Tesla Motors – A Car Manufacturer with a Difference
With an action plan in place to address the key inhibitions towards electric cars, Tesla Motors is a blockbuster in the making.
Founded in 2003, Tesla Motors is an American energy storage and automotive company which develops and produces battery systems, electric powertrains and electric vehicles. At the time of Tesla’s launch, the last successful U.S. car startup was Chrysler, in 1925, and there had never been a successful electric car startup. [1] While the jury is still out on whether Tesla Motors is, indeed, “successful”, there is no denying the fact that its Model S luxury sedan outsold all of its competitors, including industry stalwarts such as the Mercedes-Benz S-Class and the BMW 7-Series, in the U.S. in 2013 – its first full year of production. [2]
Business model
Analysts estimate that 94% of the world’s transportation runs on oil [3] and that, at the current rate of consumption, the world’s oil supply is expected to run out by the year 2066. [4] To add to this, the transportation sector emits 27% of Greenhouse gases which are responsible for global warming. [5] Tesla plans to “accelerate the advent of sustainable transport by bringing compelling mass market electric cars to market as soon as possible”. [6] The biggest differentiator between Tesla’s business model and that of other car manufacturers is the direct sales strategy. To further spur rapid adoption of its cars, and hence bring its bottom-line back into the positive, Tesla is also building a Supercharger network, which is discussed in greater detail below.
Operating Model
Direct Sales: The conventional car sales model is to have manufacturers sell to dealers, who then sell to the end customers. However, in this model, manufacturers cede a lot of control to the dealers, who can determine prices and affect customer experience, either positively or negatively. One of the biggest reasons for Tesla opting for a direct sales model is to maintain complete control over the prices and customer service. Being a new entrant in this industry, Tesla did not want to allow external parties, such as dealers, to control its fate. In another first-in-the-industry strategy, the only way for a buyer to order a Tesla vehicle is to place the order on the website. This not only reduces overhead costs for Tesla, but also appeals to the typical tech-savvy Tesla customer from the convenience standpoint.
While the direct sales model is designed to ensure that customers have a good experience with the brand, it can be thought of as somewhat of an ancillary function. The primary driver of sales growth will certainly be the product itself. It is, thus, in Tesla’s best interest to ensure that the skepticism surrounding electric cars is addressed. The two biggest factors which hinder rapid adoption of electric vehicles are range and price. Tesla’s operating model addresses, or plans to address, both these concerns.
Range: This problem has been plaguing the development of the electric car for decades. Earlier attempts at building electric cars utilized nickel-based rechargeable batteries (re: BYD Company case!), which had low capacity per unit weight of battery. Providing a high range for a car powered by such batteries would have made it too heavy, leading to a drop in performance. Instead, Tesla uses thousands of Lithium-based batteries (re: BYD Company case, again!), similar to those used in our laptops and cell phones, to power its Model S. These batteries have a higher capacity, making the car lighter while giving it a good enough range. The Model S, in fact, accelerates just as fast as, or faster than, some Ferrari models! [7]
To further address this problem, Tesla is now in the process of creating a Supercharger network. Superchargers are high-powered charging stations built to provide a rapid charging option in case the car runs out of battery power during a long drive. While regular charging provides approximately 14 miles of range for every half hour of charge, Superchargers provide 170 miles. There are currently 3203 Superchargers in the U.S., with the network expanding continuously. [8]
Price: The biggest component of a Tesla vehicle’s cost is the battery. To lower the price of its (rather expensive) vehicles, Tesla is building its very own battery production plant. This plant, commonly referred to as the “Gigafactory”, will single-handedly produce as many Lithium-ion batteries as the entire world produces today, thereby doubling the world production. Once this factory starts full-scale operations in 2017, the cost of batteries is expected to reduce to 50% of what it is today. [9]
Conclusion
Tesla’s new crossover, the Model X, has just been launched and its mass market vehicle is due to be launched in 2017. With the Gigafactory and a more extensive Supercharger network expected to be in place by then, Tesla aims to resolve the price and range issues which have hindered the widespread adoption of electric cars. Porsche’s recent announcement about its electric car getting the production go ahead is a definite indication of the ensuing battle in this space, and the strong alignment between Tesla’s business model and operating model give it the upper hand.
Sources
[1] http://www.bloomberg.com/bw/stories/2007-07-29/tesla-a-carmaker-with-silicon-valley-spark
[3] http://www.learntodrill.com/oil-energy-source
[5] http://www3.epa.gov/climatechange/ghgemissions/sources/transportation.html
[6] https://www.teslamotors.com/blog/mission-tesla
[7] http://gas2.org/2014/10/10/5-supercars-slower-than-the-tesla-model-s-p85d/
This is certainly the future in the making! Thanks for the great post!
One area of the Tesla’s story that is non-core, but certainly interesting is the charging stations.
Tesla being the absolute pioneer right now is also pioneering the re-charing network. However, what is going to happen in 10 years when say 5 manufacturers offer electric cars? What if customers across numerous countries become seriously interested? Then would guys like Shell or Texaco start offering re-charging facilities at their stations? Would Tesla actually end up having two lines of business – the car and the re-charge station line?
Thanks for the comment Maciej! Tesla has actually already expressed interest in partnering with other car manufacturers for the charging stations, provided they have a common business model (Tesla, for example, does not plan to charge for the charging at the moment). How I see it panning out in the future is that Tesla will be just one of the charging service providers, and there can most certainly be third party providers (Shell, etc.) playing in this space as well. As electricity is not Shell’s core business though, I doubt if Shell will be a big player in charging stations. Chances are that these stations will be owned either by car manufacturers or utilities. EVs will be able to go to any of these charging stations to “fill-up”, similar to what happens right now with gasoline.
What do you see as the biggest risks to Tesla’s strategy of starting out making luxury cars and gradually releasing cheaper and cheaper models until the average mass consumer is able to afford them (with the Model 3 expected to be the point at which this achieved)? Do you think the Gigafactory solves potential problems by cutting the cost of batteries by 50%, as you say? Could the continuance of cheap oil in the short term severely impact Tesla’s profitability or even challenge its solvency, or do you think Musk is more interested in the long game and is not concerned about his short term prospects?
One of the risks of such a strategy is loss of brand equity. However, as the success of a number of other car manufacturers has shown, it is possible to have multiple models in the market at very different price points in this industry. The biggest challenge for Tesla, in my opinion, would be to continue to uphold its reputation of providing a no-compromise electric vehicle. For instance, even with the anticipated reduction in the cost of batteries that the Gigafactory will bring, the cost target for the Model 3 cannot be achieved unless some other major changes are made to the basic underlying fundamentals of the car. The body of the Model S is made of Aluminum, which is much more expensive than the more commonly used steel. To meet the price target, the Model 3 cannot use Aluminum. This will lead to an increase in the weight of the car, which will lower the performance and range, making the Supercharger network all the more important. It will also be interesting to note how this change of material will affect the safety rating of the car.
The current typical Tesla customer is presumably not very price sensitive, so the oil prices may not pivotal in his/her buying decision. Having said that, as Tesla moves towards the mass market, this will certainly play a role. However, the current difference in operating cost of an electric car and that of a gasoline vehicle is so high that even at current oil prices, it is more economical to operate an electric vehicle. Another determinant here will be the composition of the electric grid in the future. With a move towards solar on the cards, the operating cost of an electric vehicle will only come down in the future. Tesla does plan to reach an annual unit sales number of 500,000 by 2020, so I would not say they are not concerned about the short term. They do seem to be relying on continuous improvements in battery technology to further reduce the operating cost of electric vehicles. In fact, I would argue that the cheap oil is likely to create an increase in demand, which will further necessitate the adoption of electric vehicles as oil supply runs out!
Thank you Saaket for your posts above, A lot of Tesla’s success lies in the R&D efforts from Mr. Musk, How will Tesla compete once Self driving cars come into the picture. They will need to compete with the likes of Apple/ Google technology and more importantly compete with them for talent. Currently Tesla is the only serious player (and BMW, i8 and i3) in the pure play electric vehicle so talent is easy to come by.
How will Tesla respond when Apple and Google claw back, and start eating into Tesla’s talent and over spend Tesla on R&D.
Thanks for the comment Aditya! Self-driven cars have come a long way over the past decade, but I still believe we still have a few years to go before they hit the customer market. Many of the shortcomings were discussed in class today. I’d argue that Google will not get into car manufacturing as there is a lot else going on apart from the self-driving technology, none of which is Google’s core expertise. Instead, how I see this space panning out is that the technology companies will provide complementary products (eg. a self-driving “module”) to the major car manufacturers, instead of trying to disrupt the entire ecosystem. There is also a move towards sharing of research and patents among companies, which augurs well for the future. However, judging from Apple’s past history, it is unlikely to license any of its technology to others and try to build an indigenous car. Having said that, if it is planning to build its own car, it is highly unlikely that it can launch before the end of this decade. If Tesla manages to launch the Model 3 in 2017 and hits its target of 500,000 vehicles per year by 2020, it will have had a huge head start over its competitors will no longer be a minor player in the industry. There will certainly be competition for talent, but that is probably for the best in terms of the evolution of the industry.
Would love to hear your thoughts on Tesla’s initial reliance on government loans and subsequent subsidies to fund its initial growth and to attract customers. Couldn’t verify the statistics, but many critics feel that Tesla was only profitable because of these subsidies its first year+ of production and that it has brought them over $300M between 2012 and 2014. When I first heard about the project I anticipated the end-product would be affordable, energy-efficient cars for the average user. Sure, they may have paid back loans, but in the spirit of the project, do you think they have a responsibility to expand into more of an everyday product that can really put a dent in reducing the number of traditional cars on the streets and not just a super-cool luxury car that probably price out any sort of scalable environmental gain? The US gov’t does feel a responsibility to help reduce emissions, but should they be funding luxury car start-ups?
Thank you for the comment Erik! That is a very valid point. I would think the strategy they have adopted has been what it has because of the initial sky-high R&D costs when developing a new technology. Historically, the major chunk of R&D costs are incurred upfront. Sure, there are improvements later on which will call for continued investments in R&D, but once the technology has been introduced, these changes are only incremental. Examples of this would be the initial high price of computers and cellphones. These high initial R&D costs tend to drive up the cost of the products. Once an initial product is launched, and there is that added revenue coming in from the sales, companies then focus on the incremental R&D to lower the cost of the product and reach the mass market. To reach the mass market and eventually make a positive impact on the emissions, the strategy that Tesla has adopted is to start off with a premium model and then get into the mass market once the premium model starts providing them with the additional source of revenue to fund that R&D. The Model 3, due to be launched in 2017, will attempt to do just this by competing head-on with the likes of the BMW 3-series, Audi A4 and Mercedes C-Class. Also, from the marketing standpoint, I’d say it is easier for a brand to expand from a premium to a mass market segment than vice-versa because mass market buyers will always value “carry-over” features from premium cars, but not the other way around.