Why Tesla Struggles To Gain Market Share

Tesla Motors (NYSE:TSLA) is in a unique position in the auto market, being the only auto maker producing fully electric vehicles at a significant scale. The problem for Tesla is that it is not really doing anything to dispel the notion that it is heading for anything other than a position as the leader of a niche in the overall car market. At the end of the third quarter, the Silicon Valley based auto maker launched its first all-electric SUV, the Model X, to much fanfare. The vehicle sells at a starting price of $132,000. To be sure, there is logic to Tesla selling cars at such a high price even though it limits the market available to the company to the ultra-luxury segment. But it also highlights why Tesla is far from posing a threat to the market share of leading auto makers like Toyota.

We have a price estimate of $170 for Tesla, which is about 20% below the current market price.

Tesla’s Market Position

Tesla is never going to be a mass market success selling cars at such high prices. Even companies like BMW and Daimler offer entry level luxury vehicles at nearly a quarter of the price at which Tesla sells its vehicles. If you consider the luxury market as comprised by brands such as Lexus, Audi, BMW and Mercedes-Benz, this market sells around 5 million vehicles a year for a combined price of around $220 Billion. This means that the average selling price of a vehicle in this market is $44,000. What’s more, vehicles sold in this segment comprise around 6% of the total sales volume of all passenger cars but contribute over 10% of the total automotive industry revenues. Taking the whole premium segment into account, premium cars contribute around 10% of the unit sales volume but 20% of the revenues and nearly half of its overall profit. Such a high profit share of a small market segment means that gaining market share in this segment could do a lot to help Tesla improve its market position. However, this looks unlikely for three main reasons.

1) Over-promises, Under-delivers: So far, however, Tesla has looked unlikely to be able to do that. Although Tesla has said in the past that it plans to release a third generation vehicle, the Model III, in 2017, which will sell at a price of $35,000, it is quite likely that Tesla will miss this date. In the past, Tesla had said that it would release the Model X by 2013, but it could only release the car by late 2015. What’s more: Tesla has said that it has received over 20,000 pre-orders for the Model X already but is unlikely to be able to fulfill those orders before late 2016. Tesla has missed almost all of its targets in the past: in 2014, the company targeted 35,000 deliveries but only managed just over 31,500; in 2015, the company targeted 55,000 unit sales but by the end of the third quarter it looks on pace for only 44,000 deliveries for the full year. ((Q3’15 Shareholder Letter, Tesla Investor Relations)) The company had also stated that it planned to reach a production rate of close to 2,000 vehicles produced per week by the end of 2015, but at the end of the third quarter it is only averaging around 1,100 vehicles per week. Even the company’s fourth quarter target of 17,000 to 19,000 vehicles in production looks unlikely to be achieved. ((Ref: 1)) This slowness is fast becoming a problem for the company.

2) Direct Sales vs Charging Stations: Tesla’s business model is not fundamentally disruptive for the auto industry. To be sure, Tesla does things that are definitely not the norm for the auto industry and these will definitely help tip the scale in favor of the electric vehicle technology, but it is not doing enough to fundamentally change the economics of the car market. For example, it does not rely on dealerships to sell its vehicles and sells through a direct sales channel. This is possible because the company’s vehicles do not need the kind of after sales service support that traditional ICE vehicles require. This saves the company a lot of money because dealerships tie up a lot of capital: a dealership sits on a huge amount of land. It needs a lot of real estate, a trained sales force, space for inventory and a staff comprised of finance and accounting people in order to be able to function. In contrast, stores are much cheaper and easier to operate. Additionally, dealerships often need to be subsidized with financing and incentives by auto makers. But whatever money Tesla saves on dealerships and makes by selling cars at high prices, it has to spend on having to build out a fast charging network to support its vehicles and on its Giga factory to produce the volume of batteries needed to produce that volume of electric vehicles. These two factors combined are why Tesla’s use of cash has come under scrutiny recently. ^[1]

3) Tesla Is Not Disruptive: If you look at the history of the car market, you’ll find that nearly every aspect of the car has been improved upon. But shifts in market share have never been correlated with improvements in technology. In fact, the main thing that has resulted in changes in market share has been improvements in the production process of cars and making cars that open up markets that previously did not exist. Historically, every innovation in car technology has been adopted by competition fairly quickly. Innovations in the production process, first by Ford and then by Toyota, took a while to diffuse, allowing these companies to gain market share, but eventually even they were copied and became normative behavior for all players in the industry.

Firstly, Tesla is manufacturing using the same Just-In-Time (JIT) manufacturing process that is the norm for the industry. Tesla’s manufacturing process does nothing to change cycle time required for producing a vehicle and ramping up to scale, even though the ability to send new features to vehicles using over the air updates does somewhat overcome the yearly refresh and launch a new model every five-six years process that is the norm for most companies. Secondly, Tesla’s Model S and Model X do not open up new markets the way the Ford Model T and Volkswagen Beetle did in the previous century. Moreover, Tesla opened up all its patents to competitors, which makes it quite likely that if electric vehicles start gaining more traction, they can just copy the company’s technology. In fact, Tesla’s stance on these aspects doesn’t even appear competitive: it has sold battery packs and power trains to potential competitors like Daimler and Toyota in the past and seems open to do so in the future if the economics make sense. All of these aspects point to the low likelihood of Tesla assuming a position as the market leader in the premium vehicle market any time soon.

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1. Tesla has discovered a new energy source: Burning shareholder cash, Quartz, November 2015 [↩]