We’ve mentioned in the two previous articles that Tesla’s efforts in all areas ultimately return to user experience and pricing.
By self-developing core components of zero parts, Tesla has established engineering technology barriers for product core competency; through system integration design, it has completed global control of the entire vehicle system to underlying parts; through maximizing product inter-part commonality, it has multiplied its advantages while improving the efficiency of the supply chain. Tesla’s vertical integration capability and product common design capability have built a “depth and universality” matrix, making it increasingly dominant in future competitive patterns.
However, when evaluating Tesla’s high valuation, Buffett once said he didn’t think Tesla would necessarily succeed. The original intention is that traditional car companies have many resources, such as cash and production capabilities. And the replacement cycle for cars is as long as six to eight years, which means that traditional car companies have enough time to adjust their strategies and turning points. Even with advantages, it is difficult to quickly reach a certain penetration rate.
What is the impact of replacement cycles on product competitive patterns?
We often use the transformation of smartphones as an example. People basically make a decision to buy a phone every two years. When someone starts using a smartphone, the people around them also want to switch phones after seeing the experience advantage of smartphones, but these people can only wait for the next replacement cycle to switch. This way, through the rapid penetration of three to four replacement cycles, the full penetration of smartphones can be completed within 6-8 years. This is also similar to our experience. For example, the emergence of iPhones in China should begin with iPhone 5. From the initial generation iPhone released in 2008 to iPhone 3G, iPhone 3GS, iPhone 4, iPhone 4S, released one per year, by 2016, smartphones had almost taken over. It is precisely because the replacement cycle of mobile phones is relatively short that the penetration rate of smartphones could be rapidly increased within less than 10 years, and Nokia and Motorola had no chance to turn things around once they realized it. Therefore, in the mobile phone market, you can fight a lightning war, but in the car market, you can only fight a protracted war.
This logic is rational, but not insurmountable.
Tesla has a hidden secret weapon, which is its super pricing. Super pricing, as the name suggests, is to achieve the ultimate price, while maintaining an excellent level of user experience. Achieving any one of these two things is relatively easy, but doing both at the same time is very difficult.
Tesla’s super pricing will make it difficult for traditional car companies to enter this market. Why is this? I think it’s more appropriate to discuss it from the perspective of timing, location, and people. Real things are extremely complex, and there are thousands of interconnections between things. That is, building a car is not as simple as just building a car.The revenue of Toyota, one of the best traditional car companies, was about $280 billion in 2019, selling nearly 10 million vehicles. Its gross profit margin has remained at around 20%, and its net profit margin has remained at around 8%. However, due to economic recession and COVID-19 pandemic in the past year, its net profit margin has dropped to around 6%. Such financial conditions have supported Toyota’s current market value of about $200 billion.
Suppose Toyota decides to develop a pure electric platform to create a product with excellent experience while achieving the ultimate price. This decision involves resource investment, such as R&D funds for pure electric vehicle models, which are mostly transferred from the R&D of other fuel vehicle models; moreover, the production cost of electric cars is higher than that of traditional fuel cars because of the battery, which may result in lower gross profit margin per vehicle than fuel cars. Additionally, further capital expenditures are required to build and maintain charging networks and other fixed asset expenditures.
Therefore, it is likely that Toyota’s pursuit of a super affordable electric car might lead to a decrease in gross profit margin per vehicle and an increase in capital expenditures on after-sales services, which together may further lower the net profit margin. The capital market may give Toyota a lower valuation based on the new profit level, and Toyota’s shareholders may voice opposition to such underperformance. Building a car is not as simple as actually producing a car. If the founder of a company does not have a clear vision of the future or strong control over the enterprise, great ideas are likely to face mid-term setbacks. For example, young Steve Jobs was fired from the company he founded. This is the reality.
It can be imagined that Toyota’s resistance to change is much higher than that of Tesla.
Market valuation is not completely rational, and high expectations have been placed on Tesla. Can these expectations be realized? I believe that Tesla’s super affordable price can be achieved through the following:
(1) Tesla’s strong engineering capabilities enable it to make the factory layout and machinery best suited for producing Tesla cars. Tesla has sold over 1 million cars to date, all of which are comprised of only 4 models. Moreover, there is an accelerating trend toward focusing on two models, the Model 3 and Y, which account for more than 70% of sales. Therefore, Tesla has designed many machines specifically for producing these cars in custom-built factories, which is referred to as “Gigafactory as a product”. This fully integrates the production process with the design of the cars and optimizes the production cost for specific vehicles.(2) Tesla aims to significantly lower the core component costs with high cost ratio by developing their own parts. For example, when Elon Musk broke down the cost of batteries, he concluded that the final cost of a battery would be the sum of all the materials used, which is $56/KWH, while the current cost is $140/KWH. So how does Tesla achieve this cost? Tesla’s Battery Day in September provided the answer. By optimizing the cost of materials, battery design, battery production, and vehicle design, it is expected to reduce battery costs by about 56%. Just imagine, without the ability to develop their own technology, it would be impossible to achieve this 56% reduction.
(3) By connecting the production and sales system and removing middlemen, which is commonly used in traditional auto companies. The middlemen need to make profit by competing with users and companies, and their profit margin is the profit margin of the dealerships. Therefore, there are many opaque areas in traditional car dealerships, and negotiation and tricks are common in the car market. Tesla’s recent Pinduoduo incident reflected Tesla’s determination not to accept any form of middlemen participating in user purchase transactions. Tesla insists on the direct sales model and eliminates all intermediate profits.
(4) By changing the focus of user experience, traditional cars believe that an excellent user experience is based on interior design and workmanship, while smart cars believe that an excellent user experience is based on automatic driving and intelligence. Assuming both are necessary for a good product. Interior design and workmanship are the shortcoming that Tesla needs to improve, while automatic driving and intelligence are the shortcoming that traditional cars need to improve. Both focus on engineering problems, but development cycles differ.
How long will it take to solve Tesla’s interior and workmanship issues that have received criticism, and how long will it take to solve the traditional car’s automatic driving experience issues? I think that the “workmanship” aspect of Tesla’s interior has improved significantly compared to six months ago, and I, as a user, feel it is not bad. As for whether the interior should be minimalist or luxurious, it is a matter of personal preferences. In order to improve the traditional car’s automatic driving and intelligent experience, they need to rewrite the components from scratch, build an integrated system for the entire vehicle, connect the transmission and electrification systems, and create a complete automatic driving system. This may take N years.
Tesla needs to achieve significant market penetration in the coming years in order to lead the new energy revolution. Therefore, Tesla needs to achieve a super price to reduce the user’s threshold for changing cars, shorten the car replacement cycle, and accelerate product penetration.
This article is a translation by ChatGPT of a Chinese report from 42HOW. If you have any questions about it, please email bd@42how.com.