BERLIN — Nothing stirs German pride like the automobile.

Germans love to take credit for its invention, an innovation that has ensured the country’s prosperity for much of the past century.

Now, they’re trying to prove they can do it again.

“Germany laid the foundation for the auto industry and developed it further over the past 100 years. Now it’s time to make the leap into digital,” German Infrastructure Minister Alexander Dobrindt said. “Anyone who wants to generate growth, jobs and wealth will achieve that primarily through digitalization of the car.”

Just as Carl Benz’s motorcar transformed the nascent automobile business in the 19th century, the technological changes roiling the auto world today will determine the industry’s future for decades to come.

“The next 10 years will be more exciting than the last century,” Daimler Chief Executive Dieter Zetsche boasted at a recent gathering of lawmakers and industry executives in Berlin.

With strong brands and deep pockets, German car companies argue they are perfectly placed to seize the opportunity to take the car from its fume-spewing present to a clean, connected future.

Germany's challenge

But are they?

Unlike the internal combustion engines pioneered by the likes of Benz and Rudolf Diesel, the next decades will be driven more by computer code than gears. Even though German auto execs boast that they’re up to the challenge, it’s far from clear they can compete in a world where software is more important than horsepower.

In a chip-powered universe of self-driving cars, the traditional core strengths of Germany’s premium manufacturers — engine performance and handling — may matter less.

Europe has a lot riding on Germany’s success. The country is a rare bright spot on the continent's economic map in recent years. Already Europe’s biggest economy, Germany will only grow in importance once the U.K. exits the European Union.

The auto industry, in turn, forms the backbone of Germany’s $3.5 trillion economy. Put simply, as the German auto industry goes, so goes Germany, and so goes Europe.

Gizmos galore

Traditional automakers have started taking their blueprints from the drawing board to the showroom, offering a widening array of digital services that go beyond film and music streaming to sensors that detect everything from a careering motorist to a moose.

Instead of trying to introduce a killer product, the way Apple did with its iPhone in 2007, old-line carmakers are pursuing a more evolutionary approach by gradually introducing new features.

Mercedes’ new E-Class station wagon, for example, can automatically change lanes, brake and park, features that are becoming standard across the industry.

So far, that deliberate approach has saved the likes of Mercedes and BMW the kind of embarrassment suffered by newcomer Tesla. The U.S.-based electric car pioneer has taken several hits to its reputation after a string of mishaps, including a recent fatal crash involving a Tesla driver who had put his car on autopilot.

In private, German auto execs scoff at what they consider Tesla’s misplaced arrogance. The upstart California company may have carved a niche for itself in the luxury e-car segment, but it has yet to prove it can turn a profit, they point out.

Still, Tesla’s autopilot function and software updates offering ever-new digital bells and whistles have captured the imagination of both consumers and investors in ways the Germans haven't. For all its problems, Tesla is worth $30 billion. That compares to $55 billion for BMW, a company with 26 times Tesla’s sales.

Volkswagen Chief Executive Matthias Müller, whose stable of brands includes Porsche and Audi, insists that in this new era it's going to take more than making fast cars to succeed.

“It is clear that building excellent cars will not in itself be enough,” he said ahead of the Paris car show this month. “But it is also clear that developing high-performance IT will in itself not be enough, either. This is about combining these two worlds — the automotive and the digital.”

Volkswagen, which is at the center of a scandal over its manipulation of engine emission systems, has learned the cost of cutting corners the hard way.

Germany’s auto industry was built on the premise that quality comes first. The question is whether that insistence on perfection is compatible with a world of risk taking and rapid technological change.

Consider Mercedes. In Paris, the Daimler unit presented its next generation electric car. Dubbed the EQ, the new line represents Mercedes’ first major foray into fully connected cars. Equipped with a full menu of autonomous-driving features, the new Mercedes will also be able to automatically check in its owner on flights and receive grocery deliveries in the trunk.

“We see the car transforming from the product to the ultimate platform,” Daimler's Zetsche said.

Sounds impressive, but the first model, a sports utility vehicle, won’t hit showrooms until 2019. Mercedes predicts it will dominate the luxury connected car market by 2025.

BMW and Volkswagen are planning their own Tesla killers in the coming years.

The more serious threat, however, is Silicon Valley. Car companies are being forced to weigh customer expectations for interoperability between the cars and devices such as smartphones, with their own competitive interests. Some have opened their cars to the software of Apple and Google, but both of those tech giants have connected car aspirations of their own.

Competition vs cooperation

Connected cars, with sensors that measure everything from location to speed and braking frequency, produce reams of valuable data for marketers and advertisers.

The result is what some analysts have referred to as “coopetition" — a tug-of-war between rivalry and collaboration that is expected to intensify as the market for connected car services explodes. The value of the connected car marketplace is forecast to nearly quadruple by 2020 to €115 billion from €32 billion in 2015, according to an analysis by PwC.

So far, the battle has focused on the "OBD-II [On-board diagnostics II] port," an interface built into most cars that allows drivers to connect to the internet by plugging in a dongle. Resembling a thumb drive, the dongle can turn old-school analog cars into connected cars, able to perform basic internet-based functions such as streaming music.

Even if most new models are equipped with integrated connected car technologies supplied by car manufacturers in the coming years, older cars aren’t. That makes control of the OBD interface a rich prize. More than 90 million cars in Europe will be connected to the internet with dongles or similar solutions by 2020, compared to 70 million via integrated built-in technologies, according to estimates of Munich-based consulting firm Roland Berger.

“There is only one OBD port per vehicle — so the first to reach a critical mass will win the race for the connected car customers,” the report, published in September, predicted.

Tech companies like California-based Automatic.com or Korean giant Samsung, which are staking their claims by offering cheap dongles to drivers overseas, have sparked the ire of Germany’s auto industry.

“As soon as I plug something [into the OBD port] which does not come directly from the manufacturer, the warranty lapses,” warned Benjamin Oberkersch, a Daimler research and development spokesperson.

The technology companies' hope is that once they’ve invaded the car, it will be impossible to get them out as drivers insist on having access to their services.

Carmakers resist

Backed by Berlin, the German carmakers are determined to fight back. In late September, they announced a new data exchange between connected cars to go online next year. Based on a mapping service called Here, which Audi, BMW and Daimler bought from Nokia last year, the move is seen as a key step in the rollout of autonomous driving in Germany.

The normally fierce competitors also recently banded together to push for common wireless broadband standards for connected cars. Dobrindt, the infrastructure minister, meanwhile, vowed to install 5G mobile networks along Germany’s main transit routes by 2025.

“We must not chase after innovation, but we must actively pave the way for it,” he said last month.

Not everyone is convinced the tech companies will succeed in the auto universe. Daniel Göhring, who studies mobile robotics and autonomous vehicles at Free University Berlin, compares the automotive aspirations of Google and Apple to Microsoft in the late 1990s. Despite Microsoft’s dominant position in software at the time, it failed to become a major player in internet search.

“Microsoft learned in the late '90s, early 2000s that even if you dominate all computers, this does not mean that you will necessarily dominate search engines as well,” Göhring said.

Indeed, some auto industry observers say their biggest obstacle is not technology but regulation. Driverless car technologies, for example, will require a whole new legal and regulatory framework. So far, basic questions about liability in the case of injury, death or property damage remain unaddressed.

“The greatest challenge will be legislation," said Ferdinand Dudenhöffer, professor of automotive business at the University of Duisburg-Essen. “Will we still need insurance or will the manufacturers automatically be liable?”

In an integrated Europe, such questions need to be decided in Brussels, rather than at the national level, industry officials say. A patchwork approach would make it impossible to travel across borders.

“The EU needs to agree on standards for the necessary digital infrastructure,” said Eckehart Rotter, a spokesman for the VDA, the German car industry’s lobbying arm. “It’s about a legal framework, and liability conditions.”

This article is part of a POLITICO Special Report: The future of driving.