It’s easy to think of Tesla Motors Inc. as purely a technology company. Its stock is valued like a technology company’s. It’s headquartered in the technology hub of Silicon Valley. And its product, the Model S, boasts industry-leading technology features, including a 17-inch navigation screen, over-the-air software updates, and new autopilot features.
But last week we were reminded that Tesla is, indeed, a car company. And that it faces many of the same quality and scale issues as the traditional OEMs in the space.
The electric-car maker reported strong third-quarter earnings. The company’s revenues stood at $849 million at the end of the quarter, up from $768 million in the second quarter of fiscal 2014. Revenues for the third quarter included $93 million in regulatory credits, $76 million of which were zero-emission vehicle credits from the state of California.
Production issues, however, caused the high-end EV manufacturer to miss its delivery target. Tesla shut down its Fremont, Calif. factory over the summer to upgrade its assembly line. Ramping up production again once the factory reopened took longer than expected due to integration issues, cutting production by nearly 2,000 vehicles.
Reduced production last quarter forced the company to sell off all showroom and test-drive inventory. Tesla now needs to produce 13,000 vehicles in the next few months to reach its 35,000-unit goal for the year.
“People don’t quite appreciate how hard it is to manufacture something,” said CEO Elon Musk. “It is really hard.”
Making one of something is easy, he continued. Making lots of something at a consistently high standard is hard. Making the machines to make the product is also hard. Having those machines and the supply chain that feeds them working at the same speed is hard too. The Model S has 70,000 unique parts that the company has to get right.
“We’ve also learned the lesson in manufacturing that you might have issues that are one out of 100, and unless you make 100 of something, you don’t see it,” said Musk.
The bottom end of the Model X will benefit from the Model S dual-motor drivetrain and chassis. But Tesla still has to finish work on some of the defining features, such as the falcon wing and additional seating, said Musk. The release of the Model X has already been delayed several times. Depending on how smoothly production goes, Tesla plans to start delivering the vehicle in the third quarter of next year, a few months later than previously expected. Those who order the Model X today likely won’t receive the vehicle until 2016, said Musk.
“This is also a legitimate criticism of Tesla: we prefer to forgo revenue, rather than bring a product to market that does not delight customers,” according to Tesla’s recent shareholder letter. “Doing so negatively affects the short term, but positively affects the long term. There are many other companies that do not follow this philosophy that may be a more attractive home for investor capital. Tesla is not going to change.”
On the call with investors, however, Musk said that in order to grow faster, Tesla might have to be less "perfectionist about future products.”
Demand is not an issue for the company. Musk said he has “high confidence” the company can achieve a 50 percent increase in net orders and deliveries in 2015. Based on demand increases following the introduction of the dual-motor all-wheel drive and autopilot features, Tesla could see orders reach as high as 70,000 “with no advertising or endorsements,” he said.
But he also acknowledged that if demand goes too far beyond the company’s ability to produce, “that would just make people upset.”
Quantity versus quality
For Tesla, selling consumers on EVs hasn’t been as difficult as some once thought it might be. Now the issue is whether Tesla can meet that demand without compromising product quality. After all, the company’s whole strategy has been to sell EVs simply by making them better cars than their gasoline-fueled counterparts. But production constraints now seem to be putting those two aims (selling lots of EVs and selling top-of-the-line cars) at odds with one another.
In an investor note entitled “Disruption is easy, execution is tough,” Brian Johnson, analyst at Barclays Capital, wrote that Tesla’s third-quarter results reminded the bank somewhat of some mid-2000s quarters experienced by General Motors. In April 2006, GM reported its sixth consecutive quarterly loss and a total of $10.6 billion in losses for 2005, and announced that it was cutting production amid slowing sales. Tesla is in nowhere near such dire straits, but it is encountering some bumps along the road to maturity.
Tesla’s stock slumped to $230 upon releasing its third-quarter results on November 5. The stock climbed back to $245 on November 6 and opened at $239 today. Analysts have set their price targets for Tesla between $150 and $320 per share.
With Tesla, “we see the Silicon Valley mentality run up against the reality of making complex cars,” said Cosmin Laslau, analyst at Lux Research.
One of the things that helps Tesla stand out is that it hasn’t been afraid to embrace new technologies (like the massive navigation screen) or new business models (by refusing to sell through traditional dealerships). Under Musk’s guidance, the company has also maintained that if you bring enough clever engineers together, they can solve any issue. This approach to innovation has made Tesla seem like a pure technology play. Now, as the company starts to scale, it’s learning some of the lessons about complex supply chains and manufacturing processes that traditional automakers learned over the last century.
“In the Silicon Valley mentality, everything is a little more virtual, and [there are fewer] physical barriers to get in the way,” said Laslau. He added that he expects production delays to be a recurring theme for Tesla. This isn’t a death knell for Tesla, but it does call into question the timing of the company’s other aggressive scale-up plans, like the Giga factory and the production of the Model 3.
Tesla’s executives remain confident in the company's approach, however. Last week, JB Straubel, Tesla's chief technical officer, said the company is already a bit ahead of schedule on the $5 billion Giga factory in Nevada, the location of which Tesla confirmed in September.
"We felt it was important to go as fast as we possibly could and start some production operations in 2016," Straubel said.
Musk said he’s not worried that the company will be “blindsided” by the emergence of some new battery technology, because any technology that’s going to be mass-produced in the next two years already has to be working in the lab right now. The battery industry also tends to suffer from excessive hype when it comes to making claims about products' capabilities, Musk added.
“The battery industry has to have more BS in it than any industry I’ve encountered,” he said. “It’s insane.”
Scaling up the new battery factory will be key to bringing the Model 3 EV to the masses. Musk predicts that the Giga factory will produce enough batteries to power 500,000 vehicles by 2020.
Oil industry association OPEC is undaunted by such projections. In the latest World Oil Outlook, it was forecast that the number of cars in the world will double by 2040, and that oil-fueled vehicles will lose only a small portion of market share over that period, dropping to 92 percent from 97 percent in 2013.
“Pure plug-in electric cars are unlikely to gain a significant market share in the foreseeable future,” according to the report.
But that doesn’t mean Tesla and other players in the EV market will have failed, said Laslau. Three percent of the global car market amounts to several hundred million vehicles. “That’s a lot of money for someone who can capture big market share or supply batteries to those vehicles,” he said.
FIGURE: Electric Vehicle Projections to 2040
Source: OPEC