Mechanical engineering | Vehicles » Tesla Motors, MGT 525

Tesla Motors – MGT 525 MGT 525 – Project Write Up – Tesla Motors Contents Company Background. 2 Company History . 3 Electronic Vehicles (EV) Industry Analysis . 5 Network Effects from Charging Stations . 8 Growth Strategy & Economies of Scale . 11 Geographic Expansion and Sales Model. 12 APPENDIX A . 13 BIBLIOGRAPHY: . 14 Group members: Connor Cassis; Shpetim Gula; Peter Laird BACKGROUND INFORMATION Company Background Tesla Motors, Inc. was founded in 2003 and is headquartered in Palo Alto, California1 Tesla designs, manufactures and markets electric cars, they also provide advanced electric vehicle powertrain components to other automakers (including: Toyota and Daimler). Tesla’s long-term aim is to be able to offer high-performance electrically powered vehicles at affordable prices. They market and sell their vehicles through Tesla stores and galleries, as well as over the Internet (direct selling distribution). The company operates a network of 80 stores and

galleries in North America, Europe, and Asia (2014). Financial Performance: On June 29, 2010, Tesla Motors launched its initial public offering on NASDAQ, raising $226 million. Despite a drop of more than 20 percent in Teslas stock price, following news of a third Model S fire, it was still the top performer on the Nasdaq 100 index in 20132, seeing its stock price quadruple. The company is now valued over $30 billion3 (GM is worth only twice as much) Year over year, Tesla Motors, Inc. has been able to grow revenues, from 2012 we saw revenues rise from: $413.3M USD to $20B USD Most impressively, the company has been able to reduce the percentage of sales devoted to selling, general and administrative costs from 36.39% to 1418% This was a driver that led to an improvement in the bottom line from a loss of $396.2M USD to a smaller loss of $740M USD (See figure 1 in Appendix A) 2 Company History Earlier History Martin Eberhard and Marc Tarpenning incorporated Tesla Motors in July

2003, and it was Elon Musk who later led the Series A round of investment in February 2004, joining Teslas Board of Directors as its Chairman. Early on, Musks main goal was to commercialize electric vehicles, his strategy was to start with a premium sports car aimed at early adopters and then move as rapidly as possible into more mainstream vehicles, this was considered by many an effective strategy for building customer awareness and a strong corporate reputation. Musk has been very successful in pursuing this goal playing an active role within the company, as he oversaw their first vehicle’s product design at a detailed level: The Roadster: The Tesla Roadster, an all-electric sports car capable of acceleration from zero to 60 mph in less than four seconds, was going to be Tesla’s debut vehicle in 2008. Tesla later sold more than 2,400 Roadsters in 31 countries through to September 2012, and most of the remaining Tesla Roadsters were sold in Europe and Asia during the fourth

quarter of 2012. The Roadster had a base price of $109,000 USD (2010). Model S: Tesla later expanded to the luxury sedan market. Model S, a zero emission and sustainable luxury sedan, was introduced as their second electronic vehicle in 2012. Global cumulative sales of the Model S passed the 25,000-unit mark in December 2013, with the U.S as the leading market with about 20,600 units sold4. Tesla’s Model S sedan targets mid-level customers, with a lower initial price of around $57,000 compared to the Roadster. The most basic Model S now costs $64,000 in America (after subsidies – March 2014). Tesla was the first automaker to market zero-emission sports cars in mass production (Mangram, 2012). Recent History The third model named Tesla model X is scheduled to enter the market in 2014. This new model is full-size crossover utility vehicle (CUV), first unveiled at Tesla’s design studios in Los Angeles on February 2012. Production was initially scheduled to start by the end of 2013,

and later postponed several times in order for the company to achieve Model S production targets and to focus on international rollouts5. Market Entry Strategy: As is discussed elsewhere in this report, the barriers to entry for car makers are fairly high. Designing and manufacturing the first car require a large, knowledgeable employee base, an R&D center, a factory, and a sales & marketing team. Tesla’s market entry strategy was very effective, however. It enjoyed first mover advantage in the electric vehicle market, but that is not the only reason its entry was successful. It pursued a low fixed-cost entry strategy that existing car makers could not compete with. It essentially found a way to lower the barriers to entry in the car industry that other companies had not successfully managed:  Its first car, the Roadster, used a chassis from the Lotus Elise. This allowed Tesla to use its relatively small amount of cash to focus on electric engine and battery R&D and

3     manufacturing, rather than on building its own chassis. It purchased chasses on a perunit basis from Lotus, allowing Tesla to scale beyond its own production capabilities At first, Tesla only sold cars online. This is the cheapest viable go-to-market route, and requires a relatively low fixed cost investment It purchased a factory at a distressed price from Toyota, rather than building one itself at a higher cost Its manufacturing facilities benefit from the most current automation techniques, saving money on labor Tesla’s variable cost structure is also lower, as they do not have large pension obligations or high union-negotiated wages and benefits Signaling and Reputation: Tesla has done an excellent job establishing a strong reputation with customers and sending a combination of different signals, via a mixture of soft and tough investments, to competitors. Purchasing a car requires a set of calculations on the part of the consumer that are different than

many other products. First, a consumer must see that a car is in an efficient place on the cost-perceived quality frontier. Tesla, by being the only serious maker of mass-market electric luxury vehicles, it established an entirely new frontier within the car market. Second, a consumer must believe that the car company is likely to remain in business for at least the life of the warranty of the car, and ideally for the life of the car. A warranty is worthless if the company is in bankruptcy. A car becomes difficult to repair if the manufacturer stops making replacement parts. Consequently, signaling corporate permanence is very important to increasing the number of cars sold. Given that Tesla is a very young carmaker, it has taken several important steps to convince the consumer that it will remain in business. These steps also serve as important signals to Tesla’s competitors:     Tesla’s initial public offering in June of 2010 raised $226M. This cash influx gave it

a more comfortable financial position, a lower discount rate, and a higher likelihood of success. Its subsequent and significant jump in share price is a signal from the market that the company is a going concern. It is investing heavily in a nationwide supercharger infrastructure to show Tesla owners it will support them for the life of their vehicle. Tesla purchased a large factory in Fremont, California in 2010. This large investment was not easy to back out of, and it indicated that Tesla would increase the number of cars its manufactured and continue manufacturing cars far into the future. The company has said that it will only make electric vehicles. In doing so, it is signaling other car makers that it is not intending to compete in the petrol or diesel engine markets, which are where the vast majority of car sales occur. The combination of a large investment in a new factory, and its commitment to remain an electric vehicle producer effectively staved off large-scale

competitive response from other auto makers during the early, fragile years as a car producer. 4 Electronic Vehicles (EV) Industry Analysis Defined: We defined Tesla’s industry based on their direct competition and close substitutes. Given Tesla’s long-term business view, we believe they operate directly in the ‘Electronic Vehicles’ (EV) industry; where they are leaders in the high-performance electric sports car market. However, Tesla also directly competes in the luxury car segment Below is an application of Porters Five Forces model (with 6th force: Complementors) to this industry: Competitive Rivalry  Broadly speaking in the electronic vehicle category, the BMW i3, Chevy Volt (General Motors), Leaf (Nissan) or MiEV (Mitsubishi) can be considered soft substitutes of Tesla’s current electronic vehicles (mainly the model S) 6.  Tesla is in a strong competitive position because of its ability to move its products from the drawing board to the assembly line at the

speed of Silicon Valley tech firms rather than slow US motor vehicle companies (faster rate of innovation). Tesla’s manufacturing chief, Gilbert Passin, says the Model S moved from first design to production in just over two years, something he reckons would take a traditional carmaker five or six years. This allows Tesla to bring new technologies to market faster than their competitors and respond to shifting market demands.  Two of the smallest automakers by market cap (2013), Nissan (NSANY) and Tesla Motors (TSLA), at $44.2 billion and $186 billion, respectively, dominate the electric car market in the US account for nearly 88% of sales in the US7 (See figure 1). Using the data from figure 1, we find the HerfindahlHirschman Index is 3934, which the U.S Department of Justice considers (>1,800) to be a highly concentrated marketplace8.  In its target segment (luxury EV’s) Tesla’s only current significant threat is BMW, BMWs new all-electric car, the i3 starts at $35,325

(significantly cheaper than Tesla’s Model S). Their soon to be released luxury car, the i8, however (a more direct competitor to Tesla’s model S) is about 40-percent more expensive than the Tesla; but, it does match the Model Ss 0-60 mile per hour acceleration times and handily beats its top speed figures9. This will be Figure 1 InsideEVs.com a fierce competitive threat for Tesla. 5 Threat of Substitute Products  The Model S last year outsold its nearest luxury rival, Mercedes’s petrol-engined Sclass, by 30% in America (also wins in terms of vehicle specifications)10.  A study by the Boston Consulting Group projected that prices would need to come down to $200 or less per kWh to make electric vehicles truly competitive with the more familiar car that relies on internal combustion11. The ‘gigafactory’ Tesla intends on opening would slash these production costs.  Established carmakers could decide to fight Tesla head-onindeed BMW’s new “i” range of electric

and hybrid cars seems to be aimed at similar buyers. In the longer term other technologies, such as biofuels, might develop faster than the electric battery.  Hydrogen vehicles are also considered a serious competitive threat. Three automakers Honda, Hyundai, and Toyota - will offer fuel-cell cars to consumers by the end of 2015, albeit in small numbers and limited areas12. However, building an infrastructure for such a technology remains problematic. Electricity chargers are all over the US, and its far cheaper to wire that last 50 feet than it is spend $1 million-plus to construct a hydrogen fueling station (first mover advantage). Threat of New Entrants  Barriers to entry for electronic vehicles are fairly high, given the high research and development costs as well as investment (Sunk) necessary for production. However, these costs are disproportionately lower for incumbent motor vehicle companies, who are in a position to leverage their complementary assets (expertise and

supply chains). This explains the lack of entirely new entrants like Tesla.  Tesla is so far in a niche, albeit with an incredibly loyal base of wealthy buyers. It will have rivals: BMW’s i3, launched in 2013, is aimed at the same market. Other carmakers will soon follow suit with many having already committed resources to do so. Bargaining Power of Customers  Products purchased from the electronic vehicles industry are differentiated (in terms of: size, design, performance etc.) and hence, premium prices tend to be charged by producers. We believe Tesla’s elasticity of demand to be somewhat inelastic at the moment, as historically it has been seen to benefit from increased sales from their price increase of the model S13. This could largely be due to the lack of real substitutes; but this could change quite dramatically in the years to come.  A Tesla vehicle represents a significant percentage of their buyer’s income; the model S represents approximately 112% of the

average US citizen’s annual income14; however, within its target segment this figure is significantly lower. The Tesla buyer group is not concentrated, since they purchase low volumes (expect single purchase) relative to the seller’s sales. All in all, Tesla’s highly priced vehicles can be justified when considering the lifetime cost of the vehicle, implying consumer power is relatively low (this is contingent on buyers perspectives being forward looking). 6 Bargaining Power of Suppliers  Big companies, such as GM, save money by sourcing components through their external supply chain. Tesla, on the other hand, builds 70% of its parts in-house15 from the battery packs to the slick touch-screen control panels. Since, Tesla own the majority of its supply for their vehicle production, they face less risk associated with suppliers. They have plans for a $5bn USD facility to double its output of lithium-ion batteries’ storage capacity16.  However, much of Tesla’s supply

is asset specific, this leaves them more prone to the hold-up problem (threat of contract renegotiation to less favorable terms). Tesla is working on reducing these threats by contracting with multiple suppliers for the same inputs (diversification of supply).  Tesla like many car manufacturers internalizes their supplier’s risk; but experiencing shortages in supply can be harmful to their reputation. Musk has said a key hurdle to launching that mass-market electric car in late 2016 or 2017 is todays inadequate lithium-ion battery supply.17 As with the hold-up problem, substitution across multiple supplier contracts can resolve this issue. Complementors  As of March 2013, 5,678 public charging stations existed across the United States, with 16,256 public charging points, of which 3,990 were located in California, 1,417 in Texas, and 1,141 in Washington18. The availability of recharging stations has provided a unique market environment for the development of Tesla. The

prevalence of charging stations increases the value of electronic vehicles.  Tesla is working towards setting up a network of free fast recharging points for its customers to top up their batteries on the road19. 7 Network Effects from Charging Stations Tesla has spent a great deal of its resources building a strong network of charging stations. Whilst Tesla’s plans are the most ambitious, Nissan and many other providers of electronic vehicles are also committing more to building a network of fast-charging stations around the US20. Economic Intuition: There is a positive network effect between ‘electric vehicles’ and ‘fastcharging stations’. The more fast-charging stations there are, the more convenient it becomes to own an electric car. Also, the more people buying electric cars, the more it makes sense to invest in more fast-charging stations, these reinforcing network effects create a virtuous cycle. However, in this framework we see significant scope for free

riding, as competing EV companies’ customers can use each other’s charging stations. Tesla has strategically tackled this economic dilemma by designing and building their electronic chargers in a way that their own customers derive more value from them, relative to their competitor’s customers21:  Free charges for Tesla owners: A properly equipped Model S can charge for free at any charging point. They are unlike gas stations that require you to pay for each fill-up  Tailored electric charges (more effective for Tesla’s vehicles): A Supercharger is a fastcharge station capable of delivering up to 50% battery capacity to Model S in about 20 minutes (roughly 16 times faster than most public charging stations). All 85 kWh Model S and Supercharging-enabled 60kWh cars are capable of Supercharging. “Superchargers” will only work for Tesla’s Model S (and future models). So, for example, drivers of Nissan all-electric Leaf car– the electric vehicle of choice for the

middle class – won’t be able to use the Tesla superchargers22 (separating benefits).  Strategic Coverage: Charging points are centered around Tesla’s consumer base. They are also strategically situated in a way to incentivize their customers to use their Tesla’s more and to allow owners to drive from station to station with minimal stops: “we want to encourage Model S owners to take road trips.” ‘Super Charging’ Coverage Summary: North America Today – 87 stations (complete West and East Coast coverage) 2014 – 80% of the US population. 2015 – 98% of the US population. International Europe Today – 14 stations. China Today – 2 stations. Note: 16,256 public charging points altogether (including ‘Super Figure 2: Supercharger locations by 2015 charges’) Coordination: Automakers have complained that a key barrier to greater public adoption of electric vehicles is a deficiency of quick-charge public charging stations. 8 Strategic Positioning and

Differentiation Tesla currently competes in two semi-distinct market segments: the market for luxury vehicles and the market for electric vehicles. In the market for luxury vehicles, Tesla’s highest end offerings compete with vehicles from mass producers such as BMW (with the M-series) and Mercedes (with the AMG) in addition to the small luxury players like Lamborghini and Maserati. In this market, Tesla is competitive on specifications and price, and stands out in this segment as the only electrified competitor (see figure below). Source: Motor Trend In the market for electric vehicles, Tesla stands out as the only competitor with high performance, and currently stands alone at the high end of the market. Source: Motor Trend However, as competitors such as BMW move into the electric market, the lines between luxury and electrified luxury may begin to blur. And BMW is coming; the firm just completed a partial release of the BMW i3, an electrified crossover 23 To boot, BMW has a

very strong reputation for quality and is planning on offering the i3 for roughly $30k less than Tesla’s Model S.24 9 Tesla is not the first car company to face an eroding differentiated position in the automobile industry. Saab faced a very similar situation in the early 1990’s and provides an interesting case study for Tesla given the similarities between the two firms: Both Saab and Tesla produce a limited line of sporty sedans and were pioneers in mass producing a new powertrain technology (turbocharging and electric motors respectively); both also put this differentiating factor at the core of their company ethos and marketing strategies. Like an electric engine, a turbocharger boosts both power and fuel efficiency and has a significantly different torque profile than a standard internal combustion engine (read: drives differently). Additionally, both variants are expensive and carry some cachet, appealing to the higher ends of the market. Saab once owned the market for

turbocharged cars, but lost this positioning as Audi and BMW began to recognize the benefits of the technology. Over time, Saab lost its ability to price at a premium in the market. As the electric engine becomes less unique in the marketplace, Tesla will face the same problem and may lose its ability to maintain its high profit margins. Once this happens, Tesla will need to increase its scale or differentiate in some other way – such as developing intellectual property around battery technologies and vertically differentiating across specifications like range and power. 10 Growth Strategy & Economies of Scale It is clear that Tesla is attempting to scale up their operations, and for good reason. The complexity of modern automobiles raises the bar for minimum efficient scale quite high. The industry “values economies of scale and requires production of hundreds of thousands of cars to cover fixed costs of R&D, engineering, manufacturing, marketing and distribution”.

25 Currently, Tesla lacks such scale, producing just tens of thousands of vehicles. So it is no surprise that while Tesla “lacks the engineering resources and volume efficiencies of an established automaker”,26 they are rapidly expanding their capabilities. Yet Tesla must be careful; as evidenced by the Saab case, scale can come at a high cost. The push for economies of scale helped unravel Saab’s strategic market positioning. Matthias Holweg and Nick Oliver of Judge Business School argue that Saab found itself tangled in a ‘catch-22’.27 Saab needed greater economy of scale to survive, but scale diluted the individuality at the core of the Saab brand. In the 1990’s, GM (Saab’s parent company) recognized that the minimum efficient scale for Saab was somewhere above 100k units and attempted to boost production and sales. To do this, among other things, GM boosted operational and design efficiencies by forcing Saab to share platforms (and other systems) with their other car

lines. The GM designed Vectra platform, introduced on the Saab 900 in 1994, resulted in reduced handling and safety and had deleterious effects on consumer perception of the brand. Eventually, Saab found itself competing against the mass-producing firms such as BMW and Audi while churning out about as many cars as Lamborghini. Saab had won over a niche portion of the market, but alienated that market in trying to grow. It soon found itself caught in an unprofitable, middling position along the cost-quality curve. Tesla entered the market a bit farther up on the curve, as high cost producer with extremely high quality, and has employed a very different strategy for growth. Instead of partnering with a mass producer and attempting to rapidly integrate design to leverage economies of scale, Tesla has invested heavily in its own production capabilities, raising $2.3 billion in March to help fund two ‘giga-factories’ that will produce batteries. Michael Robinet, managing director of

industry consultant IHS Automotive, observed “There’s no doubt that this type of sourcing strategy is unconventional, but Tesla is good at breaking a lot of practices that are standard in the industry.”28 Ramping up production organically in this manner allows greater control over quality and may help Tesla maintain band integrity as they scale. 11 Geographic Expansion and Sales Model As Tesla scales up, it has decided to take a novel approach to geographic expansion, opting to have virtual sales rather than build a physical footprint in the areas it serves. This strategy is coherent with their product and timeline but has been generating legal challenges as it threatens the 3rd parties that rely on the traditional business model. Tesla’s high-end customers are presumably scattered across the country making it imperative for the company to expand nationally. To reach this demand, Tesla has opted for a direct sales model, bypassing the dealerships. Tesla’s customers are

presumably highly educated and computer literate, so the online model seems coherent with their customer base; it might be a while before GM’s Buick, for instance, would be able to successfully implement this strategy. The online model has also allowed Tesla to expand their geographic footprint to the larger national market in a very short period time. In addition, Tesla also does not seem to be facing much consumer backlash from forgoing the dealership model. Recent changes and innovations have disrupted the model for car dealerships, making much of the value they add obsolete. Karan Girotra of INSEAD breaks down the diminishing value proposition of the dealership model, summarized below:29     Search and discovery o While consumers used to rely on car salesmen for information, the internet has largely made this service obsolete. It is remarkably easy to log onto a website like Cars.com and compare 5 or 6 different models Relationship Management and Trust o Pretty

much all major brands have strong, established reputations that negates the need for a 3rd party seller to act as a trusted intermediary for the wary buyer. Local Inventories Allow for Instant Delivery o This is becoming less important as sellers offer customizable vehicles, taking a page of out of Michael Dell’s book. After Sales Service o As cars become more reliable, less service is needed, and this becomes less important. Unsurprisingly, the backlash Tesla has caught has been from the dealerships themselves. Tesla’s model is a real existential threat to this segment of the industry, and has caught a lot of media attention. Lawsuits have sprung up in large markets like New Jersey and Texas, calling on already-existing bans on direct sales. However, the FTC has very recently been defending Tesla’s model,30 and it seems likely that Tesla will prevail in the legal arena. 12 APPENDIX A Figure 1: Tesla Income Statement (2010-2013) Source:

http://investing.businessweekcom/research/stocks/snapshot/snapshotasp?ticker=TSLA (Accessed May 2nd, 2014) 13 BIBLIOGRAPHY: 1 http://investing.businessweekcom/research/stocks/snapshot/snapshotasp?ticker=TSLA (Under ‘Tesla Details’, nd last accessed May 2 , 2014) 2 http://www.kiplingercom/article/investing/T052-C008-S003-best-stocks-of-the-nasdaq-100-in-2013html 3 http://www.economistcom/news/business/21597893-tesla-gains-new-admirers-it-heads-towards-mass-marketfully-charged 4 Mark Rogowsky (2014-01-16). "Tesla Sales Blow Past Competitors, But With Success Comes Scrutiny" Forbes Retrieved 2014-01-17. Almost 18,000 units were sold in the US in 2013 5 Bradley Berman (2013-03-12). "Tesla Model X Production Won’t Start Until Late 2014" The New York Times Retrieved 2013-03-12. 6 http://green.autoblogcom/2014/02/28/is-bmw-the-only-real-competition-to-tesla-motors/ 7

http://www.foolcom/investing/general/2013/08/27/7-things-to-know-about-battery-electric-vehiclesaspx 8 http://www.justicegov/atr/public/guidelines/horiz book/15html 9 http://www.businessinsidercom/bmw-heres-why-the-i3-is-better-than-tesla-model-s-2014-1#ixzz30atyXfepi8 10 http://www.economistcom/news/business/21597893-tesla-gains-new-admirers-it-heads-towards-mass-marketfully-charged 11 http://www.economistcom/blogs/schumpeter/2014/03/teslas-gigafactory 12 http://www.greencarreportscom/news/1088916 can-hydrogen-fuel-cell-vehicles-compete-with-electric-cars 13 http://insideevs.com/tesla-increases-price-of-model-s-60-kwh-and-85-kwh-p85-version-gets-price-reduction/ 14 http://money.cnncom/2013/09/17/news/economy/poverty-income/ 15 http://money.cnncom/2011/09/28/autos/tesla business planfortune/ 16 http://www.eiucom/industry/article/771664261/teslas-plans-for-a-battery-gigafactory/2014-03-26 17 http://www.reuterscom/article/2013/11/06/us-autos-tesla-idUSBRE9A415E20131106 18 U.S Department

of Energy (2013-04-09) "Alternative Fueling Station Counts by State" Alternative Fuels Data Center (AFDC). Retrieved 2013-04-10 19 http://www.economistcom/news/special-report/21576218-tesla-has-high-hopes-its-high-spec-electric-carsgeneral-electric-motors 20 http://www.treehuggercom/cars/nissan-building-more-100-direct-current-fast-charging-stations-usdealershipshtml 21 http://www.teslamotorscom/supercharger 22 http://blogs.wsjcom/corporate-intelligence/2013/05/30/teslas-walled-garden-of-charging-stations/ 23 http://www.motorwardcom/2014/04/bmw-i3-electronaut-edition-launches-in-america/ 24 http://www.foxbusinesscom/industries/2014/03/28/bmw-takes-on-luxury-electric-car-market/ 25 http://money.cnncom/2011/09/28/autos/tesla business planfortune/ 26 http://money.cnncom/2011/09/28/autos/tesla business planfortune/ 27 http://chalmeristbloggen.fileswordpresscom/2011/12/mholweg final report 111220pdf 28

http://www.bloombergcom/news/2014-04-29/tesla-plans-at-least-two-battery-as-musk-emphasizes-speedhtml 29 www.forbescom/sites/insead/2014/03/25/tesla-model-s-disrupts-big-autos-stalled-business-model/ 30 http://investorplace.com/2014/05/tesla-stock-news-tsla/ 14