Such has been the remarkable success of Tesla Motors that news of its production and financing challenges came as a surprise for some. Tesla plans to raise an additional $640 million from capital markets, and downgraded its 2015 delivery forecast by up to 5,000 vehicles, citing potential complications with supplier qualification and the ramp up of manufacturing for the Model X SUV.
This news serves as a timely reminder of the enormity of the challenge that Tesla is pursuing in bringing its high-performance electric vehicles to market. Basically, building cars is a very expensive business. A new vehicle costs at least $1 billion in development and tooling, and Tesla is developing two new vehicles concurrently (the Model X SUV and the smaller Model 3).
However, Tesla isn’t just building cars; it is also building a vertically integrated supply chain and a proprietary recharging network. A consequence of this strategy is that greater investment is required by Tesla to build these multiple businesses simultaneously. Tesla is making a profit on each vehicle it sells today, but is burning cash as a company to make these major investments.
Tesla’s path to profitability relies on harnessing the multiple reinforcing feedbacks to bring down battery costs rapidly and grow the global market for electric vehicles. Growth in Tesla sales will accelerate the accumulation of production experience, realize economies of scale in manufacturing (see “Does Musk’s Gigafactory Make Sense?”), and provide revenue to invest in R&D, driving down battery and vehicle costs, resulting in yet more sales of Tesla vehicles. Increasing revenues should also allow Tesla to expand its product portfolio, and continue to expand the network of Supercharger recharging stations that enhance the appeal of Tesla vehicles, delivering further sales.
If these feedbacks operate positively as described, the meteoric rise of Tesla will continue, with Tesla vehicles becoming increasingly affordable and sales growing, leading to bottom-line profits. However, these feedbacks can also be vicious rather than virtuous: if battery costs do not come down as planned, vehicle costs will remain high and sales low, slowing the rate at which Tesla can realize further battery cost reductions. By investing aggressively in battery production capacity, R&D, and fast-charging availability, Tesla is building the capabilities that it hopes will keep these feedbacks turning in the right direction.
Elon Musk has articulated a bold vision to transform global automotive markets with electric cars, and Tesla is developing each of the elements needed to realize that vision in-house, from batteries to charging stations. With new announcements of Tesla’s technological wizardry appearing seemingly every day, it would be easy to assume that Tesla’s success is already assured. The reality of Tesla’s finances, and consumers’ wavering appetite for electric vehicles, make that future somewhat less certain. Patience, and plenty of capital, is what Tesla will need to make it happen.
David R. Keith is an assistant professor in the System Dynamics Group at the MIT Sloan School of Management.
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