important second half of Stan Shih’s value creation smile.   

When China went all in on its lithium-ion battery manufacturing sector 10 years ago, China was probably not really interested in fabricating lithium-ion batteries.  What interested China was, and still is, the global automobile market.  There is little doubt that as the market for electrified vehicles grows, a large number of Chinese consumer-branded electric vehicles will be competing for market share, perhaps successfully, with offerings from incumbent manufacturers in North America, Europe and Japan.  It is from the manufacture and sale of those vehicles that the Chinese government hopes to earn a return on its substantial investment in battery fabrication.

The challenge to building a robust lithium-ion battery supply chain in North America is this conundrum:  the strategic part of the supply chain you most need to build (i.e., cell fabrication) is the most commercially unattractive part of the entire supply chain. 

There are two approaches to solving this conundrum.  The first is the China Approach and the second is the Tesla Approach.  They are not mutually exclusive.

The China Approach recognizes that battery cell manufacturing is lousy commercial business but that it has long-term benefits for other parts of the supply chain.   The Chinese government expects to recoup its investment in cell fabrication not through the cell makers but through the product applications that the cells enable.  Over the last 10 years, the Chinese government has supported its domestic cell manufacturers in many ways.  The most successful has been a hard push for vehicle electrification combined with a “white list” of domestic cell manufacturers from which the vehicle batteries effectively had to be purchased.  The China Approach anticipates a return on investment.  But the return will come from other businesses, not from the cell makers themselves.

The Tesla Approach is vertical integration of the entire lithium-ion battery supply chain, including cell materials, cell fabrication and the vehicles that the cells power including their important and highly valuable relationship with the ultimate consumer.  This appears to be what Tesla has in mind and announced at its last Battery Day.  Whether Tesla will ultimately follow through with its ambitious battery cell manufacturing plans is anyone’s guess.  But the principal behind the plan is clear.  Tesla hopes to recoup its investment in what would otherwise be an unprofitable cell fabrication business from the sale of its cars.  Cell fabrication will, in theory, allow Tesla to sell its vehicles at a lower price and in higher volume.  Like the China Approach, the Tesla Approach anticipates a return on its investment in cell fabrication.  The return just comes in a different way.

North America can choose the China Approach or the Tesla Approach, or both.  But it is difficult to see how North America can build a robust lithium-ion supply chain without including domestic lithium-ion cell fabricators at the core of that chain.  In the lithium-ion battery world, the cell makers control the supply chain.  Without one or more domestic cell maker champions that have the ability and inclination to purchase goods and services from other domestic supply chain companies, developing a robust North American lithium-ion battery supply chain may not be possible.

Discussions

Matt Chester's picture
Matt Chester on Oct 22, 2020

These are terribly important issues to consider-- and I'm wondering if you think that elevated importance means we'll see increased levels of spending in material recovery for end of life batteries? How much can we harvest from the 'dead' LI batteries and how much can that minimize the supply challenges if we really focus on those hurdles? 

James Greenberger's picture
James Greenberger on Oct 23, 2020

Yes, I expect there will be a growing interest in recycling lithium-ion batteries in order to harvest feedstock for new batteries.  Given the rapidly growing market for lithium-ion batteries and the lag time between when batteries are put into service and when they reach the end of useful life, it will probably be well more than a decade before recycled material makes up a significant percentage of the feedstock used in new batteries.  But in time, it should.  Recycling, or urban mining, is important for other reasons as well.  The reason why energy materials mining (i.e., nickel, cobalt, lithium, rare earth minerals, etc.) takes place offshore is primarily because the United States has effectively offshored the environmental problems associated with that mining to other countries.  A fair-minded person might find something wrong with that.  And there may be more fair-minded people running the U.S. government soon.  Recycling/urban mining is one way to address that moral problem.

James Greenberger's picture

Thank James for the Post!

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