Why Big Auto just can't squash Tesla

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Originally published at evannex.com.

In what must be one of the longest headlines in history, Bill MacDonald asks, “Why don’t bigger car companies such as Ford start producing electric cars, eliminating Tesla’s presence in the emerging market, thus claiming said market share for themselves?”



Above: Tesla's Model 3 (Image: Vlad Tchompalov)

The answer, as MacDonald reveals in a recent article published in Quora, is simple: Because they can’t.

Many have mocked Tesla for “bleeding cash,” although Tesla would probably rather describe what’s been going on as “investing in new products.” As the legacy automakers expand their EV offerings, they will soon be bleeding cash as well, as one after another Big Auto exec has admitted.

Shifting production from ICE vehicles to EVs can’t be done by simply flipping a switch on the assembly line. “New battery and powertrain tech has to be engineered,” MacDonald writes. “Manufacturing for those parts has to be established. Supply chains for new types of raw materials have to be established. Platforms that accommodate efficient EV operation have to be engineered. Branding and marketing strategies have to be figured out. Shipping, sales, and service logistics and training have to be established. And in the end, the product can’t just be any EV. It has to be competitive with a Tesla.”

The old-school OEMs can choose to bed down on a rock - build new factories and logistics networks for EVs - or on a hard place - dismantle existing facilities and retool them to produce EVs.



Above: Factories producing internal combustion engine cars will need to adjust to address battery electric vehicles (Image: The Manufacturer)

Either option is going to require massive new investment. How much? MacDonald figures it will cost “roughly the time and money that Tesla spent, minus some savings for being more efficient about it than Tesla has been. Even if you can do it 30% more efficiently than Tesla has done it, you are still talking about 11 figures [tens of billions].”

If and when the automotive giants do start producing EVs in volume, their woes will be just beginning. The greenie and techie early-adopter buyers have already gone electric, so once the volume market gets rolling, every buyer of an EV will be one less buyer for a dinosaur-burner. That means the automakers will be cannibalizing the ICE business that they are still paying big money to operate. Right now, they’re enjoying huge margins on gas cars, especially trucks and SUVs, but they aren’t able to earn anything like those margins on EVs - indeed they’re lucky to make any profit at all.

MacDonald sees that situation reversing over time. “The minute your EVs become competitive, you will slowly start making less and less money on ICEVs, as the volume drops and economies of scale reverse. The margins on ICE will dry up much faster than the margins on EV will grow. There will be a gap. During this gap, you will still be pouring cash into EV factories and logistics, while your profits have suddenly dried up.”

The worst parts of the story for the majors have to do with battery supplies and sales and support logistics. Today, only Tesla and BYD have control over their own battery cell supply chains (although Daimler has taken a step in the right direction with its acquisition of German battery-maker ACCUmotive). In order to secure enough batteries at a competitive price, the legacy brands will have to make massive investments of time as well as money, long before they start seeing much profit from EV sales.


Above: According to UBS, Tesla's batteries are 20% more cost efficient than the next best on offer from LG Chem (Source: Financial Times via UBS)

Furthermore, the majors’ business model is based on franchise dealerships, which MacDonald calls “a way of subsidizing the sales and support logistics of making cars, via the heavy cost burden of routine service and non-warranty repair.” But service revenues for EVs are sure to be much lower. As Tesla has shown, they may turn out to be virtually non-existent. How are the automakers going to respond when their dealers lose their most reliable income stream? “If they have a higher cost of routine maintenance than Tesla, their cars will be seen as inferior and people will buy Teslas instead. If they match Tesla’s lack of maintenance [requirements], their sales operations will go out of business and they will have to spend even more money to build a non-franchise sales and service operation just like Tesla had to do.”

In the end, the old guard will end up in the same situation they’ve been knocking Tesla for: “burning cash and being unable to generate profits, staring at a massive chasm of time and money that stands between them and re-established profitability.”

Tesla just barely managed to cross this Valley of Death three times, and the giant automakers, which have access to plenty of capital, should be able to do so as well. But some current trends are ominous. Auto sales are slowly contracting as more people opt not to own vehicles. Trade wars and high tariffs are also hurting, as are the costs of trying to keep up with rising emissions standards in some key auto markets. Some of the smaller and/or less well capitalized brands may disappear.

As MacDonald sums up, the legacy automakers are facing a hard choice: “Keep making ICEs and slowly watch your profits get eaten by Tesla, BYD, Nio, etc, or risk a dangerously expensive crossing through a transition period of cash burn and negative margins.”

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Originally published at evannex.com.

Written by: Charles Morris; Source: Bill MacDonald via Quora
 
#2
Nice summary. And don’t forget the valley us even harder when battery economies of scale mean that they will heed to match Tesla or China inc. prices but have higher cost
 
#3
Great article. I would, however, caution on the following; in 2008 when it became apparent that the iPhone was going to become huge and would completely upend the entire market, there was talk of potential competitors not having access to the screens necessary to make their own iPhone-like devices.
As enough investment began to take an interest in that, the ramp up was quick and Samsung had competing devices out in time to establish themselves where they are now.

While the batteries needed for EV's dwarfs the smartphone market by several orders of magnitude, now that it is becoming indisputable the Tesla and BEV's are about to do to the car industry what the iphone did to the phone business, the majority or large hedge funds and investment managers are now directing lots of money to BEV development and specifically to battery research to improve energy density and life-cycles. What all this means, in my humble opinion, is that the auto industry will see a shift where the legacy ICE makers will be relegated to the fringes and will find other ways to leverage their existing infrastructure for other purposes like making body parts (which they've proven to be very good at) and other items for the new brands that will take their place as the mainstream BEV makers.

Regardless of how exactly you believe the future will turn out, this is certain. Tesla is the dominant maker of luxury and high quality BEVs and power storage solutions on residential and industrial scales and they have already secured their dominance for a few decades to come via their long term outlook in how they invested into researching and developing all these new products and technologies.

With all this in mind, looking at their stock price, below $500/share is still a good price to buy and hold. This stock will likely exceed $1k by 2020 (with 1mil plus TM3s on US roads) and I suspect that will be even after a split and I would not be surprised to see them split the solar and power storage portion of Tesla into their very own separate entities since those will become much bigger than the EV business.