Tesla: Redefining a Trillion Dollar Industry
In the span of a few short years, Tesla has completely reconceptualized what it means to be a car company and forced every major auto manufacturer to adapt in response. Matt S…..I’m sorry in advance.
When technology visionary Elon Musk launched Tesla Motors a little over a decade ago, many believed that he was undertaking an impossible challenge. In seeking to disrupt the automotive sector by founding an electric car company, Musk was taking on an established, capital-intensive industry with deep-pocketed incumbents. Silicon Valley was not, most believed, in the business of making cars. The last successful startup car company in America was founded in 1925: Chrysler. For close to a century, very little had changed about the way that the U.S. auto industry did business.
In the span of a few short years, Tesla has completely reconceptualized what it means to be a car company and has forced every major auto manufacturer to adapt in response. Its share price has jumped from $17 at its 2010 IPO to $225 today. The Tesla Model S was rated by Consumer Reports magazine as, literally, the best car ever made (the publication had to recalibrate its entire rating system after giving the Model S an unprecedented score of 103 out of 100). Tesla is steadily advancing its ultimate mission of reducing mankind’s dependence on fossil fuels by making electric vehicles widespread. The company’s phenomenal success and bright future stem in large part from the tight alignment between its unconventional business model and innovative operating model.
Tesla’s Business Model
A few key elements of Tesla’s business model enable it to create and capture massive value—all of which involve challenging deeply-held conceptions in the auto industry.
- “Insanely high-quality” product and upscale branding: Before Tesla, electric cars were ordinary-looking in design, with a marketing focus on functionality and environmental impact. Tesla took a completely different approach, positioning its first models as high-end luxury vehicles that directly compete with brands like Mercedes-Benz and Porsche (see Figure A). Tesla’s first two cars, the Roadster and Model S, were both priced above $100K, and customer demand at this price continues to outpace the company’s ability to even manufacture the cars. Tesla justifies this high price point through unparalleled engineering and product quality. The Model S is the fastest 4-door sedan in history, going from 0 to 60 mph in 2.8 seconds. It received the highest NHTSA safety rating of any car ever tested by the U.S. government. It is the industry’s most aerodynamic car. Tesla, in short, turned on its head the accepted notion that electric vehicles were inferior in performance quality to gas cars; in doing so, it has generated enviable margins for itself.
- Direct-to-consumer sales: Another element of the car industry that Tesla has re-envisioned is distribution. Unlike other auto manufacturers, which sell cars through franchised dealerships, Tesla is unique in selling directly to customers. The company has established an international network of company-owned showrooms and created a streamlined process for customers to order cars online. By cutting out the middleman of dealerships—previously accepted as an indispensable part of the car sales process—Tesla significantly boosts its profits. Perhaps more importantly, it gives the company complete control over the customer buying experience (an approach that many compare to Apple’s wildly successful brick-and-mortar stores).
- Nationwide “Supercharger” network: Perhaps the single biggest barrier to electric vehicles’ success and widespread adoption is range—their ability to go long distances before running out of electricity. Tesla has taken it upon itself to directly address this concern by building a nationwide network of “Supercharger” stations—locations where drivers of electric vehicles can charge their cars. Tesla has aggressively executed on this ambitious infrastructure project: it has already built 561 Supercharger stations (see Figure B) and is opening a new one on average every 24 hours. To give a sense of these charging stations’ accessibility, in California a driver is now never more than 42 miles away from a station. By going beyond the mere production of automobiles and focusing instead on optimizing the entire product experience, Tesla has created massive value for its customers.
Tesla’s Operating Model
Tesla’s operating model directly links to and supports its business model, making possible the company’s compelling value proposition.
- Technology-centric approach to engineering: Tesla’s website describes the Model S as an “app on four wheels.” This reflects the company’s philosophy of placing technology at the center of its engineering process as it reimagines what a car should be from the ground up. In contrast to the primitive user interfaces in many cars, Tesla cars are controlled by a state-of-the-art touch screen in the front seat (see Figure C). When the company’s engineers come up with additional functionalities for the cars, they can automatically push these out to customers’ vehicles as software updates over the Internet. For instance, one morning in October, Tesla Model S owners woke up to find that their cars had a new, fully operational “self-driving” mode. Tesla technicians can often service and fix customers’ cars remotely over the Internet without ever having to touch the car, saving Tesla drivers considerable time and inconvenience. As these examples show, taking a technology-centric approach to its engineering operations has enabled Tesla to rapidly innovate in a product class that had remained largely static for decades. In turn, as discussed above, this allows the company to offer superior-quality vehicles to its customers and to capture much of the resulting value through premium pricing. Unsurprisingly, its competitors have been forced to respond defensively: both GM and Ford have reportedly been hiring software engineers by the hundreds recently.
- Verticalization and integration: Tesla has verticalized as much of the car production process as it can, choosing to manufacture components in-house rather than to rely on modularized suppliers. Almost every part of its cars, all the way down to the seats, is produced in-house in the company-owned factory in Fremont, California. The most prominent example of this integrated approach is the $5B Gigafactory that Tesla is currently building in Nevada. When complete, this massive factory will produce all the batteries for Tesla’s cars (the most important component of an electric vehicle), eliminating the company’s reliance on the vast, complicated international supply chain for battery manufacturing and distribution. This verticalization in production has direct parallels in Tesla’s direct-to-consumer distribution model and its Supercharger infrastructure, discussed above. By owning the entire end-to-end value-creation process—from manufacture through sales to vehicle servicing and infrastructure—Tesla has complete control over the product experience, allowing it to ensure superior quality for its customers.
Conclusion
Overreliance on fossil fuels is, many believe, one of the greatest challenges mankind will face in the coming century. By placing electric vehicles squarely at the center of the transportation industry’s future—where they had not been a decade ago—Tesla is at the forefront of addressing this challenge. Its success can be largely attributed to its innovative and highly cohesive business and operating models.
Sources
Great story! I agree that Tesla has changed the rules of the game in the car industry, but I wonder if their business model is sustainable. At a price tag of $100K+, their target market seems very small. We are going through tough economic times, with a widening gap between the rich and the poor and an eroding middle class. Making a car that is not accessible to the majority of the population makes one wonder about the future prospects of the company. What made Ford successful at the turn of the century was the fact that he democratized cars during an era where only the rich could afford them. Could Tesla leverage its capabilities to develop a high quality car available to the masses? If they do not make this a primary focus in the near future, I will not be surprised that an incumbent comes up with such an offering. For a long time, Toyota and Honda focused their efforts in developing affordable high quality, fuel efficient cars, while the majority of the US companies were still building fuel guzzler vehicles. When these companies entered the US market, they attracted a lot of consumers and also redefined the rules of the game, forcing US companies to emphasize fuel efficiency. Will Tesla get ahead of this problem ?
Great question, Mepossi/Carrie – really glad you asked it. The approach that you describe–producing an affordable, mass-market electric vehicle–is exactly what Elon Musk’s and Tesla’s long-term vision is. Most observers believe that Tesla, while a fascinating company and story now, will only begin to have a truly transformational impact on the world when they make a car that is commercially available to the masses. Which is to say, what the company has accomplished to this point is just the beginning.
It won’t let me paste this image in, so check this link out for a very simplistic but helpful graphical representation of Tesla’s long-term business plan, addressing this question: http://28oa9i1t08037ue3m1l0i861.wpengine.netdna-cdn.com/wp-content/uploads/sites/4/2015/06/pyramid2.png
I really liked your comparison of Tesla’s vertical integration with Apple and their desire to control the user experience. My biggest concern would be that Tesla is Apple circa 1985 just after they created the Mac. Tesla has truly innovated, but now there are dozens of well-capitalized competitors who have a lot to lose if Tesla wins. Although there is some loss of control, I’m guessing that relying on specialized suppliers ultimately results in lower costs. What happens in 10 years when BMW is producing a car with the exact same capabilities as a Tesla but it costs 30% less? It makes me think of how PCs eventually beat out the mac (at least through the 90s) because they had a more open platform and were better able to leverage innovation from the market.
So first of all, no need to apologize, as I’m a big fan of Tesla’s business. I think you hit on several reasons why they’ve been successful, namely:
– Rethinking what an electric car can be…they didn’t build a great electric car, they built a great car, period, that happened to be electric. By not handicapping their design they were able to create mass-market appeal.
– Dealer network…this I think might be their biggest edge. The traditional selling process of automotive is very antiquated. Dealers are given far too much discretion which makes it hard to control the brand at the most important part – the actual customer experience. Not to mention cost control issues. I guarantee every OEM in America would rather have Tesla’s model right now, but the incumbent dealer lobby is extremely strong. Tesla is right to stand by their model and lead the political fight to overturn the existing structure.
– Vertical integration, as the guys above mentioned, is huge. Electric is a viable technology, but it still can’t compete with the internal combustion engine for convenience. Until you can “refuel” an electric in a couple minutes, the convenience factor will be a huge obstacle. Tesla has done well to develop the refueling infrastructure…the overall electric market is small, so capturing a huge piece of that doesn’t amount to much. But if they can increase the size of the market they will see huge dividends down the road.
Couple causes for concern that I see:
– Quality…the original Roadster, while a great proof of concept, had numerous problems with build quality. They’ve largely addressed a lot of this, but electrics do have some big long-term question marks that we won’t fully know for several years. I recently read a report that the powertrain may only have an expected life of 60,000 miles…significantly lower than conventional drivetrains. Whether that’s true…who knows. We really need to see a 10-year lifecycle to know how sustainable the product is. There’s also the question of when and how to dispose of the batteries – it’s one of the most harmful things to do to the environment. Tesla must get the disposal right to avoid ruining all the green street cred they’ve built.
– Operational efficiency – Tesla still loses money on every Model S, making their profits through other sources. While it’s getting better, the last estimate I saw was about $4k per car. Despite the massive media attention, they’re still small. And they still haven’t mastered production – they’re playing catch up with the established OEMs here. I think they’ll get there, but they need to keep focus on operations as well as their development and marketing.
Further to Meiosis’s point, Thinking about how Mercedes, BMW, and luxury car brands position themselves and market themselves as a luxury brand but still have cars at somewhat “accessible” price points (the “C” class, for example”, does Tesla have the ability to offer a car at a lower entry point for those who would be tempted without ruining their position in the market? I would imagine that the cost of investing in charging stations all over the nation was quite large and in order to keep making the charging more convenient, they will have to continue to spend or at least support spending for charging stations. Given that their market is smaller, would it not be beneficial for them to be able to offer a car at a slightly lower price point to those who are extremely interested in the technology and innovative brand approach? Also curious to how this model will support product proliferation, or if we think it is key to remain completely focused on two or three core products.
Great question, Mepossi/Carrie – really glad you asked it. The approach that you describe–producing an affordable, mass-market electric vehicle–is exactly what Elon Musk’s and Tesla’s long-term vision is. Most observers believe that Tesla, while a fascinating company and story now, will only begin to have a truly transformational impact on the world when they make a car that is commercially available to the masses. Which is to say, what the company has accomplished to this point is just the beginning.
It won’t let me paste this image in, so check this link out for a very simplistic but helpful graphical representation of Tesla’s long-term business plan, addressing this question: http://28oa9i1t08037ue3m1l0i861.wpengine.netdna-cdn.com/wp-content/uploads/sites/4/2015/06/pyramid2.png
Thanks for this post Rob – really interesting read.
For me, it’s a particularly interesting example because the auto industry is so heavily regulated. Everything from manufacturing to distribution suffers from more intervention than seems to make sense. Do you think it will be possible for Tesla to continue innovating its business and operating model within this environment? It seems that they have already hit their heads against restrictions in, for example, allowing cars to be sold online. Its unlikely that the old powerhouses in the auto industry will give up their strangle-hold on the various regulations designed to protect the status quo.