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Five myths about Tesla

August 31, 2018 at 2:34 PM

Does the future of electric vehicles really depend on Tesla? (Spencer Platt/Getty Images)

Tesla — manufacturer of elegant, high-performance electric vehicles — and its high-profile CEO, Elon Musk, have been in the news lately, but not always in the best light. One week, the company is going private; a few weeks later, no deal. The company isn’t the biggest electric-vehicle manufacturer, but it’s the one with the most buzz. And with that, come some big myths.

Myth No. 1

Tesla is
destined to fail.

The company is burning mountains of cash, accumulating $9 billion in operating losses since it was founded. For the quarter ending in June, the net loss ballooned to $717 million. It’s among the most shorted stocks on the market, with investors having sold about 25  percent of tradable shares in the belief that it’s overpriced. Some Tesla bears, like credit analyst Vicki Bryan, think that “Tesla could be headed to bankruptcy unless it can quickly resolve serious near-term pressures, including ominous debt maturities that threaten to deplete its rapidly eroding cash.” Musk’s erratic behavior, including his recent going-private, “funding secured” tweet and the resulting Securities and Exchange Commission investigation hasn’t helped this outlook

But the company has many strengths, including a record of designing and producing attractive, exciting cars. Consumer Reports gives high marks to Tesla’s vehicles, and perhaps most important, Tesla drivers love their cars. Even the much-debated stock price remains near its all-time high, providing the company with room to raise additional capital when needed. The Model 3 is successfully outselling (nonelectric) luxury offerings from BMW, Lexus, Porsche and Mercedes.

Tesla does face significant production challenges: It has consistently  missed its own targets , and there are many reports of difficulties in its Fremont, Calif., factory. But the success of its products suggests that the company will be worth salvaging, even if the current management team can’t make it profitable. Even in the worst case — a liquidity crisis, bankruptcy or a massive legal judgment that wipes out shareholders — Tesla would probably still be viable as a luxury carmaker. It would just be one like Porsche, with an estimated value of $10 billion , rather than the $50 billion Ford or the $500 billion (and then some) that Musk foresees

Myth No. 2

The future of mass-market electric cars depends on Tesla.

Many believe that major setback for Tesla would be an ominous sign for electric vehicles. “If Tesla falls, who can we count on to carry the torch on EVs?” asked a recent Forbes article. “The electric vehicle revolution still needs Tesla,” Axios asserted in early August. 

But the technology is charging ahead. Tesla is one of many manufacturers of EVs. Nissan, Ford, General Motors, BMW, Kia and others all sell electric cars. Jaguar’s new EV, the I-PACE, is getting reviews that suggest it’s equal to or better than Tesla’s in terms of driving experience. A broader view of electric-vehicle technology tells an even more encouraging story: In 2017, Toyota sold 30,000 plug-in Prius Primes with an EV range of 25 miles, and more than 150,000 traditional hybrids that don’t plug in to recharge. Toyota sells more hybrid cars in six months than Tesla expects to sell all year. EVs are close to 5 percent of sales in California, hybrids and electrics make up 52 percent of the Norwegian market, and EVs are seen as a major tool for reducing air pollution in Chinese cities. That market share will increase with or without Tesla.

Myth No. 3

Elon Musk knows
what he's doing.

Observers marvel at Musk’s genius, offer advice about how to be creative like him and generally fawn over his accomplishments . One new book compares him to Albert Einstein. Since the passing of Steve Jobs, Musk has assumed the mantle of the most venerated entrepreneur in Silicon Valley. With that admiration comes a presumption that he always knows what he’s doing or, as one investor said, “Whatever it is, he’ll get it sorted out.” 

While Musk has created a narrative focusing attention on exceptionally cool products or the generalities of production, Tesla’s failure to recognize and respond to the profound challenges of scaling belies an inability to absorb expertise based on more than 100 years of automobile manufacturing. Perhaps Musk’s supreme confidence has gotten in the way of transforming his vision into reality. Even he has admitted some big mistakes, such as “excessive automation,” and it is clear that his “funding secured” tweet was an unforced error.

More fundamentally, there is an inherent contradiction between being an innovator and knowing what you’re doing. Innovative entrepreneurship is about building into the unknown and the unknowable. As Yogi Berra said, making predictions is hard, especially about the future. The more fantastical Musk’s vision of the future is, the more likely it is he’ll make a wrong turn trying to get there.

Myth No. 4

Tesla can be profitable
if it hits Musk's goals. 

Musk says the Model 3 will be profitable as average costs decline with scale. He set a goal of producing 5,000 Model 3s a week by the end of the second quarter. That led him to undertake a heroic effort in late June that included the unprecedented step of setting up a temporary production line in a tent in a parking lot. The 5,000-unit goal was achieved just hours after his self-imposed deadline. Corresponding to the production increase, with the introduction of the Model 3, Tesla’s revenue growth has been dramatic: Revenue from April through June was $4 billion, 43 percent more than in the same period in 2017. 

However, the goal of 5,000 units per week exists because Musk set it. There is no reliable evidence that costs per unit are coming down or that 5,000 units is some magic inflection point. The only reason we believe that Tesla’s costs will be low enough at 5,000 cars per week is because Musk said so. In fact, there is no proof that the company will be able to sell 5,000 Model 3s a week profitably. There are several hurdles it will need to overcome to do so.

First, selling lots of product does not mean a business is profitable. Some of us remember eToys.com, which grew quickly in the late 1990s. Unfortunately, the costs of buying toys wholesale and shipping them were higher than the revenue from selling them. Popularity doesn’t always equate to profitability. Musk refuses to supply a $35,000 version of the Model 3, stating that this cannot yet be done profitably. But that’s where the bulk of demand is. Despite the hubbub about the 500,000 customers who made $1,000 deposits and the resulting delivery backlog, new customers are waiting onlyfew weeks for souped-up Model 3s, suggesting that many pre-orders were for the basic $35,000 model and that demand for the only type of car that Musk can produce profitably — the high-margin $50,000 or $60,000 one — is soft. The question is not whether the Model 3 is cool, it’s whether that cool car can be built and sold profitably. 

Myth No. 5

Tesla is more than
a car company.

Tesla is based in Silicon Valley, not Detroit. Teslas have large displays and more highly integrated software than other cars on the market. A Tesla’s operating system can be updated over the air, just like a phone’s. “Tesla is a technology company first, and a car manufacturer second,” as TheStreet put it recently. Tesla is vertically integrated and makes its own batteries, prompting some to see promise in its energy storage business . While many companies are talking about self-driving cars, Tesla’s Autopilot feature is deployed today. One argument for the valuation of Tesla is that it is disrupting the auto industry, creating a new type of company.

Nonetheless, it would be a mistake to conclude that Tesla is anything but a car company — and subject to the same realities as any other. Battery production notwithstanding, not only do most other major manufacturers have significant capabilities in these areas, they have something else: a proven ability to produce at scale. Since before Henry Ford, scaling has been the bane of new car companies, and it has emerged as the bane of Tesla. Musk himself has made clear that Tesla will live or die by this capability. (Tesla’s residential and commercial solar business accounts for only a small portion of its overall revenue.)

How Tesla is framed has real consequences for the business. Since Tesla is a car company, it matters that it is very difficult to make money selling automobiles. It is even more difficult to make money selling electric ones. Large, diversified manufacturers like Ford, GM and Nissan have financed the development and production of electric automobiles from sales of internal combustion cars. Tesla has had to resort to selling stocks and bonds to investors, interest-free customer deposits , Energy Department loans and the sale of zero-emission vehicle credits in California . If Tesla can be framed as something else, then it can continue to raise money based on an abstract promise of a disrupted future. But if it’s just a car company, then it needs to start making money by selling cars.

Twitter: @brentdg2
@darchivist

Five myths is a weekly feature challenging everything you think you know. You can check out previous myths, read more from Outlook or follow our updates on Facebook and Twitter


Brent Goldfarb is associate professor of management and entre­pre­neur­ship at the Robert H. Smith School of Business at the University of Maryland. He is a co-author of “Bubbles and Crashes: The Boom and Bust of Technological Innovation.”

David A. Kirsch is associate professor of management and entre­pre­neur­ship at the Robert H. Smith School of Business at the University of Maryland. He is a co-author of “Bubbles and Crashes: The Boom and Bust of Technological Innovation.”

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