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STRATEGYt

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AN INTERNATIONAl. PERSPECTIVE

The first four editions of Strategy: Process, Content and Context were co-authored by Bob dc Wit andRon Meyer. The fifth and sixth editions were authored by Bob de Wit.

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Strategy: An International Perspective © 2017, Cengage Learning EMEA6th Edition ALL RIGHTS RESERVED. No part of this werk covered by the copyrightBob de Wit herein may be reproduced er distributed in iny form er by any means,

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By Dipl. Kfm. Envin Hettich

Case study“You‘U be able ta tra pci forfree, frirever, anpure sunlight.

Eton MusL. CEO und chief producc architect ofTesla Motors

‘The present is theirs; Hie future, Ihr which 1realiv worked, is mine.“

Nikola Tesla

W hen Elon Musk drove to work with bis Model5 electric car on February 24, 2014, he knew

ihat he was also steering a revolution in the automobile industry. lt took Tesla Motors, Inc. only 10 yearsand 30 000 vehicles to pass the market valuation ofcar-making giant Fiat and reach half of the vaiueof General Motors — a company that had manufactured 450 million cars over its more than 100 yearsof existence. Riding on significant tailwinds frombullish analyst reports on Tesla‘s visionary businessmodel and its most recent announcements to connectthe car to the Internet und build the world‘s laest“Gigafactory“ for balteries, Tesla‘s market capitalization rose to $30 billion. The analyst Adam Jonasfrom Morgan Stanley recently attested that “Teslamay be in position to disrupt industries weil beyondthe realm of traditional auto manufacturing,“ andnoted that ‘it‘s not just cars.“ Tesla‘s once boldlyformuiated vision to “create the most compelling carcompany of the 2Lst century by driving the world‘stransition to electric vehicles“D (EVs) may these daysnot even be hold enough anymore.

So far. Tesla‘s journey to become one of mostadmired pioneers in the electric mobility domainbus been a jolty one accompanied by Iiquidityissues, supply uncertainty, and ongoing skepticismabout its long-term viability in an immature marketund the Iooming competition of powerful incumbents. In his first company blog post in August

and Prof Di: Günter iVJüller-Stewens

2006, Tesla Chairman Elon Musk revealed the“secret“ master plan underlying the firm‘s ambitious endeavor: enter at the high end of the market,where customers are prepared to pay a premium,und then drive down the market as fast us possible 10 achieve higher unit volume und lower priceswith euch successive model. Beyond that, Muskrevealed that Tesla aims 10 provide zero-emissionpower-generation options.3 Since its inceptionuntil today, Tesla bus taken groundbreaking dccisions that deviate from traditional business mod-eis in the automobile industry. Thus far, however,protits have been murginal. With the path takenund many decisions Iying ahead, Tesla‘s businessconcept may turn out to be a revolution or a bigbust. While Tesla‘s short history bus Iargely been astory of success, many issues that must be resolvedstill remain. Musk and his team fuce serious challenges and have to answer pressing questions.such as How to configure a viable business modelthat would defend against powerful incumbents?‘and ‘How to reap arising opportunities in a radically changing business landscape und position thebusiness for future growth?‘ These are importantquestions that require answers.

Background 011 Tesla

The earlyyearsTesla Motors was founded in Silicon Vailey byMartin Eberhard and Marc Tarpenning in 2003. Theywere soon joined und funded by Eton Musk, whohas served as chairman since 2004. Musk was weltexposed to entrepreneurial endeavors, notably as aco-founder of PayPal, SpaceX, and SolarCity. Thecompany‘s initial goal was to produce fully electricsports cars not for ultimate cost, but rather for performance, aesthetics, and sex appeal.4 Early on, Musk

Tesla Motors‘ business model

AUIhOrS: Dipl. Kfm. Erwin Heuich, Institute of Management Universicy ui St. Gallen und rrof. Dr. Günter Müller-Slewens, Institute of Management University or St. Gallen

02013 by Researeh Associate Enjn Heltich und Professor Dr. Günler Müller-Siewens Universily tif St. Gallen. All dghls rcserved. No pan ofluk publication may he wprodueed, s[orL-d in a retrieval system. used in ii spreadsheet, or transmilied in any form or hy any means — eleetronic.ineclianical. photocopying. recording. or (aherwise — wiihoui the permission of ihe copyright owner. fle case is intended as a basis for dass discussion naher thun in illustrate either effeetive or inenective handling er management situations. The caw was eompiled from published souxces.

759

760 SECTION V CASES

took a decisive role in designing and developingthe first prototypes ofTesla‘s Roadster, which wereintroduced to the public in July 2006 and achievedan unprecedented range of 245 miles (394 km) on asingle charge in company tests.

The market Iaunch was accompanied by intensemedia attention and backed by celebrities such asLeonardo DiCaprio. Jay Leno, and George Clooney,who paid S 109 000 in advance to receive one of thefirst 100 Roadsters, which were scheduled to bedelivered in 2007; however, the first Roadster wasnot delivered until February 2008. An internal auditrevealed that the cost of building the car had climbedto $140 000, vastly overrunning the projected cost of$65 000. Tesla lost money before a single unit wasdelivered, and the company faced financial trouble.The board of directors unanimously decided to dismiss Eberhard. Tarpenning, who was vice presidentof electrical engineering, supervising the development of electronic and software systems for theRoadster, also left the company in 2008. Musk Lookover as CEO in Ociober 2008,

When Musk Look over responsibility, Tesla wasselling fewer chan 200 Roadsters and filling a nichein an industry that chums out millions of vehicles peryear. The parts for he Roadsters were sourced separately and largely ussembled one by one, in a garagebehind a showroom in Menlo Park, California. basedon the Lotus Elise templale. The Roadster, however,was simply the launchpad for Musk‘s next step tobuild the more sophisticated Tesin Mode) S, a stylish four-door sedan. In the summer of 2008, he hiredMazda‘s lead North American designer, Franz vonHolzhausen, and told hirn that he wanted a four-doorcar that seated seven (offering seating for five adultsand two children). “That‘s an SUV, not a sedan,“ vonHolzhausen responded, while Musk pointed to anopportunity to design something new.6

On the bdnk ofbankruptcyWhen the economic crisis hit in 2008, and financialmarkets dried up, Tesla‘s cash reserves reached acritical level. Despite the continuous improvement offinancial figures due to increased production efficiencies and renegotiated supplier contracts, the companywas facing “near-death experiences.“7 Musk wasconstrained by his second venture, SpaceX, whichconsumed a large amount of resources, and he couldliltle afford any further investments. At the last possible hour, on Christmas Eve in 2008, Tesla managedto secure financing to keep the business going.

Prospects increased dramatically in 2009. Musk‘sstrategy to seIl battery packs to finance Tesla‘s operations paid off when Herben Kohler, Daimler‘s head ofadvanced engineering signaled interest to come andsee what Musk had to offer. In less than six weeks,Jeffrey Straubel, Tesla‘s chief technical officer, managed to conven Daimler‘s Smart into an electricallypowered vehicle. Convinced of the compatihility ofthe hattery packs, Daimler signed a deal buying 1 000battery sets worth more than $40 million. In March2009, von Holzhausen unveiled the prototype ofthe Model 5, which allayed all concerns of Daimlerand led to the company‘s acquisition of a 9 per centstake for $50 million. Besides gathering the urgentlyneeded fresh capital, this deal made Tesla worthmore than $500 million and gave credibility to whatwas until then just a bold experiment. lt also helpedto stage a successful initial public offering, pavingthe way forTesla‘s subsequent expansion.

Three months after the unveiling of the Model S,the federal government granted Tesla an alternativevehicle loan of $465 million to market the model,w‘hicji brought the company another step cioser tomass production. However, the payout was restrictedby the precondition that sufficient production capacities existed. Fortune was on Musk‘s side, when just

in time Akio Toyoda, president of Toyota, offered uphis manufacturing plant in Fremont. California, forsale. after its crisis-shaken partner General Motorswithdrew from joint operation. Musk seized the

moment, bought these facilities dimensioned for

500 000 vehicles a year, and shifted production fromLotus sites in England to Fremont in 2010. Unlikethe Roadster, the Model 5 was developed as a flex

ible platform allowing multiple variations comparahIe to most advanced systems such as Volkswagen‘smodular production.9

From rich man toy to mass market

In January 2010, Tesla Motors announced its filing

of a registration statement with the Securities andExchange Commission for an initial public offering

(IPO) — the first American automaker going public

since Ford in 1956. Around the same Urne, Tesla andToyota formalized an agreement to jointly developan electric version of the Toyota RAV4. Toyota also

announced the purchase of 550 million worth ofTesla stock at the forthcoming lPO.

Six months later, Tesla placed its shares weil above

the expected range at $17 (Ticker: TSLA): even so.shares surged 41 per cern on the fu-st day of the WO

CASE 10 TESLA MOTORS‘ BUSINESS MODEL CONFIGURATION 761

and closed at $23.89. Despite having accumulated

a loss of more than $300 million since its founding,Tesla was valued at $2 billion and managed to raisenearly $230 million of fresh capital. The companycontinued to run losses that peaked in 2012 when itwas $396 million in the red due to massive investments in the factory ramp-up, building new storesacross the country, and training workers. In June 2012,Tesla delivered its first Model S after three years ofdevelopmenc The fast quarterly profit of $11.2 million was reponed in 2013. In total, 4,750 dehveries ofModel S were booked in the first quarter of US sales—

more than any of the similarly priced gasoline-powered cars from he top three German luxury brands:Mercedes-Benz S-Class, BMW 7 Series, and Audi AS.

Early in 2012, Tesla unveiled an early prototype,the Model X crossover, produced on the Model 5platform in 2015. The carmaker also announcedit would soon begin to add lower-priced vehicles,which according to Musk “should be quite aftordable

on the order of $35 000.“ 0 With a stabilized financial situation, enthusiastic capital markets und customers, and a promising launch of its core product,a multitude of paLhs and challenges opened up forTesla‘s future business model configuration. Tesla‘simpressive growth, however, has not yet translaiedinto significant profits (Figure 1).

TizeModelS

and 85 kWh, with base prices (before tax credit) of$52 400, S62 400, and $72 400. respectively“ Withranges above 265 miles, the Model $ more than doubles the next-best market offer — BMW‘s i3 five-doorurban car. which allows the driver to cover a distanceof 90 miles. The reach of the Model 5 far exceedswhat is demanded by customers, who in 80 per centof cases have to cover less than 50 miles dailyi Tocomplement range capabilities for long-distancetravel. Tesla offers fast-charging technotogy at itsSupercharger facilities. The fast-charge capabilityallows Model 5 owners to replenish 50 per cent ofthe battery park in as little as 30 minutes. Moreover,the Model 5 incorporates a modular battery park atthe floor of the vehicle, which enables it to make useof the battery-swapping technology — to exchange adischarged battery for a fully charged one instead ofcharging the vehicle‘s battery — at swapping facilitiesthat will reportedly be installed in the future.

According to Tesla‘s l0-K reporting, the Model 5provides a lower cost of ownership as compared withother vehicles in its dass, when purchase price, rostof fuel und the rost of maintenance over a six yearownership period are Laken into consideration.‘3 Thiscalculation assumes the residual values, warranties,insurance costs and promotions, and customer incentives of other cars in the luxury sedan-dass. At current conditions of 11.2 cents per kilowatt-hour und$3.32 per gallon (average prices for electricity undgasoline across US, see Figure 4), the cost of fuel forthe Model 5 is expected tobe approximately $1 800per year less than would be the case for u comparablepremium iniernal combustion engine sedan.‘4 Fewer

In 2013, Tesla soLd 22,477 units of its Mode! 5, thusoutperforming all forecasts. The Model 5 comes witha variety of battery-pack options — 40 kWh. 60 kWh

FIGURE 1 Tesla motors quarterly earnings 2009—2013 (Source: Qz.com)

$600 million

400

200

0

—2002010 2011 2012 2013

762 SFCTIONVCASES

moving parts and the absence of certain components,such as oil, oil filters, spark plugs und engine valves,mean lower maintenance expenses thun comparablepremium conventional internal combustion engines(ICEs).

The Mode! 5 is designed on the basis of an adaptable platform architecture und common electric powertrain thut is intended to be leveraged by creatingmore electric vehicle models in the future. The powertrain and buttery pack have a modular design, whichwill make it possible For Future generations of dectric vehicles to incorporate a significant amount ofthis iechnology. The upeoming Model X is designedas a crossover to fill the niche between the roominessofa minivan and the style of an 512V, powered by anall-wheel dHve system. Tesla also plans to launch theModel E (Gen 3), a compact car with a range of perhaps 400 miles [hat would cost just S35 000)

The electric vehiele marketThe market for EVs is split into three segments:

• Hybrid electric vehicles (HEVs): Vehicies thatgenerate all their electric energy onboard thevehicle. HEVs include all varieties of hybridsthat use electric motors for traction, includingseries hybrids, parallel hybrids. through-the-roadhybrids, und mild hybrids.

• Plug-in hybrid electric vehicles (PHEVs): Vehides that are propelled by an electric motor thatreceives power from the grid but also have an ICEto extend the range of the vehicle

• Battery electric vehieles (BEVs): Vehicles that useenergy sourced from the grid. They get all theirpower from battery packs and thus have no interna! combustion engine.

Hybrids (HEVs) have emerged as a viable alternative to ICEs since the introduction of the firstcommercially available hybrid-electric vehicle,the Toyota Prius, in 1997. The sedan bad the Iowest consumption in its category (3.61/100km). Afterthe company captured the Japanese niche market, itlaunched its Prius II in California in 2000. At present, more than 1 million HEVs arc sold each year,however, at lower rates than in previous years)°

The market for plug-in electric vehicles (PEVs)comprises both plug-in hybrid electric vehicles(PHEVs) and batterv-electric vehicles (BEVs). Vith180 000 PEVs sold worldwide in 2012, this market isstill in its infancy, accounting for only 0.02 per centof the global passenger car markeL“ Unlike HEVs.which are charged through energy recuperation whiledHving (for example, a brake system). PEV diffusionis strongly dependent on die availability of charginginfrastmcture at home, at work. or other public places.Until now, the reason for this has largely been insufficiently developed charging infrastructure. whichhinders battery-only propulsion technologies (i.e.,BEVj) from competing with ICE vehicles, and thusdie markets remain small, limited, and niche in scope.One of the biggest hurdles to BEV adoption is “rangeanxiety“: Owners worry about being stranded by theside of die road with a fully discharged battery)

The global marketParticularly over the past 10 years, the world busseen a significant risc in vehicle electriflcationdriven by volatile oil prices, massive decline ofurban air quality. and public attempts to decarbonizetransportation. The BEV sales arc expected to reach6 million units by the end of 2020. and more than10 million by 2025 (Figure 2). These figures imply

1

1FIGURE2 PHEVStanley Research)

0

20

15

10

5

0

vs, BEV sajes breakdown, world markets: 2011—2025 (Adapted from: Morgan

BEV

— nJ m

o o 0 0 0r.4 rN fl.J r-.J N

PHEV

t0 N C 0 — r m— — — — nJ flJ fl IN INo 0 0 0 0 0 0 0 0 0IN IN IN IN IN IN IN IN IN IN

CASE 10 TESLA MOTORS BUSINESS MODEL CONFIGURATION 763

growih at a compound annual growth rate (CAGR)Dr approximaiely 31.5 per cent fron 2013 to 2020,almost wnfold as compared with the ICE market,which has an anticipated CAGR of 3.7 per centthroughout the same periodi9 BEVs arc expectedto generate even greater sales by 2023 and expandtheir share at the expense of PHEVS in subsequentyears These forecasts indicate that PHEVs couldact as a bridging technology between conventionalpower trains (ICEs) and PEVs. Overall, the globalmarket for PEVs is projected to surpass $415 billionin 2020 und $636 billion in 2030,20 accountingfor 5.5 per cent of global car sales by 2020 and15 per cent by 2025.21 Owing to technological, economic, and regulatory uncertainty, however, studies vary widely about PEVs‘ future share of newvehicies, with figures ranging fron 1 per cent to33 per cent over the 2020—2030 timeframe.

At present, four main regions crystallize as thelead markets with, on aggregate, roughly two-thirdsof all PEVs registered worldwide: The United States,China, Japan, and Western Europe (Figure 3), whichis also where the major PEV production is expectedto shift. In fact, the most likely customers for elec

• tric vehicles were found to be in India and China,where between 50 per cent and 60 per cent of car

• owners were willing to buy PEVs, forming a starkcontrast Io other countries, such as Japan (4 per cent),France (5 per cent), Germany (9 per cent), anS theUnited States (12 per cent).23 PEVs arc particularly

popular in dense urban areas with above-averagewealtb, limiied commuting distances, developedcharging infrastructure. and a high fleet penetration.Currently, a large amount of sales is attributed toileets, such as electric taxis (for example, in Shenzhen und Hangzhou in China) orcar-sharing schemes(such as Autolib in France or Car2Go in Germany).

Batteries make up more man one-third of theoverall vehicle price of around $12 000—51 5 000.Therefore, the market for PEV batteries including materials required for production. plays a purticularly crucial role for PEV manufacturers. Inthe best-case scenario, this market was expected togrow to between 59 billion und $10 billion in 2015and to $50 billion by 2020. Market consolidationis ongoing. since R&D expenses are high, und produetion capacities today arc estimated to be twicethe demand. Five frontrunners arc set to control 70per cent of the Lithium-ion (Li-ion) world market:AESC, LG Chem, Panasonic/Sanyo, A123 and SBLiMotive.4 While markets for PEV battery are predominantly located in Europe, the United States, andJapan, we might see an increasing shift toward Chinain the future, where rare earths und critical raw materials are found.

The US marketAccording to Pluginamerica.com, 183 620 PEVswere sent onto US roads from December 2010

2012 World PHEV Sales, by CountrySource: EVI, Marktine, Oatabai.

FIGURE 3 PHEV and BEV sales in 2012 (Source: International EnergyAgency)

United States70%

Japan12%

2012 World 8EV Sales, by Country

Netherlands

Canada

China

Other

8% • Unted States

2% • Japan

2% • Nethedands

6%• Canada

• China

Other

38 585

6 528433112881 201

3266

‘edSates China FranceNorway

Japan 26% 16% 11% Germany

28% UK

Lz

• Japan

• United States

• China2% • France2% • Norway9% • Germany

• Unfted Kngdom

Other

15937

14592

8 733

6 067

38831 2941167

5 009

764 SECrIONV CASES

through the end of February 20I4. More thun half of

these PEVs were sold in 2013. doubling sales [rom

2012.25 As of 2013, EVs account for less thun 1 per

cent of cars sold in the United States, which means

there is “a huge umount of untapped demand,“ as

Musk notes in a company report.6 The market for

PEVs is highly concentrated in five cities buying

more than half of all PEVs sold in the United States:

Atlanta, Los Angeles, New York City, San Fran

cisco. und Seattle. With a well-established charging

infrastructure, tux cuts, and exclusive parking und

traffic lane access, the incentive in these cities to go

electric is very appealing. A study on electric mobil

ity found that current EV buyers or leasers ure more

thun twice as wealthy as most Americans (national

median income $51 914), male (79 per cent), highly

educated, und on averuge 46 years old. Those that

ute interested in buying EVs ure younger, less

wealthy, less idealistic about environmental issues

und have hgb expectations concerning the quality

und performance of EVs.2‘

Recent growih has been fueled by significant

price cuts for electric cars. as automakers race for

economic scale effects und fulling battery prices. For

instunce, BMW announced lt will charge $41 350 for

its new i3 (before tax credits), while Ford and Nissan

reduced prices on their Focus und Leaf models by

$4 000 und $6 400, respectively. for 2014. With

an udditional $7 500 in nix credits for several PEV

models (including the Tesla Model 5). the total cost

of ownership (TCO), which comprises the costs over

the whole lifecycle of vehicles, is significuntly low

ered, ullowing electric vehicies to exceed the pric

ing thresholds thut are acceptable for mass murkets.

Besides governmental incentives und infrastructure,

the oil price and technologicul advancements. und

particularly battery expenses. which account for a

substuntial portion of PEV costs, are criticul for PEV

versus ICE buying decisions (Figure 4).

The best-selling 8EV model today is the Chevy

Volt, with over 48 000 vehicles now on US roads

competing with 15 other light-duty models of PEVs

thut are currently on the market. With the exception

of the Cadilluc ELR (six sold in 2013, sturting at

$76 000) und the Porsche Panamera S-E (86 sold in

2013, starting at $99 000). the 13EV market is doini

nuted by economy und compact-class cars (Figure 5).

lncluding all gasoline hybrids und fuel-cell EVs,

consumers can choose among more than 56 models

of electrically powered vehicles. The schcduled

introductions of several PEVs suggest that Tesla is

ubout to fuce more headwinds, as major carmukers

ure moving into the electric luxury segmenl after

Teslu bad largely bad this segment to itself since the

launch of its Model 5 in 2012. In an uttempt to coun

ter the loss of trendsetting und affluent customers,

several deep-pocketed rivals huve announced PEV

luunches, such us the BMW i8 ($135 000), Audi R8

6.OD

FIGURE 4 US EV projected competiüveness with conventional vehicies (Adapted from:

C urnegi eendow me n t.org)

g 5.00

4500.

‘:4.00

w

1. 3.50w2 3.00

2.50

PHEVs are competitve ..“ •ttt -

Hybrid-electric vehiciesare competitive

r—

Stateof 2011

Stateof 2014

2.00150

iCE ehcIes are compebtve

200 250 300 350 400 450 500

Battery prices, $ per kilowatt hour (kWh)

550 600 650 700

CASE (0 TESLA MOTORS‘ BUSINESS MODELCONFIGURATION 765

2013 JAN FEB MAR APR MAV JUN AUG SEP ocr NOV DEC 1 Total

Chevrolet Volt 1 140 1 626 1 476 1 306 1 607 2 698 1 788 3 351 1 766 2 022 1 920 2 392 23 094

NissanLEAF 650 653 2236 1937 2138 2225 1864 2420 1953 2002 2003 2529 22610Tesla Model 5 1 200 1 400 2 300 2 100 1 700 1 350 1 800 1 300 1 000 800 1 200 1 500 17 650Toyota Prius PHV 874 693 786 599 678 584 817 1 791 1 152 2 095 1 100 919 12 088

Ford C-Max Energi 338 334 494 411 450 455 433 621 758 1 092 941 827 7 154Ford Fusion Eneryi 0 119 295 364 416 390 407 600 750 1 087 870 791 6089Ford Focus Electric 81 158 180 147 157 177 150 175 110 115 130 158 1 738T0yotaRAV4EV 25 52 133 70 84 44 109 231 167 91 62 28 1096Mitsubishi i-MiEV 257 337 31 127 91 39 46 30 20 28 12 11 1 029smartED 2 0 0 0 60 53 58 182 137 111 153 167 923RatSOOe* 0 0 0 0 0 0 150 160 50 40 125 120 545

HondaFitEV 8 15 23 22 15 208 63 66 35 40 23 51 569

ChevroletsparkEV 0 0 0 0 27 103 102 78 66 87 76 539HondaAccordPHV 2 17 26 55 58 42 54 44 51 71 68 38 526PorschePanameraS-E 0 0 [ 0 0 0 0 0 0 0 35 4 47 86Cadill:ELR

77j__404f2 7 138 8 292 ?f73 8 027!i5 9 :60 95:42

e-tron ($150 000), Volkswagen XLI ($146 000),Porsche 918 Spyder ($845 000), and the Mercedes-Benz SLS AMG Electric Drive ($544 000), ariongmany other smaller-sized models, such as the Mercedes B-Class (less thun $40 000). Recently, RudolfKrebs. the VW Group executive in charge of electric vehicle programs, revealed VW‘s plan to roh out40 different PEVs over the next several years.29 Thefuture is not looking rosy for every manufacturer,however. By the end of 2013, Fisker Automotive.Tesha‘s main rival located next-door in Anaheim,California. filed for bankruptcy after sufferingfrom safety recalls, the insolvency of a battery supplier, and severe losses of shipments during 2012‘sHurricane Sandy.3°

The role ofgovernmentThe global market for ehectric mobility is promotedthrough various govemmental policies und programsincentivizing sales und fucihtating technological transition. Severa] governments support their nationalmurkets through subsidies to purchase costs, producdon facilities, reseurch und devehopment, und charging infrustructure development, but also throughthe purchase of fleets for public organizations and

favorable regulution (for example, special lunes, taxation, und parking). In terms of incentivizing vehicle adoption, the United States clearly takes the leudwith more thun $30 billion of overall funding from2010 to 2017, far exceeding the second-largest progrum that is in place in China (S5.4 billion from 2006to 2016)?

Governments also releused ambitious roadmapsdesigned to increase widespread ucceptunce ofelectric mobility by targeting individual customers. commercial, und public fleets (Figure 6). Disincentives on ICEs, such as emission-based taxationund fuel economy regulation, have also been put inplace and tilted economies toward electric vehicles.For instance, in Europe, C02 emission limits wereset at an averuge of I30g/km und will be phused inbetween 2012 and 2015. The European Commission intends to tighten this limit to 95g/km by 2020.In China, new fuel-efflciency standards have beenannounced, changing prospects for electric cursthere for the bettet.

In addition, public organizations work alongsideprivate ones to address a lack of standurdization inareas such as charging infrastructure, billing, undsoftware, w‘hich inhibits customer acceptanceund higher sales. Govemment-backed demonstrution

FIGURE 5 2013 monthly sales chart for the major BEV uutomakers (Source: http://insideevs.com/finul-201 3-plug-in-sules-rankings-for-the-us-are-in-who-did-well-who-did-not-infographicf)

j

766 SECTIONVCASES

und commercialization programs have been estabIished 10 provide a testing ground und spur the uptakeofelectric mobility technology. Thus far, govemmentaction at all levels has greatly influenced PEV salesund the integration of these new vehicies mb theelectrical grid.

Tesla‘s business model

Key resources

Battery technology. Tesla considers its core competencies to be the engineering of electric powertruins, including the battery pack, power electronics,motor, gearbox and the control software that enables the components to operate as a system. Thebattery pack System has been designed to allow forinterchangeability of battery cell chemistry of independent manufacturers. Tesla aims 10 capitalize onsubstantial battery cell investments and advancements 10 quickly drive down the cost of batteries. flecompany itself compares und tests available Iithiumion cells on energy storage capacity. Iongevity. undpower delivery to choose among the suppliers undchemistry types with the best value and performancefor its battery packs.32

BaLtery technology plays u particu!arly important role: lt constitutes a central competitive

lever in the EV market because of its high shareof the overall cost und its significance for customer acceptance, as it reduces “runge anxiety,“charging time, and concerns about security. Whilebattery costs are declining at a rapid pace, they arcexpecied to make up a majorcost factor in the future(Figure 7). Prices dropped more thun 50 per cent inthe pasl four years from $1 000 per kWh in 20101°less thun $400 per kWh in 2014 (Figure 4). Basedon the assumption of a 10 per cent learning rateper year und continuously improving economies ofscale, most recent analyses see further price cutsuntil at least 2020.

Software technology. The Model S is equippedwith the largest automotive buch screen in theworld und the ability to add new features und capabilities using over-the-air software. This softwarealso permits innovative car repair und performanceupdates. The ability to send updated software wirelessly to vehicles helped Tesla to instantly fix29 222 Model S‘s that posed a fire risk because ofoverheating charger plugs. In other cases, Tesla created updates following customer requests, such aschanging the suspension settings, which give the carmore traction ab high speeds. or a re-installed “creep‘function that some customer were used to in [CEs,which slowly moves cars forward when the brakepedal is released. Commenting on wireless repairs,

sales targets of selected countHes (Source: International Energy Agency)FIGURE6 PEV

6 000 000 —

5 000 000 -

4 000 000 -

E 3000000-D

2 000 000 -

1 000 000 -

0—2010

lndia .0

Netherlands .0

PortugalCerman

France//

Spai

Japan

2012 2014 2016 2018 2020

1China

CASE 10 TESLA MOTORS‘ BUSINESS MODEL CONFIGURATION 767

Musk tweeted that no vehicies were “physicallyrecalled,“ and that in fact “the word ‘recall‘ needs tobe recalledT34 Tesla also introduced apps that allowcar owners to manage the charging process, tracktheir movements on a map, analyze their divingbehavior, und heut or cool the interior before driving.

Charging infrastrueture. Since 2012, Tesla hasimplemented company-owned Supercharger stationsthat rapidly recharge balteries in high-traffic coffidorsacross North America, Europe, und Asia. Tesla‘s current charging network allows coast-to-coast travellingacross the United States. European customers, Muskannounced, “will be able to travel almost unywherein Europe using only Superchargers“ by the end of2014. Supercharger technology provides a charge ofbetween 90 kWh and 120 kWh, enough power forthree hours of driving with only 20 minutes ofcharging, which means stops arc frequent as on uny roadtrip, as Musk said.3‘ While Investments of $100 000to $175 000 per Supercharger station seem high,Tesla actually rucks up more than it invests throughthe credits it earns for each zero-emission vehicle(ZEV) sold in California.36 lt is estimated that Teslamuy carn up to $250 million in ZEV credits in 2014,thanks to its Model 5. These revenues far exceed thefunding required for the 237 Supercharger stutions thecompany plans for the United States und Canada inthe coming yeurs.37 Most charging, however, occurs

ut home through a standard plug (92 hours for a fullcharge) or a high-power wall connector (10 hours fora full charge), which muy also be extended with atwin charger (five hours for a full charge) doublingthe charging capacity.

Tesla, however, not only relies on charging technology but also experiments with buttery swappingus an option alongside its Supercharger network.The switching station concept pioneered by BetterPluce, the now-bankrupt electric vehicle company,would provide an alternative to charging. UnlikeBetter Place, Tesla announced it would install battery swap stations in addition and next to its existIng Supercharger locations, enabling the customer tochoose between two options: charging batteries forfree (30 minutes), or swapping batteries (90 seconds)for a service fee amounting to roughly $60 to $80,the equivalent of 15 gallons of gas at current rates.Car owners may then opt to return for the older packto the station, have them delivered for a fee, or keepthe replacement pack with Tesla charging the valuedifference of the battery pack based on its age. Teslaestimates the cost per battery swap station to bearound $500 000.

Energy management and storage. While theproduction and storage of energy and solar power inparticular do not form an explicit business segment,Tesla hus teamed up with partner SolarCity (SCTY)

F 1 GU RE 7 Expected distribution of the price of an EV in 2020, by component (Source: Statista 2014)

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768 SECTION V CASES

10 distribute solar panels through the website 10 complement its product portfolio. Both firms ute collaborating 10 develop a smart energy storage system byusing stored electricity to reduce peak demand — Ihehighest amount of electricity used within the hill-Ing period. The business approach is to balance thegeneration and consumption of electricity by producing it through solar panels or retrieving it from thegrid during daytime in order to store und discharge itinto the EV (for example, Model 5) at night. Besidesoffering grid-independent backup power in case ofoutages, both the demand und prices for energy arelowered. Tesla provides battery systems to store theelectricity and promotes sotar-power systems amongits customers, and SolarCity installs the hardwareund contributes its software to optimize utility chargesavings for customers.

Human resources. Musk considers human capitalto be of the highest imponance, and he has u handson role in personally interviewing und hiring manyof the job candidatesH‘° The company‘s value, to alarge degree, is made up of the quality of the talentand intellectual property (IP) lt has generated overthe years. According 10 Musk, working for Tesla islike “you are choosing to be the equivalent of SpecialForces,“ as employees are expected to work at least50 hours a week. Employees are asked to challengethe status quo and allocate sufficient time for innovation. The firm‘s culture rather resembles that of atechnology startup than of a traditional car manufacturer. Tesla‘s engineering team is about 80 per centsmaller than the average team of a car manufactureras the company tries to compensate for quantity withquality by hiring only the best engineers. In 2013,Tesla was listed ninth among the “most innovativecompanies“ in a global innovation study.3°

To draw on best practices from diverse fields ofbusiness, Musk hired an experienced top executiveteam with exceptional skills, including Franz vonHolzhausen (Design: VW, Mazda, aM), GeorgeBlankenship (Sales: Apple, GAP), Chris Porritt(Engineering: Aston Martin), Doug Field (ProductDesign: Apple), Gilbert Passin and Rich Heley (Manufacturing: Toyota, Apple), Kristin Paget (IT: Apple,Microsoft). and Simon Sproule (PR: Renault-Nissan). Arnnon Geshuri, Tesla‘s HR director, who camefrom Google in 2009, assembled a highly talentedteam and created a culture geared toward interdisciplinary collaboration. Most of Tesla‘s facilities arelocated in California, allowing the firm to capitalizeon the pool of highly qualified employees graduating

from top universities and some of the world‘s mostinnovative firms. Today, the company employsapproximately 6 000 employees. nearly twice asmany as in 2013. To meet its aggressive expansiontargets, Tesla is expected 10 grow al ihe same pace inthe future.

Strategic partnerships

Daimler. In 2009, Daimler acquired a stake in Teslaund took a seat on the company‘s board of directors.Today, both lirms are intensely connected and leverage theirjoint strengths through Tesla‘s agility undDaimler‘s experience in order to drive the globalcommercialization of EVs. Over time, this collaboration increased to become a strategic partnership.which today covers knowledge exchange in vanous fields, such as engineering, production and supply cham. Musk noted that, in retrospect, Daimler‘sinvestment was most decisive for the firm‘s survivalinjecting capital when Tesla faced illiquidity. Today,both flrms maintain strong ties und Bodo Uebber,Daimler‘s chief financial officer, recently said thatDaimler is still Iooking “for more cooperation“4lwith Tesla.

Toyota Motor. The alliance between Tesla Motorsand Toyota Motor Corporation was established in2010 to cooperate on the development of EVs, parts,manufacturing system, and engineering support.Toyota intends to dose the gap with other automobilefirms that went ahead with pure EVs in the market.Moreover, Toyota wants to learn from the Tesla‘schallenging spirit, quick decision-making, und flexibility. In 2013, this pannership produced what wasdescribed by the press as the “cheapest Tesla on themarket[ the RAV4 EV — a smali Toyota SUV outfitted with a Tesla-built battery und an all-electricdrivetrain. -

Panasonic. In 2009, Tesla entered into a partnership with Panasonic Corporation to secure batterycell supply and insulate itself from Iithium-ion supplymarket uncertainty. The following year, both firmsintensified their partnership, and Panasonic becamea shareholder when lt invested $30 million in TeslaMotors. In late 2013, both parties updated an earlieragreement to expand Panasonic‘s supply to nearly2 billion cells over four years. Owing 10 fierce competition and declining battery prices — panly caused byan oversupply of key raw materials — the lithium-ionhattery business added 10 Panasonic‘s near-record net

CASE 10 TESLA MOTORS BUSINESS MODEL CONFIGURATION 769

j

lass in the past year. Nevercheless, the company viewsthe battery business as a key source of its turnaroundstrategy and future growth assuring lt will increaseproduction capacity of battery cells to serve Tesla‘sgrowing demand as it ramps up EV output.32

SolarCity. Tesla maintains strong ties to SolarCity,a corporation based in San Mateo, California, andchaired by Musk, that designs, instalis, und seils soiarenergv systems. The bulk of SolarCity‘s businesscomes from the leasing business, where SolarCityprovides a system for free in exchange for a 20-yearlease contract without the usually high upfront costsfor customers, Partnering with SolarCity, Tesia aimsto deploy its battery know-how to create a completeoff-the-grid kit for home solar-power storage. Thispartnership is somewhat of a famiiy affair, sinceMusk is the cousin of SolarCity co-founder and CCCPeter Rive.

Eariy an, Rive reveaied bis plan to design systemsfor powering homes and cars. SolarCity‘s first forayinto eleciric car-charging stations foliowed in 2009.when the company calluborated with Tesla to instullsalar-powered charging equipment on US Route 101in Caiifomia between San Francisco and Los Angeles.43 Musk indicated the pannership could be intensiried by pairing soiar-pawer systems and grid storagecomponents with the Supercharger siations to reducemarginal energy costs caused by “demand charge“— fees for demand during large spikes. ImplementIng solar power, however, wouid double the capitalcast of Supercharger stations, excluding grid storagesyslems.“

AT&T, TeliaSonera, Telefonica. in the past fewmonths, Tesla announced several partnerships withmobile communications operators. The companycollaborates with AT&T in the United States, andTeliaSonera and Telefonica in Europe to wireiesslyenable and connect its vehicles for safety diagnostics, remote monitoring. and repair via machinete-machine (M2M) interconnection.

Key value-creation activities

Design, engineering & production. The designand engineering activities for external clients, suchas battery packs, drive units, gearboxes und software,account for raughly 10 per cent of the company‘s revenue with a decreasing tendency. Tesla designs. testsand manufactures fully electric powertrain Systemsfor ather automakers, such as for its strategic partners

Toyota (RAV4) and Daimler (Mercedes-Benz andSmart). Autamotive production contributes about75 per cent to the firm‘s income. This last segmentincludes vehicles and related sales (vehicle options,accessories, and vehicle service). Another revenuestream is the saies of regulatory credits, such as ZEVemission credits or reimbursements received as partof the federal efficiency pragram (15—20 per cent).Since the production af the Roadster was phasedout, the Model S is the only vehicie in Tesla‘s product portfolio, although there is an option to reservethe upcoming Modei X crossover. As cars are builtto order, there is na storage and very little inventoryinvolved in the Tesla production system.

Sales, servicing and charging. To seil its cars,Tesla relies on a non-traditional direct sales approachaiming to create an “experience“ via companyowned stores, galleries, and service networks — andless on traditional adveaising concepts as the media.Stores are designed to be informative and enjoyabiewithout inventory an site, in contrast to traditionaldeaierships that maintain a large fleet of cars. Thecompany employs “product specialists“ rather thandealers. who are trained to explain Tesla‘s productsund answer questions about EVs in general — withoutany ulterior motives (commissian) or authority toseil the company‘s products. um Chen, Tesla‘s vicepresident for regulatory affairs, points out that thedirect-distribution approach, including incentives fordealers to push EVs, is rather weak because of thesmali car volumes and servicing profits generatedby Tesla‘s products as compared with combustionengine vehicles.

Orders may aniy be placed over the internet,thus cutting out sales representatives and the apparatus that goes with them. Since many of the salesare processed online, Tesla developed a highly interactive and comprehensive homepage that featuresseveral configurators that meticulously calculatereach, charging time, and savings, amang many atherthings, before visitors proceed to vinually assemble their desired vehicle in the “design studio:‘ Thecompany‘s homepage is also an important marketinginstrument featuring “customer stories“ that advertise Tesla‘s model through real-life experiences.Stores are positioned in visible and high foot-trafficretail iocations, like shopping malls, ta inform potential customers before car-buying decisions are made.Tesla‘s approach is to interact with future customers und “educate“ them about the benefits of gaingelectric early an. In this context, its buoyant biogs

770 SECTION V CASES

constitute a critical channel of customer feedbackund are an invaluable source for product improvement and innovation. In addition, Musk blogs andmakes frequent use of social media to communicatethe firm‘s advancements, reach out to the Tesla community, and generally create awareness for the firm.

Service is a top priority for Tesla. Its goal is notonly to fix things but to make them better thun theywere throughout the product lifecycle (for example, through software updates). To address concernsabout owning and driving EVs, 24-hour roadsideassistance (ranger service), remote diagnostics,and system monitoring were introduced. Tesla Service Centers arc planned to be erected across NorthAmerica so that Tesla customers will have to travelless than 50 miles to reach a Tesla Service Center.Technicians, concerned with repair and maintenance around the world, are tightly connecled to theresearch and development facilities located in SiliconValley and draw on this large Pool of knowledge viaonline channels to quickly resolve any problems.

A central part of Tesla‘s service proposition is itswidely accessible charging infrastructure, which hasbeen aggressively expanded over the past few years.Activities around the charging process have not beendesigned to create additional revenue (profit centers),but rather to create some added value to boost itsModel 5 sales. Customers pay a $2 000 access fee forthe Supercharger network und thereby receive accessto electricity ‘tor free, for life‘ Beyond that, Tesladistributes additional home-charging devices thatenabling faster charging processes.

Major challenges

Infrastruetural patchwork. Publicly availableelectric vehicle supply equipment (EVSE) has beendeployed across different locations, such as residential, office, retail, and street. EVSE expands quickly,particularly in the United States and Japan, with eachmaintaining approximately 20,000 non-residentialcharging stations, followed by China with roughlyhalf the amount (Figure 8). Countries that currentlyhold over 90 per cent of world EV stock announcedcumulative targets of more thun 2.4 million chargersby 2020. Access to most non-residential chargingstations is still restricted hecause of subscriptionsand roaming charges, or limited to certain EV modeis. Moreover, various charging standards, such asthe CHAdeMO (Nissan, Mitsubishi) or the SAEplug (OM, BMW) were established by the market

players, hampering access. Officials said Tesla isalready working on an adapter that is compatiblewith SAE Combo Chargers and is also willing tolicense its Supercharger technology if conditions areright. “We‘re not trying to create a closed system,“Musk clarifled. “Wejust need to solve the problem oflong-distance travel, and we can‘t wait for others toagree with our strategy.“3‘

Regulatory guesswork. The EV sector has receivedsubstantial backing from governments around theworld in an attempt to stay ahead of the technologyrace, lessen dependence on oil and damaging pollution. Public money fortax incentives, subsidies, as weilas favorable regulatory conditions, spurred innovationand the diffusion of EV technology over the past fewyears. Tesla has considerabiy benefited from revenuesthrough ZEV credits in the past ($119 million in 2013only). Recent developments show that regulatory conditions may quickly change und have serious implicaLions for Tesla‘s business model.

Several states, such as New Jersey, Texas, Virginia,Maryland und Arizona, prohibited or restricted carmanufacturers from selling vehicles directly to consumers, while others, such as New York, Minnesota,und Georgia, arc about to foilow the ban. Pushed bya strong ICE lobby, this decision threatens to shakeTesla‘s direct-sales model in favor of incumbentdealerships. The argument is that franchise laws wereput in place to prevent a manufacturer from unfairlyopening stores in direct competition with an existing franchise dealer and that a franchise middleman keeps carmakers from ripping off consumersund protects price competition. “I‘d rather fight onefederal battle,“ Musk said, who is preparing to go toWashington soon.

Technological risks. Tesla has been a technological pacesetter over the past few years. In contrastto its large incumbent rivals, Tesla faces a twofoldchallenge: scaling up production and its proprietaryinfrastructure, and keeping pace with technologicaladvances. Both tasks demand high capital und humanresource investments. Tesla‘s research and development budget ($270 million in 2012; $250 million in2013) makes up only a fraction of what is availableto competing incumbents (Figure 9). For instance,an already massive research effort is underway toexpiore autonomously driving (or self-driving) carsby firms like Google, BMW, and Volvo. A recenttweet by Musk, which called for applications of engineers interested in autonomous driving, indicates thatTesla is taking this challenge very serious.36

CASE 10 TESLA MOTORS‘ BUSINESS MODEL CONEIGURATION 771

FIGURE 8 Non-residential EVSE stock in selected countries, by fast and slow chargers in 2012(Source: International Energy Agency)

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Daimler

______________________________________

General Motors

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772 SECTIONVCASES

An unsophisticated produetion process, relativelyloose supplier relationships, and little experiencewith assembled parts contribute to Tesla‘s exposureto multiple risks of delivery failure (such as qualitydefects or supply shortages). Moreover, there is somereal concern about the safety of Tesla‘s battery technology after its Model 5 repeatedly caught fire. Mostof Tesla‘s technology is new und has not had comprehensive market testing. While many problems canbe fixed through software updates, some hardwareissues remain. In a recent case, a Model 5 blazedwhile parked in a garage, prompting the company tosend the owners new charging adapters and softwareupgrades to prevent overheating. To pre-empt damage to the company‘s reputation, Musk announced toamend the current warranty policy to cover damagedue to fire. Today, Tesla faces recalls and even a federal inquiry into the security of its cars, which mightcall its quality and safety into serious question afterit received record scores for being the “safest car inAmerica“ (National Highway Traftic Safety Administration) and the “best car in history“ (ConsumerReports — 99 out of 100 points). The benchmarkagainst which Tesla‘s quality is measured is high.

Market challenges. On several occasions, Muskhas emphasized the importance of the battery supply as the bottleneck of the company. Particularly, thesupply of lithium and cobalt as the most crucial rawmaterials carry significant risk for Tesla‘s business.A large portion of the global supply of cobalt originates in the unstable Democratic Republic of Congo.While interruptions in delivery could cause rapidprice increases, producers are ahle to swap out cobaitfor other materials, like manganese. This is differentfor lithium, which is an indispensable ingredient ofTesla‘s current battery technology, posing a seriousthreat to Tesla‘s battery supply chains.4‘ While anoversupply of lithium exists today, the situation mightchange in the future as an increasing share of supplyflows into competing demand for smart phones, tablets and other computing devices. Musk expressedbis concems about the company‘s supply base and itsability to keep up with Tesla‘s fast-paced growth.35

But there could be more problems ahead for Tesla.With new models introduced from high-end competition (such as BMW, Audi, and Mercedes), and alarge amount of models already available in the midmarket segment (for example, Nissan, Chevrolet,and Toyota), Tesla risks being squeezed into a nicheposition. To respond to this threat, it seems crucialfor Tesla to expand its capacity and operational

efficiency to lift economies of scale and distributeproduction cost on a larger output volume. However,with roughly around 25 000 cars produced, Tesla hasa long way to go to receive suppiy conditions comparable to those of its far larger competitors.

Above all, the question remains whether marketdemand will allow further scaling or lock Musk‘s firmin a luxury niche. Tesla‘s business model has beencontigured, and its operation has been developed toserve the mass market. At some point, Tesia will seilautomobiles with a sticker price for less than $40 000.However, scaling is crucial not only to reduce production costs and lower sales prices for muss commercialization but also to reach the profitable operationof many other activities included in Tesla‘s businessmodel — most impoaantly, to achieve an increased utiiization of battety charging and swapping infrastmcture,and to fully expioit the potential of its saies network.

Product risks. Analysts expressed doubts aboutthe viability of Tesla‘s current business model forpotentiaiiy high costs of ownership involved due tothe uncertainty of Model 5 value retention. To eliminate these doubts and lower upfront payment hurdies, Tesla announced an alternative financing optionoffered in cooperation with US Bank and WellsFargo. A lease/ownership hybrid is available, wherecustomers get 10 per cent off the car with fundingfrom banks and then pay a monthly fee, and inciudesan option to seil the car back to Tesla at a minimumof 50 per cent of its original cost after three years ofuse. However, current predictions see battery costdeclining by half over the next three years, thus posing a severe risk to the deiicate resaie-value promise.Appiying a current industry average of around $400!kWh, the battery pack on its own is worth $34 000,roughiy 46 per cent of the total cost of the vehicle. Ifprices drop as forecasted, Tesla‘s value will deteriorate faster than expected, causing guarantees to comeat significantly higher costs to the company.

Looking aheadMost recentiy, Musk announced to build a $5 billionUS factory by 2020 and claims it will make morelithium-ion batteries than all other plants on earthcombined. A press release stated that Tesla aims tO

leverage demand for lithium-ion batteries to reducecosts faster by achieving economies of scale andminimizing costs through innovative manufacturing.The target is to reduce battery costs by 30 per cent by2017. The battery factory is planned in cooperatiofl

CASE 10 TESLA MOTORS‘ BUSINESS MODEL CONFIGURAT!ON 773

with strategic battery manufacturing partners (forexample, Panasonic) to share the risk, optimize colocated processes, and reduce overhead costs.

Analysts arc also confident that Tesla‘s SiliconValley location will give ii a head start in autonomous driving technolog. fle iPad-like control panelof the Model S and a recent meeting with Apple‘shead of M&A set oft speculation that the two firmsmight soon join forces for deeper iOS Integration inbaiteiy technology. Musk remained silent about concrete plans, however, only leaking that any scenarioof a partnership or acquisition would need to bringTesla closer 10 its pronounced goal of becoming amass-market car manufacturer.

Musk has also revealed that he has been in talkswith Google to bring driverless technology to Tesla‘svehicles. Musk says he believes autonomous driving is the next logical step in the evolution of carshut thinks Google‘s lechnology (which uses sensorsinstead of an optical system) is too costly. “1 thinkTesla will most likely develop its own autopilot sys1cm for the car, as 1 think it should be camera-based‘Musk said und added, “However, it is also possiblethat we do something jointly with Google.“4°

Tesla seems to be headed toward a more digitallyinterconnected business model. In April 2014, Telefonica made official that it will support the wirelessconnectivity for Tesla cars across the United Kingdom,Germany, the Netherlands und Spain. Telefonicz willprovide Internet connectivity for various in-car “infotainment‘ und telematics services (driver habits andusage), including navigation, streamed music, Internetbrowsing. und remote vehicle diagnostics. lt followssimilar caffler deals Tesla recently signed with AT&Tin the United States, und TeliaSonera for Sweden,Denmark, Finland, Estonia. and Latvia. Generating datafrom car drivers bus become a stralegic issue for Teslato conven cm‘s from mere mcml 10 mindfiil companions.

On 24 Febmaty 2014, Tesla raised almost $2 billonon the market to help fund a giant battery factory. Teslanow holds more cash than it ever bad in the brief bistory of the company. Cash and cash equivalents at firstquarter end of 2014 increased to almost $2.6 billion —

a considerable sum for future investments.

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