A Blog by Jonathan Low

 

Apr 22, 2020

Why Tesla's Leadership May Be Insurmountable

Tesla was not designed merely to produce electric vehicles. It's leadership advantages are rooted in superior engineering based on a holistic approach to a future in which transportation as a service will determine financial, operational and brand success.

The company has embraced vertical integration in the Apple model - but has kept manufacturing in the US as a core component of its production and marketing strategy, while also expanding in China, the second, and possibly future lead market. The overarching approach is one of optimization based on core areas of expertise from which adaptability and dominance can spring. JL


Randall McAdory reports in Medium:

Those who value Tesla only as a traditional automaker producing electric vehicles might be missing core competencies important to the value of its business as transportation changes. Musk is using vertical integration as a moat: Tesla’s product and process advantages (motors, batteries, electronics, vertical integration) allow the company to beat competitors with new tech at a faster pace: expertise in AI; its own software for vehicle operating, infotainment and autonomous driving; its own retail network, Supercharger network, and vehicle repair. Transportation as a service will (be) an $8 trillion market opportunity. That includes electric vehicles, autonomous driving and mobility. Tesla is best positioned to lead into that future.
Those who value Tesla only as a traditional automaker producing electric vehicles (EVs) might be missing evidence of the company’s collection of core competencies unmatched by rivals. While it’s easy just to focus on Tesla’s vehicle production and deliveries, revenue, and losses, doing so minimizes the fact that Tesla has a chance to be more than just “another automaker producing EVs.” Tesla is building an expertise in artificial intelligence and machine learning, which is required for the development of autonomous driving systems. This growing capability seems to be overlooked by many analysts. For example, NYU finance professor, Aswath Damodaran, recently told CNBC that Tesla would need to have the margins of Apple, combined with the revenues of Volkswagen, while making large investments in manufacturing to justify its lofty valuation. That might be a reasonable assessment if Tesla is valued only as a producer of EVs. But there’s more to Tesla’s future than just the EVs the company sells today. Tesla is developing competencies that ultimately will be more important to the value of its business as the business of transportation changes in the future.
For now, let’s assume that Tesla’s only competencies are being an automaker that engineers, produces and sells EVs. Many experts believe that as the large established automakers enter the EV market, they will quickly erode any advantages Tesla may have today. Yet, there’s growing evidence that Tesla’s EV lead might be insurmountable. In fact, Sam Jaffe (Cairn Energy Research Advisors managing director), recently told CNBC that even traditional automakers are now well-aware that Tesla’s vehicle engineering advantages are so substantial that they cannot be easily copied or surpassed. Tesla’s head start in EV development has made it very difficult for traditional automakers to quickly catch up.

EV Development that’s Engineering Magic

“Magic” is the term used by Sandy Munro when describing the engineering in Tesla’s Model 3. His company, Munro & Associates, sells cost analysis and reverse engineering services for clients by disassembling vehicles down to the individual component level. One vehicle the company has analyzed for its clients is the Tesla Model 3. Let’s start with the Model 3 motor. It costs less, weighs less, and is smaller, than electric motors in competing vehicles like BMW’s i3 and Chevrolet’s Bolt. Tesla’s motor incorporates a technology called a Halbach array design. This design seems to be very difficult to engineer, particularly when combined with the requirement of producing it in high volume. This motor design also develops more power than the motors in competitive vehicles.
Tesla’s vehicles consistently have more driving range than EVs from competing automakers. Much of this range superiority is due to better battery engineering. In fact, Munro believes Tesla batteries have the best design in the world due to better engineering at the cellular and battery pack level. Cairn Energy Research states that Tesla is the only EV maker using cylindrical battery cells in its battery packs. Other automakers use prismatic or pouch battery cells, which are less efficient. From a cost perspective, Tesla is actually extending its lead in building electric vehicle battery packs. The company has reduced the price per kilowatt-hour of their battery down to $158 from $258 per kWH four years ago. Battery packs from other automakers averaged more than $200 per kWH in 2019.
Munro describes the Model 3 electronics as “military grade,” unmatched by any other automaker. The car has forty-percent less electric wire harnesses than competing models. The vehicle does not have a traditional fuse box like other automakers use in their cars. The Model 3 even has the lowest number of cooling hoses versus others. This all points to a better vehicle development process at Tesla that other automakers have yet to match.

Photo by Bram Van Oost on Unsplash

All is not perfect with the Model 3 design by the way. One notable area lacking competitiveness with others concerns the Model 3 body. According to Munro, the body is over-designed, uses too many parts, and is significantly too heavy. Body engineering is an area where traditional automakers seem to be much better than Tesla. Elon Musk supposedly recognizes this weakness in his vehicle design, and will not make the same mistake with future models like the upcoming Model Y.

Vertical Integration

Elon Musk is using vertical integration as a moat that will be difficult for competitors to mimic. In fact, Ark Investment Management describes Tesla’s vertical integration strategy as one that mimics what Apple has accomplished. Like Apple, Tesla hasn’t waited for the supply chain to catch up to the engineering needs of the company. For hardware, Tesla produces the vehicle chassis, the battery pack, and the self-driving computer. Tesla develops its own software for the vehicle operating system, infotainment system and autonomous driving applications. Tesla also operates its own retail network, Supercharger network, and vehicle repair service. Unlike Apple, Tesla also assembles vehicles in an assembly plant in California, with a new plant recently opened in China and another one planned for Germany in 2021. Vertical integration allows the company to quickly develop assets and competencies that create competitive advantages. The Supercharger network is a good example of this. This network has allowed the company to offer customers the reality of long-distance travel with their EVs, which has been difficult for competitors to quickly replicate.

Photo by Andreas Dress on Unsplash

Last year Tesla began producing its own Full Self-Driving computer (FSD). At the time, many experts believed the better decision would be for Tesla to buy self-driving processors from a company like Nvidia. According to the company’s website, Nvidia’s self-driving computer can run an array of neural networks to handle fully autonomous driving. But Nvidia’s computer also has to support a large number of different sensors and self-driving vehicle architectures from multiple automakers. Tesla’s FSD computer only needs to support the sensors and neural network on its own vehicles. Although the Tesla FSD computer has half the performance of Nvidia’s processor, its design is optimized specifically for Tesla vehicle usage. Ark Investment believes Tesla’s FSD computer puts the company years ahead of the competition. Automakers using Nvidia’s latest computer will have to test and qualify the self-driving computer for their vehicles. This requires significant lead time and lengthens the time needed to deploy this computer in their cars.
It’s clear that Tesla’s product and process advantages are many (motors, batteries, electronics, vertical integration). This allows the company to beat competitors with new technologies and capabilities at a much faster pace. In a Harvard Business Review article, Nathan Furr and Jeff Dyer, stated that it can be very difficult for traditional automakers to execute new and different vehicle architectures like those established by Tesla. Doing so requires developing new capabilities while abandoning old ways of conducting business. In the words of a senior automotive executive interviewed by Furr and Dyer, “It’s just hard for us because historically we have been great mechanical engineers, not great software engineers. But we need to become software engineers.” Similarly, another automotive competitor commented “We cannot do it,” after reviewing a Tesla Model 3 FSD computer teardown conducted by Nikkei Business Publication. These technology advantages will take years to equal or surpass. And there’s no evidence that Tesla engineering will become stagnant and cease to advance.
But what about future business opportunities born out of Tesla’s competency with EVs? Could Tesla already lead in the creation of new sources of future revenue born out of today’s capabilities?

Transportation-as-a-Service (TaaS)

Dan Ammann, CEO of General Motor’s Cruise autonomous vehicle subsidiary, recently stated in a recent CNBC article that TaaS will represent an $8 trillion market opportunity. According to UBS, Alphabet’s robotaxi subsidiary (Waymo) could generate $114 billion in revenue by 2030. Mobility solutions driven by autonomous EVs will be a massive business opportunity for companies. Consumers also will benefit from TaaS. In his book, Autonomy, Larry Burns (former VP of research and development at GM) calculated the cost of owning and operating a car today at $1.50 per mile. In a TaaS world of shared electric and autonomous vehicle solutions, the cost to consumers will plummet to $0.20 per mile — a significant $1.30 per mile savings. Consumers will save $5,625 per year. This savings combined with the projected $8 trillion market opportunity suggests a future TaaS world that’s beneficial to both companies and consumers.
So where is Tesla along this journey to attack the future of TaaS? Unlike Cruise and Waymo (the two self-driving businesses generating much interest), Tesla already has a large fleet of vehicles in the hands of customers today that generates significant amounts of the data required for self-driving vehicle development. This data is critical to the neural networks that train the self-driving vehicle algorithms. The more data that goes into these self-driving algorithms, the better the machine learning gets at developing autonomous driving capability. And which company has the most real-world self-driving data today?
Tesla!
Tesla’s real-world autonomous driving data is orders of magnitude bigger than the competition due to hundreds of thousands of Tesla vehicles on the road equipped with self-driving hardware and software. There are estimates the company has access to +2 billion miles of real-world driving data versus only +20 million miles of real-world data for Waymo. This data advantage seems to be overlooked by most analysts. In fact, last year, many were not impressed when Elon Musk discussed robotaxis development during the Tesla Autonomy Investor Day. Maybe this skepticism is based on Musk’s penchant for missing deadlines. But missed deadlines do not necessarily mean Tesla trails competitors regarding autonomous driving capability. Tesla’s vast amount of self-driving data suggests the company actually is leading competitors to a world of autonomous vehicle capability by a wide margin.
“The Only Vehicle I Look Forward to Driving Every Day”
It seems clear that when analyzing EV hardware, software, vertical integration and self-driving machine learning, Tesla has a substantial lead over others. There is anecdotal evidence of Tesla’s leadership stature as well. Much of this evidence comes from Tesla owners. One such owner I spoke with recently is a case study in favorable opinion for an automotive brand. He’s a Model S owner; a high-level U.S. corporate executive; a former chief engineer for a global automaker; an owner of several luxury vehicles from premium brands like Mercedes and BMW; even an owner of a high-end pickup truck. This is the type of guy that many in the automotive business would describe as, “a car guy.” When asked about his Model S, his comment to me was, “this is the only vehicle I look forward to driving every day.” This is the type of owner whose opinion really matters to automakers. This is the kind of buyer craved by the industry. He’s not the kind of owner who can be described as some obsessive Elon Musk fanboy, of which there are many. This is an owner who is interested in buying another Tesla, not as a replacement, but as a second Tesla vehicle.
“Disrespect turns into envy”
What was once a novel little EV company, trying to be the first U.S. automaker since Ford to go public in 1956, has now caught the attention of the biggest automakers in the world. Herbert Diess, CEO of the Volkswagen Group, is pushing VW to buy software companies, while also investing in sustainable vehicles and battery cells just to catch up with Tesla, according to Automotive News. Diess recently described the competition with Tesla as an “open race.” It’s very unusual for an automotive CEO to publicly admit that Tesla has any type of competitive position in the automotive business. Yet automakers like VW are acknowledging Tesla’s stature, even if only measured by their EV and autonomous vehicle investments, which are massive. Sam Jaffe told CNBC recently that automakers are now well-aware of Tesla’s advantages. There was a time when automotive engineers made fun of the company. Not anymore, according to Jaffe. Today, there’s “respect and envy” for what Tesla has accomplished.

Photo by Annie Spratt on Unsplash

Tesla’s Valuation

Does any of this justify Tesla’s lofty valuation? That’s a difficult question to address. But valuing Tesla as “just another auto company that happens to make electric vehicles” is an incomplete view of the company’s advantages. During a Kara Swisher, Recode Decode podcast interview in 2018, Musk stated that no company will develop a generalized solution for self-driving vehicles before Tesla. And like the automotive executive interviewed by The Harvard Business Review, Musk believes that other automakers will not be a serious competitor in self-driving because, “they’re just not good at software. And this is software problem,” according to Musk. Of course, Musk’s comments are self-serving. But if the future of transportation is one that includes a combination of electric vehicles, autonomous driving and mobility solutions, then Tesla is the company best positioned today to lead into that future.

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