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Tesla

Dr CR Rajan
Entry

• Tesla Motors attempts to become the first US firm (since

WWII) to successfully enter the car industry with a mass-

produced car. We will explore its strategy.

• Should BMW expect Tesla to grow into a strong direct

competitor like Audi, versus Tesla being limited to a niche

or being just a flash in the pan? Is Tesla at a competitive

advantage or disadvantage? How will that evolve?

• What do you think of Tesla’s entry strategy? What barriers

did it have to overcome? Should Nissan learn something

from Tesla’s approach? Will other firms follow in Tesla’s

footsteps?

• How do you expect the industry to evolve?


Elon Musk discussing first Tesla Model S

• https://www.youtube.com/watch?v=9E3Si8FWb1

• The problem led to a Model S software change

that keeps the car higher off the ground at

highway speeds.

• The problem led to a Model S software change

that keeps the car higher off the ground at

highway speeds.

• http://www.youtube.com/watch?v=dGoobeIU4b

Q
Tesla Videos

• https://www.tesla.com/models

• https://www.youtube.com/watch?v=5XdiGMI

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Tesla’s position

Should BMW be nervous that Tesla will become a

strong competitor, like Audi? Or is Tesla more a

flash in the pan or a niche player?

– Quantitative analysis of competitive advantage. Does

Tesla have competitive advantage right now??

– How will their position evolve?

– Economies of scale and learning will give strong

improvements by the end of 2014, but they may

have to lower price and start advertising.

– Audi or flash/niche?
Tesla’s Entry puzzle

• But Tesla shouldn’t even be here! This industry

has huge barriers to entry.

• There has indeed been no entry in the US since

WWII.

– What are the barriers to entry? –

– CAPEX, Distribution, Vendor ecosystem,

Marketing/Advertising, Design

– How did they overcome these barriers?

• Brand: high-end entry gives a halo effect. Other advantages

of high-end entry?

• Build own sales network: Did dealers not want to distribute

Tesla?
Barriers

• The most important barriers are:

• Brand: GM and Ford both spend about $4bln per

year; BMW’s brand value was estimated at about

$30bln.

• · Distribution network: Toyota has 1600 dealers.

• Service network

• Production plants and production know-how: one

plant costs about $1-2bln.

• Supplier network: about 1000 suppliers for a car.


Barriers

• Design cost and know-how: $1bln to up to $6bln for design.

• there are also some barriers specific to entering with an electric car

– lack of acceptance and issues with range anxiety, lack of charging

infrastructure, and uncertainty about technological future.

– As a point of reference for these barriers to entry, Tesla had about $1bln in

funding by the time of the Model S launch (some $300 million in start-up

funding, $250 million in equity funding since its IPO, and a $450 million

government loan).

– Entry barriers are systemic sources of sustainable competitive advantage for

incumbents

– All these barriers to entry are indeed stocks of resources and capabilities,

with some multiplier effect from scale and from the fact that they need to do

many of these things at the same time (pattern).


How did Tesla overcome barriers

• Disruptor at high end - It gives them a halo effect, so they get their marketing for

free.

• How important is this? Even with their massive scale, Ford and GM spend about

3% of revenue on marketing, so this benefit is huge.

• This approach of entering on the high end is a considerable departure from the

approach of other manufacturers, such as Toyota and Nissan. These firms entered

in the mid-market with their hybrid and electric vehicles.

• Apart from this halo effect, is entering on the high end a good or a bad idea? High

end entry has some important advantages for Tesla. First, sales at the high end are

smaller, so Tesla is at less of a scale disadvantage (and market demand better

matches its capacity).

• Second, margins are (likely) higher, giving Tesla more room to breathe with a cost

disadvantage.

• High end customers are less price sensitive, so competing on price has limited

benefits
Tesla entry strategy

• Dealership

• Infrastructure –charging etc

• Customer connect

• Pedigree ?
Partners -Ecosystem

Partner with Lotus for car body and assembly while

developing drivetrain, then go into assembly:

How would the other way (first assembly then

powertrain) have worked out?

Know-how:

1) hire mixture of employees, some with long experience

in the car industry,

2) unconventional (design, distribution) makes

knowledge obsolete

3) smart tech choices such as use commodity batteries to

overcome battery know-how and scale 4) opportunistic

purchases of plant and equipment


Design: Simplicity

• There’s something puzzling: Tesla designed the Model S for

half the money than a regular design, even though this was

Tesla’s very first car. And the car wins about every award

and top safety rating on the planet!

– How can they do this design magic? (Silicon Valley) But Nissan

also developed the Leaf in less time than a run-of-the-mill CV?

Simplicity.

– What are other implications of simplicity? (Cheaper design, less

suppliers, simpler logistics; simpler and faster assembly so less

labor and smaller plant; less quality problems; less service

problems: cheaper and better car). How does that affect

Economies of Scale (and Minimum Efficient Scale)?

– Less service: how do dealers like that?


Imitation and Industry Evolution

• Does this give a sustainable competitive

advantage to Tesla?

• Which other things can others imitate? Can

Tesla prevent others from following its high-

end entry path? Should it do so?

• How will the industry evolve?

• Effect of smaller Economies of Scale: easier

entry, more competition.


Simplicity

• Other effects of simplicity? (Modularization;

potentially Tesla Inside)

• Should Tesla try to push their battery on others?

(Slow Nissan by limiting scale and learning.

Increase entry and competition at car level to

capture

• Should Nissan have copied their approach?

• Should Nissan have used the same battery?

• Should Nissan have entered from the high end?


– A second dimension is dynamic fit: how choices of

today fit with the expected path of the firm and with

the expected choices of tomorrow. The optimal

battery choices of Tesla vs Nissan are a nice example.

– An explicitly dynamic strategy can be very powerful.

Such strategy guides how to enter and sequence and

where to invest in learning. It also makes the path

clear so that employees choose today what they will

need tomorrow.

– A final important dynamic dimension is how industry

may evolve.
• An explicit strategy can be a powerful guide for decision-making.

Having the strategy developed or announced by the CEO makes it

more credible, increasing the likelihood of execution. Musk’s

statement illustrates all characteristics of a strategic decision.

• Even high entry barriers can be overcome with a smart path, with

an unconventional approach, and by leveraging change. A firm

needs to think carefully about how to prevent others from imitating

(close door to high-end entry) or from gaining an advantage (sell

batteries to slow Nissan).

• A factor such as complexity can have dramatic impact, both on the

firm itself and on industry structure. High-end entry can be

effective.
Innovation ecosystem ?

• First, while Silicon Valley has always been a hotbed of innovation,

most of that innovation is targeted to IT. Tesla is one of the few

Valley firms to target a more traditional industry and definitely

the one targeting the largest traditional industry.

• That leads to the second unusual feature: Tesla is a VC-funded

company making a frontal attack on an industry with some of the

world’s largest companies.

• Two of the 10 largest US companies are car companies: GM and

Ford. This is like trying to go head-to-head with Boeing as a VC

funded firm.

• Third, there is obviously the person of Elon Musk. With Tesla,

SpaceX, and SolarCity, he’s a central player in three of the most

significant technological revolutions of the moment, and he’s doing

it simultaneously. (With SpaceX, he is going, in some ways, head to

head with Boeing!) If he pulls this off, he will be – with some

hyperbole – a business legend. But will he?


Competitor’s perspective

• Should BMW anticipate that Tesla will become another

Audi?

• The Tesla Model S and Model X seem to compete directly

with BMW. In fact, when describing the future Generation 3

(now referred to as Model E), Elon Musk explicitly referred

to the BMW

• BMW thus seems to be an important reference point for

Tesla’s positioning: sporty high-end luxury cars. “The

Ultimate Driving Machine.”

• How worried should BMW be? Will Tesla survive and thrive

and become a strong direct competitor, like Audi? Or is it

doomed to be a niche player or just a flash in the pan?.


Strong Competitor/Audi

• Tesla is already profitable • Tesla is not profitable

• Their cost will go down, • · Once the newness is off, their

especially battery cost will go up (advertising, no

• Incredible product; even cheap machinery) and their

more attractive once newness price has to come down (no

is off (and fear of new is down) exclusivity, most interested

buyers have one).

• Resale value guarantee; start • · Niche product; less attractive

on high end where people once newness and exclusivity

don’t see a Tesla as such a big is off. BMW has a much more

investment. trusted brand.

• · People don’t trust electric

cars. Big investment in

something uncertain. Any fire

makes people anxious.


+ and -

• Most people don’t need • Range anxiety will remain

range. Battery will a key hurdle.

improve and battery can

get swapped. • Once this market takes

• Ultimately, CV will be off, BMW can just jump

replaced anyways. Tesla in. They let Tesla test the

will then have a huge waters and beat a path.

competitive advantage. They will follow and

Very hard for traditional overtake Tesla.

mfg to make electric cars • There will be many other

alternative energy

• Tesla is building a sources.

competitive advantage

with its proprietary

charging stations.
Range etc

• Some people see range anxiety as an important issue, others don’t.

How should Tesla think about that? It is useful to make this more

concrete.

• Suppose that for a third of people range anxiety is a deal breaker, a

third doesn’t care, and a third values an electric car $10,000 less. Is

this good or bad for Tesla? This is good: a third of the market is

huge~ 2 mn

• This raises two interesting points: First, for a challenger or start-up,

variance in preferences often matters more than average

preferences.

• Second, since it is variance that matters, it is important to go

beyond your own personal preferences to see the range.

• Does the case have any information that can help us think about

the range anxiety issue? Less than 1% of trips exceed 100 miles.

20% of households owned 3 or more cars. High-income families are

more likely to have more cars and less likely to do long trips by car

and thus less sensitive to range anxiety issues.


Quantitative Analysis

What do the numbers say?

Is Tesla profitable?

Does it have a competitive advantage?

The best starting point for this discussion are the

income statements in Exhibits 12 and 14 of the

case.

Tesla’s situation doesn’t look great but also not

disastrous: Tesla seems to have a considerable

competitive disadvantage ($13 disadvantage per

$100 spent on a BMW) but its total operating

income is only slightly negative.


Tesla vs BMW

Tesla 2013 ( $ Th) BMW 2013( Euro Mn) Tesla ( indexed 100) BMW (100)

Revenues 847531 57293 88 100

ZEV credits 119400 12

Costb of Rev 770128 40377 80 70

Gross Profit 196803 16916 20 30

R&D 107171 3993 11 7

SG&A 107008 6369 11 11

Total Expense 214179 10362 22 18


Loss -17376 6554 -2 11
Tesla vs BMW ( Excl ZEV credits)

Tesla 2012 ( $ Th) BMW 2012( Euro Mn) Tesla ( indexed 100) BMW (100)

Revenues 847531 57293 100 100

ZEV credits 119400 12

Costb of Rev 770128 40377 91 70

Gross Profit 196803 16916 9 30

R&D 107171 3993 13 7

SG&A 107008 6369 13 11

Total Expense 214179 10362 25 18


Loss -136776 6554 -16 11
Quants

• Before we proceed with these numbers, let’s make

sure that these are the right numbers to look at, if we

want to understand Tesla’s competitive position?

• These are definitely not the right numbers to look at:

Tesla’s revenue includes income from ZEV certificates

• Both the quantity and the price of these certificates

are expected to drop quickly as other manufacturers

ramp up their production of electric cars. So this is a

temporary source of income that should be excluded

to get to strategic performance


• BMW competes with the Tesla Model S in the

(representative) customer’s mind

• how much revenue – including subsidies –

Tesla would get (if the customer bought a

Tesla instead).

• There are no precise data about that in the

case, but the case mentions that the total cost

of ownership of a BMW and a Tesla are similar.


Exhibit 9

• One possible approach is to take the data of in the case and

assume that these are comparable cars in the customer’s mind.

Note that for $48725 that the customer spends on the BMW, he

would spend $61070 on the Tesla (which is not unreasonable given

the $1500 per year savings in fuel costs alone and given the

different ratings), but Tesla receives $71070 thanks to subsidies. So

for every $100 spent on the BMW, if that is the choice, Tesla would

receives $146, if it were chosen. The adjusted numbers (for both

this adjustment and the ‘direct sales adjustment’) are then in TN

Exhibit 3b.

• Tesla’s cars compete with the regular BMWs (which they clearly do)

and these regular BMWs are a stronger competitor, then that is the

right comparison. You want to compare with your real and toughest

competitor product.

• What matters are which products the customer considers as being

competitors, not how these products compare physically.


Adjustments

• Let us take both indexed to 100

• Then BMW price ~$48725

• Tesla price ~61070

• Add ZEV then TESLA gets $71070


Like to like ( two ways- Price-value)

Tesla BMW Tesla ( value BMW

adjusted)

LT Rev 100 100 146 100

Cost of Rev 96 70 140 70

Gr Profit 4 30 6 30

R&D 13 7 13 7

SG&A 7 18 7 11

Tot Exp 20 18 20 18

Profit/loss -16 11 -23 11


Economies of Scale:

• Tesla expects to ramp up production to 40,000 units by the

end of 2014 and probably more beyond

• Economies of scale will drive the average fixed costs down.

• Annual production is currently only 20,000, this would cut the

average fixed cost in half.

• To estimate effect, we need to determine the fixed costs in

the income statement.

• For the cost of revenue, we can get some : in production and

production overhead (excluding R&D), partially fixed cost

items are about 1/3 of the cost of revenue.

• About half of this is probably really fixed. However, this

estimate is for a car ‘on scale’ – so that its average fixed cost

will underestimate the average fixed cost of a sub-scale

producer like Tesla – so we need to compensate for that.

• Overall about 25% of this ‘cost of revenue’ maybe really fixed


FC on scale up

• Estimate that 80% of R&D and 80% of SG&A are fixed. (Any

reasonable number will do here. R&D will not grow in proportion to

revenue

• For these estimates, TN Exhibit 5a (resp. TN-4a) shows the updated

income comparison. It is clear that the effect of scale is massive.

• First, with another doubling of scale, the plant will be getting close

to full scale and so the economies of scale on that level will soon be

exhausted.

• Second, the share to which scale applies has become smaller: while

doubling scale a first time cuts the fixed cost in half, doubling it the

second time then cuts half of half, i.e., one quarter.


Price-value- Scale improvement

Tesla BMW Tesla ( value BMW

adjusted)

LT Rev 100 100 146 100

Cost of Rev 96 70 140( -17) 70

Gr Profit 4 30 6 30

R&D 13 7 19 (-8) 7

SG&A 7 18 10 (-4) 11

Tot Exp 20 18 29 18

Profit/loss -16 11 -23 11


Learning or Experience Curve:

• Costs will also decrease through learning.

• The case mentions a 90% learning curve on defects and assembly time.

The effect of this particular learning – defects and assembly time – is

mainly to lower average fixed costs: with a higher rate of (defect-less)

production, the fixed costs of plant and labor get spread over more units.

• But there will be learning in the whole system, from SG&A to better and

cheaper parts and inputs.

• Assume for this analysis that the average learning curve for all costs is 95%

• The purpose of this analysis is to get a feel whether learning may

meaningfully change the picture.

• To calculate the effect of learning, -the cumulative production at the end

of H1 was about 10,000 cars. By the end of 2013 that would have doubled

and by the end of 2014, that would have quadrupled. With a learning

curve of 95%, that means a reduction of each cost item to about 90% (=

.95^2) of before, or a 10% reduction of the cost


Price-value-Learning Curve effects

Tesla BMW Tesla ( value BMW

adjusted)

LT Rev 100 100 146 100

Cost of Rev 96 70 140( -14) 70

Gr Profit 4 30 6 30

R&D 13 7 19 7

SG&A 7 18 10 11

Tot Exp 20 18 29 (-3) 18

Profit/loss -16 11 -23 11


Price effects

• A first question is whether current prices will be sustainable, especially if

Tesla wants to double production. Cumulative production by itself, even

without doubling scale has a double negative effect on demand (or on

customer value).

• First, it reduces the exclusivity of the brand and thus the value to buyers

• Second, as Tesla fills more of the existing demand, it needs to start selling

to people down on the demand curve, who may be less enthusiastic

about Tesla or more worried about range anxiety. Customer value will thus

go down and the price may have to come down too.

• Second, Tesla bought its plant and its machinery on the cheap,

thanks to the crisis (and potentially thanks to the fact that they were not

yet seen as a threat). In the future, such bargains may be harder to come

by. And to start really competing with BMW, they will need to expand

capacity.
Outlook

• Third, government support for EVs may run out in a few years:

according to the current law, Tesla cars will start losing their subsidy

once Tesla reaches 200K cumulative cars (at which time Tesla’s will,

after a short transition, be at a $7,500 price disadvantage versus

other electric cars!).

• If so, the price either goes up by $7,500-$10,000 or Tesla’s revenue

will go down. This is equivalent to a 10-15% price cut, wiping out all

Tesla’s estimated profits at the end of 2014.

• However, by the time that these benefits expire, both Tesla’s scale

and its learning should also have grown further.

• Moreover these programs may be (partially) extended, as they have

been in California (???)


Advantages

• Currently, Tesla does not need to spend on advertising but that may

change when it needs to reach new customers, when its halo effect

decreases (because of going more down-market), and when competition

in its segment increases.

• These negative effects will not kick in as quickly as the scale and learning

effects. But by the time that they kick in, the scale and learning effects will

likely have leveled off a lot. This suggests that Tesla will see an inverted U-

shape in its margins (especially if the subsidies do indeed stop).

1) the massive effects of scale and learning and how this may really distort

the profitability picture of an early venture

2) details of these cost structures – for example, at what level the plant will

be at scale – is key to be able to get a full picture

3) a careful analysis of dynamics may turn up many interesting insights.


How did Tesla overcome barriers

• Disruptor at high end - It gives them a halo effect, so they get their marketing for free.

• How important is this? Even with their massive scale, Ford and GM spend about 3% of

revenue on marketing, so this benefit is huge.

• This approach of entering on the high end is a considerable departure from the

approach of other manufacturers, such as Toyota and Nissan.

• These firms entered in the mid-market with their hybrid and electric vehicles.

• Apart from this halo effect, is entering on the high end a good or a bad idea? High end

entry has some important advantages for Tesla.

– First, sales at the high end are smaller, so Tesla is at less of a scale disadvantage

(and market demand better matches its capacity).

– Second, margins are (likely) higher, giving Tesla more room to breathe with a cost

disadvantage.

– . High end customers are less price sensitive, so competing on price has limited

benefits
High End

• While these two are generic benefits from high-end entry, there

are some other benefits that are more specific to Tesla’s situation:

• at the high end, customer value is higher (or relative price

sensitivity is lower) for benefits such as quiet, fast, green, low

service needs;

• higher-end customers are more likely to have multiple cars so range

and reliability are less of a worry;

• for the very high end customers, this is not a big investment, so

they are less worried about resale value and disappointment,

making this is a good segment to start building customer

acceptance;

• moreover, the very high end customers bring their own halo

effect.

• Entering on the high end clearly has a lot of benefits and was an

important part of Tesla’s. entry

Distribution Network

• To distribute its cars, Tesla creates its own

sales network. It is useful to follow up here as

this point comes back later: Did Tesla create

its own sales network because dealers did not

want to distribute Tesla?

• No: dealers would in fact love to sell Tesla and

are trying to pass laws (in Texas and North

Carolina) to stop Tesla from selling directly to

customers.

• dealers may have a conflict of interest in

selling both CVs and EVs


• Plants and Equipment: Tesla gets bargains on its

plant and part of its equipment(fortuitous timing

also partially due to not being considered a threat

at the time.)

• Overall, Tesla is estimated to have spent less than

1/3 of what it would usually cost: US $300 mln

instead of $1bln. (How much does this matter in

the bigger picture? Not so much on an average

cost basis, but a huge deal from the perspective

of reducing its initial capital needs.)

Collaborative Ecosystem

• Know-how: Tesla partnered with Lotus for the Roadster

and hired experienced people from the car industry in

both management and plant positions.

• It chose standard batteries and motors, but improved

on their usage. (There is a lot of know-how in how the

batteries are put together, i.e., safety features, charging

and de-charging, temperature management, etc. Tesla

has patents on these technologies.

• Tesla has about 200 patent applications with 90% of

these battery and powertrain relate

• Tesla’s sequencing of capabilities: they first developed

know how on powertrains while partnering with Lotus

for the assembly and only later started developing

their own assembly know how.

Simplicity
• Design: A simpler product is faster and cheaper to design.

• Production: Fewer parts make it easier to find suppliers

and to manage logistics and inventory. Faster and easier

assembly saves on labor cost and on plant (as you can produce

more cars in the same plant, driving down average fixed cost)

and other fixed costs. Less errors (in assembly) reduce labor and

material cost (for rework) and reduce the space needed for

rework, saving on plant. It also leads to less quality problems

and higher ratings

• Vs Nissan

• First, they keeps many of the traditional design features of CVs,

so they probably don’t leverage simplicity as much. Second, they

build the Leaf on a line shared with traditional cars, which will

also limit the benefits they can get.

Simplicity

• Service: Fewer errors in assembly reduces warranty costs

and quality problems, as does the much simpler powertrain

by itself. Nine out of 10 repairs are on drivetrains. The most

frequent service task (oil change) is eliminated. This results

in higher quality and lower service needs.

• How do dealers feel about that? They don’t like this at all:

most of their profits come from service and repairs and

from selling service plans up front.

• So how will dealers think about a conventional car versus

an electric car? Clearly, they prefer to sell conventional

cars.
• This throws a very different light on why Tesla prefers not to

work with dealers: dealers have all the wrong incentives.

Dynamics

• Dynamics are an essential part of good

strategy

A first important dimension of dynamics is the

evolution of competitive advantage:

• This is driven mainly by the learning curve and

economies of scale.

• These dynamics are especially important for

understanding and managing start-ups and

innovation, and will likely increase in importance as

faster change means more time spent on the steep

part of the curves.

Conclusions

• Dynamics are essential to strategy

– Sustaining competitive advantage

– Scale and learning curve

• Managing start ups and innovation in a fast

changing industry

• How will the industry evolve?

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