Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
Related questions
Question
What are the weakenesses of Tesla Inc. in 2018?
Transcribed Image Text:Tesla, Inc. In 2018
In 2018, Tesla was one of the most talked about companies in the world. What had started as an unlikely and
risky venture to produce an all-electric luxury sports car had grown into a company with almost $12 billion in annual
revenues that produced multiple car models, owned Solar City (a solar panel leasing company), and produced energy
storage systems (e.g., Powerwall) and solar. Though it was not yet posting profits, it had a market capitalization of over
$47 bilion. Most importantly, it looked like it might survive-perhaps even thrive. This was astonishing, because there
had been no other successful auto manufacturing startup in the United States since the 1920s
The road leading up to Tesla's position in 2018 had been anything but smooth, and many were still betting against the
company. In fact, as of August 2018, the company had over $13 billion worth of shares sold short (Le., shares that
investors borrow to sell, betting that the price will drop so that they can buy shares to replace those borrowed at a lower
price).
In 2017, Tesla delivered 103,020 cars, a 35-percent rise over its 2016 figures. In the first quarter of 2018, Tesla
delivered 29,980 cars, of which almost one-third were its newest model, the Model 3. The company also had a growing
waiting list for all three cars, highlighting both a strength and a weakness of the company: People were enthusiastic
about the cars, and demand was high, but Tesla was having trouble ramping up production to meet that demand.
Some of the production capacity for its earlier models, Model S and Model X, had been reallocated to production
of the new Model 3, and getting the new model's production up and running had been rougher than expected. The
company's CEO, Elon Musk, had forecasted producing 5,000 Model 3 cars a week by the end of the first quarter of
2018, but instead production was closer to 1,000 cars a week by the end of the first quarter, triggering an onslaught of
criticism by analysts.
To make matters worse, the company's rapid expansion of production capacity meant that it would likely require
additional capital within the year, causing stockholders to worry about dilution of their shares. Tesla had made bold
moves and impressive progress, but there were lingering concems over its viability. Would it be able to turn a sustainable
profit on its automaking operations? In the niche market of luxury automobiles for the "eco-wealthy," it had a privileged
position with customers who were relatively price-insensitive and were seeking a stylish, high-performance car that
made an environmental statement. To compete for the mass market, the car would have to compete on value and
efficiency with larger, more established rivals.
History of Tesla
In 2003, an engineer named Martin Eberhard was looking for his next big project. A tall, slim man with a mop of
gray hair, Eberhard was a serial entrepreneur who had launched a number of startups, including NuvoMedia, which he
sold to Gemstar in a $187-million deal. Eberhard was also looking for a sports car that would be environmentally friendly-
he had concerns about global warming and U.S. dependence on the Middle East for oil. When he didn't find the car of
his dreams on the market, he began contemplating building one himself, even though he had zero experience in the
auto industry. Eberhard noticed that many of the driveways that had a Toyota Prius hybrid electric vehicle (or
"dorkmobile" as he called it) also had expensive sports cars in them, making him speculate that there could be a market
for a high-performance, environmentally friendly car. As Eberhard explained: "it was clear that people weren't buying a
Prius to save money on gas. Gas was selling close to inflation-adjusted all-time lows. They were buying them to make
a statement about the environment."
Eberhard began to consider a range of alternative fuel options for his car: hydrogen fuel cells, natural gas, and
diesel. However, he soon concluded that the highest efficiency and performance would come from an entirely electric
vehicle. Luckily for Eberhard, Al Cocconi (founder of AC Propulsion and one of the original engineers for GM's il-fated
EV-1) had concluded the same thing and produced a car called the tzero. The tzero could go from zero to
60 miles per hour in 4.1 seconds, but it was powered with extremely heavy lead-acid batteries, limiting its range to about
60 miles between charges. Eberhard approached Cocooni with the idea of using lighter, lithium ion batteries, which
offered six times more energy per pound. Cocconi was eager to try out the idea (he had, in fact, been experimenting
with lithium ion batteries), and the resulting lithium ion powered tzero accelerated to 60 miles per hour in 3.6 seconds
and could travel more than 300 miles. Eberhard licensed the electric-drive-train technology from AC Propulsion, and
founded his company. Tesla Motors (named after Nikola Tesla, a late 19th- and early 20th-century inventor who
developed, among other things, the AC electrical system used in the United States today).
Meanwhile, another entrepreneur-one with much deeper pockets-was also interested in developing electric
vehicles based on the tzero: Elon Musk. In 2002, Musk was a 31-year-old South African living in California, who had
founded a company that ultimately became PayPal. After selling PayPal to eBay in 2002 for $1.5 billion, he started a
company called SpaceX with the ambitious goal of developing cheap, consumer space travel. (SpaceX's Dragon
spacecraft ultimately made history in May 2012 by becoming the first commercial vehicle to launch and dock at the
International Space Station.) Musk's assertive style and astonishing record of high-tech entrepreneurship made him one
of the inspirations for the Tony Stark character in Jon Favreau's Iron Man movies
Like Eberhard, Musk thought electric cars were the key to the United States achieving energy independence,
and he approached Cocconi about buying the tzero. Tom Gage, who was then AC Propulsion's CEO, suggested that
Musk collaborate with Eberhard. After a two-hour meeting in February 2004, Musk agreed to fund Eberhard's plan with
$6.3 millon. He would be the company's chairman; Eberhard would serve as CEO.
The Roadster
The first Tesla prototype, the Roadster, was based on the $45,000 Lotus Elise, a fast, light sports car that seemed
perfect for the creation of Eberhard and Musk's grand idea. The car would have 400 volts of electric potential, liquid-
cooled, lithium ion batteries, and a series of silicon transistors that would give the car acceleration so powerful the driver
would be pressed back against the seat. It would be nearly as fast as a Porsche 911 Turbo, would not create a single
emission, and would get about 220 miles on a single charge from the kind of outlet you would use to power a washing
machine. Furthermore, rather than creating new large-format batteries to power the car, they connected nearly 7,000
small, cylindrical 18650 lithium-batteries together into a pack. 18650 batteries are the type used in many consumer
devices, including laptops, and over a billion a year are manufactured. This meant that the Roadster was using a battery
that had been thoroughly "debugged" that already had a good ratio of energy capacity to price, and for which there was
already large production capacity.
While the men worked well together at first, personality clashes soon emerged. Both were technically savvy and
vigorously addressed problems within the company. As described by Laurie Yoler, Eberhard was just brilliant, and he
has this tenacity that is unbelievable... He is the guy you want around in those early days when you have naysayers
all around." However, Eberhard could also be abrasive and critical. Musk, in turn, was not content to just financially back
the company. He began to get intimately involved in decisions about the car's design and the operation of the company.
Soon Musk and Eberhard were at odds over decision making. Eberhard preferred to stick with the fiberglass body panels
used in the original Elise; Musk wanted to use the lighter, stronger-and more expensive-carbon fiber. Eberhard had
approved the hiring of PR professionals to build publicity for the car before its launch; Musk fired them, believing his
own involvement and the car itself would generate enough publicity. Eberhard wanted to reap the cost savings of sticking
with the Elise's original crash-tested, off-the-rack chassis; Musk wanted to lower the doorsils by two inches to make the
car easier to enter and exit. Musk also wanted to redesign the headlights and door latches, and replace the Elise's seats
with more comfortable-and again, more expensive-custom seats.
In each case, Musk prevailed. He insisted that "you can't sell a $100,000 car that looks like crap." Musk's views
were hard to ignore given that, by 2007, he had put $55 million of his own money into the company and had also raised
money from wealthy friends, including eBay's second employee, Jeff Skoll, and Google founders Sergey Brin and Larry
Page.
Musk's insistence on the best materials and parts, however, combined with Eberhard's inexperience as the
manager of a major firm, resulted in delays and runaway costs. At a staff meeting in June 2007, Tom Colson, head of
manufacturing, revealed a cost analysis suggesting that the average cost of the cars would be over $100,000 for the
first 50, and would decline only slightly with increased volume. Eberhard could not answer the financial questions of the
venture capitalists on Tesla's board, and their confidence in him was eroded even further by his defense: "In any other
company it's the CFO that provides those numbers... I'm an engineer, not a finance guy." In August 2007, the board
removed him as CEO and demoted him to president of technology. In October 2007, Musik arranged for Eberhard to be
ousted from the company entirely. Furious, Eberhard started a blog detailing what he called the "Stealth Bloodbath"
going on at Tesla, and he would later sue Musk for libel, slander, and breach of contract.
Meanwhile, Eberhard's temporary replacement was Michael Marks, former CEO of Flextronics. Marks
immediately created a priority list that identified items with potential to delay the car. He mothballed any plans for side
projects and focused the entire business on streamining costs and launching the Roadster. Despite his efforts, the
Roadster missed its deadline for beginning production at the Lotus facility, triggering a $4-million penalty built into the
manufacturing contract Eberhard had signed with Lotus.
By the beginning of 2008, morale was at an altime low. In March, however, production began on the Roadster.
and by July 2008, most of the production problems had been forgotten as the first seven Roadsters (the "Founder's
Series") hit the road. Enthusiasm for the cars was astonishing-an allstar list of celebrities made reservations to buy
one, and everywhere a Roadster appeared, people stopped to stare.
The Model 3
Musk's ambitions did not stop at a niche, high-end car. He wanted to build a major U.S. auto company- a feat
that had not been successfully accomplished since the 1920s. To do so, he knew he needed to introduce a less
expensive car that could attract a higher volume of sales, if not quite the mass market. In June 2008, Tesla announced
the Model S, a high-performance, all-electric sedan that would sell for a price ranging from $57,400 to $77,400 and
compete against cars like the BMW 5-series. The car would have an all-aluminum body and a range of up to 300 miles
per charge. The Model S cost $500 million to develop; however, offsetting that cost was a $465-milion loan Tesla
received from the U.S. govemment to build the car, part of the U.S. government's initiative to promote the development
of technologies that would help the United States achieve energy independence.
By May 2012, Tesla reported that it already had 10,000 reservations from customers hoping to buy the Model S
and Musk confidently claimed the company would soon be producing and selling 20,000 Model S cars per year. Musk
also noted that after ramping up production, he expected to see "at least 10,000 units a year from demand in Europe
and at least 5,000 in Asia. The production of the Model S went more smoothly than that of the Roadster and, by June
2012, the first Model S cars rolled off the factory floor. The very first went to Jeff Skoll, eBay's first president and a major
Investor in Tesla. On the day of the launch, Skoll talked with Musk about whether it was harder to build a rocket or a car
(referring to Musk's SpaceX company): "We decided it was a car. There isn't a lot of competition in space."
To build the car, Tesla bought a recently closed automobile factory in Fremont, California, that had been used
for the New United Motor Manufacturing Inc. (NUMMI) venture between Toyota and General Motors. The factory, which
was capable of producing 1,000 cars a week, was far bigger than Tesla's immediate needs and would give the company
room to grow. Furthermore, though the plant and the land it was on had been appraised at around $1 billion before
NUMMI was shut down, Tesla was able to snap up the idled factory for $42 milion. Tesla also used the factory to
produce battery packs for Toyota's RAV4, and a charger for a subcompact Daimler AG electric vehicle. These projects
would supplement Tesla's income while also helping it to build scale and learning curve efficiencies in its technologies.
In the first quarter of 2013, Tesla announced its first quarterly profit. The company had taken in $562 milion in
revenues and reported an $11.2-million profit. Then more good news came: The Model S had earned Consumer
Reports highest rating, and had outsold similarly priced BMW and Mercedes models in the first quarter. In May 2013
the company raised $1 billion by issuing new shares, and then surprised investors by announcing that it had paid back
its government loan. After repaying the loan, Tesla had some $679 million in cash. Musk had announced confidently
that he felt it was his obligation to pay back taxpayer money as soon as possible, and that the company had sufficient
funds now to develop its next generation of automobiles without the loan and without issuing further shares.
Model X
The Model X, unveiled in 2015, was designed as a high-end sport utility vehicle (SUV) that seats seven. Several
distinctive features set it apart from the crowded luxury SUV market. In addition to being all electric and able to go from
zero to 60 miles per hour in just 3.2 seconds, it featured a panoramic windshield and distinctive, gull-wing doors (that
open upward rather than swinging out) that open automatically in response to the driver's approach. "It will triangulate
my position," Musk said: "It will open the front door without touching. When you sit down, it will close the door." The
Model X had a range of about 250 miles (like the Model S), but could tow 5,000 pounds. Its selling price would start at
$70,000, but could exceed $100,000 depending on the options selected.
In the United States, the mid-size luxury SUV market was about five times the size of the high-end luxury sedan
market, and the Model X rapidly attracted a long waiting list of people who placed deposits for the car. Musk projected
a fast production ramp up, with goals of producing 85,000 to 90,000 Model X and S vehicles in 2017. Analysts at the
time doubted that production could be ramped up so quickly, but despite several supplier parts shortages, Tesla's
estimates ended up being very close to the mark The company produced a total of 83,922 cars in 2017.
Reviews of the car were mixed. Consumer Reports found the car disappointing, citing rear doors that were prone
to pausing, the car's limited cargo capacity, and a ride that was "too firm and choppy for a $110,000 car." Car and
Transcribed Image Text:Driver's review also expressed doubts about the wing doors, but gave the car overall a rating of five out of five stars.
stating. "There are no other electric SUVs at the moment. And even against fossil-fuel-ded SUVs, the Tesla's effortless
performance and efficiency can't be matched."
By the end of 2016, the Model X had accumulated total sales of 25,524, ranking it seventh among the bestselling
plug-in cars in the world (notably, cumulative sales of Tesla Model S reached 158,159 by the end of 2016, making it the
second-bestselling plug-in car in the world, behind only the Nissan Leaf). By the end of 2017, cumulative sales of the
Model X reached approximately 72,059 units.
Model
3
To achieve Musk's goal of making a real dent in fossil fuel use, Tesla needed a truly mass-market car. Thus, in
Fall 2016, he announced the Model 3, a midsized, all-electric, four-door sedan with a range of 220 to 310 miles
(depending on the battery option), and a base price of $35,000. Within a week, Tesla had received 325,000 reservations
for the car, ranking it among the most sought after cars in the world. A review in Road and Track said that the "Model 3
proves that Tesla is thinking far beyond the edges of the Model S and X. Stepping out of the 3, you realize that, as far
as the S and X pushed the envelope, they were always meant as intermediaries, stepping stones designed to draw
people away from comfortable convention and into the future of the automobile." Popular Mechanics gave the car its
2018 Car of the Year award, and Automobile Magazine gave it the 2018 Design of the Year Award.
The company announced an extremely ambitious production ramp-up plan, with a goal of being able to produce
500,000 total units (across all three models) by the end of 2018. This would require a massive expansion in production
capacity that many experts viewed as unattainable in such a short time frame. The Model 3 would also incorporate new
hardware and software to enable automated driving that created significant new design and production challenges. By
early 2018, it was clear that Model 3 production was well behind Musk's initial ambitious projections, and criticism from
analysts and the press was coming at a furious pace. As one analyst at Cowen and Co. noted, "Tesla needs to slow
down and more narrowly focus its vision and come up for a breath of fresh air... Elon Musk needs to stop over promising
and under delivering
Obctsole to the Adoption of Electric Vehicles
Numerous obstacles had slowed the adoption of electric vehicles by the mass market. The first was the price:
Electric vehicles were, typically, significantly more expensive than comparable internal-combustion models.
Complicating matters further, most consumers had a very difficult time estimating the cost of ownership of an electric
car. How much would they pay to charge at home? How much would they pay to charge away from home? What would
the maintenance and repairs of an electric vehicle cost? How long would the battery and/or car last? Would it have
resale value?
To lessen these concerns, Elon Musk set out to make the cost of owning a Tesla as certain as possible. First,
he created a "Supercharger network that Model S owners could use for free, for the life of the car. As noted by Musk
"The clearest way to convey the message that electric cars are actually better than gasoline cars is to say charging is
free." The hitch was that a user had to be within range of a Supercharger station. Second, Musk announced an
unprecedented price-protection guarantee that permitted a Model S owner to trade in the car for a designated residual
value anytime within the first 3 years of the car's life. Musk also announced plans to offer free repairs, and a free
replacement car while a customer's car was being repaired. Needless to say, analysts scratched their heads at the
potential costs of these guarantees
The second major obstacle to the adoption of electric vehicles was their limited range and the associated "range
anxiety" (concerns about driving in places where owners were not sure they would be able to charge their cars). These
concerns were not so much of an issue for Tesla cars due to their exceptionally long range. Other "mass-market electric
vehicles faced tougher hurdles. For example, though a Nissan Leaf could be charged at an ordinary, 110-volt household
outlet, a full charge by this method could take 8 hours. Level 2 charging with a 220-volt outlet could shorten that time to
4 hours, but this was still completely impractical for recharging during a trip. DC Fast Chargers and Tesla's
"Superchargers" promised to fully charge a vehicle in 30 minutes or less. While this is still significantly longer than the
typical 6-minute gasoline fill-up, it meant that charging could be feasible if it were collocated with other services that
drivers might appreciate, such as restaurants or coffee shops. DC Fast Chargers and Tesla's supercharging stations
were expensive to purchase and install- up to $250,000 depending on the location - and they had to be close to heavy-
duty electricity transformers. By June 2018, Tesla had deployed over 10,000 Superchargers around the world.
The Global Electric Vehlole Market
In 2017, global sales of electric vehicles reached nearly 1.3 milion vehicles and were forecasted to hit almost
2 milion by 2018. Though this still represented a tiny fraction of the global auto market-under 2% of total unit sales -
it also represented extremely fast growth. Some analysts estimated that plug-in electric vehicles could account for half
of all auto sales by 2027. Globally, China led the pack in electric vehicle sales, and Chinese automakers Beijing
Automobile Industry Corporation (BAIC) and BYD were among the biggest electric vehicle manufacturers in the world.
The Chinese auto market is the largest in the world, with over 28 million cars sold in 2017 compared to
17 million in the United States. Furthermore, the Chinese government had announced regulation that would push for
100% of autos to be electric by 2030. Seizing on this opportunity, in July 2018, Musk announced that Tesla would build
an auto manufacturing plant in Shanghai, China, capable of producing 500,000 cars a year (roughly the same as the
target capacity of the Fremont plant). Though full details of the deal had not yet been disclosed, it was revealed that the
Shanghai govemment would help fund some of the capital costs of the project, and Tesla would own the plant
independently, making it the first foreign auto manufacturer allowed to build a plant in China without a partner.
Tesla's Strategies
• Automated Manufacturing
Tesla's manufacturing process was highly automated, with extensive use of 8 to 12-foot-tall red robots (most
produced by Kuka), reminiscent of Iron Man. The largest robots were each named after characters from the Marvel
series "X-Men" and could It entire cars and maneuver them into position in the plant. Each robot had a single,
mutjointed arm. While typical auto factory robots perform only one function, Tesla's robots perform up to four tasks:
welding, riveting, bonding, and installing a component. Eight robots might work on a single car at each station of the
assembly line in a choreographed pattern, like ballet. The robots produce up to 83 cars a day and can be reprogrammed
to produce different models on the same assembly line.
• Distribution
Musk saw the franchise-dealership arrangements that U.S. car companies use to sell cars as an expensive.
margin-killing model. Furthermore, selling an electric vehicle is more complicated than selling an internal combustion
vehicle. Because consumers are less familiar with electric vehicles, they required more explanation about the electricity
costs, service issues, potential resale value issues, and more. Musk thus chose to sell direct to consumers with boutique-
ike stores in upscale shopping malls where salespeople could provide high-touch service and answer customer
questions without using high-pressure sales tactics. As of early 2018, the company operated 200 Tesla stores, 120 of
which were outside of the United States. The company also sold direct to consumers on the internet.
Musk's decision to own and operate Tesla dealerships himself was a controversial move that provoked the ine
of dealership networks. In the 1950s, regulation had been passed in the United States to protect dealers from exploitation
by what were then very powerful auto manufacturers. This regulation prohibited auto manufacturers from competing
with their own dealers by directly selling cars to consumers. The industry, however, had become increasingly competitive
due to globalization, thereby lowering the power of auto manufacturers. Though most economic analysis suggested that
the industry would be more efficient if the dealership restrictions were removed, the regulation remained largely
unchallenged until Tesla's entry. Tesla was chipping away at them one by one. In 2018, over half of U.S. states still
banned or limited direct sales, making it extremely difficult for Tesla to enter.
Marketing
Tesla spends no money on advertising, nor does it have any plans to hire advertising agencies or run ads in the
future. General Motors, by contrast, spent $3.2 billion in advertising in 2017; Toyota is estimated to have spent over $4
billion; and in 2016, Nissan spent $4.3 million on ads for the Leaf alone. Tesla has relled wholly on free attention from
the press and the visibility of its cars, charging stations, and stores, which are located in high-traffic, high-rent locations.
Thus far demand for Tesia vehicles has vastly exceeded supply, and there is a waitlist for each model.
Not just a Motor Company
In 2016, Tesla began dropping the "Motors" from its name, signaling it was no longer just an auto company. In
July 2016, Tesla opened Gigafactory 1 - a giant, lithium-ion battery factory built near Reno, Nevada, with its partner
Panasonic. Musk justified the vertical integration move by arguing that the Gigafactory 1 would ultimately drive battery
production costs down by as much as 30%. In addition to producing batteries for Tesla automobiles, the factory would
build Powerwall and Powerpack energy storage devices. The Powerwall was a device for consumers to store solar
energy at home. The Powerpack enabled industrial users to manage variable energy needs and provided a source for
backup power.
In August 2016, Tesla also finalized a plan to acquire SolarCity, a company that leases and installs solar panels,
for $2.6 billion. Solar City was founded in 2006 by Peter and Lyndon Rive, Elon Musk's cousins. Musk had sketched out
the concept for the company around the time of Tesla's founding and had helped his cousins start the company. He also
served as its chairman of the board. The company had an innovative business model that enabled consumers to have
solar panels installed on their roofs with no upfront costs, and to pay instead for the power generated by the panels at
a price that was comparable to or less than the price they would normally pay for electricity.
In the same month that the Solar City acquisition plan was finalized, Musk announced that the company would
begin producing house roofs made entirely from solar panels. "I think this is a really fundamental part of achieving
differentiated product strategy, where you have a beautiful roof," Musk said. "It's not a thing on the roof. It is the roof.
By early 2018, Tesla had also built a new Gigafactory 2 in Buffalo, New York, and reported that manufacture of solar
roofs was already underway.
Tesla's cars had rapidly attracted a large and loyal fan base, and sales were growing at an impressive rate
However, designing and launching multiple major car platforms while simultaneously building a large-scale battery
company, a network of charging stations, and operating Solar City was a lot for a company to take on in its first 15 years
This left some analysts scratching their heads. Was Tesla trying to do too much too quickly?
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