CHAPTER 6

Epilogue: Into 2019

Introduction

During the early years at Tesla, it was a design company, a component or subsystem supplier, in some ways a typical Silicon Valley technology entrepreneurship. In order to manufacture all-battery EVs of mass-market viability, however, it needed to become another kind of company—more like the traditional system integrator, an OEM in the key position in a complex and extensive supply chain, one that went all the way from raw supplies of lithium and cobalt, to a utilities-like manager of recharging infrastructure. However, it could prove pathological if in the pursuit of scale and mass markets, Tesla returned to an obsolete, top-down, risk-averse, and arguably un-innovative bygone era. Organization form and function would prove instrumental, not just technology and marketing. Just reviewing events to as recently as possible suggests that something had to happen.

Key Techonomics terms in this chapter include:

Industry overcapacity and firm capacity

Global strategy and multinational strategy

Global supply chains and multinational supply chains

Procurement risk and intellectual property risk

Scope, schedule, cost—pick any two

Transition to Maturity—In a Way

Tesla incorporated at about the same time it became obvious how much capital it would take to become the first manufacturer of commercially viable all-battery EVs. Yet even this accomplishment was not as great as the ambition of doing all this for the global mass market, en route to saving the planet.

It wasn’t just a question of market size and related economies of scale and scope, it was also a question of satisfying evolving market-demand characteristics.

First, unit prices had to come down very considerably—say, on the order of 25–50 percent. Second, but at the same time, range (and recharging convenience) would still dominate purchasing decisions. Third, on the other hand, consumer priorities were beginning to shift as market niches and advanced segments

In addition to being price-sensitive, mass markets consider things like reliability (i.e., what “quality” becomes), replacement battery costs (tens of thousands of dollars), and hardware upgrades (e.g., autopilot), and in a few words, total cost of ownership (resale, subsidy effects, home power upgrades, costs of recharging.) “Sizzle” may still be the order of the day for technophiles and wealthy environmentalists, but the more pragmatic mass market expects high quality at good prices, and is able to tell the difference. It cannot be said that the EV industry was approaching technological maturity, but demand characteristics were starting to show signs. As an industry approaches maturity, the key is to successfully navigate the treacherous transition period; afterward, things become relatively stable.

Being proactively engaged in encroaching market saturation is a significant challenge and failing at it has caused the demise of countless firms.

It often starts by the players themselves of collective overinvestment during a period of optimistic growth. This shoots collective production capacity above collective market demand, and shakeouts occur (Grant 2002; Porter 1980).

Overcapacity is one result of mistiming slowing market growth, plus underestimating similar expansion plays made by the competition, and triggers desperate strategies.

Sooner or later, demand flattens out and that is a treacherous problem, since Wall Street is unrelenting about growth imperatives. If firms want to grow in a mature, saturated market, where firms survive based on repeat purchases made by sophisticated consumers, that means they need to wrest market share from each other. Marketing efforts emphasize repeat purchasers. Price wars are common just to sustain production economics. Self-destructive tactics often ensue to preserve market share (by slashing prices) to maintain economies of scale.

During maturation, the innovation emphasis shifts to incrementally improved, high-quality products produced at low unit cost. Some players become desperate; meanwhile, consumers might vainly hope for a “technological breakthrough.”

Eventually there isn’t enough profitable business to go around and the bubble bursts. It may be time to completely abandon attempts at major product enhancements. It may be time to only improve the product if it helps to improve processes, quite a reversal from earlier phases. Short of making a jump to another product technology, a focus on process (e.g., manufacturing) technologies becomes the focus, where capital investments are more likely to make thin but positive, that is, acceptable returns considering the risks.

Thus, a poorly anticipated transition to maturity can be strategically catastrophic, and this includes the transition of an organization to fit best with the changing environment.

It is the anticipation that matters. Tesla needed professional management, but on the order of which profession?

Through 1Q2019: A Work in Progress

As 2018 turned into 2019, here are some facts and figures concerning Tesla and EVs more generally (Eisenstein 2019):

• Tesla had 83 percent of the battery-only EV market share in the United States.
• As much as 200 billion U.S. dollars could be spent on all-battery electrics in the coming decade.
• The totals were still small compared to the global market for all autos.
• And was small compared to the potential of the Chinese market.
• By 2022, 207 EV models were projected to be on the roads.
• By 2023 225 billion U.S. dollars would be spent on combined EV R&D altogether.

This section follows events chronologically, and at the same time divides things according to the major kind of risk.

Cash Flow and Capital Risk

In December 2018, the entire stock market had experienced a crash of its own, that in the early months of 2019 began to revive but not without some nervous trepidation. From the perspective on Wall Street, much of the 1Q news about Tesla was just a continuation of the expectations that closed out 2018. One thing that became thematic in the media was that demand for Tesla EVs specifically looked to be weakening. While the previous problem was making enough cars to meet demand, stay ahead of the competition, honor car downpayments, and beat the expiration of tax benefits, now the danger of not having enough customers in the first place became a concern. At least, Tesla cut vehicle prices by several thousand dollars at a time it could hardly spare the cash.

Corporate cash flow is largely determined by Capital Project Free Cash Flows. There, project cost risks derive from project hurdle rates, which derive from the cost of capital itself. To close the circle, cost of capital is a function of other kinds of project risk.

Meanwhile, driven by popular appeal and a surge in the ability of the United States to provide of its own energy, demand for regular “cars” waned, but it was partly replaced by a surge in demand for pickup trucks and SUVs. Also, considering all the announcements made across the global industry, overcapacity of vehicles and batteries types seemed inevitable:

Global Procurement Risk

This was a time when the trade war with China, as well in the EU and NAFTA, seemed to make progress and then degenerate quickly. Tariffs on steel and aluminum were continued despite loud calls from industries like auto, but later were revoked to stoke the chances of “NAFTA 2.0” being ratified by the respective three governments. This was important first, because of the component cost of steel and aluminum in all autos, second, the massively complex auto supply chains across all borders, and third, the import–export costs of whole autos themselves. The tariffs cost GM and Ford each 1 billion U.S. dollars in just a portion of 2018. In a matter of months, the “trade” war shifted emphasis from things like the current account (“balance of trade”) and job losses, to intellectual property—“forced” technology transfer as a condition for market entry, and the much more insidious issue of intellectual property theft.

Procurement risk rose to the highest strategic levels. Tesla’s moves regarding China had more the appearance of what academics call a “multidomestic” or “multinational” strategy; the point of which is to not only produce where the markets are, but also source locally.

As far as practical, in a multidomestic strategy, each market’s supply chain would be self-contained and self-serving.

Procurement risks vary accordingly. Scale was becoming achieved through networks, consortia, partnerships, and the like, which in turn were innovating new means of financing high-tech ventures. Even technology development develops locally in many cases. Science itself is no longer the exclusive province of advanced countries with the best university systems and traditional corporate powerhouses. A more multinational approach might best obviate the trade tensions that were dividing up the world:

The most obvious downside of a multinational strategy in the new era is the sacrifice of some global economies of scale, but after all, China was by far the largest EV market in the world with economies of scale on its own that would “subsidize” unit costs globally. As well, robotics, artificial intelligence, and other production advances were continuing to change the very nature of parameters like facility capacity, economies of scope, and so forth.

In contrast, a true “global strategy” means much more than just doing business all over the world. A global strategy views the entire world as one market where products can be standardized as much as possible, in turn aiming to consolidate as much as possible where production scale can be maximized, with supply chains structured with as little regard to political boundaries as possible. In the present story, more sensible hybrid strategies were seeking to optimize the pros and cons of global scale versus local responsiveness.

“Pure” strategies of any kind are generally difficult in such a complex and dynamic world.

Technology Risk

First, General Motors seemed to be taking the challenge even more seriously than it had prior. Despite the more famous Volt and Bolt, much of its EV strategy seemed focused on institutional markets for autonomous vehicles and altogether, compliance with regulations at all levels. Still, early in 2019 it made an announcement that finally seemed directly responsive to Tesla:

Second, but related, even as small as the EV market still was as a percentage of the whole, the availability of recharging solutions was not keeping up. In 2019 the global EV fleet reached a million cars, and there were 632,000 public charging outlets worldwide. It was forecast that between 14 and 30 million charging stations would be needed by 2030 (Eckhouse, Stringer, and Hodges 2019). This assumes EVs would reach 30 percent of the global market share. Clearly, the U.S. EV industry was not going to be determined by a battle between two American companies, Tesla and GM. It was possible—through very unlikely given their savvy—that either one or both could be locked out!

In the commercial evolution of markets and industries, there is no greater technology risk than being locked out of technology standards and dominant designs.

It was still far from true that any charger would do the trick for any EV owner under any of a set of common conditions. Some chargers provided only 10 miles of range for 30 minutes of charge time. Regular household power could need 12 hours to charge from 20 percent back to full charge, in effect overnight. In the middle, some roadside chargers could provide 10–60 miles of range in a 60-minute charge. Fast chargers could provide 75 miles in 30 minutes, and of course was most expensive; eight charges a day would reach the breakeven point for each charger:

The growth problem now was about standardization as much as recharging time.

In the United States, there were still three charging standards, and within each, payment schemes varied. One competing standard was Tesla’s, which already had 12,000 chargers at over 1,400 sites worldwide including China. China had one standard, mandated by the government. In the United States, auto makers were playing a larger role than in other countries where governments were more active, though state governments continued to vary greatly in their support. At any rate, Tesla’s massive capital investments hinged on delivering EVs that must be compatible with the recharging standard in China. But the three standards that already existed in the United States were largely being resolved by depending on market forces that do not, history shows, always pick the “best” technology.

Mass markets demand dependability of the companies they patronize and enough product technology predictability that their decisions won’t suddenly become obsolete.

Competing products don’t need to be functionally identical (which would work against differentiation anyway), but they should at least be technologically compatible (and perhaps create network externalities). Therefore, overall mass-market growth itself is often inhibited by a lack of technology standards and a dominant design.

Contracting Risk

VW had announced great EV plans, but it did not plan on going alone. Of course, it must be said that some of it was a result of VW’s settlement with the U.S. government over an egregious emissions-monitoring software scandal. On the other hand, WV already targeted becoming completely carbon-free by the year 2050, so perhaps motives didn’t matter much. The news brought Tesla—otherwise a clear nemesis—into their emerging business ecosystem:

Or in other words, VW was content to partner with Tesla about some of its recharging issues, but in a limited fashion and no doubt, politically motivated. Given Tesla’s history and Musk’s personality, perhaps that was entirely suitable—even for the best. VW seemed to have its hand in everything, and it was clearly hedging its bets when it came to battery technology.

In an era of rapidly shifting alliances, managing contracting risk should also consider the pass-through of intellectual property to third parties.

“Dropping down” a level of analysis—to “batteries” that is—much the same story continued:

Like several others like it, that article went on to discuss solid state battery technology being developed by a promising startup. VW was again involved, with a 100 million U.S. dollar investment. The new battery might increase the range of the VW E-Golf from 186 to 466 miles, and competitive with gas model ranges. If true, that would be a stupendous jump in range, anyway.

These observations are typical of the myth of the “technological breakthrough.”

An interesting quip came from one of the principals:

The long development timeline for these start-ups is a sign of how difficult pushing battery technology can be … You’re talking about a generational technological shift that has to happen … In 150 years of batteries existing, there have been four commercially relevant chemistries to come to market. And every time you go to these new chemistries, they get harder (Zaleski 2019).

Conclusion: The Ultimate Deliverable

There is an axiom in project management: “Scope, schedule, cost—pick any two.” The joke is that in truly challenging projects, management is aggressive enough to make it difficult to achieve all three major traditional constraints—at least not easily—and therefore some trade-offs are almost inevitable. Tesla always managed to meet one constraint by making EVs that people loved, but missed the other two in ways that made investors worry.

In the middle of the first quarter, Tesla announced long-awaited and happy news. To this point Tesla had been making the Model 3, delivering 145,610 units, in fact, but still priced much too high. With a base range of 220 miles:

That represented the major deliverable—a viable mass-marketable all-battery EV. But FCF and EVA were certainly negative, and deadlines were missed.

With that, Musk admitted to structurally obstinate cost problems, and that the company would not be announcing a quarterly (accounting) profit. He had hopes for sustained profitability afterward, but of course, he always did. Evidently and by Musk’s own admission, the mass-market Model 3 was now a consumer reality, but the business model it represented was still not sustainably profit-able in real economic terms. Yet there was no sign of slowing the firm’s expansion goals.

Exercises

Define each of the following terms individually, and then relate the terms in pairs:

Industry overcapacity and firm capacity

Global strategy and multinational strategy

Global supply chains and multinational supply chains

Procurement risk and intellectual property risk

Scope, schedule, cost—pick any two