Is Tesla still the OEM benchmark?

Tesla announced its 2023 fourth quarter and full year results this week.  A dramatic fall in gross profit margin grabbed the headlines, down by a quarter year on year to 17.6% for the quarter, 18.2% for the full year.  This was largely attributed to the dramatic price cuts that have become a feature of Tesla’s approach to market over the last 15 months or so.  There was also an announcement that Tesla had started to roll out AI-enabled ‘Full Self-Driving’ (FSD) to employees and selected customers, but had failed to secure any supply agreements with other OEMs.  That is not surprising given the current US Justice Department investigations into the performance and marketing of FSD, but significant insofar as the potential for FSD is highly valued by some investment analysts – up to US$75 billion in annual revenue by 2030 according to Goldman Sachs.  The market response was a 12% drop in the share price yesterday, now trading at US$$186, less than half where they were in November 2021.

The gross profit margin now sits in the same ballpark as the better-performing traditional brands such as Volvo, yet despite the recent share price drop, the market capitalisation remains a multiple of even the largest groups such as Toyota (1.8x) or VW Group (4.6x).  Tesla has long been held up by consultants, investment analysts and OEM top management as a benchmark – ‘why can’t you/we be more like Tesla?’  That task might be getting easier, not because the traditional OEMs have started running harder, but because Tesla is increasingly becoming ‘normal’.

There is no question that Tesla enjoys a significant product cost advantage, and that has allowed it to make deep price cuts whilst still securing a competitive gross profit.  Some of that relates to things like battery cost, but a lot (including that battery cost) is driven by huge volumes across a limited product range that hardly changes.  Most manufacturers do a major model change every 7 years or so, with a mid-life refresh that in part is designed to protect their collision parts revenue by changing all the bits that get most frequently damaged.  Although I understand that under the skin there have been many changes to the Model S since it was launched in 2012, it only received a facelift last year.  Tesla has focused its efforts in finding ways to get cost out, including pioneering the use of ‘gigapresses’ that combine many parts into one very large casting, and are now being adopted by other OEMs  This technology is hugely expensive, and only works if you have high production volumes with low variety.

Tesla has focused manufacturing into just six ‘Gigafactories’ each with a capacity of around 400,000 units, and which until recently have quickly been brought up to full capacity to support the rapidly growing sales volumes.  With more capacity still coming on line, but sales growth slowing despite price cuts, the close to 100% capacity utilisation looks to be under threat, and with increasingly intense competition from both legacy and new entrant brands, there can no longer be the confidence that customers will beat a path to the Tesla door.

This normalisation of competition is what has primarily led to the recent price cuts, which was to be expected, but the way in which they have been applied has been more Saturday afternoon fruit and vegetable stall than a masterclass in dynamic pricing.  The consequences on customer satisfaction and residual values have been huge, which combined with low customer demand as a daily rental offer has led Hertz to dispose of their Tesla fleet in the US at a loss.  The company can no longer rely on Musk’s star status to draw customers in either.  After a decade of proudly having a zero marketing budget (they even removed the line from the published accounts because it was not material in an accounting sense) they are now considering advertising, just like everyone else.

Obviously close to my heart from an ICDP perspective is cost of distribution, generally around 30% by the traditional definition for legacy manufacturers, sometimes more, but reportedly 15% for Tesla.  However, that figure must understate the reality if considered on a like for like basis.  As a direct seller, there is no list price as such, the revenue reflects what would be considered net revenue after discounts and some variable marketing expenses by traditional manufacturers.  Where they support price promotions and fleet deals, MSRP remains the same (the baseline for cost of distribution), but costs (variable marketing, dealer bonuses, etc.) all go up.  Add in some advertising spend, and the Tesla number will be increasing.

Looking at distribution channels, the very simple and stable product offer I mentioned earlier, with barely any options, has supported a much simpler distribution model with an effective online channel and a lean physical network.  Customers ‘self-serve’ to a much greater extent than they do with traditional brands as there is no need to worry about whether the 22” wheels can work with the comfort suspension and the towing option.  Powertrain (2 choices), colour (5 choices), wheels (2), interior trim colour (2), tow hitch (yes or no) and two software enabled self-driving options and we’re all done with less than 150 build combinations.  This is a clear advantage for Tesla that other OEMs could do to replicate.  However, the Tesla physical networks are getting larger, and the management complexity increasing.  There are rumours in Germany that they are speaking to dealers about taking the outlets on, presumably on an agency basis, something we predicted a few years ago, but at the moment it’s ‘watch this space.’

As with much in the industry today, there is a lot of change to the Tesla business model.  It is coming from a different direction, and that brings them advantages in terms of not facing a need to address legacy.  They have made some policy decisions that if sustainable will continue to give them an advantage like the simple product offer and longer physical product life cycle.  But they are also joining the mainstream in terms of having to compete for attention and market share.  That may be a harder landing than Elon Musk or the investor community might like.