I wrote about Tesla motors a couple of times last week. No sense stopping now though, there’s plenty more to say…
The first one was about the CEO Elon Musk’s “secret plan”. Basically he has a long term plan to drag Tesla up by its bootstraps: first build a supercar; use the profits to develop a mass market luxury car, use the profits to develop an electric car for the people – Tesla’s version of the Model T.
What are they calling it? The Model 3.
The second one was about a very important part in that plan: Tesla’s batteries. To make an affordable electric car you need a good lithium supply and a giant, enormous battery factory. Tesla is working on that too – it’s building a “gigafactory” out in the Nevada desert, near a big lithium mine.
It’s been a great week for Tesla: after the launch of the Model 3, the company’s stock hit an all-time high. Everyone’s toasting Elon Musk’s vision and derring-do. Heck, even I wrote:
“Last Friday was a huge day for Tesla Motors (TLSA:US) and the motor industry. (And who knows, maybe the planet.)”
Today I want to cool the jets a little bit. Because great and all as Tesla Motors is, it still has so much to do. And if it doesn’t execute flawlessly over the next year and a half, there’s a chance it could literally go out of business!
Here’s what’s going on under the hood.
Silicon Valley cool
Musk keeps telling everyone his “secret plan” is all about scale. He says he’s going to use the money from supercars and luxury cars to build manufacturing scale, and use manufacturing scale to build an affordable electric car.
Everyone (including me) has focused on that idea: scale. But in fairness to Musk his plan has another clever benefit. By starting at the top with a “no compromises” sports car, just as good as a Ferrari, he’s building a great brand.
Tesla cars are now known for being futuristic and sporty. Fast as a Lambo. Quiet as a Boris Bike. They have Silicon Valley cool. The fact that they’re electric is only part of their appeal.
We saw the effect of this when Musk unveiled the Model 3 two Fridays ago. Over 300,000 people have already put their money down to secure one. They queued in their hundreds outside Tesla stores in suburban shopping malls.
I’ll wager that most of those customers aren’t too pushed about electric cars. But they want a Tesla, because Teslas are cool.
So Musk’s secret plan has two benefits: it allows him to build the scale he needs to make an affordable car, and it builds up Tesla’s street cred. The supply side and the demand side coming together in a giant explosion of engineering, branding, sales and success… right?
The hardest problem
The problem is that mass producing an electric car for less than $35k (the Model 3’s selling price) is really, really hard.
Tesla’s biggest seller right now is the Model S, a luxury sedan car. If Musk’s master plan is working as it should, Tesla should be making increasing profits on each model S it sells, as it builds scale. But that’s not what we see. In Q4 2014 Tesla was making 31% gross margin. By Q4 2015 that had dropped to 20%.
The way Musk explains it, Tesla has had to learn a lot about mass production. For example, Tesla unveiled a Model X SUV in 2015 with fancy Deloran style flying wing doors. But they turned out to be a nightmare to manufacture at scale. The design feature didn’t make it into the Model 3. In another nod to manufacturing efficiency, the Model 3 will be built out of steel, instead of aluminium as in previous Tesla models.
Here’s what Musk had to say:
“Model S was really the first car we ever made ourselves. So, we were designing to make it work, as opposed to designing it from ease of manufacturing, whereas the Model 3 is really designed for ease of manufacturing.”
The upshot of all this is that Tesla is burning through cash while it tries to figure out its manufacturing problems. In the car industry gross margin doesn’t include R&D, so, for every car Tesla sold in 2015 it burned through about $40k in R&D and CapEx. It’s still not made a profit.
That’s what I meant when I said before that there’s a chance Tesla goes under in the next year or two. It’s managed to convince the public to buy electric cars by the hundreds of thousands. The gigafactory should solve the battery problem. Making cars could be the hardest problem of them all.