Tesla Motors - America's Next Behemoth

By Farzad Mesbahi

Innovation has always been, and forever will be, the driving force behind the growth of human civilization.

Even today, the human race still experiences some pretty incredible changes to the fabric of daily living. The first innovation that I was personally able to grasp was the computer, and soon after it the internet. These two things gradually transformed into the smartphone; first with the Blackberry, then with the iPhone. Nowadays there's a familiar vibe surrounding a particular electric car company, and we could all be witnessing something that may be on par with the ground shattering impact of computing and the internet.

There isn’t one single reason why I say this. There's usually a number of advantages that a new innovation brings forward that end up being drastically better than the tech it replaces. It also usually starts at a small scale, but filters its way through the masses as the economies of scale and acceptability in our society take over. With Tesla, I see five major reasons (and many more smaller ones) that I think will take this car maker from industry darling to industry giant. These five things are its lack of dependency on foreign oil and oil's impact on the climate, cost of ownership & reliability of an EV vs. ICE (internal combustion engine) cars, autonomy & self-driving, batteries, and the "Innovator's Dilemma".

Dependency on Foreign (and domestic) Oil & Oil's impact on the Climate

Americans tend to be a prideful and stubborn bunch, with good reason. We are the strongest economy in the world, have the best Higher Education system, and the best technology sector with companies such as Apple and Microsoft taking the lead. Tesla is arguably the pinnacle of what can be called an American company. Tesla's cars are currently manufactured in Freemont, California. These vehicles are built by Americans, tested by Americans, and sold by Americans. However, the biggest and most important fact to take away from this point is not that it’s made in America, but that it can ultimately be powered by America.

When you plug in your EV to charge, you will tap a variety of energy sources. According to Wikipedia, 51% of the energy in electrical usage is generated by coal mined in the United States. The rest of it comes from a mixture of natural gas, nuclear and solar. Oil comes in at a measly 1%. When you fill up at a gas station, the petroleum often comes from a country other than the U.S. According to the EIA, 40% of oil consumed in the U.S. comes from imports.

An additional interesting angle that continues to emerge is Tesla's relationship with SolarCity, a solar panel and power distribution company (of which Tesla CEO Elon Musk is the chairman and yes, an American company), as well as other Solar companies throughout the world.

What this means is the following:

  • EVs are not dependent on oil to be powered, unlike ICE vehicles. They can be plugged in and take advantage of power generated by solar, wind, hydro, coal, or any other source currently available (yes, even oil). If the growth of solar continues, we could one day have all EVs powered fully by sunlight.
  • Dependency on foreign oil falls sharply, even with today's current grid make up. This will naturally decrease our interest in foreign relations and their impact on the production of oil, which lately seems to be a sore spot due to growing concerns around terrorism and our involvement in the middle east (i.e. ISIS).

As it pertains to the climate - I won't rehash the impacts of burning fossil fuels. There's a million articles with a billion numbers thrown around that very strongly allude to the fact that burning fossil fuels is having a material impact on our climate. Elon Musk famously calls the above the 'dumbest experiment in history'. We tend to agree with him.

Lastly, the impact of having the grid supply power to EVs cannot be ignored. Any nation, estate, or household has the option to make their electricity as clean as they want. This is not an option we have with ICEs today - it's either oil or bust.

Cost of Ownership & Reliability

Let’s start the comparison by looking at the cost of gas and other expenses for a current ICE (internal combustion engine) vehicle:

  • At $2.50 for a gallon for gas, with the average car getting ~25mpg, and the average driver traveling 40 miles a day 250 days a year, we come to $1,200 yearly cost of gas @ 10,000 miles, which over 5 years it nets out to be $6,000
  • For maintenance, in order to account for tires, rotations, alignments, fluids, emissions, etc., let's add about $500 a year on average, which nets out to be $2,500 over 5 years
  • This nets very conservatively to a total of $8,500 for 5 years in maintenance and fuel. This number is likely going to be reserve for extremely reliable and fuel efficient cars.

Next, let's look at the cost of "gas" (in this case, electricity) and other expenses for a Tesla (or any other EV):

  • At a national average of about $0.11 per kWh for electric cost we can deduce the average cost of filling a typical 85 kWh battery, which according to Tesla's website has the ability to travel 270 miles on a single charge. This means that the total cost to fill up a Tesla battery is 85 x 0.11 = $9.35. In order to figure out how many fill ups we need to travel 10,000 miles (an entire year), we can divide 10,000 / 270 = 37 fill ups. Therefore, our total "gas" cost for an entire year is 37 x $9.35 = $345.95, which extrapolates to $1,730 over 5 years. If you compare it to the above, that's a savings of about $4,300 compared to a typical ICE vehicle.
  • For maintenance, EVs need to be looked at a little different. There are no engines, transmissions, alternators, timing belts, clutches, radiators, catalytic converters, engine mounts, sensors, etc. that could go wrong and need maintained. The only real maintenance cost in an EV are tires and rotations, brakes, and alignments. A typical tire swap, alignment, and brake change can be pegged at around $750. Since this cost would only be happening once in the 50,000 that we would drive the car, we can add an additional $250 for 5 years worth of inspections. This brings the total maintenance cost of a Tesla to about $1,000 over five years, a savings of $1,500 over a typical ICE vehicle.
  • One very important thing to consider is that maintenance and fuel costs can vary greatly between ICE vehicles. A Range Rover costs quite a bit more to maintain and run vs. a Honda Accord. EVs, due to the fundamental nature of the vehicle, have very consistent costs of operations. There's not much difference between the cost of running a Nissan Leaf vs. a Tesla Model S, and the parts that run both are very similar in nature, so we won't see the wild swings we do in cars today. Due to this, the ~$5,800 in savings we would realize over 5 years would be consistent regardless of what EV we drive vs. an average ICE vehicle. Naturally, these savings would be greater if we were to compare them to a gas guzzler who's notorious for expensive maintenance costs.

You will notice that there's a key component I left out for an EV car - the battery. According to Green Car Reports (http://www.greencarreports.com/news/1096801_tesla-model-s-battery-life-how-much-range-loss-for-electric-car-over-time), a typical Tesla will see 92% battery retention over 100,000 miles, meaning that after 5 years, if we figure the degradation is linear, we will have roughly 96% battery left of the original 270, which equals to about 260 miles of range leftover.

Given this small degradation over a relatively long period of time, I'm going to bake in the "cost" of a battery into the general depreciation of the Tesla, which is on par with many luxury vehicles currently in the market.

As far as reliability goes, logic tells us that due to the fact that EVs have significantly less parts that can break (i.e. engine, transmission, etc.), there's less risk of an EV breaking down. In the case of Tesla, its recent troubles with reliability have been very widely covered (http://www.consumerreports.org/cars/tesla-reliability-doesnt-match-its-high-performance). It is definitely a problem that Tesla needs to address in order to become mainstream, and it seems to be well on its way (http://www.engadget.com/2015/10/22/musk-tesla-model-s-consumer-reports-response/).

However, once logic takes hold and Tesla matures as a manufacturer, and as other automakers flood the market with EVs, these issues will come to pass. In very few years times, ICE vehicle will transform from routine maintenance hogs too maintenance-free electric transportation devices.

Autonomy & Self Driving

I'm pretty sure a lot of people have already seen this video:

It just so happens that Tesla has already positioned itself as the leading car manufacturer that includes self-driving assist in their vehicles, which Tesla calls "Autopilot." This system can automatically speed up and slow down with the flow of traffic, steer by itself within a lane, and automatically switch lanes at a tap of the blinker stalk. However, the game-changing technology that Tesla has up its sleeve is the ability to seamlessly upload code and information to each car in the fleet. Moreover, each car is able to learn from its surroundings, pick up on its driver's habit, and upload all this information to the main Tesla server (think Skynet). Each car in the Tesla fleet will then be able to tap into this main server to learn from every other car, effectively creating a network of cars learning from each other, which is growing by the day.

The implication of this technology is massive:

  • Tesla now stores information from each one of its drivers that has real world, usable, and live data which can be analyzed and implemented automatically to any car in its fleet, as well as potentially sold as proprietary data to any other car manufacturer (or to the tech companies that supply the self-driving hardware)
  • From its ever growing fleet, Tesla is able to get so incredibly good at autopilot that they will reach a point where autonomy is achievable with a hardware upgrade. Tesla could flip a switch and overnight become the first mass automaker to enable its drivers to have full autonomy without the public having to purchase the next iteration of the car. For the Autopilot upgrade, Tesla included the necessary hardware for Autopilot in all the cars it made roughly 1 year before the software was released.
  • Tesla should be able to leverage its massive database and vehicle fleet to release an Uber-like service using an army of self-driving cars. Of course, governments have to catch up to this first, and the technology needs to be tested and fleshed out. However, who better positioned to take advantage of the opportunity than Tesla?

I encourage everyone to take a test drive at your local Tesla dealership and try out this Autopilot feature. It is truly impressive. Here's a more detailed video that truly show the power of the system in its current form:

Batteries

There are many analysts and authors out there arguing that Tesla will live or die by the success of its cars. Although true to an extent (if your product sucks your company will fail,) it is my belief that Tesla has already crossed the chasm for it to have a significant impact. Tesla's mission has always been to accelerate the advent of electric cars, but the manufacturing of batteries will likely bring it many times the profit than selling cars would. This will facilitate the complete reinvention of how we think about power distribution on this planet. It just so happens that half of Tesla's strategy to get EV adoption to take hold is the mass build out of batteries and battery technology.

Let's try and identify the pieces to this puzzle:

  • Today, Tesla buys battery cells from supplies (primarily Panasonic*), stuffs them in a pack, and puts the pack in each Tesla car
  • In the near future, Tesla will begin manufacturing their own cells in partnership with other suppliers at what Tesla calls the Gigafactory, a massive manufacturing facility in Nevada. Once this factory is fully operational (in 2020) Tesla will be able to manufacture and produce the same amount of Lithium Ion batteries (what EVs normally use) equal to 2013's* total production (in effect, Tesla will double today's production of batteries). Tesla has plans to build many of these Gigafactories with the hope that the entire vehicle fleet on the planet will be replaced by EVs
  • Tesla has unveiled a line of home and utility-scale battery packs designed to harness renewable energy, as well as take advantage of peak/troth pricing in the grid today, with what they call the Powerwall and Powerpack.

The very important thing that Tesla has been able to accomplish (and will continue to accomplish) is leverage their economies of scale to create a proposition for cheap, effective, and ultimately world-changing battery technology. Not only will this battery tech get better over time (Elon Musk himself expects the improvement of battery tech to get better by about 8% year over year http://cleantechnica.com/2015/09/21/tesla-gigafactory-battery-improvements-could-cut-battery-costs-70/,) it will also get cheaper as more channels are tapped through manufacturing and supply chain. Let's explore the two most likely results from having cheap and effective batteries:

  • Mass adoption for EVs will become real. Affordable electric cars with useful real world range (i.e. 200 miles + per charge) become the norm, as well as cars that can travel for hundreds of miles more than cars today (at an extra cost of course), rendering ICE vehicles obsolete. Tesla itself plans to have a luxury mid-size car that can travel 200 miles on a single charge and sell for $35k in 2017 before any tax credits
  • Home and utility-scale batteries become very affordable due economies of scale driving battery costs down from the boom of EVs (which in turn lowers the cost of utility and home batteries, and the loop continues.) Homes, businesses, and utility companies are able to lower their energy costs by installing battery packs that take advantage of lower electric prices during the night, as well as store usable renewable energy that would otherwise go to waste without batteries (i.e. solar, wind, etc.)

A key component to the second point outlined above are developing nations that haven't had a chance to build out their fleet and energy infrastructure. In countries like India and China, and the very many African nations that are currently in the 3rd world that will soon join in, the electric grid is one that leaves quite a bit to be desired. Frequent blackouts or non-existent power are the norm. Instead of building out the massive infrastructure required to have a grid, it can be significantly more feasible to harness the power of the sun with solar panels as well as other renewable sources, and use batteries to store said power. Solar panel farms could become the norm in developing nations, and will allow these countries to have a state of the art, reliable, and completely renewable energy source. A good analogy to use here is the cell phone. Many of the locations in these countries didn't have land lines available to its people, but the cell phone came around and completely changed that.

With EVs, as the popularity and demand for them continues to grow, there will be a tremendous opportunity for car makers to make a very pretty penny. I'm sure we've all read about Apple looking to enter the market of EVs, as well as other companies such as NVIDIA and Faraday Future. Remember that every EV that is built requires batteries to power them, and Tesla is currently positioning itself to be the cornerstone of that market. One could make the case that all EVs in the future will be powered by Tesla batteries, unless other companies choose to make the massive capital investment that Tesla has chosen to partake. But what about all the existing automakers? Will they join the party and compete in a very lucrative space? The interesting thing here is that they're likely doomed if they don't, but also potentially doomed if they do. This brings us to our last point...

The Innovator's Dilemma

The Innovator's Dilemma is a concept that describes the ability, or lack thereof, of a well established company to capitalize on a seismic shift in any given industry (I'm going to go ahead and give a plug for a book that discusses this at great length - truly a great read http://www.amazon.com/The-Innovators-Dilemma-Revolutionary-Business/dp/0062060244.) In our case, the most well known established players in the car space are GM, Ford, Volkswagen, Mercedes-Benz, BMW, Toyota, Honda, and the like. Let's try and break down the fundamentals of the Innovator's Dilemma and what it may entail:

  • Car company A is very freaking good at making cars. They churn out millions of cars a year, with very steady profit. They are paying their shareholders boatloads of money. They have a very strong following. Car company A has good enough profits to support its entire business, but due to the fact that they are so large and move so much volume, profits margins aren't great. Car company A has been around forever
  • Car company A also has a tremendous network of suppliers, partners, and dealerships. They keep an entire industry alive by doing exactly what they do on a daily basis
  • Car company A is very iterative - meaning they make few tweaks on a yearly basis so as to not incur too many costs. The public is OK with a car that's only slightly better in the new model year (10 more horsepower, a shiny new trim, different headlights, etc.) This makes the investors very happy since Car company A is able to recycle a ton of parts year in and year out.
  • Car company B enters the market. This company has a vastly different product fighting in the same space. Car company B doesn't require fuel to power its car since it's electric. They also offer free charging for the life of the car as long as you use Car company B's charging network (in this case for Tesla, the Supercharger network.) They offer the ability to download improvements to their cars seamlessly thru the internet (like autopilot) rendering model years obsolete. Car company B also has no dealer network, no significant supplier network (yet), but has an incredibly loyal fan base. Car company B requires little to no maintenance, since it doesn't have a fraction of what it takes to power a regular car today. They also have unmatched performance (I'm sure many of you have seen a Tesla Model S P85D with Insane/Ludicrous mode completely smoke the competition.)

The assumption here is that Tesla offers a product that's vastly superior to existing automakers (I won't list the unending awards the Model S has received.) One of the key points made in the book I listed previously is the concept of "crossing a chasm," which is basically crossing the point of no return. The theory is that after a specific point a company has gathered enough momentum that, barring any catastrophic event, the company will fundamentally disrupt the industry that it's competing in. Let's assume either way that Tesla is very close to that chasm or has already crossed it. Let's try and identify what the next steps could be while identifying where we are today:

  • TODAY: Tesla is far and away (it truly is not even close) the best selling, most respected, and most liked EV manufacturer in the world. They currently are performing very strongly in the luxury large sedan segment in most countries that they are in. They only account for a fraction of a percent of total car sales. They have just released a luxury SUV (the Model X) to compete against the likes of Porsche, Mercedes, etc., generating a ton of buzz while doing so (I'm sure you've seen those falcon wing doors and heard about "Bioweapon Defense Mode.") Tesla is currently gearing up their Gigafactory facility to start the production of batteries for their existing models, as well as get ready for the release of their affordable EV in 2017 (the much anticipated $35k car.)

Now for the fun part - what could tomorrow look like?

  • The Model X proves to be a large success in the same way the Model S was in its own category. Tesla is now starting to sell enough cars to put luxury car makers under some pressure (think Jaguar, Porsche, Land Rover, etc.)
  • Tesla releases the Model 3 (the $35k car), which again proves to be a large success. Tesla begins to ramp up production in the hundreds of thousands. Tesla is now starting to put some very real pressure on luxury car makers. This puts companies such as GM, Ford, and Toyota on notice. These incumbent start releasing "competitors" to Tesla's vehicles, but in reality they are just inferior products using legacy infrastructure (or cars are built on a new infrastructure that fall short in a variety of places compared to Tesla's cars, sort of like the BMW i8, Nissan Leaf, FIsker Karma, Chevy Volt, etc. vs. the Model S today)
  • Over the years, we begin to see new manufacturers start to produce their own electric cars (think Apple, NVIDIA, Faraday Future, who knows maybe Saab comes back under an EV mantra.) This continues to accelerate the adoption of EVs
  • After a while Tesla is selling in the millions, all the while building out their battery storage business that we spoke about previously, which is bringing in additional profits on top of their already thriving car business. In addition, new car makers are continuing to enter the fray (think back to the day of the number of American car companies that existed in the 30s 40s and 50s) Luxury car makers are now getting desperate. Luxury car companies such as Volvo, Jaguar, Lincoln, etc. are on the brink of bankruptcy. Bigger car makers such as Porsche, Land Rover, and BMW are starting to experience some very real losses. Electric Vehicles are now the preferred choice of car for the luxury segment. The luxury car makers are now forced to make a decision.

This very last sentence is what the Innovator's Dilemma encapsulates. Keep in mind that all of the companies we've outlined above (outside of Tesla) have made all of their money from building out, over many decades, a manufacturing infrastructure that is fundamentally based on the creation of ICE vehicles. In order to scale and match the profits they are currently making on ICEs from an EV infrastructure, these companies would have to invest billions upon billions of dollars to scale up. However, this is where the dilemma arises. Let's look at the possible outcomes in an extremely simple manner:

  • If company decides to invest in EV infrastructure, and if it's not a success, the company will very likely go bankrupt. They will have spent countless dollars to retool their entire operations. They will partially cannibalize their current ICE fleet. They will show massive losses on their balance sheet. Investors will be very pissed. The value of the company disappears.
  • If company decides to invest in EV infrastructure and is a relative successful, the company will experience very serious losses. They will have realized some return on their investment, but the capital required to tool up and completely rebuild their infrastructure will take years, if not decades, to be offset by gains. They will experience very real cannibalization from their ICE fleet. Investors will be pissed. Value of the company is diminished greatly. Company might go bankrupt, and it will have undergone a dramatic change in its core that may not be sustainable.
  • If company decides to invest in EV infrastructure, and it's a runaway success, the company will still experience losses from the get go, which is very different from the countless years of consistency and profits they've shown. They will have a successful product at their hands, but this product will entirely cannibalize their current fleet. Since this new runaway success has a tremendous amount of capital attached to it (like all the others above it,) it'll take years to offset the losses, but they will have movement in their fleet to stay afloat. Investors will be upset, but they understand that the product they've released will make them successful in the future if they continue to execute, since a string of bad quarters could very easily jeopardize a once-thriving ICE carmaker. Investors will have to get used to the company posting losses or extremely low profits, which is a vastly different change from its ICE days. All the while Tesla is making money hand over fist.
  • If company decides not to invest EV infrastructure, the company dies due to its product becoming obsolete, or is such a shell of its former self that its entire value proposition and heritage is lost.

As you can see if/when the chasm is crossed, and EVs become the preferred vehicle of choice, an incumbent automaker's real chance to survive is to go all in on an EV infrastructure and hope to god it releases a product that the public will love. What's almost hilariously ironic is that if a company survives long enough to be able to shift their volume fully to EVs, Tesla will be the primary player in the manufacturing of batteries due to what was outlined above previously (there's a very real possibility that a large majority of EVs in the future will be "powered by Tesla.") How many companies today are willing to take the risk? They're currently posting profits and keeping their entire network of suppliers, dealers, and investors happy. Why in the world would they want to take such a tremendous risk? The unfortunate part of it all is that by the time most automakers realize that their business is dying, it'll potentially be too late. I'm going to go ahead and list a couple once-great companies that have experienced this exact phenomenon due to disruptive innovation:

  • Kodak (digital camera)
  • Blackberry (smartphone)
  • Radio Shack & Sears (Amazon and online shopping)
  • Blockbuster (Netflix)
  • Borders Books (Amazon, again)
  • Myspace (Facebook, Twitter, every other social site basically)

In short, the Innovator's Dilemma is a real problematic scenario for any company, especially in industries where innovation hasn't occurred in a real long time.

Conclusion

Let's try and simplify Tesla's formula to world domination:

  • Tesla is in the process of captivating the population by proving that an EV is superior to an ICE car in every way (cost, reliability, performance, technology, etc.)
  • Once a significant number of the population realizes EVs are the way to go (i.e. the "chasm") Tesla will already be positioned as the primary manufacturer of batteries through its Gigafactories by expanding its home and utility battery projects, which will allow it to maximize its profitability in order to expand ASAP
  • Tesla will begin taking large share of wallet away from incumbents. New manufacturers will be able to enter the market leveraging Tesla's already existing supply chain and infrastructure that's built specifically for EVs. These new manufacturers will take share of wallet from incumbents as well
  • Incumbents will either begin to fail and disappear, or will be able to adapt at great loss. Anyone who survives will likely end up buying batteries from Tesla

In short, we are about to witness one of the most fundamental changes to human transportation, and Tesla is perfectly positioned to lead the way into a new future.

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*Corrections made thanks to reader's comments (Panasonic instead of Samsung and 2013 vs. today's production)