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Executive Summary

As consultants to Tesla Motors, we recommend that Tesla expand its product line with the Gen 3 to capture the growing mainstream market. Tesla can do this by expanding its supplier base, developing new distribution centres and increasing its online presence.

With demand for Electric Vehicles (EVs) expected to grow in the future, Tesla must address several key issues, including the financial feasibility of expanding manufacturing and distribution capabilities, supply risk caused by single-source suppliers and brand positioning within the automotive industry.

While Tesla did achieve profitable growth in its most recent year, its capacity to expand its operations will dictate the company’s sustained success moving forward. With global competitors entering the EV market every year, Tesla must implement its new strategy quickly to preserve its first movers’ advantage in sustainable battery technology and capture the sustainable vehicle market during its infancy.

In addressing these issues, we considered the following alternatives:

• Begin Value Car Production: Tesla could pursue the mainstream market through high-volume production of the affordable Gen 3 model.

• Increase Premium Car Production: Tesla could leverage industry growth and establish itself as a leader in the premium segment of the market, exclusively selling the Model S and X lines. This would allow Tesla to maintain its luxurious brand image without alienating its existing customer base.

• Manufacturing Supplier: Tesla could leverage its core competencies in battery technology production to become a supplier for traditional car manufacturers who are planning to enter the electric vehicle market. We evaluated each alternative based on a set of criteria: financial feasibility, long-term sustainability and operational viability. While the first option requires significant capital, it strategically positions Tesla to become a market leader in both the premium and low-cost EV market. Our implementation suggests coupling this strategic decision with an expanded supplier base and the incorporation of distribution centres to level production and meet current capacity constraints.

Introduction

In 2003, Tesla Motors was founded with the goal of bringing a high quality electric car to the masses. With the 2012 release of the mass-produced premium “Model S” bringing the company critical acclaim and its first profitable year, Tesla looks to realize its goal through an affordable Gen 3 model. A turbulent political environment, hesitant target market, and increasingly threatening competition make achieving this vision difficult. This report will analyze Tesla Motors’ operations strategy and suggest how it can use its capabilities to become a mass manufacturer of electric vehicles (EV).

Background

Political

Federal tax credits and selective state rebates have made EV’s more accessible to the general population, increasing customer demand. This makes the industry more lucrative for competitors, making it more difficult to launch a successful mass-produced vehicle. The United States government, however, has clashed with Tesla on its distribution strategy. The success of the traditional dealership lobby in blocking Tesla sales in some states hinders the company’s ability to capture sales and achieve its mass-manufacturing goal. Though the potential for expansion is growing, Tesla must make sure its sales tactics are consistent with regulation.

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Industry

The American automobile industry is driven by a concentrated group of valuable brands supported by a network of dealers across the country. Niche companies must eventually reach beyond word of mouth to capture a large audience. Those looking to capture a mainstream audience, however, are challenged by the advertising expenditure of entrenched brands like BMW who have an estimated brand value of $30 billion. Dealership franchises, which locally serviced, marketed and sold cars, have established customer relationships and dominate distribution. Dealers profit by providing maintenance and service to customers at a recurring cost. Additionally, existing players undergo a costly and lengthy process to retool their plant for a new product, creating an opportunity for entrants who can optimize their production to reduce lead-time. Tesla can bypass dealers and outpace the competition with operations optimized for quickly releasing high quality products with limited service needs.

Electric Cars

Electric cars are differentiated by their design simplicity and battery cost. With battery production expected to increase, efficiency in energy storage distinguishes the competition.

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Competitors

Nissan Leaf

The Nissan Leaf is a fully electric, low cost, mid-sized sedan that would directly compete with Tesla’s Gen 3 product. The manufacturer has leveraged its existing brand and customer base to quickly establish Leaf as the green alternative in the marketplace. Nissan also has a first-mover advantage through its proprietary Li-Ion battery technology, creating opportunities for optimizing operations, increasing energy storage, and reducing costs. Sales of 26,000 cars in 2012 may indicate that the market for low cost EVs is limited, or that Tesla still has an enormous opportunity to capture the market and become a market leader.

Tesla

Strategy

Tesla incorporates a vertically integrated operations strategy to design, build and sell EVs and EV powertrain components. This structure enables the company to establish its expertise in a rapidly evolving industry and quickly develop new products. Tesla’s responsive operations address critical design and performance issues that have limited EV adoption, supporting its goal of becoming a mass electric car manufacturer.

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Positioning

Tesla sells high performance EVs with technically advanced value-added features. The company’s blended focus on performance and long-term cost savings position it in both the premium and environmentally friendly electric car market (Exhibit 1). Tesla successfully achieves this positioning by leveraging the design of the EV, placing the battery at the bottom of the car to achieve superior handling and performance in products like the Model S. Its limited distribution and focus on design creates an exclusive brand image that contributes to its perceived value as a premium car manufacturer. This puts its products in stark contrast to the Nissan Leaf, whose value proposition and design is focused on being environmentally friendly. In order to provide these features and maintain this differentiation, Tesla exerts significant control over its operations.

Supply Chain Management

Almost all of Tesla’s production occurs in-house to produce custom parts and develop operational efficiencies (Exhibit 2). By owning each aspect of production, Tesla gains experience in creating the car’s components as cumulative units produced increases, reducing per unit costs and overall product development time. Despite the burden in coordinating various aspects of the supply chain, Tesla successfully automates core processes through the use of multi-purpose robots, and has developed core competencies in computer-aided design, engineering, and crash testing to minimize lead times.1 This has allowed the company to produce world-class components and accumulate significant informational resources through its extensive patent portfolio.2 Tesla is able to learn from other company and industry applications by selling its powertrain to companies like Toyota and using its battery technology to sell energy storage applications for homes and commercial sites. Over time, Tesla has reduced its battery costs to less than half of direct competitors like Nissan. This battery cost advantage is instrumental in differentiating Tesla’s vehicles in the industry.

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Distribution

Tesla sells its vehicles through company-owned stores operated by salaried employees. The significant investment to setup stores in high-traffic locations is a trade-off in what could otherwise be spent on improving operations. Tesla does this, however, to maintain relationships with potential customers, educate the public about its technologies, and showcase its products. Though customers can order directly from stores, most choose to customize, meaning stores do not carry large inventories and new products are made to order.3 Tesla continues to successfully capture demand by implementing a backorder system, allowing customers to reserve a model in advance.

Organization

Tesla’s diverse team enables the company to use its human resources to achieve its broad, vertically integrated strategy. Members of the Tesla team come from backgrounds in technology companies and the automobile industry and possess a wide array of business and technical skills. Current vice-presidents have backgrounds from companies like Ford, GM and Toyota, giving Tesla the insight to competitively organize its resources. Tesla also hires many engineers from Silicon Valley, who serve as key resources in giving its products a software advantage over conventional and EVs. Elon Musk’s entrepreneurial experience coupled with his technical background make him the ideal decision-maker to position Tesla for long-term growth. His focus, however, is potentially limited with his simultaneous involvement in companies like SpaceX and SolarCity. So far, Musk has incorporated positive components from his previous experience into shaping Tesla’s operations, like incorporating the layout of SpaceX’s production warehouse for the Tesla Factory.

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Key Issues

Tesla has developed a number of competencies that enable it to produce high quality components and EVs. It has done so operating as a niche brand serving a small market relative to its competitors (Exhibit 4). The company’s ability to grow into a mainstream manufacturer, however, is constrained by its limited financial capabilities, capacity, supply sources, and distribution methods.

The recent success of the Model S has allowed Tesla to turn a profit and caused the stock price to skyrocket. With a last reported cash position of only $800 million and typical capital requirements of $1 billion or more, however, Tesla has limited financial capabilities to continue investing in vehicle production.4 The company was fortunate to purchase its current factory and equipment at discounted prices during the recession. With the economy inevitably expected to improve, it is unlikely for these opportunities to reappear. Tesla’s recent success has enabled it to pay off a significant debt to the U.S. government, reducing its debt to equity ratio and enabling future financing through debt (Exhibit 5). Tesla could also finance by issuing additional shares, taking advantage of its high stock price at the cost of diluting existing shareholder equity.

With all three of the company’s major models to be produced at the central Tesla Factory, Tesla’s manufacturing facilities are under significant pressure to meet demand. Tesla currently operates a responsive supply chain that can produce a limited quantity of high quality, customizable products. A focus on growth would require a shift to an efficient supply chain focused on simpler product specifications and greater production volume. Tesla’s factory equipment can only reasonable handle the production of 100,000 units annually, a figure the company is projected to meet in 2015 (Exhibit 3). With the Model X and the Gen 3 in regular production by 2018, Tesla will have outgrown its factory production capacity of 500,000 annual units.

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Tesla sources approximately 2000 parts from 300 suppliers, many of which are single source suppliers.5 Though this is the industry standard, it puts Tesla at a risk of stocking out. Tesla is especially at risk given its currently small, homogenous product portfolio and above-average use of critical materials like battery cells. The company has recently decided to invest in a Gigafactory solely focused on the production of battery technology to solve this problem, but it isn’t expected to reach full production capacity until 2020.6

Tesla’s current means of expanding its distribution are slow and costly. The company faces a significant upfront cost in acquiring and developing stores in high-traffic locations. This takes away resources from its operations and adds additional management overhead, diverting the company’s focus. Tesla will find it difficult to compete against incumbents with decentralized dealership networks that individually promote, sell and service conventional and EVs.

Alternatives

Strategic

Value Car Production

Tesla could proceed with pursuing the mainstream market through the high-volume production of the affordable Gen 3 model. This is the most likely option to achieve management’s goal of becoming a mass electric car manufacturer. This also addresses the gap in the lower-end electric vehicle market, which was unsuccessfully targeted by Nissan. With significant volume, Tesla could achieve economies of scale, driving down costs of production. In the short-term, however, current capacity would still have to be upgraded. Serving a different market segment, the affordable Gen 3 could dilute Tesla’s premium brand image, adversely affecting overall company sales. The company would also have to invest

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resources into marketing the new product for a brand new audience, where it would likely face heightened competition from traditional manufacturers, including Nissan.

Premium Car Production

With the EV industry expected to grow, Tesla could choose to maintain its foothold in the premium segment of the market. The company would exclusively produce the Model S and Model X lines. This would maintain the company’s premium brand image, leveraging its existing customers and fit current factory capacity constraints. This option, however, does not fully capture the mainstream market and therefore does not completely align with management’s preferences. This also leaves the market open for competitors to establish themselves. Traditional manufacturers could then leverage their capabilities from the mainstream market to encroach on the premium segment, threatening Tesla’s long-term sustainability.

Manufacturing Supplier

Tesla could leverage its core competencies in producing battery technology and powertrains to provide the supply and infrastructure for other car manufacturers. This would capitalize on the industry’s expected growth to $25 billion in 2020. Operating as a niche player in the industry has enabled Tesla to develop a series of valuable proprietary technologies. Though these could be leveraged as part of a broad plan in becoming a mainstream manufacturer, such a move would require Tesla to outpace decade-old incumbents with established competencies in the development and distribution of vehicles. Recognizing this challenge, Tesla could instead profit by selling its technology to manufacturers, ultimately enabling the mainstream adoption of the EV while not necessarily directly providing the product. By empowering its competitors with its proprietary technology, however, Tesla is potentially diluting its competitive advantage.

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Tactical

Leasing New Factories

Tesla could lease additional space near the current Tesla Factory to meet capacity constraints, without a significant upfront cost. Leasing a property near the main factory would also allow the company to retain production in close proximity to ensure alignment and responsiveness. Though this provides a time buffer to make additional investment in the long-term, the company will be disproportionately affected financially when the lease ends. Tesla would also face additional overhead adjusting its operations and moving equipment to a long-term location at the end of the lease.

Supplier Trade Partnerships

Supplier partnerships could be developed with other car manufacturers, which would exchange currently single-sourced supplies for Tesla’s powertrain or battery technology. This would meet Tesla’s short-term supply constraints in the event of a demand shock, while leveraging Tesla’s core capabilities. A potential risk with this alternative is that Tesla would be effectively supplying its future competition. The upside, however, is continuing Tesla’s EV production, which ultimately contributes to the development of its operational processes and its overall competitive advantage, keeping the company ahead of other manufacturers.

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Online Sales and Distribution Centers

Tesla could create a production buffer by making cars to stock in distribution centers, which would be purchased through company stores or online. Customers would purchase cars online which would be available at local distribution centers in regional centers. A single distribution center for the sole purpose of holding inventory for customer delivery replaces the need multiple company-owned stores in an area, which served as an expensive point of sale. Tesla could now stock units in advance of reservations, enabling customer responsiveness and reducing capacity pressure during demand shocks. Though forecasting may be challenging during the company’s growth stage, Tesla can leverage its reservation system in the event of a stock-out.

Recommendation

As consultants to Tesla Motors, we recommend that the company pursue the production of the Gen 3 model, expand its supplier base through trade partnerships, and prioritize online sales with delivery from newly developed distribution centers. Despite its strategic fit, expansion through the Gen 3 model was constrained by Tesla’s current operations. The use of an inventory buffer, however, allows for Tesla to continuously produce vehicles to meet demand shocks. The expanded supplier base ensures Tesla will have the required resources to continue producing vehicles. As a result, the tactical decisions compensate for Gen 3’s immediate shortfalls, enabling Tesla to effectively pursue its goal of becoming a mass electric car manufacturer.

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Implementation

To successfully position itself for mainstream production, Tesla needs to invest throughout its value chain (Exhibit 6). In the short-term, Tesla should begin establishing trade partnerships with suppliers that provide critical production components. The company can then begin to raise capital primarily through debt to take advantage of its low debt levels and avoid diluting existing shareholder equity. It can use these financial resources to build its distribution centers across North America. With the tactical infrastructure in place, Tesla can begin retooling its plants to produce its Gen 3 model in 2017.

Risks and Contingencies

Focusing on online sales may limit the public’s awareness and engagement with Tesla’s brand. To mitigate this risk, Tesla could employ pull marketing tactics, like touring countries with its products, educating customers on their merits and allowing test-drives.

The mass production of an affordable model may dilute Tesla’s premium brand image. This is an unavoidable trade-off that Tesla needs to make to produce a low cost vehicle for the masses. Tesla could leverage its engineering talent to produce value-added technological features that enhance the Gen 3’s driving experience.

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Appendix

Exhibit 1: Competitive Positioning Map

Eco-friendly

Affordable

Exhibit 2: Tesla’s Supply Chain

Premium

Pollutants

Design and EngineeringRaw Materials SourcingComponent ProductionPaintingAssemblyTechnologyDistribution

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Exhibit 3: Capacity Utilization

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Exhibit 4: Operations Strategy Summary

Resources Base Physical Resources Huge manufacturing plant in Silicon Valley PP&E comprise one-third of assets Human Resources Skilled labour with a strong management team with diverse backgrounds IP, Software, and Methods Over 200 patent filings. Focus on proprietary technologies: custom power train and battery technology. Experience learning curve Utilize engineering and design in production and value-added services. Possible partnerships with Apple & Samsung Ecosystem Resources Sources 2000 parts from over 200 global suppliers (Model S). Lots of customization. Panasonic partnership on battery technology. Partnerships enable possibility for capital investment through initiatives like Gigafactory. Maintain excellent relationships with suppliers. Financial Resources Profits used to create more affordable cars. Abundant cash position enables further capital investment. Resource Integration Centralized Coordinated assembly line Diverse backgrounds enable partnerships and intellectual property. Continually seek out educated employees from Silicon Valley and Stanford. N/A Resource Development and Acquisition Financial capabilities enable further development through acquisition or leasing. High stock price enables possible stock issuance. Stable debt to equity levels indicate possibility for future financing through debt.

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Exhibit 5: Financial Ratios

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Exhibit 6: Implementation Timeline

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Works Cited

1. 2. 3. 4.

WIRED, https://www..com/watch?v=8_lfxPI5ObM Tesla Motor, Inc Annual Report, Item 1 Business, page 5 Tesla Motor, Inc Annual Report, Item 1 Business, page 11

Tesla Motor, Inc Annual Report, Item 8 Financial Statements and Supplementary Data, page 92

5. Tesla Motor, Inc Annual Report, Item 1 Business, page 14

6. Greentech Media, http://www.greentechmedia.com/articles/read/Tesla-Giga-Factory-Update-4-to-5-Billion-Price-Tag-With-Production-Slate

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