May 9, 2017 — Tesla’s moment of truth is nearly here. This year’s introduction of its Model 3 may be the auto industry’s most critical vehicle launch since Ford’s Model T took over America’s roads more than a century ago. Whether the fledgling company becomes the ultimate disruptor and a truly viable automaker will be determined by the launch’s success — or failure.
And Tesla’s retail strategy may be the Model 3’s biggest challenge.
Tesla’s story is multi-layered with numerous aspects — the first of which is defining what success actually looks like for Tesla. Founder Elon Musk laid out a four-step plan (his master plan) 11 years ago. According to a recent blog written by Musk, it included the following elements:
- Create a low volume car, which would necessarily be expensive (the Roadster)
- Use that money to develop a medium volume car at a lower price (Model X and Model S)
- Provide solar power (Solar roofs, energy storage)
Tesla accomplished the first two, although, not profitably. It is on the cusp of moving into the third step.
In 2016, the automaker sold 47,119 vehicles (Model X and Model S) in the U.S. according to data from InsideEvs. (Editor’s Note: When talking about sales or deliveries, Tesla executives mostly do so in the context of global sales, which totaled more than 76,200 in 2016. U.S. sales accounted for approximately 62% of Tesla’s overall sales).
Founder Elon Musk established bold targets of 500,000 sales (global) in 2018 and a million in 2020. That translates into approximately 320,000 sales in the U.S. next year and 640,000 in 2020 (based on current U.S./global percentages. The addition of the Model 3 may change those numbers significantly). The company plans to introduce an electric semi-tractor trailer in the fourth quarter of this year and a pickup truck not long after. And the Model Y is slated for launch sometime in 2019.
According to the production schedule Musk shared during last week’s earnings call, the company will produce:
- 1,000 vehicles a week in July (when Model 3 production is slated to begin)
- 2,000 vehicles a week in August
- 4,000 vehicles a week in September
- 5,000 vehicles a week by the end of the year
- 10,000 vehicles a week by the end of 2018
(Note: Tesla has the capacity to build 2,000 Model X and Model S vehicles a week now).
Does Tesla need to sell 500,000 vehicles in 2018 for the Model 3 launch to be considered a success? Probably not. Wall Street has yet to “punish” Tesla for its inability historically to meet production deadlines and sales goals set by Musk.
But Tesla does need the Model 3 to come out of the gate strong, whether that is toward the end of this year, or sometime in the first half of 2018. That means production with minimal hiccups and a vehicle with few problems once its launched.
If Tesla doubles its global sales in 2018 — which would likely be in the 200,000 to 220,000 units range — it would be a remarkable feat. And one that will continue to embolden the investment community. Beyond that, Model 3 sales have to show continued and sustained growth into 2019 and 2020. Profitability is a key concern, but less so as long as Tesla is able to continue raising money.
A recent $1.8 billion (5%) investment from Chinese tech firm Tencent coupled with a $1.2 billion capital raise selling 1.3 million common shares at $262 per share for about $350 million in equity and debt in the form of $850 million in convertible notes helped drive the stock soaring to $316 last week.
The extraordinary valuation based on its more than $300 stock price is driven Wall Street’s belief that Tesla is a society-changing company whose business model is far from mature. Cheap and sustainable energy acquisition and storage are part of Musk’s vision of the future. Ride sharing leveraging autonomous technology also is a key part of Tesla’s future business model.
Nevertheless, delivering an affordable Model 3 in large volumes is the keystone of Musk’s strategy. Besides sending Tesla’s stock price to unimaginable levels, a successful launch will change the automotive industry as we know it. It will usher in an era where electric vehicles are mainstream. It will also create seismic cracks in the dealership retail model by proving a company does not need independent dealers to sell and service vehicles, putting the century-old business model at risk.
But a weak Model 3 launch with tepid growth likely would hit the company hard — both in the credibility of its leader and in the wallet.
Whether the launch is successful will be evident within 18 months.
The rest of the report will focus on Tesla’s retail strategy in the U.S. A key question is whether the Model 3 launch will expose weaknesses in Tesla’s retail approach.
The Banks Report has argued in the past that Tesla has been able to hide the weaknesses in its retail model because it wasn’t yet fully in the retail business. Selling a few thousand high-priced luxury vehicles to cash-paying customers, or customers with near perfect credit ratings let Tesla bypass the normal dynamics that come with selling cars at a volume level.
It’s an aspect ignored by most analysts and investors mainly because they don’t see the retail strategy as being an issue. Tesla is seeking to reinvent how vehicles are bought and sold. Instead of using an independent dealer network, Tesla is choosing to sell its vehicles directly to consumers. The conventional wisdom on Wall Street — and in the media — believes Tesla’s direct-to-consumer strategy is a much friendlier and more efficient process than the independent dealer model that has dominated car sales for nearly a century.
But historically, many companies have tried to circumvent the traditional dealer model and have failed. For Tesla to be successful, it will have to solve numerous difficult aspects of the automotive retail process, that thus far, only independent dealer networks have figured out.
Whether Tesla’s model is ultimately friendlier and more efficient is open for debate, although most customer surveys do reflect a high level of customer satisfaction with Tesla’s sales process. Tesla’s challenge will be scaling its process to handle mass number of buyers.
Can it do that without leveraging an independent dealer network? It’s a critical question because, if Tesla stumbles in its retail execution, the launch will be a failure. And that means Tesla likely will not exist in its current form within the next three to five years.
Meanwhile, its retail strategy continues to evolve.
Below are the pieces of the retail puzzle Tesla needs to solve for the Model 3 to be successful.
Tesla is fighting numerous legal and political battles at the state level to secure the right to sell cars as a manufacturer. Most states have strict franchise laws prohibiting manufacturers from selling vehicles directly to customers.
The legal battle is not insignificant and will handcuff Tesla as it seeks to add significant growth. Currently, five states prohibit Tesla from selling vehicles — Michigan, Texas, Connecticut, Utah and West Virginia. Furthermore, most of the states allowing Tesla to sell its vehicles have capped the number of retail centers Tesla may have.
A key battlefront to watch is in Michigan where Tesla is suing the state for the right to sell its vehicles there. If it wins, it will open the door for Tesla to operate without independent dealers nationally. A loss will keep Tesla only out of Michigan.
If Model 3 sales take off in the next 18 months to 24 months, look for state politicians to come under more pressure to roll back the strict franchise laws requiring manufacturers to use independent dealer networks to sell vehicles.
In 2008, the federal government began granting tax credits of up to $7,500 to customers that purchase a qualified plug-in electric vehicle (PEV). Once an automaker hits 200,000 U.S. PEV sales, the tax credits begin a step-by-step 12 month wind down period.
A common misunderstanding is that when an automaker hits the 200,000 number, the $7,500 tax credit immediately stops. But it’s much more complicated. The government established a convoluted formula in which a wind down conceivably could take 18 months.
The wind-down begins during the second calendar quarter after the calendar quarter in which the automaker hits the magic 200,000 number. The full tax credit will still be available to customers for at least a full quarter or more after the 200,000th sale. It depends on the timing of that sale.
During the second calendar quarter, the wind down begins with a 50% ($3,750 tax credit will still be available) reduction in the tax credit for six months. And then another 50% reduction (or 25% of the original $7,500, meaning, $1,875 will still be available) for another six months. After the second six month period, the tax credit disappears entirely.
It would be easy to overplay the importance of the tax credits, but it’s clear their availability will impact the roll out of the Model 3 and its competitors.
In last week’s first quarter earning’s call, Musk begged the federal government to end the PEV tax credits. Because the timing of the Model 3 launch and the aggressive sales timetable, Tesla should be the first automaker to hit 200,000 U.S. sales — probably early 2019. And Musk believes this puts Tesla at a disadvantage.
According to data compiled by InsideEvs.com, here are the overall qualifying PEV U.S. sales from 2010 (as of April 2017) for GM, Tesla and Nissan:
- Chevrolet (includes Volt, Bolt and Spark EV): 136,828
- Tesla (includes Model S, Model X and an estimated 1,000 Roadster post 2009 sales): 122,600
- Nissan (Leaf): 107,928
Chevrolet is ahead right now, but Tesla likely will surpass it later this year based on current sales growth and the launch of the Model 3. It will be interesting to see whether Musk manages the roll out of the Model 3 to make sure as many customers as possible are able to make use of the tax credit. Tesla wants to minimize the window of time in which Chevrolet Bolt customers have access to the tax incentive when Model 3 buyers do not.
This dynamic likely is also playing into Chevrolet’s roll out strategy of the Bolt. In short, the automaker first to the 200,000 mark could win the battle but lose the war.
Another key question about tax credits in general is just how much do they drive EV demand? Edmunds conducted an intriguing case study of what happened in 2015 in Georgia when the state ended a $5,000 tax credit for EV buyers. (It’s worth the read).
Released a couple of weeks ago, the study found that sales of high-end luxury EVs (mainly sales of Tesla vehicles) were immune, for the most part. But sales of the more mainstream and affordable Nissan Leaf crashed, which should create concern for Tesla as it launches the Model 3, and certainly for GM and Nissan, whose federal tax credits will likely disappear by 2019 or 2020.
Tesla’s retail infrastructure may be the most critical aspect of its strategy. It includes facility footprint; service capacity; personnel — both quantity and quality; financing; remarketing; and local market knowledge.
In addition to creating two phenomenal vehicles, Tesla has provided a top-notch customer experience — at least during the initial sales process. Its online transaction and streamlined delivery process allows customers to avoid the typical dealership process.
But as we wrote above, selling a few thousand high-priced luxury vehicles to cash-paying customers, or customers with near perfect credit ratings let Tesla bypass the normal dynamics that come with selling cars at a volume level.
The point is counterintuitive. Selling an affordable and mainstream vehicle at high volume levels requires a more robust and involved retail process. For example, purchases made by high-end luxury customers are typically less dependent on financing and trade ins of used vehicles. Tesla will have to learn how to manage a new type of customer.
Meanwhile, one initiative Tesla is considering is integrating the sale of its vehicles with its solar roof and powerwall energy storage device. We may start seeing integrated packages for sale on Telsa’s website and in some of its sales centers.
A key question is whether Tesla’s infrastructure is equipped to manage sales going from about 3,900 a month in the U.S. to 25,000 or more a month within a 12 to 18 month period.
The answer is, not yet. But Tesla likely will spend about $2 billion this quarter ramping up production and retail capacity (it spent $552 million in the first quarter). One big advantage for Tesla is that it does not have spend money in marketing. It already has a database of more than 400,000 hand raisers who have paid a $1,000 refundable deposit to reserve one of the early Model 3s.
Having that database of customers who have already paid money for the vehicle is a huge advantage.
The retail investment will be on two strategic fronts: Expanding sales and delivery capacity while increasing service capacity. The tactics Tesla will use to accomplish both goals include expanding its facility footprint; adding employees and streamlining the sales, delivery and service processes.
Streamlining Sales. It appears much of Tesla’s strategy for increasing sales capacity lies in streamlining the sales process. Ganesh Srivats, Tesla’s North American Vice President of Sales, told attendees at last year’s Fashion Tech Forum, “We spend a lot of time thinking about simplification – one touch contracts, one-touch leasing. So you can speed up the process. You can go into your iPhone right now and buy a Tesla. And that’s how we’re going to scale. It’s through the diversification of ways in which we are going to reach people.”
Sales Facility Footprint. In a recent earnings call, Musk told analysts, “As part of our Model 3 launch preparations, we are significantly expanding our infrastructure to support Tesla owners by increasing the density and geographic footprint of our presence.”
Tesla has 107 sales centers and galleries in 27 states and Washington D.C. It has galleries in some of the states it’s not allowed to sell in — Utah, Michigan, Texas and Connecticut. Potential customers can visit a gallery in these states, but depending on state law, Tesla employees are not allowed to answer questions or provide test drives.
The facility strategy is a tad muddy because Tesla is employing different types of facilities:
- Sales and delivery centers where people can actually purchase a vehicle
- Service Plus — facilities that have both sales and service operations
- Galleries where customers can only buy online (often in malls). In states where Tesla is not allowed to sell, customers may look at the vehicles on display — and depending on the state, may or may not ask the onsite Tesla employees questions. But they may purchase online — without assistance.
- Boutique centers inside luxury stores such as Nordstrom. Again, online or mobile transaction is the method used to purchase the vehicle.
Globally, the company plans to add about 100 sales and service facilities this year. How many Tesla plans to add in the U.S. is unknown, although, it likely will be in the 20-25 range.
Tesla’s planned facility numbers — at least on the sales side — are in line with typical dealership throughput. In 2016, AutoNation, the country’s top selling dealer group, sold a combined 563,335 new and used retail vehicles out of 260 dealerships. Yes, the comparison is weak, because Tesla’s model doesn’t rely on physical facilities for sales, but it shows that Tesla realizes physical facilities are still necessary.
Streamlining the Delivery Process. According to Musk, much of Tesla’s investment on retail operations will be the delivery process. He told analysts in February, “The delivery of the cars is where the investment is needed. We need to deliver three or four times as many cars. But we don’t want to have three or four times as many delivery centers.”
Initiatives will include finding ways to reduce paperwork and the red tape that comes with delivering a vehicle. Musk also wants to remove much of the process from the actual delivery to pre-delivery, such as providing instructional videos prior to vehicle pickup. The goal appears to be driving delivery times down from one hour to mere minutes.
Regarding the instructional videos, Musk says it would be better for the customer not to have to watch videos to learn how to operate systems on the vehicle. Instead, it’s better to build a vehicle that is intuitive for customers to operate.
Recently, Tesla began experimenting with another concept — large delivery hubs. Already, Tesla has hubs in Los Angeles, San Francisco, Hong Kong and Beijing and is planning to expand the concept to other locations. These are strictly delivery centers where customers come to pick up their vehicles. It takes the pressure of the delivery process off of smaller sales centers.
Look for Tesla to start testing group delivery orientations. Instead of one-on-one deliveries, Tesla may try to conduct the entire delivery process with groups of people as another way to streamline it.
Service and Repair. Tesla has come under fire recently because owners are reporting significantly longer wait times to get their vehicles serviced. The Banks Report has talked to customers who claim to have waited as long as three to seven months for repairs.
Lack of necessary infrastructure is part of the problem as is a lack of parts availability. Regarding parts, Tesla’s manufacturing is nearly 100% focused on vehicle delivery and reportedly has not built up a supply of parts for repairs.
Tesla says it’s taking the following steps to improve the service experience for its customers:
Expanding the Facility Footprint. Tesla currently has 66 service facilities (some of which are paired with sales centers) in 25 states with plans to add facilities in Oklahoma City, New Orleans, Detroit and Miami in the next few months. New service facilities will be larger with significantly more lifts — anywhere from 40 to 80 lifts, compared with two or three lifts many of the original service facilities have today.
Meanwhile, repairs requiring body and collision work have been a growing problem. In response, Tesla is opening its own body repair shops later this year and plans to expand the network of third-party Tesla certified collision centers in upcoming months. In March, Jon McNeill, Tesla’s Head of Global Sales and Service, wrote on a Tesla owners online forum that Tesla will add 300 body shops to its network while dropping poor performing shops.
Tesla’s response sounds good, but it will have to solve the parts issue. And it will have to significantly increase training to develop technicians who are skilled at Tesla repairs — much of which includes understanding the vehicle’s software.
Finding and developing skilled technicians is perhaps, a much bigger problem than Tesla executives may realize. It has plagued traditional car dealerships for years. And as vehicles become more dependent on software, the repairs become more complicated.
Streamlining Service and Repair. Tesla says it will add 100 mobile repair trucks this quarter. Called “Tesla’s Rangers,” the technicians will travel to the customer’s location and perform service or repairs that do not require putting the vehicle on a lift or taking it to a service facility. Tesla supposedly is designing its vehicles to make it easier for techs to perform work without needing a lift.
The company said in its recent earnings release, “Tesla’s mobile strategy is unique given the direct relationship we have with our customers and because our cars are designed so that most repairs can be done without raising the car on a vehicle lift. Our mobile strategy scales quickly , is capital efficient and lowers cost because proactive service and scheduling more than offset technician drive time to the customer. Best of all, mobile service saves Tesla customers the time traveling to and from a service center.”
Tesla technicians also use remote diagnostics to identify problems even before the customer notices. The company says remote diagnostics has helped it reduce repair times by 35% in recent months. In addition to diagnostics, Tesla also uses over-the-air updates (For more analysis: Over-the Air Updates No Sure Thing) to remotely add software updates and fixes.
Again, from its earnings release, “Our vehicles are designed with the capability to wirelessly upload data to us via an on-board system with cellular connectivity, allowing us to diagnose and remedy many problems before ever looking at the vehicle. When maintenance or service is required, a customer can schedule service by contacting one of our Tesla service centers. Our Tesla Rangers can also perform an array of services from the convenience of a customer’s home or other remote location. Our company-owned service centers enable our technicians to work closely with our engineers and research and development teams in Silicon Valley to identify problems, find solutions, and incorporate improvements faster than incumbent automobile manufacturers.”
Clearly, Tesla sees the need for increased investment in its retail infrastructure. Many of its innovations are intriguing and possibly could be adopted by traditional dealerships.
Tesla’s biggest challenge is that it has yet to compete in the automotive retail world. Elon Musk has done what no other automaker has been able to do — create stunning and high-end luxury electric vehicles that has captured the country’s imagination. He has done this by the tenaciousness of his personality and ability to communicate a vision of the future. Tesla’s customers have bought into the vision. Up till now, buying a Model S or Model X required the customer parting with what for many, was disposable wealth. The vehicle is a status symbol and often, a toy for those who are in the upper echelon of society.
And in that arena, Tesla was the only game in town.
But the launch of the Model 3 changes everything. Tesla will not be operating in a vacuum anymore. The Model 3 likely will be an incredible car, but it will be several steps down from the Model S. It will compete with the Chevrolet Bolt and the Nissan Leaf — both equally impressive vehicles — along with other vehicles whose powertrains are traditional gasoline-powered. Traditional automakers have much more flexibility than Tesla has to massage the pricing to drive sales. A real question is whether Tesla can create enough scale for the Model 3 to be profitable at $35,000. Probably not. Tesla, though, may be able to generate significant revenue and profitability from its supercharger strategy along with an autonomous ride sharing initiative and the sale of its energy solutions — the solar roof and the powerwall.
Tesla also is at a disadvantage because it is assuming all of the costs and risks that come with selling and servicing vehicles. In 2016, Tesla generated $7 billion in revenue, but spent $2.6 billion in selling, general and administrative costs — much of which is attributed to the retail costs. And that doesn’t include the capital expenditures of owning or leasing the facilities and real estate as part of the sales and service.
In order to sell a vehicle to the masses, Tesla will have to compete in the rough and tumble world of automotive retail. At the volumes Musk is talking about, Tesla will have to learn how to deal with subprime customers and customers that have a trade in. Dealerships that have mastered the art of massaging the financing and the trade with the price of the vehicle have a decided advantage at putting customers into new vehicles. And Tesla will have to compete with those local dealers who have decades of experience of knowing how to move the metal.
Furthermore, Tesla has much to learn about the used vehicle industry. It will have to play in that arena, but it’s learning curve is huge. At smaller volumes, it’s easy to partner with a third party to appraise and manage the used vehicles. But at large volumes, Tesla will have to learn how to master the residual values of its vehicles to make sure it’s not at a competitive pricing advantage in the future. These are not simple lessons.
The question is whether Tesla can redefine how cars are bought and sold while ignoring what traditionally have been critical ingredients of successfully selling vehicles. Historically, many companies have tried and many have failed.
Can Tesla do it? Check back in 18 months.