CHAPTER 5

2018: One “Hell”
of a Purgatory

Introduction

Presciently, an article appearing a few years earlier had set the stage for 2018:

In the traditional model, discoveries in science lead to technology, and then technology, lead to new product ideas, and those new product ideas then force manufacturing adaptation and support, after which the manufactured goods are distributed for sale. This paradigm has become largely obsolete in both practice and theory. Nowadays, rather, in the most advanced industries and firms, it’s all considered to be one holistic problem of innovation.

Mastering this broad-based and multidisciplinary capability establishes a competitive advantage in innovation that matters.

Before continuing with this theme, though, it is helpful to take note of other things that Tesla needed to be concerned about, things that siphoned off much of its financial resources if nothing else. Some concerns were imposed from without—mostly by government regulators and competitors—while others were created from within proactively as a matter of strategy.

Key Technomics terms in this chapter include:

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

Capability and competitive advantage

Facility capacity and facility size

Bargaining power and value-chain appropriability

Outsourcing and make-buy

Peanut butter and jelly … and bread

Side Bets and Distractions

The word “corporate” connotes a level of management and an approach to developing a portfolio of businesses. There, diversification optimizes the pros and cons of risk and return. In the modern era, a corporate portfolio should be centered on a common set of competencies and capabilities. There, technologies are first-and-foremost, and then come human competencies and organization-wide capabilities. This idea is consistent in the engineering and management disciplines (Betz 1993). Sometimes, however, it is difficult for a nontechnical person to see what “technology” underpins a given corporation’s product lines, especially across a line of business, across divisions, that is to say, that compete in seemingly different industries. The simplistic word “battery” helps illustrate.

Batteries

One way to assess technological progress on a macrolevel is to monitor patents. While a crude measure in many respects, understanding battery limitations leaped back and forth from making reasonable market expectations, to assessing the business models somewhat caught in the middle. Concerning lithium and the main combatants:

This line of thinking, illustrated above, reflected a significant commitment to battery production, but one that was not predictable. The following words have clear connections to concepts like technology S-curves and technological discontinuities and from there, technology standards and dominant designs:

The first excerpt alludes to the crudeness of measuring progress merely by counting patents. The latter, probably without realizing it, alludes to the dynamics of technology S-curves and so forth (Chapter 1). From a high level of analysis, that is, a crude macro view, the so-called battery of individual electrochemical cells hadn’t changed much since its original invention well over a century earlier. Everything done to them since was incremental compared to technologies such as fuel cells, photovoltaics, and ultracapacitors.

This is only one interpretation, as similar observations could be made at both higher and lower levels of analysis. Flexibility is an advantage of the S-curve technique.

An example was the shift in the early 1990s from nickel-cadmium to lithium. Even at that time, the energy density of lithium technology was twice that of NiCad, with clear room for improvement on its S-curve. The basic construction was also simpler and could be stored for longer periods of time. But lithium technology was relatively fragile, for example, the circuitry needed protection. Then, of course, there was the fire hazard that simply did not exist with other technologies. Toxicity perhaps (cadmium, lead, acids) but not fire.

Advancements in one battery parameter (energy density, recharging time, recharging cycle limits, size, weight, and, of course, cost) can injure progress (or even cause regression) in another parameter, which had always been a frustrating characteristic of making better batteries. There simply was no perfect battery, or at least there was no perfect one-size-fits-all solution. They each needed to be designed with specific operating environments and the demands of particular applications in mind. As such, there were always reports and rumors of better batteries being developed in the lab stage, touting their natural potentials but almost always, with the disappointing caveat that they faced scaleup and other commercialization problems that, about as often, were unique to specific applications and markets.

This history did not abate right up to the fielding of the first truly mass-market EVs such as the Model 3 and the Bolt. The “big technological breakthrough” was always in the future and indeed always seemed to be right around the corner—so much the case that eventually one was forced to doubt that there was any such thing as a “breakthrough” at all. For example,

Well, let’s hope so, because stories like that seemed apropos to many preceding decades, word-for-word. For the time being, anyway, that article went on to detail the replacement of graphite with silicon as the basic material in lithium battery anodes, with many times more “room” for ions. True to form, there were caveats: “The trick is, silicon brings with it countless technical challenges. For instance, a pure silicon anode will soak up so many lithium ions that it gets ‘pulverized’ after a single charge” (Mims 2018). The article then noted that the nanotechnology was proprietary, but several new, young firms were pursuing it, with predictions of up to 40 percent more energy storage. Factoring in things like a space trade-off, EVs might see a 30 percent range increase.

The strategist should muse, “at what point, if ever, should I abandon my existing technology that seems exhausted, and commit to one like this with greater natural potential?”

As mentioned previously but one level of analysis up, equally interesting were advancements in solid-state battery technology, where the traditional liquid electrolyte was replaced by a solid (i.e., a different meaning than many people will recall from earlier days of vacuum tubes and consumer electronics, “transistor radios,” etc.) Continuing:

That sounds too good to be true, which is correct for strategic purposes because a capital commitment would need time and deep pockets. “[T]the technology works in the lab. Now they must ensure they can mass produce the batteries and then show they can survive … the new formulation probably won’t be in widespread use until the middle of the coming decade” (Eisenstein 2018). Thus, some major players were named, along with a few relative startups in various forms of collaboration: BMW, Toyota, Mazda, and Panasonic (already making Tesla batteries). Altogether, then, if a firm wanted to make EVs, waiting around for the perfect battery was likely a fool’s errand.

In short, and working backward through the logic built to this point.

If mass markets are the target, low unit costs are imperative.

That goes hand-in-hand with mass production.

This points to finding and exploiting (not the same) economies of scale.

Economies of scale usually incur large capital investments in either large facilities or high-tech production equipment, and often both.

The real issue in modern times, though, is capacity correctly measured as a rate of production, not a measure of facility size per se.

Capital commitments are risky to the extent that there is “asset specificity” in the property, plant and equipment involved.

These risks can be reduced once technology standards have been (practically) established and dominant designs (formal/institutional or de facto) look to be dependable.

Timing (of technological discontinuities), not just time-to-market (of specific products) is critical when making commitments to technology (product and/or production).

First-mover advantage (the preclusion of effective competitive reactions) and cost of capital is at stake, as are the competitive advantage(s) they imply (especially in combination).

By early 2018, market share in the early mass market phase was already taking shape with the Bolt and the Model 3—both based on lithium ion though Musk, of course, always bragged that Tesla’s technology was leading edge. Either way, “first-mover advantage” was by no means guaranteed by time-to-market, and “fast-followers” might prove the wisest in the long run, but strategies that postponed entry very much longer would likely miss the change to participate favorably in the development of network externalities and a dominant design, not just brute market share. The story was one for the ages and still anything but fait accompli for Tesla or anyone else. At any rate and probably for the reminder of the decade, any commercializeable battery EV needed to be designed around lithium.

Highly conveniently for Tesla and most others, at about that time the logistical situation concerning lithium constraints reversed itself. The world had plenty of lithium it now seemed, though extraction technologies varied (somewhat analogous to the way crude oil might be extracted from shale, sand, undersea, etc.) and the global infrastructure would need much expansion for EVs alone. It is difficult to overstate the implications of this relief for battery suppliers and EV designers alike, and the EV movement on the whole, though the media seemed to understate it except in narrow commodities trading news markets.

Specifically as it concerned Tesla, related was its commitment to lithium battery technology not only in its vehicle designs but again, in massive, capital-intense but asset-specific facility commitments like the enormous Gigafactory. Now GM’s decision to outsource batteries to LG Chem (discussed previously) stands in a different light, as do other supply chain decisions made by the major manufacturers. Moreover, back a bit into 2017, consider:

Cobalt was an even more a costly ingredient for some EV batteries. Shortages were predicted to occur by 2020, which was not far away in terms of the needed exploration, extraction, and supply chain development:

Other nations were being courted for exploration and sourcing by as many as 100 companies globally, up from only 30 in 2015 (Rodriguez 2018). First, though, an ironic condition of oversupply would likely happen for a few years before shortages became serious. The commodity price for cobalt thus was becoming volatile, since commodity prices are highly sensitive to such news. In conditions like this, volume buyers (like Tesla and/or its suppliers) often embark on “hedging” procurement strategies; for example, locking in good prices in return for guaranteed large volume purchases. This is proper financial management, but it stresses the importance of any EV design commitments.

Stored Power

The word “battery” implies human competencies in the science of electrochemistry, and broad organizational capabilities in products that include both EV batteries and things like Tesla’s Powerwall. More arguable was whether the marriage of the science of photovoltaics and solar panels was synergistic with the science of electrochemistry and batteries. It would make sense if viewed from the “product” end, since solar tiles were limited unless the solar energy could be stored in another product like the Powerwall.

The point is to draw the distinction between a product market, and an organization as a set of competencies and capabilities.

To illustrate, it does well to overall media accounts during 2017 and 2018. To start:

That wasn’t the only development in solar panel technologies, of course, but it did have an additional relevance to something else discussed previously:

Musk’s promise was kept on time, leaving Tesla in a good position in one of the world’s largest and most promising markets for products within its capabilities. In the context of managing innovation, those three words—markets, products, and capabilities—go together like peanut butter and jelly—and bread. That metaphor is meant to be whimsical, but at the same time makes one of the most important points in the book.

Managing technological innovation means managing a three-part challenge of managing markets, technological competencies, and organizational capabilities.

However, in other ways the SolarCity business seemed lacking and in need of attention if its global reputation for customer service was deemed important. The problem was not unlike that which also developed in EV “stores,” but seemed more severe:

Here was a capability where Tesla was evidently lacking—end-to-end supply chain management, despite Musk’s boasts of vertical integration at the factory.

The Tesla Semi

In a story that was first announced during 2017, its importance seemed to grow into 2018:

Not as early as September, but in November observers were wowed at an event where not only the Semi was unveiled, but out of its trailer sprung a new Roadster with a 600-mile range, by far the longest of any available battery EV:

As the story continued, it became apparent that Tesla’s opportunities would not go uncontested. But before reading the following excerpt, recall that while fuel cells had always suffered size limitations, they had already been fielded in larger vehicles such as urban buses. Then again, urban buses do not voyage far from their motor pools and refueling points:

Time and again, and on behalf mostly of investment communities, the media refocused attention to on the Model 3 as the urgency of most pressing business concern. Should Tesla diminish as a viable business investment, its leadership of all stakeholder groups would fade proportionately and perhaps fatally.

Regulations

A related concern was that Tesla was drawing closer to no longer being eligible for the 7,500 U.S. dollar tax credit that U.S. buyers of EVs could take. Each automaker was allowed to sell 200,000 EVs before its limit was exhausted. The present rates meant that Tesla would meet that total by the middle of 2018. As Tesla approached its limit, however, newer entrants still had plenty of room before reaching 200,000, and the tax credit applied to all-battery electrics and hybrids. However, the limit was to become renegotiated in Congress, without final resolution as of this writing.

Conversely, there was plenty of effort both public and private to promote EVs and greener autos in general. Naturally, California led most efforts, and sometimes opposed the Trump administration overtly:

With that irony, the “law of unintended consequences” comes to mind. Regardless, the article also discussed subsidies of over 1 billion U.S. dollars proposed across several states for recharging infrastructure, which triggered battles over existing prohibitions on public utilities from owning chargers—and related, the fairness of rate-based remuneration of the subsidies: “consumer advocate groups often object to this, saying that such investments only benefit a relatively narrow and affluent class of
EV owners” (Roberts 2018).

On the global scene, a major development happened about mid-year:

At the time, that article stood in stark contrast to China’s ongoing intransigence about similar policies that had become acute bones of contention in the ongoing trade war.

Enemies on Wall Street

Musk’s personal relationship with Wall Street was growing not only contentious, but potentially felonious. Certainly Elon Musk was well aware of the business, financial, and technology risks he had been taking, but he also seemed to be taking some of the naysayers personally, at least the ones that materially threatened Tesla’s financial position:

Short-selling is the traditional practice of “borrowing” stock (electronically) and then selling it in the expectation that its price will go down. Then the stock is repurchased later at the lower price. The logic is simply the reverse of buying stock in the expectation that it will go up. Though the intuitive appeal seems odd at first, it is completely legal and not unusual. This story would blow up and conflate with related issues in 2018.

Musk’s Other Ventures

Not under the Tesla’ corporate umbrella but distracting as well were other of Musk’s personal involvements such as SpaceX and The Boring Company. (The latter was a tunneling company, one that was proposed to revolutionize urban auto commutes and intercity travel.) These concerns did not consume Tesla Inc.’s investment capital and resources, until one considered Musk himself to be key intellectual capital with the same hours in a day to spare as anyone else. Regardless of the legal distinctions, investors had reason to take pause. As the last months of 2017 passed, concerns like the following were heard well into 2018:

As if all that was not enough for any one corporation to manage, the main issue was still to be solved, next.

Back to Basics: Scaling Up for Mass Production

Back in October 2017, Musk had first tweeted that the company was in “production hell,” and before long the words became both famous and infamous (No author, “Tesla,” October 7, 2017). At that time the Model S was still having ramp-up problems, but the infamy to come applied largely to the Model 3. That’s not all Tesla had to worry about.

By going straight from niche markets to the mass market and mass production, Tesla had awakened the massive global auto incumbency. This is not to say that nothing had been going on internally within the traditional players, it is just to say that their signals became obvious, certainly by intent. It became a concern whether all players were creating a ruinous condition of overcapacity.

Nascent industries are typically “fragmented” either by market segmentation or technological variety (often, incompatibility). Unless a firm strategizes to truly “differentiate” early, markets converge and technologies standardize, compelling cost-driven strategies.

It could be argued that fears about an overcapacity condition were based on assumptions that pertain best to an industry that is in its mature phase or at least, sometime beyond the appearance of critical dominant designs. The EV competitive domain was neither, it was still in the emergence phase. A true mass market is one that isn’t just large but more importantly is relatively homogenous in the demand characteristics of the typical consumer. Globally, this means universal price sensitivity (high price elasticity) and the universal expectation that product quality (in the form of reliability) is already high.

That much was already known and basically true about “advanced” countries. In contrast, recall that India was subsidizing the development of a national champion to develop a 15,500 U.S. dollar EV, where there was no interest (bidding) shown by the global incumbents—in the nation with the second-highest population in the world. And so on in all countries where there are lots of cars, awful environmental records, and economic struggle. China was a story all its own, but that accentuates the point.

Next, maturity implies that product substitutability is very high—that is, performance / price ratios of products available to consumers are similar/comparable, because if for no other reason, designs are compatible and network externalities exist.

This was far from true. In short, the “global” EV market was not ready to be served by “global” EV products. Regardless of large production and supply chain capacities, the global market was still fragmented not by demand characteristics, but by technological constraints that all came down to batteries. “Range anxiety” was still persistent, and sticker price spoke for itself—still in the luxury category. But the industry “dinosaurs” were moving in with massive financial, production, and supply chain capabilities, some creating their own supply chains along the way. Developing autos of any kind from scratch takes years, and some incumbents no doubt had been quietly pursuing fast-follower strategies of their own. So it is not surprising that most of the global giants had made eye-popping announcements about entry into the EV domain, a few almost immediately and others a few years off.

Traditional forces that determine industry profitability were starting to congeal. The industry was growing up if still not growing much. But technology issues were not going away, since performance/price was still not quite “there.”

Pressures from Wall Street would soon cause serious fissures among all stakeholders. Elon Musk had made two daring promises: one, to become profitable (in his own words) by the end of 2018; second, to accomplish this feat largely on the back of making 5,000 Model 3s per week, a number that would grow additionally from there. This was as important to satisfying customers with reservations, as it was to investors waiting on an entirely different line of their own. Tesla was “burning capital” at a rate of about 1 billion U.S. dollars per quarter and investors were still waiting for a positive return on their investments.

The media was abuzz with news about Tesla and its predicaments. During January–February 2018:

During March–April, Musk startled onlookers by saying that the company had gone bankrupt—as an April Fool’s joke. Like many such jokes this was not so funny, at least not on Wall Street. Within days Musk promised that Tesla would not have to borrow any more capital that year, and in fact would begin to show a steady positive cash flow beginning in the third quarter. Cash flow is not profit, but it’s a promising step toward it. Still:

In other words, Tesla’s market cap was no longer tops in the U.S. auto business. Again:

It was not difficult to sense signs of stakeholder stress concerning how Tesla might best be spending its attention and related resources, which were getting more precious all the time—hence, costlier capital itself, a bellwether for an EVA miss.

On the other hand, that article misses the idea that the Y would be the first derivative of the Model 3 as a platform. A main point of a design platform is to enable economies of scale and scope, which the new model would ostensibly begin exploiting. With that perspective:

It is impossible to deduce from these accounts whether solving the Model 3 problems now would prevent Tesla from experiencing the same problems for the Model Y, and on for other platform derivatives. If so, that would be an immediate economy of scope. For the competitive strength of the company to become the “productization” of the factory—Musk’s own word—these things should all work in concert, or at least not exacerbate each other. Short of better operational data, unfortunately, these important strategic points must remain hypothetical.

Tesla’s production rate of Model 3s was then about 2,500 per week, half the target that was said to be necessary for profitability on the car and hopefully Tesla in turn. The Economist said that Tesla would need as much as 3 billion U.S. dollars soon (Barrabi 2018a.) “Tesla shares are down more than 20 percent since March 1 on concern over the company’s ability to raise production levels … Moody’s Investors Service … lowered the company’s corporate debt rating further into junk territory last week” (Barrabi 2018b). Junk bonds are very costly to the issuer by definition. Tesla’s access to capital was one thing, but what the issue really amounted to was the cost of (the) capital raised. It is a serious threat to making positive capital project returns and overall corporate earnings.

On the global front, it became increasingly evident that most EV players were not embarking on a go-it-alone strategy, though some of the major moves were instigated by government policy in China concerning that giant market alone. That and the trade war were beginning to affect fortunes at all levels. Tesla’s specific situation notwithstanding, Wall Street especially hates uncertainty with a passion.

Musk began personally overseeing production at the Freemont plant. Progress happened but sometimes in fits and starts, at times alternating between planned stoppages, unplanned stoppages, and maximum effort: “Musk has said the planned stoppages are intended to give the company time to perform upgrades that will help it reach a goal of building 6,000 vehicles per week by the end of June ... all Model 3 production would begin working around the clock” (Sage 2018).

As April turned into May, the corporate world was stunned as Tesla shareholders voted on a proposal to oust Musk as chairman (Barrabi 2018). At the June meeting of stockholders, the ouster coup was rebuffed. However, the whole affair was a wakeup call for many, and a shock to others. The “media narrative” changed, and Musk’s relationship with it began to disintegrate ground that had already become shaky. Snips like these could be considered quite snarky: “On Tesla’s recent quarterly results conference call … Tesla was making it difficult for even ‘believers’ to own the company’s stock. Musk responded that investors worried about volatility should steer clear of Tesla’s shares” (No author, “Tesla,” 2018).

It was perhaps a sign of the overall stress in the situation that strong but contradictory opinions emerged from equally strong stakeholders. In the span of a few weeks:

Then again:

About 10 days later:

Another worrisome forecast came from Goldman Sachs, which said that Tesla would need to raise another 10 billion U.S. dollars in the upcoming two years just to maintain the solvency needed to survive. As May turned to June, Goldman Sachs’ pessimism was echoed: