Up Ahead: Tesla's Next Exit

How can the electric car company steer themselves around obstacles in their road to success?

In early 2012, Tesla Motors (Tesla), considered the rising star of the electric vehicle (EV) industry, was struggling. The company was incurring significant losses, burning four times more cash than it earned in revenues, and was embroiled in a myriad of supply chain issues. However, Tesla reversed its course over the second half of 2012 – through the introduction of a new product line (the Model S) and a momentous ramp-up in production. Tesla grew from manufacturing five cars per week in July, to 100 cars per week in October. Tesla continues to grow rapidly and is expected to increase production to 385 vehicles per week in 2013, the same year it is projected to generate positive cash flow.

Tesla is at a turning point in its dynamic history and intends to challenge the internal combustion engine’s dominance in consumer vehicles. However, significant obstacles lie ahead. In order to revolutionize the auto market, Tesla must gain traction by successfully commercializing the EV, something traditional auto manufacturers have failed to do – the Chevrolet Volt being a recent example. To succeed in the long-term, Tesla must resolve technical issues relating to battery charge time, a lack of supporting infrastructure, and negative consumer perceptions that have sent past electric vehicle models to the graveyard – a place for good ideas before their time.

The Company

Founded and directed by CEO and Chief Product Architect Elon Musk of PayPal, Tesla is Musk’s attempt to accelerate EV adoption. Tesla produces high performance, fully electric vehicles at price points similar to mid-range BMW and Mercedes-Benz models. In 2008 the Roadster, a luxury electric sports car, was Tesla’s first entry into the car market. Although the vehicle was revolutionary and received great fanfare upon release, the Roadster ultimately was a proof-of-concept for EVs and has since been discontinued.

Tesla’s second release and current production vehicle, the Model S, is a four-door luxury sedan priced between US $49,900 and $97,900, after a $7,500 federal tax credit. The Model S has received critical acclaim for its superb quality and performance (achieving 0-100 kph in 4.4 seconds) and has won numerous awards, including Motor Trend’s 2013 Car of the Year.

A midsize crossover titled the Model X is planned for delivery in 2014, offering additional cargo space at the cost of ~10% reduction in driving range relative to the Model S. Both the Models S and X are targeted towards an affluent market as an environmentally friendly alternative to standard luxury vehicles. In contrast, Tesla is currently designing a third generation (Gen III) of vehicles geared toward mass production and offered at a significantly discounted price to its current model. These vehicles are expected to roll off the line in 2015. Tesla also develops electric powertrains for Daimler AG, which owns 4.7% of Tesla, and Toyota, which owns 2.5%.

EV Concerns

The major concern with purchasing an EV is the range. To com- bat consumer pessimism, Tesla has built six ‘Supercharger’ stations to provide free electricity to Tesla vehicles in California and has roadside assistance teams available. Superchargers – the EV industry’s answer to gas stations – charge vehicles five times faster than a wall connection, providing 240 km of range after a 30-minute charge. Over 100 Superchargers are planned across the US, with key locations being completed by 2015. Delays in establishing Supercharger stations outside California could limit Tesla’s sales in other lucrative markets, such as the Eastern Seaboard.

To further persuade consumers to purchase an EV, Tesla is currently building showrooms in high traffic locations such as shopping and entertainment centers in North America, Europe, and Asia Pacific to display the Model S for potential consumers. Validating EV technology and creating brand awareness is crucial to consumers make an EV purchase. Currently, Tesla sells its vehicles entirely through an online reservation system unlike firms with widespread dealer networks. Since the company needed capital to produce vehicles, potential buyers were required to make a fully refundable $5,000 deposit to reserve their right to purchase a vehicle. If the buyer followed through and purchased the vehicle, the sale price less deposit was paid upon delivery. In Q3 2012, 1,700 reservations were placed with Tesla, bringing total order backlog to 13,200 vehicles. Production is expected to eat through this backlog by 2014.

Are Consumers Ready for Tesla’s Offerings?

A study completed by J.D. Power indicates that consumers have historically purchased EVs primarily for their environmental benefits. However, a significant shift is occurring in buying be- haviour – the largest consumer group interested in purchasing EVs are now drawn to the vehicles’ fuel cost savings. Unfortunately, there is a stark distinction between buyer perception and reality regarding EV product quality. For example, most consumers who avoid purchasing an EV do so because of concerns regarding driving range and fuel availability, despite the fact most EV owners only commute 34 km daily, well within the battery range of 426 km. Combustion engine vehicles require service every 8,000 km, meanwhile, Tesla vehicles are expected to pro- vide over 19,000 km of use before service is recommended due to fewer moving parts in EVs decreasing vehicle wear-and-tear.

Tesla is now at a crossroads. The company is coming off the heels of its best quarter yet, but is still too small to conquer the rapidly evolving EV industry. Faced with changing consumer preferences, stubborn attitudes towards battery technology, and high infrastructure costs, Tesla may need the resources and distribution network of a larger player to lead the industry. In the long run, growth through a sale of the company may be the best way forward for Tesla; however, several steps must be taken immediately to create maximum value for share- holders and position the firm as an attractive acquisition target.


Marketing Campaign

It is clear that Tesla is intent on transitioning away from solely targeting EV enthusiasts towards the larger market of consumers interested in quality luxury vehicles. Therefore, a marketing plan should be directed at this emerging segment in the US. Model S test drives are currently offered at certain Tesla locations and special events, but taking vehicles directly to the consumer will increase Tesla’s brand awareness and kick-start relationships with potential buyers. By offering a coast-to-coast test drive tour, Tesla would allow consumers to experience its products and create the necessary excitement to increase reservations. The tour would target locations of future Tesla facilities and Supercharger stations, providing the additional benefit of showing consumers exactly where they would be able to charge their purchased vehicle. The campaign could then be repeated for the Model X. Getting more consumers behind the wheel is critical to increasing sales and addressing consumers’ misperceptions.

Furthermore, to provide peace of mind to apprehensive buyers concerned about limited battery technology and service issues, the capabilities of Tesla’s roadside assistance teams should be ex- panded to include emergency services. These teams could oper- ate as Tesla’s proprietary AAA service, delivering charge or re- placement batteries for Tesla vehicles in emergency situations.

Halting Design Contracts

Once Tesla achieves a greater level of annual run-rate production and the related economies of scale, they should reconsider the implications of supplying electric powertrains to other manufacturers. Currently, the market is small enough that capturing any part of an EV sale aligns with Tesla’s interests. However, as the market grows, Tesla will stand to benefit more from selling a complete vehicle than manufacturing for competitors. To prepare for this shift, Tesla should complete its current design contracts and refrain from signing additional agreements. Tesla stands to gain more production efficiencies, and grow at a faster rate, by focusing on its core business of producing complete vehicles.


Licencing Supercharger Technology

Although the rollout of supercharger stations deals with the limitations of battery technology and alleviates some buyers’ hesitations around driving range and fuel availability, they also come at a significant cost. Tesla bears the capital investment, and accrues no recurring cash inflow from charging. By exploring licensing opportunities with the charging technology (the configuration that allows Tesla vehicles to charge at stations) with other manufacturers (and by extension, other vehicle types), Tesla can increase revenue while keeping charging costs low for consumers. Furthermore, once other auto manufacturers further develop their EV operations, they may contribute to expansion of Supercharger stations, allowing Tesla to move away from the capital-intensive process of building a worldwide network of charging stations on their own.

The Final Step: Selling the Company

Despite pursuing the value-creating strategies described above, Tesla will still not have the distribution and volume production needed to support the introduction of their forthcoming Gen III line in 2015. Given Tesla’s limited resources, and Musk’s vision of widespread consumer adoption, Tesla shareholders should consider partnering with and eventually selling to, a volume-based manufacturer. This would allow shareholders to realize significant gains from the firm’s growth, and provide Tesla with access to both a global distribution network and the manufacturing technology to make a lower cost model a reality.

Though increased cooperation with a volume producer would be ideal, neither Toyota nor Daimler is the ideal partner. Daimler cannot provide the scale necessary for a Gen III rollout as the thirteenth largest auto manufacturer, and Toyota’s Vice-Chairman has indicated that they will not pursue fully EVs any further, choosing to focus on the less risky hybrid alternative. Therefore, it is recommended that Tesla develop a relationship with Volkswagen Group, with the ultimate goal being an outright sale.

Volkswagen is the king of manufacturing mass-market vehicles at a consumer friendly price, and also maintains a portfolio of luxury brands such as Porsche, Bentley, and Lamborghini. This mix of products aligns well with Tesla, who could continue to support models across a broad range of price points. Volkswagen has also indicated an interest in entering the EV industry, with plans to release an electric Golf in 2014. However, the Golf is ex- pected to possess a range of only 150km, less than half that of the Model S. Volkswagen can benefit from Tesla’s technological prowess and experience and is much better suited to take over the establishment of the Supercharger stations. Tesla simply does not have the capacity or capital resources to build Superchargers on a large-scale, while a big player such as Volkswagen has the financial capacity and stands to benefit from the development of Superchargers, and by extension the expansion of the EV market. Initially, Tesla’s established management team can direct the company as it launches Gen III, and Musk can pass off control to achieve his goal of proving the consumer EV a viable concept.

These recommendations can strengthen Tesla’s operational capabilities and create value for both parties. Tesla needs to address the three primary concerns: battery technology, supporting infrastructure and consumer misconceptions currently preventing widespread commercialization of EVs. In doing so, Tesla will position itself as an attractive acquisition target and ensure the industry is prepared to benefit from Tesla’s offerings in the long-term. The road towards mass adoption of electric vehicles may come with several obstacles, but careful planning and sound strategic decisions will make the journey an exciting and successful ride.