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Monday, July 25, 2016

Clearing the Smoke on Tesla Deux

Mike Smitka

While Tesla the car company continues to burn through cash, Elon Musk is touting a capital-hungry vision of integration of his multiple ventures. As emphasized on Slate (The Folly of Elon Musk's New Master Plan), his core vehicle operations are crying out for operational attention. But without the battery plant, his future products won't exist, and without both the cars and the solar panels, his battery plant can't keep busy enough to make ends meet. Any one of the pieces alone is a daunting business challenge. Peer through the PR smoke-screen, and what he's saying is that none of the pieces stand alone. It's triple or nothing. That should give investors nightmares.

...[his strategy] is triple or nothing ... that should give investors nightmares...

Apropos to this blog, let me focus on the vehicle end of his house of cards. All would-be electric vehicle manufacturers continue to face the challenge that customers are uninterested in paying for being "green", outside of Musk's status symbol segment. Subsidies can kick-start the segment, but the budgets involved explode if sales prove robust, and become unsustainable politically. Even China set up its subsidies to phase out over time, or as sales (and costs to the government) rise.

His plan dismisses the competition. Musk isn't the only one aiming to reduce battery costs, but the gigafactory is a gigabet on one product. Others are ramping up in increments, as they add customers, with an "s". Now scuttlebutt from my co-blogger who lives in the vicinity is that battery plant is way behind schedule. Meanwhile if you add sales of the product pair of the Leaf and the Clio, you'll find that Nissan-Renault outsells Tesla. Their products are assembled on the same lines as standard "sister" cars. So they don't have to keep a billion-dollar factory busy with just one product. Plus when GM or R-N announce a new product to launch in 3 years, they hit that launch date, give or take a couple weeks. Not plus a handful of quarters.

One additional piece: inventory. To survive Musk will need dealerships that can provide service. Currently he has to haul cars that need repairs to and from one of his handful of shops, and provide "loaners" in the interim. As he moves downmarket, people won't have multiple "drives" in their car warehouse, and that will be both unacceptable to customers and too expensive relative to the cost of the product. Tesla dealers will also need 30-60 days of cars, and an ability to take trade-ins and provide finance. All these functions require real estate, too.

Carmakers have tried direct sales on and off for the past 100 years, including Henry Ford himself, and at Ford in 2000 (under Jacques Nasser). Now the success of dealership groups shows that it is possible to manage dozens of stores; dealerships don't have to be family businesses dominated by locally-based entrepreneurs. But Tesla ranks at the bottom in surveys of the quality of dealerships. If he is to move towards the mass market in the next 5 years, he really should be rolling out sales points, building service bays, hiring better managers, and spending hard cash on training now. After all, by the time he gets to market there will be multiple electric vehicles available. Customers may come to him, but as it stands his distribution system will drive them away.

...Musk is set to run out of cash and credibility, much the same thing...

The capital requirements for distribution are daunting. In the aggregate in the US there is $230+ billion in inventory for new cars. Real estate adds tens of billions more. Thanks to just-in-time production, inventories in manufacturing are but $30 billion, and that includes parts suppliers and not just vehicle manufacturers. If Tesla wants 2% of the market – 320,000 cars – then Musk will need to raise a lot more cash than he has to date, perhaps $5-6 billion just for distribution. Or he has to admit that his vision was illusory, and change his business model. He's running out of time – unless his next model really won't be ready until 2020. In that case, he'll have run out of cash and credibility, much the same thing.

To his credit, Musk has shown that thanks to the capabilities of supply chain and independent engineering houses, the entry barriers into manufacturing motor vehicles are lower than they have been in a century. The Chinese firms Chery, Geely, BYD and Great Wall, among others, provide additional testimony. Manufacturing however isn't enough; 30% of the industry's costs lie downstream, while keeping factories busy requires a careful product strategy that can roll out new vehicles on time and on budget. For new firms, those vehicles also have to be consistent good sellers. Musk has shown little or no recognition of those barriers, which have been the death of the visions of 4,000-odd ventures since the start of the industry. Tesla will make 4,001.


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