Tesla is Designing Distribution
Investors are enamored with Tesla, and what's not to like? Tesla is transforming the vehicle market with battery powered cars, whose style and performance are the equal of the best cars on the road. The cars even drive themselves. Tesla has manufacturing facilities that display the latest advances in robotic technology. The largest battery manufacturing plant in the world provides an innovative battery that stores power for an entire house. With Tesla’s recent acquisition of SolarCity, the vertical integration is complete as they deliver one stop shopping for the consumer in the electric car market. In a world where the platform is everything, Tesla may have the greatest advantage of all their competitors: their network of charging stations spanning the US and, eventually, the globe.
Tesla is delivering a platform that may make even Apple weep at its reach. The drivers of the world look with envy at the Tesla Model S and X, while they await the Model 3. Paragons of style and performance, they are the quintessential expression of the age: technology abundant and environmentally friendly. The cars can drive themselves and receive updates remotely to enhance performance. To meet the required demand for batteries in the car, Tesla began designing and manufacturing batteries for the needs of automobiles and homes. Solar power was the final addition to make the vertical integration complete: Tesla has control of the whole value chain from energy source to car consumer. Distribution, however, may be where it transforms diverse businesses from automobile dealers and gas stations to public transport.
Electrifying Cars. Tesla began the race into electric vehicles in 2006 with its prototype. The focus was on saving gas and performance: people not only want to save the world but enjoy the experience. The biggest challenges facing the car's development were those similar to racing cars: the balance between performance and weight. While the absence of a traditional motor reduced weight, the significantly heavier battery packs increased weight. Using lighter materials that included aluminum and carbon fiber addressed the weight problem. Delivering the improved performance was because of a century old insight from the inventor whose name adorns the company, Nikola Tesla.
The Tesla's electrical engine uses alternating current (AC) versus the direct current (DC) found in batteries and solar panels. The rationale for selecting AC is quite practical and the mirrors the reasons it is deployed in power plants: it was simpler to implement and, critically, more reliable over a range of speeds: a requirement for a sports car. With the engine delivering the performance requirement and weight manageable, Tesla focused on the next impediment: electricity.
Needing Energy. As Tesla was launching their electrical car ambitions, the world was in a commodity super cycle that was driving up the price of oil. The need to deliver a more cost efficient fuel for automobiles was an easy sell; however, the price of electricity was accelerating at the same time. The rising energy cost left Tesla with a dilemma: to deliver a cost effective fuel that helped reduce pollution was a significant hurdle with rising electricity costs. The perceived trade-off is switching one fossil fuel for another, which could relegate Tesla to a niche product within the high-end automobile market.
The solution to the electricity challenge was solar. As solar panel installation costs continued their decline, it has become economical to generate power at the residential house versus receiving it from the utility in some states. While the migration to solar energy has competition from other alternative sources, it didn't deter Tesla with its purchase of SolarCity. Tesla knows that solar power installation costs will eventually fall to a level that makes them cost competitive. The trouble with solar is timing: how to keep the electricity when the sun isn't shining.
Batteries were the answer. The cost of electrical storage, however, was a problem for both automobiles and solar generation at home. With the cost of batteries dropping significantly and more production capacity coming online to augment the capacity that Tesla has already achieved, the price of electrical storage will continue to fall further. The production capacity will support demand at home and on the road, not to mention at the utility.
Distributing Success. Tesla faced a hurdle in manufacturing their cars. A reference didn't exist for manufacturing automobiles that were simpler to build because of the absence of an engine and transmission. Without the need to follow established protocols, Tesla focused on automating the manufacturing process to enable the ability to scale in the future. The production process is a sight to behold: robots moving at high speed to assemble the product. There were bumps along the way and delivery shortfalls; however, the issues seemed mostly addressed as Tesla gears up to deliver the mass market Model 3.
A great product needs a great distribution network and, as they had in design and production, they rewrote the book. Tesla placed display stores in malls so people could see the cars while they shopped. The tactic ran up against the National Automobile Dealers Association, who wanted to control distribution. Traditionally, car dealers are required to be independent of the car manufacturer. A logic that adds costs; however, it may provide local employment and benefits. The critical element for Tesla was control over the buying experience, which is an experience that most of us do not enjoy.
Driving Autonomy. Tesla is not only focused on automating production and operating autonomous distribution, but they also want to develop autonomous driving. The world was given a peak in 2003 at the first self-parking car, and from there technology progressed. The battle for self-driving cars it pitting tech heavyweights against each other as they seek to become first to market. While they have reached their goal of a self-driving car, the regulators are still a little bit behind.
The automobile has long been an expression of freedom with its the ability to escape your routine and explore new places. This freedom has also long been associated with the burden of traffic and searching for parking. Autonomous driving could reduce or remove the burden of traffic and parking. The return of the lost time from commuting, traffic, and parking would be a material gain for people. It seems Tesla is set to redefine every dimension of the automobile experience and improve the consumer experience for everyone in a vertical integration of which the auto sector has never seen.
Strategy Risk. The stock market highly values all of Tesla's innovations, which is pricing Tesla as more valuable that Ford and GM, companies who are global leaders in sales while Tesla currently runs at a 100,000 unit rate and might deliver 500,000 in 2018. Tesla is providing innovative cars that consumer and reviewers like; however, it is highly doubtful that it will be the only electric car company in the world. The consumer automobile industry has evolved since the days when "Any customer can have a car painted any colour he wants so long as it is black."
There are many competitors in the market, and the traditional car makers are leading the race. As discussed in a previous post, the competition is severe in the autonomous automotive industry. Tesla will most likely be one manufacturer among many competitors, which is not a poor outcome. Their more lasting business model may be their horizontal expansion into related businesses, mainly the one things all the car will need: electricity generation, storage, and distribution.
It is unquestioned that Tesla has built and continues to expand the largest charging network in the world. The strategic rationale was at first to ensure Tesla drivers would be free to drive where they needed without fear of being stranded without a charging station. The rationale has most likely evolved as the realization dawns that there will be more than one electric car company. Even if Tesla doesn't sell the vehicle, they can still recharge it. Further, if they don't own the recharging station, they can sell the battery or even the solar generation infrastructure. Tesla is well positioned to help define industry standards for recharging stations and power generation at the local level.
A further outcome of the network is that Tesla will have stations everywhere across the developed world. This network provides them with a critical advantage: they can use these stations as way points for transporting passengers across the US or the world. This transportation system can replace most of the current intercity commutes in the US already, not to mention making gas stations redundant, a long held goal of Elon Musk. Car repair garages could also be redundant with their computerized self-diagnostics telling them when to return to a garage for repairs.
The threat to intercity bus and train service is not trivial: Uber and Lift already have the software to handle the logistics of pooled riders. With a network in place, a passenger can pick their destination, and the car will pick them up and deliver them wherever they need. The current bus and train infrastructure could quickly become redundant, along with the car for hire market, which may the be the largest disruption.
Imagining the world of continually moving cars circulating between network points and picking up passengers at their door is easy. Instead of buying a car, the consumer could purchase a membership in transportation as a service (TaaS), where for a monthly fee there is a car on demand. Just call the vehicle, and it shows up at your door. The logistics optimization problem is complicated, but the logistics already works for Uber and Lift. The day of the High Occupancy Vehicle Lane (HOV) may be coming to an end as the day of the Autonomous Vehicle Lane (AVL) replaces it.
Whatever the outcome, Tesla seems well positioned to have some hand in the outcome, while the strategic risk to the transportation service such as bus, trains, subways, and human driven car for hire markets is severe. The platform that Tesla is building is not so much about cars but is about the distribution business: whether it is people, electricity, or even goods. Thinking of Tesla as more than a car company might even help justify its sky-high valuation.
Note: Updated for style changes on August 14th, 2017.