A Case study on Tesla

 A case study on Tesla, Inc : The world’s most exciting Automobile company | by Ashley Lobo | Medium

Thomas Edison’s lightbulb ushered out the gaslight era as completely as it ushered in the age of electric power. But the gas companies didn’t fall victim to disruption immediately, and it could be argued they never entirely succumbed. When Edison’s invention first threatened gas lighting, incumbent firms borrowed the filament technology from the electric bulb to improve the efficiency of their gas lighting fivefold, starving Edison’s new company of profits for 12 years and nearly bankrupting him. Experts in disruptive innovation point to that kind of move to bolster a doomed technology as the last gasp of a dying industry, and of course they’re right: Edison and electric lighting prevailed in the end. But by the time the disruption was complete, gas companies, having bought themselves more than a decade of breathing room with their gas-powered lightbulb, had prepared a profitable exit into the adjacent heating business.

Responding to disruptive innovation may be one of the greatest challenges managers in established firms face. On the one hand, they’ve been warned that disruption can sneak up and quickly destroy their business. On the other hand, experience tells them that disruptions can take years, sometimes decades, to play out.

This disruption seems to be playing out again in the Automotive industry with the traditional auto manufacturers refusing to let go of traditional Internal Combustion Engines (ICE) and embrace the newer hybrid technology, because again most of their profit and business comes from the developing world where majority of the population values social image higher than fighting climate change, and this social image is tightly related to owning materialistic things and activities like buying a car bolsters this social image. With ICE being around for such a long time the manufacturers have managed to get the price down which is fraction of what an entry level Hybrid vehicle would cost thus a people from these developing countries looking to get their first car would inevitably get an ICE Vehicle because of the lower barrier(which us cost) of entry. Thus there isn’t a strong incentive for the auto makers to embrace the newer technology because they still benefit from serving these markets and investing in R&D for newer technology has a lot of risk attached to it which the auto makers aren’t willing to take. But one company which has been on the forefront of this revolution and embracing technology is Tesla.

Few companies have attracted as much scorn and adoration as Tesla. When Tesla launches a product like the Cybertruck, the reception tends to be divisive: critics see it as further evidence that founder Elon Musk is out of touch and doomed to fail, while supporters buy in — within a month Tesla received 200,000 preorders for the new vehicle. Compare that to the Ford-150, the world’s best-selling car in 2018, which sold just over 1 million vehicles that year. Disagreements aside, there is no question that the company has shifted the auto industry toward electric vehicles and achieved consistently growing revenues (passing $20 billion in 2019). At the start of 2020, Tesla was the highest performing automaker in terms of total return, sales growth and long-term shareholder value. Surely, there is a method to what seems like madness to so many [1]. Tesla’s recent breakout market performance is proving some of its skeptics wrong. In mid-January of 2020, Tesla’s market capitalization had reached $107 billion, and it surged past the giant German automaker Volkswagen to become the world’s second most valuable auto company behind Toyota. Tesla’s valuation now exceeds that of Ford and GM combined. [2]

Are certain industries so difficult to enter that they are destined for lower levels of entrepreneurship and innovation? If one looks at Porter’s five forces analysis, industries like the automobile industry seem especially immune to the threat of new entry and upstart competitors. Numerous factors that Porter identifies, including economies of scale, learning curves, access to distribution channels, patents, unrecoverable up-front R&D expenditures, and other capital requirements can serve as barriers to entry, and all of them seem to be present in the auto industry. Thirty-five years ago, Porter wrote, “In the auto industry economies of scale increased enormously with post-World War II automation and vertical integration — virtually stopping successful new entry.”[3] At that time, General Motors, Ford, Chrysler (plus AMC/ Jeep), Honda, Nissan, and Toyota constituted six of the seven top-selling car companies in the United States, and the same is true today. [4]

The high costs of entry in the auto market have led many to speculate that even if a better product existed, incumbents could successfully keep it off the market. A prime example is the electric car, which has long been a dream of those seeking to reduce auto emissions but a product that many considered as too difficult to introduce. Electric cars benefit everyone by reducing emissions and improving air quality and are “a winner for consumers.” However, it says that electric cars “are a threat to the profitability of the conventional gas-powered auto industry” so “economics and corporate power stopped California’s electric car program in its tracks.”[5] Compared to gas powered vehicles, electric cars lack a refueling infrastructure and a distribution and service network. To frame the problems using the language of potential market failure, introducing an electric vehicle means facing network externalities associated with electric cars (such as the need for new charging stations compared with the fueling stations that gas-powered vehicles already have) and high barriers to entry (such as the high fixed costs of introducing new technology and building the production capacity that incumbents already have).

Although innovation in an industry does not necessarily require new entrants (incumbents will and frequently do innovate whenever they can), [6] new entrants often view industries in a totally different way and embrace such change. Yet entering certain industries is more difficult and that has the potential to affect outcomes in an industry. In 2011, one observer stated, “The higher the capital requirements, the higher the barriers to entry…When there are high barriers to entry, then you don’t see new entrants, and you don’t see innovation. It’s really that new entrants are what drives innovation.” This observer was Silicon Valley entrepreneur Elon Musk, Tesla’s initial investor, co-founder, and CEO, who viewed all of the barriers in the auto industry as ones that could be overcome [7]. As Musk explains, “Our goal when we created Tesla a decade ago was the same as it is today: to drive the world’s transition to electric mobility by bringing a full range of increasingly affordable electric cars to market.”[8] Tesla’s long-run success, with or without current preferential tax treatment, is to be determined. Nevertheless, within twelve years, Tesla has created one of the top-selling full-sized luxury cars in the United States and Tesla’s Model S has won multiple car of the year awards and earned an all-time top rating from Consumer Reports.

In an industry with many challenges, including large fixed costs, network effects, and incumbents that might prefer to preserve the status quo, Tesla is showing that a Silicon Valley startup can overcome many seemingly insurmountable economic problems. Tesla also has relied heavily on alliances, allowing Tesla to leverage expertise and infrastructure of other firms rather than having to constantly reinvent the wheel [9].

Musk noticed that companies like General Motors were not developing electric cars as effectively as they could and that led him to enter that space. According to Musk, “the single largest macro problem that humanity faces this century is solving the sustainable energy problem — that is, the sustainable production and consumption of energy,” but rather than waiting for a solution, Musk states, “the only way I could think to address that was with innovation.”[10] Although electric cars do not necessarily reduce the consumption of fossil fuels or emissions overall, they have the potential to, especially if lower emission power sources like nuclear become more widespread. The “well to wheels” emissions equivalents for electrics vary based on how electricity is generated and when one draws from a grid, and electric car battery storage also has the potential to draw from the grid at non-peak hours or more effectively utilize intermittent energy sources such as wind or solar. [11] Musk states that it is tempting to reason by analogy and infer that the market will be similar to how it exists now. However, entrepreneurs are capable of bringing products to market that others have not envisioned. As another Silicon Valley entrepreneur, Steve Blank, has stated, “Capitalism is an evolutionary process where new industries and new companies continually emerge to knock out the old.” Following Schumpeter, Blank explains how “entry by entrepreneurs was the disruptive force that sustained economic growth even as it destroyed the value of established companies.”[12] Despite the fact that many thought that electric cars could never compete with gas-powered vehicles, Tesla has shown that Silicon Valley style thinking can help overcome entry barriers even in the most established of industries.

Theoretical underpinnings of Tesla, Inc: Disruptive innovation & High-end encroachment

Disruptive innovation theory was originally published by Christensen [13]. A disruptive innovation is defined as “a product or service that displaces an incumbent product or service”. Danneels [14] defined disruptive innovation as “A Technology that changes the bases of competition, changing the performance metrics along which firms compete”. The most recent definition was by Gilbert [15] who defines it as “A new technology is that which unexpectedly displaces an established one”. A 2013 study by the authors of this paper undertook a review of the theory and discovered that disruptive innovations are more expensive than existing technologies, the new technology will be less developed than the incumbent but the disruptive technology will possess added value features. It was also found that disruptive innovations will firstly fill niches towards the top of the market, and will then diffuse downwards into the more competitive mass-market levels [16]. Disruptive innovations initially enter niches that are not attractive to incumbent firms [17]. These markets are unappealing mainly due to low volume sales potential, and because they demand specialized products that could not be produced at an economically viable price. This means that incumbent firms cannot produce a product that will maintain existing profit margins. This makes it easier for the disruptive innovation to enter these markets, as there will be no existing competition. In these niches the new technologies are not seen as a threat to incumbents [16]. However once unit sales are increased and costs reduced they can diffuse down the market, it is as this stage that they become actually disruptive to the market leaders sales and profits. Christensen did not include high-end encroachment in the original definition of disruptive innovation [17]. However much subsequent literature [17] does present a good case for including high-end encroachment into the theory. Additionally the mobile phone, which is an example of high- end encroachment, is classified as a disruptive innovation by Christensen [13, 1]. The effects of high-end encroachment on the market can be immediate and significant, meaning that innovations that enter markets via high-end encroachment are disruptive [20].

There are three types of high-end encroachment. These are New Market, New Attribute and Immediate High-End Encroachment. The type of high-end encroachment depends upon the level of Core Attribute and Ancillary Attribute Performance changes compared to the incumbent innovation [19] as shown in Figure 1. The first customers who purchase high end innovations are typically innovators, as based on Rogers [21] theory. These innovators typically place a higher value on the performance advancements of the high-end innovations, more than low end customers would [22]. New Market encroachment depends upon the highest level of core attribute improvements along with strong ancillary attribute improvements. The innovations will also be high priced; these innovations open up new markets at the top of a market [23]. This is usually the first stage of a market entry strategy and the innovations will generally diffuse down from this high-end market to progressively lower markets as cost reductions are achieved. This is the market entry approach that Tesla Motors have used, their first model the Tesla Roadster was targeted to high-end customers in a new market space at the top of the electric vehicle market. New Attribute high-end encroachment is where core attributes are improved to a similar extent as new market encroachment. With this strategy ancillary attributes are only moderately improved compared to incumbent technologies. These innovations have higher costs than incumbent technologies, but the difference in cost is less significant than with new market innovations. These innovations enter the top of existing markets, they do not open new markets, and the innovations then diffuse to lower market levels [23]. Innovations in the automotive sector that fit this pattern include hybrid vehicles where ancillary attributes are moderately improved but core attributes are often much improved over comparable Internal Combustion Engines (ICE) vehicles. On market introduction hybrid vehicles were more expensive than ICE vehicles but less so than the Tesla Roadster or Tesla Model S. Both Fuel Cell Vehicles (FCVs) and Battery Electric Vehicles (BEVs) are disruptive innovations. They are both automotive technologies entering a highly competitive market. They share a number of characteristics such as zero tailpipe emissions, silent operation, electric drivetrain, smooth acceleration and high torque figures. They also have some shared barriers to market entry, they are disruptive innovations, costing more than incumbent ICE vehicles, and both suffer from poor infrastructure access at present. The higher than average prices of Tesla vehicles makes the comparison especially useful, this is because BEVs are expected to cost significantly more than conventional ICE vehicles due to the novel materials used and initial lack of economies of scale. It should be acknowledged that for disruptive innovations high-end encroachment is not the only appropriate market entry strategy. Low end encroachment where technologies enter at the bottom of the market in low value applications is also possible [24]. Low-end encroachment is not being explored for BEVs because this market entry strategy would not be possible. The high prices inherent with BEVs mean they would not be able to compete with incumbent ICE vehicles on price. According to Van Van Orden et al., 2011 [19] there are 6 types of encroachment patterns, 3 high-end and 3 low-end encroachment patterns, as shown in Figure 1.

Figure 1: The six encroachment types as determined by new product performance and core and ancillary attribute dimensions [19]

An overview and history of Tesla, Inc.

Since its founding in 2003, Tesla’s vision was to manufacture mass-market battery electric vehicles (EV) that offered a compelling customer value proposition including long range and recharging flexibility, energy efficiency, low cost of ownership and high performance which didn’t compromise design or functionality [25]. Tesla got its start with a $6.5 million investment from Elon Musk and leased a warehouse in Silicon Valley just big enough to assemble a few prototype vehicles [26].

Retrofitting Existing Car with Electric Power

Figure 2: The original Tesla Roadster (a Lotus Elise with an electric drive train) [56]

The company focused on developing the Roadster (shown in Figure 2), a premium EV sports car based on the Lotus Elise platform. The intent was simply to replace the internal combustion engine (ICE) powertrain with an electric one, consisting of lithium ion batteries, power electronics, motors, gearbox, and control logic. Tesla used standard 18,650 battery cells and combined many thousands in parallel to form a battery pack. Within four months the first prototype of the Roadster was completed with less than 20 employees. However, developing a robust battery required engineering solutions to keep them cool, prevent them from catching fire and causing explosions. In 2005, Tesla engineers performed many fire and explosion experiments, in order to develop a robust and safe battery pack. Being a start-up, Tesla brought a can-do attitude to engineering and manufacturing. This had the advantage of solving individual problems quickly, but slowed down progress when changes in one area of the car had knock-on effects into another area. As a result, while Tesla originally planned to ship the first Roadster in 2006, the delivery date continued to slip due to engineering and manufacturing issues into 2008. Tesla delivered approximately 2,450 Roadsters between 2008 and 2012 [27].

Hiring Experienced Auto Engineers

Tesla started work on the Model S (shown in Figure 3) in 2007 and by March 2009 had finished the prototype design [28]. At this time, the company had a few hundred employees and was also manufacturing the Roadster. In contrast to its approach with the Roadster, Tesla hired a team of seasoned automotive engineering and manufacturing specialists to design and develop the Model S, with experience at companies including Audi, BMW, GM, Jaguar, Mazda and Toyota. Engineers from leading automobile companies, were hired, alongside engineers with electrical, electronic and IT backgrounds from leading Silicon Valley firms. This included Franz von Holzhausen, Chief Designer of the Model S (from GM, Audi and Mazda) and Gilbert Passin as VP Manufacturing (from Toyota). In 2010, 2011, and 2012 Tesla had 899, 1417, and 2964 employees, respectively [29]. Of a total of 1417 employees (Tesla had at that time), Tesla had 315 (22%) in R&D and 216 (15%) in Design and Engineering, which is a much higher percentage than a traditional car company. Tesla stationed its design engineers at the manufacturing facility, reducing total overheads and increasing interaction and feedback between the engineering and production departments [29]. The characteristics of the Model S were a sleek design with an all-aluminum light weight body. Tesla abandoned the conventional ICE layout, and mounted the battery pack on a large rigid and flat floor [30]. This led to a low center of gravity and good weight distribution between the front and rear axles, which in turn gave very good handling. Electric motors and the gearbox were located at each wheel and designed around the battery packs. The number of moving parts was very small, reducing noise and vibration.

Figure 3: The Tesla Model S [76]

Making Model S Safe through Design Choices

In terms of the powertrain, Tesla focused on the core intellectual property of four components — the advanced battery pack, the power electronics module, the high efficiency motor and the electronic control software [31]. A key strategy that Tesla adopted was that the battery pack could accommodate different battery cell chemistries and was designed to allow for multiple suppliers. Tesla argues its integration of these components is more valuable than the sum of parts and is therefore a core competency providing the company with competitive advantage [32]. The Model S design choices led to it achieving the highest safety ratings in history [26] and the car becoming the most awarded car of 2013 [32]. The large floor space enabled Tesla to install battery capacities up to 85 kWh, so that the car could run for up to 300 miles on a single charge — and beyond the requirements of most customers. In addition, the Tesla architecture was designed to be a platform for models beyond the Model S: “with an adaptable platform architecture and common electric powertrain to provide . . . the flexibility to use the Model S platform to cost efficiently launch new electric vehicle models subsequent to the start of production of the Model S” [30].

The Model S was the first luxury battery EV sedan with high performance, accelerating faster than many sports cars, with some models reaching 60 mph in circa 3 seconds [33].The Model S also incorporated at lot of innovation from the IT sector, including an electronic dash board and a 17” touch screen, which enabled all controls of the car to be manipulated. The embedded IT functionality, allowed features such as the summon feature, auto parking and autopilot to be incorporated. The combination of a heavier use of electronic components, fewer moving parts and online connectivity, meant that Tesla’s cars could be upgraded via software easily and much more substantially than conventional ICE cars [34].

Tesla’s original plan was to make 10,000 Model S sedans per year and spend $130 million on development and manufacturing [26]. While CEO Elon Musk had been successful producing the Roadster as the first stage in the master product plan, Tesla was not profitable and faced bankruptcy in December 2008. Critical to Tesla’s ability to develop the Model S was the funding it secured in 2009 and 2010. Up to that time Tesla had spent about $185 million and delivered less than 1000 Roadsters (which amounted to about 100 million in sales). In mid-2009, Tesla secured a US Department of Energy (DOE) loan of $465 million to support (i) engineering, production and assembly of the Model S and (ii) development of a manufacturing facility to build electric vehicle powertrain components [25].

Buying Existing Auto Plant

A major coup for Tesla was the purchase of the NUMMI factory in Fremont, California(shown in Figure 4) for $42 million from Toyota in 2009 [25].The factory had produced up to 450,000 cars per year for Toyota and GM and was valued at over $1 billion. The purchase also enabled Tesla to meet the pre-conditions for the release of funds under the US Department of Energy (DOE) loan scheme. Tesla adopted a vertical integration model to a much larger degree than other automobile companies. It produced 95% of its stampings in-house, developed its own software to control the car and installed 185 robots at the NUMMI factory to automate more manufacturing operations than any other car factory in the USA [29].The vertical integration approach helped Tesla learn quickly and maintain control of all the key design details. Tesla went further, vertically integrating its retail sales channel and building its own network of charging stations. The first Model S sedan was manufactured in June 2012. In addition to the DOE loan, Tesla received tax breaks and incentives from the California Alternative Energy and Advanced Transportation Financing Authority (CAEATFA). These totaled $31 million in 2011. Buyers of Tesla vehicles were also entitled to a tax break due to the Zero Emission Vehicle (ZEV) program of up to $7,500 per vehicle. In 2009, Daimler recognized Tesla’s leadership in battery-pack design, agreeing to a battery supply agreement for their Smart cars and later invested $50 million for 9% of the company, valuing it at over $500 million.

Figure 4: NUMMI factory in Fremont [62]

In June 2010, Tesla Motors conducted an initial public offering on the New York Stock Exchange, becoming the first new U.S. automobile company to do so since the 1950s [1].Tesla raised $226 million from the IPO, valuing the company at $2 billion. In the same year, Panasonic invested $30 million under a battery partnership and Tesla raised a further 172 $million in May 2011 and 192 $million in September 2012 via secondary offerings. Capital expenditures between 2008 and 2012 (when the first Model S was delivered) totaled $486 million and research and development expenditures between 2006 and 2012 totaled $737 million [25].The core elements of Tesla’s strategy have been:

(i) proprietary integrated electric powertrain,

(ii) vertical integration from development through to production and retail sales

(iii) significant incorporation of IT capabilities into the auto

(iv) uncompromising focus on battery electric vehicles

(v) building a supercharger network and free charging for customers.

However, the above strategy cannot fully explain Tesla’s success. Timing and vision played a significant role. Tesla was one of only a handful of pure EV car makers globally in the mid-2000s and probably the first to develop a robust EV powertrain and battery pack. The company was a first mover in betting that lithium-ion battery costs would continue to decrease for many years to come. Tesla’s hard charging nature, led by CEO Elon Musk and its unique branding approach enabled it to distinguish itself from other car-makers and attract loyal customers, despite many missed deadlines in the early days of the Roadster and Model S development. Contrary to our expectation from reading Jacobides, MacDuffie, and Tae [35], Tesla suggests that at least in the EV space developing the capabilities to produce a safe car is not that difficult. Tesla’s journey with the Model S shows that a well-funded company could develop a new EV from scratch and into production within 3 to 5 years, with about $1–2 billion of capital for design, development and manufacturing (and a bit of luck).

Strategic Concept

The company’s original strategic concept was to emulate the typical life cycles of products in the technology industry and have the research and development of new products paid for by previous products sales. Tesla is hoping to achieve this through the implementation of a three stage development strategy of the firm’s products that is in unison with Roger’s Diffusion of Innovation Theory (shown in Figure 5)

Figure 5: Representation of Roger’s Diffusion of Innovation Theory [70]

Firstly, the innovators were targeted with the Tesla Roadster; a high-priced, high performance electric sports car and had a low volume of production. Following this by the Model S, a mid-priced sedan with a medium level of production, was produced as a more practical car to further target the innovators. According to Rogers [21] the innovators have more of less embraced the concept of green cars within the USA as figures suggest that HEVs, PHEVs and BEVs have an adoption rate of just over 2.5% [37]. Then the Model 3 was released in 2016, an affordable relatively low-priced automobile which is produced in high volumes, and is aimed at targeting the early adopters as the technology becomes more widely accepted and the benefits versus cost of adoption is more widely understood [21]. The company implies that if you are purchasing any model of Tesla automobile you are investing in the development of future models and consequently making green technology more affordable, which further adds value to the idea of purchasing a Tesla product.

The firm have slightly deviated from this strategy presumably in order to adapt to customer demand within the market and have developed the Model X, a utility vehicle which recent trends suggest have grown in popularity and have overtaken sedans as the most popular body type of new vehicle to be registered in the USA [38]. Also the Cybertruck a very unique looking, polarizing pick-up truck was unveiled on 21st November, 2019 with quite the buzz because of a host of reasons, one of which was the shattering of the ‘unbreakable’ Armor glass when one of the presenters on stage threw a metal ball on the glass as a part of the demo (shown in Figure 6). Still the Cybertruck had 250,000+ preorders in the first month itself which is quite impressive and many predicted it would overhaul the record set by the Model 3 with 400,000+ pre-ordered vehicles throughout its lifetime given that the Cybertruck is scheduled to release in 2022.

Figure 6: Elon Musk standing in front of the Cybertruck with broken Armor Glass [18]

The company differentiates itself from the standard dealership model currently dominating the US automobile market by vertically integrating the sales operations. Traditionally automobile manufacturers have to sell their products through third party dealerships and franchises. However, Tesla encourages online sales and is the only car dealership that has set up methods of direct customer sales. In states where the direct sale of cars by auto manufacturers is illegal or restricted, Tesla have opened up so called “Galleries” with the intention of merely providing a place for potential customers to come and view the product before purchasing it online (Figure 7). This has met considerable criticism from law makers and other manufacturers but the unique position Tesla has created seems to be stable as other manufacturers are adopting similar sales models [39]. This issue is unique to the US market due to the unique model of car sales but is relevant as this is currently Tesla’s largest market.

Figure 7: Tesla gallery in Troy, Michigan [67]

Openness as a critical success factor for Tesla

The evolution of success factors

The ability to create and keep competitive advantages is crucial for a company to make profits and survive in the long term. Besides traditional factors like time, cost, quality, etc., in recent years secondary factors have evolved that enable companies to hold their position while market conditions or the industry environment are rapidly changing. Flexibility and adaptability, for example, have become as important as the primary success factors these days [40, 41]. In addition to that, there are many examples of highly competitive companies (e.g. Local Motors, Wikipedia, Quirky, InnoCentive, etc.) whose success cannot be described with the traditional view on corporate competitiveness as they follow another paradigm of value creation. The borders of companies are more and more dissolving towards (open) production or value co- creation systems [40, 41].

Beyond that, meanwhile the most companies act in a highly dynamic business environment with decreasing time- to-market and ever-shorter product lifecycles where the ability to constantly innovate is equally important [42]. Considering scarce budgets for internal R&D has put even more pressure on the companies. The search for new ideas and innovative technologies beyond the company’s walls has led to the idea of open innovation where also external sources may be utilized [43]. Production systems that are based on participation, cooperation and interaction with several external stakeholders (e.g. customers, competitors, suppliers, scientists, communities, etc.) to boost innovations are also referred to as “Bottom-up economics” [40, 41].

Theory of distributed production

To explain the idea of a distributed production, we will discuss two contrary perspectives on market and competition. On the one hand, there is a classical market with fixed boundaries and a near-constant size where different players act in a highly competitive environment. The companies are focused on the differentiation from their competitors and thus try to gain additional market shares up to the production- related (local) maximum (Figure 8, left part). A different approach is to consider the companies as players within value creation systems. Their aim in contrast is not to split the market, but to widen the overall market jointly (Figure 8, right part). In this constellation, openness is an essential requirement for success. Cooperation and value co-creation lead to a network of production systems that also fosters the occurrence of emergence effects. Considering changing characteristics of a market (e.g. maturity, size, industry, etc.) might cause its players to adapt their strategic approaches to one or the other direction. These days more markets require a strategy of openness in order to remain innovative and thus competitive. In this case, the ability for cooperation and collaboration turns out to be a critical success factor.

Figure 8: Two perspectives on the strategy of a company [36]

Openness as a new strategic approach

From closeness to openness

The strategic approaches just mentioned before represent two contrary perspectives on a value creation system: Closeness and openness as opposing extremes in a wide spectrum. Figure 9 shows a classification system that clusters success factors for each characteristic with regard to architecture of the value creation artifact, the value creation process as well as the value system structure. [40, 44] With Tesla, the IP rights were drastically affected by the announcement of the CEO as this top- down initiative can be interpreted as a quasi-free license to use their technology.

Figure 9: Cluster of value creation characteristics [17]

The new age of (open) innovation

So far, we have seen that the traditional understanding of innovation and innovation processes has changed over time. Schumpeter argued that innovative companies are (internally) able to generate competitive advantages that leads to a temporary monopoly with monopoly profits [45]. Chesbrough defines this process as closed innovation: The value creation process takes place within a company’s sphere and thus range of control (Figure 9, left side) [43]. However, innovation pressure has forced companies to also search for new ideas beyond their spheres. This concept is referred to as open innovation (OI). External ideas may enter the innovation process of a company, but also internally sourced ideas may be harnessed outside the firm’s walls (Figure 9, right side). Reichwald and Piller understand the open innovation concept as a complement to the traditional innovation process that may enhance the competitiveness of a company [46].

Open source as part of an open innovation strategy

Open source is one of many feasible models that enable companies to harness their technology in the spirit of open innovation. The basic idea is to jointly develop new technologies and share the rights to make use of it. Essentially, there are four open source strategies that can be differentiated with respect to company’s situation and aims: Pooled R&D, spinouts, selling complements, donated complements [47]. In the software industry, many cases have proven how the spirit of the open source philosophy was able to influence an entire industry and create profitable business models. The question would be then whether this approach is also successfully applicable to an industry patenting their technological know-how and producing physical goods.

The implementation of openness

The implementation of open source strategies in a traditional tech-industry where patents guarantee competitive advantages and add to the intangible assets, but are also essential for defensive IP-strategy purposes requires a different approach. On the one hand, long-term strategic planning, high R&D costs, but also legal and shareholder related and other issues hamper a radical change in the IP strategy. On the other hand, changes in the industry or market environment might force a company to change it in one or the other direction. Thus, the proper degree of openness has to be adjustable.

Tesla and its business environment before the announcement of the open source movement

Technology and IP portfolio

Right from the beginning, Tesla has been a highly innovative company with a skilled engineering workforce. The technological know-how, however, was not only used for their own cars, but was also offered to other car makers (Daimler, Toyota) that wanted to electrify their models in terms of engineering services and component supply. Meanwhile, Tesla is the leading EV car maker concerning performance (0–60 mph in under 4 seconds) and efficiency (range of nearly 300 miles). Their lithium-ion battery packs have an energy density that is 3 times higher than the ones of competitors, the battery costs per kWh are half as high. Additionally, they developed the fastest DC rapid-charging station (Supercharger) available on the market (50% recharged after 20 minutes). They also run their own rapidly growing network of charging stations all over the world (more than 500 stations, e.g. coast-to-coast in the USA). The stations are compatible to other automobile manufacturers’ models as well, but only Tesla drivers may enjoy the rapid charging feature [42]. Figure 10 gives a categorized overview of Tesla’s broad IP Portfolio. The patents add up to nearly 250 mainly US patents and it is obvious that they put their emphasis on the battery and charging technologies [48].

Figure 10: Tesla patents by category [48]

Strategic partnerships

While building up its production capacities und processes, Tesla has always been strongly dependent on strategic partnerships not for economic reasons only, but also in terms of knowledge and know-how sharing. Since 2008, they cooperate with Daimler where Tesla developed a battery and powertrain system for their electric fleet that is produced and delivered by Tesla as well. The same type of cooperation exists with Toyota since 2010. Another cooperation agreement was concluded with Panasonic. The Japanese cooperation is not only the long-term main supplier of the battery packs, but also a project partner in the Giga factory project (a huge battery research and production site in Nevada, USA). [42]

Electric vehicles market

Different, but interconnected trends have been reviving the overall demand for electric mobility and the third age of EVs [49]. A PESTEL analysis gives a brief overview of the most important drivers:

Figure 11: PESTEL analysis of global trends for electric mobility 36

According to PORTER, the EV market can be characterized as immature. As such newly formed markets are emerging (e.g. because innovation, changing consumer behavior or socio- cultural changes) they are accompanied by a high degree of technological and strategic uncertainty [50]. Only few rules have established throughout the industry, neither has the most promising business model. Time pressure, governmental grants and high initial investments are business possible constraints at this stage, too. The focus, however, is on the customer side: Marketers need to convince potential customers either to use a new product or to switch from a substitute. Thus, a company has to try to beneficially position itself within that immature market in a way that enable it to influence the rule setting phase.

Although the outlook for the next decades has a broad range, an ongoing strong growth of EVs seems very likely. The overall car market is expected to grow from 63 million cars in 2012 to 86 million in 2020 and 99 million in 2030 [44]. The corresponding share of EVs is 9% in 2020 and 30% in 2030 [44]. With respect to Tesla, the share of BEVs shall be 0.8% and 8.8%, respectively [44]. However, these days there are many challenges to face in order to foster the major breakthrough. The prices for EVs are still way above conventional cars (150%) and will remain expensive in the near future (60% in 2025) despite expected cost reductions through breakthroughs battery research [51]. Another problem is the slow expansion of area-wide charging infrastructures that along the price is a crucial precondition for potential EV drivers [51]. Finally, for further cost reductions and technological interoperability there is an industry-wide demand for standardization of vehicle communication interfaces and charging systems. To address these issues, new business models and rearranged comprehensive value creation models have to be developed [51].

Figure 12: Sales targets of the most important EV countries [14]

Industry situation

With the upcoming age of EVs, the over 150-years-old car and car supplying industry is facing a disruptive restructuring phase. Traditional value creation processes and global supply chains that have evolved and were improved over years are undergoing a massive change. New disciplines (e.g. software, chemical science, battery technology, etc.) and materials as well as production processes are going to replace existing technologies (e.g. combustion engine, transmission, exhaust system, lubricants, etc.) thus major investments in production technology and R&D are necessary. Unfortunately, most of the big car makers are focusing their business activities on developing markets where they sell huge volumes of conventional cars rather than developing large-scale EV programs. [51]

However, the emergence of a new market offers a wide range of business opportunities not only for existing market players, but especially for start-ups and industry pioneers. New players with innovative ideas and new concepts may shape the immature industry’s structures and position themselves in an early stage as technology leaders. [52]

In doing so, quickly building up new basic knowledge and competencies is crucial. External sourcing of knowledge for innovation by means of strategic partnerships/alliances, joint ventures or acquisitions, etc. is an efficient way to grow the know-how of a corporation. These strategies imply a certain degree of opening and thus foster economy of scale effects and reduce business risks as well as developing costs. Actually, KAMPKER claims that the ability to manage those relationships effectively and efficiently would lead to major competitive advantages in the EV business environment [51].

Implications of the open source movement for Tesla

Receptions and reactions

Tesla’s patent announcement caused a huge (social) media coverage with a broad spectrum of opinions, but mainly positive tenor (from “only a PR stunt” over “risky bet “to “What Tesla knows that other patent-holders don’t”, “makes sense” and “clever move”). On the industry side, however, the news did not arouse great interest. Daimler claims the patent approach a “PR move”, BMW meanwhile has its own strong technology base with the “project i” and the big US car makers are not interested in Tesla’s technology either. Toyota, on the other hand, impressively reacted by announcing to grant a free license to 5,700 patents until 2020 in order to boost the advance of their favored fuel cell technology.

Furthermore, US patent experts mostly are also critical of the patent announcement with regard to the legal force, the terms and conditions as well as the duration of the offer. The supplement “in good faith” would be vague and leaves space for interpretation (on Tesla’s side), too. No competitor could seriously utilize Tesla’s technology without further clarification of the offer and the conclusion of a contract. In fact, nothing would have changed as Tesla still holds the patents and the announcement could only be seen as a kind of “free” license that should rather be interpreted as an offer for cooperation towards the big car makers. [53]

Despite the criticism, the quasi offer of the complete IP portfolio within an industry like the automobile is a courageous approach and one has to consider that a high-tech company is highly dependent on its technology base in terms of competitive advantages especially if your resources are rather small compared to your competitors. The necessity of the EV market development and the business opportunities arising with it, in Tesla’s view, seem to outweigh the risks of the opening.

Opportunities

Tesla’s knows that its technology leadership and the good strategic position is nothing worth, if in the long run the EV market won’t be big enough to sell high-volume affordable cars as this is the precondition to run a profitable business in this sector. Therefore, any measure that could possibly stimulate the market growth has to be considered. On condition that the market would grow, Tesla’s revenues would increase as well, even if its market share would stagnate which is not very likely because of Tesla’s superior market position. Furthermore, giving free its battery technology might lead to a comprehensive industrial engagement that would decide the race for the predominant propulsion technology for Tesla’s benefit. This would not only boost the sales of vehicles, but also the demand for battery related components such as charging stations and lithium-ion battery packs. Additionally, the open source approach boosts the reputation of the company as highly innovative also in terms of employer attractiveness and brand awareness. It might even encourage other marketers or even industries to open up as well. A comprehensive approach of cooperation and collaboration would also cause network effects that would advance the restructuring of the industry for both market players and customers benefit [54]. Given the fact that even a big player like Toyota does same thing indicates Tesla’s strategy as a promising one.

Another rather important consequence of the announcement could be to strengthen Tesla’s position in terms of industry-wide standard setting. The offer might attract not only car producing competitors to use Tesla’s technology, but also the public sector or cross-industrial players and suppliers with regard to charging infrastructure or the propulsion of other transportation related means. Minor but still interesting aspects to consider are: Additional revenues via complementary sales or the increase of know- how for Tesla if a cooperation partner would share knowledge in return.

Risks

A courageous and unconventional strategic approach is accompanied by risks and threats to a company. In this case, one of them is the loss of revenues via licensing of technology. The holder of a patent may temporarily preserve a monopoly on the protected invention and therefore generate a competitive advantage as well as higher rents or additional income through licensing in order to compensate the R&D costs. With the patent release, these advantages are obsolete. In Tesla’s case, this also might apply and result in lost sales in the short term. In the long term, however, the revenues in a then developed mass market would be much higher.

Another threat is the free rider problem and a crowding out effect for Tesla in the aftermath. A big player with high resource base could utilize the technology and compete with Tesla. Theoretically, the bigger company could beat Tesla because of economy of scale advantages. However, this risk seems very unlikely as Tesla would have an ongoing technological advance and at this early stage of the market, any competition would be good for Tesla, too. With respect to PR, if for any reason Tesla would have to reverse the IP opening in the near future, this would have a tremendous negative impact on the reputation. There is also a possible threat of patent litigations. However, Tesla still is capable of using its patents for defensive purposes as it allowed the use of its patents without releasing the rights of them

Summary and outlook of the open source movement by Tesla

The aim of this section was to present a new strategic approach for organizations based on the theory openness where collaboration leads to a widening of the overall market and, thus, to a benefit for all players. Unlike traditional competitive strategies that are focused on closeness, an adaptable gradual opening and thus collaboration throughout all value creation processes as this behavior stimulates advanced market growth and innovativeness.

Tesla’s strategic approach along the open source movement (although it is rather a light version of it) and the application of aspects of openness are revolutionary for a (small) corporation in the highly competitive car industry. There are some risks related to it, but they are clearly outweighed by the business opportunities. The strategic situation of Tesla and the special environment of the EV market right now seem to offer the perfect conditions to a strategic turn around. However, we cannot yet assess whether Tesla will be successful in the end and whether surrounding challenges (beyond Tesla’s sphere of influence) regarding the shift towards electric mobility will be met.

According to its specific situation within a certain market, an organization should check whether a more open and collaborative approach might, in the long term, enhance the company’s overall situation in terms of innovativeness and market position.

However, further research and study is necessary to analyze under which circumstances business strategies based on openness are superior to traditional competitive strategies. What are the characteristics a corporation has to feature and what are industry and market conditions under which openness leads to competitive advantages rather than lost revenues. Since digitalization and globalization revolutionize the world’s economies traditional economic views on markets and marketers, their behavior will constantly have to be checked against validity.

How Tesla Reduced Costs of Entry and Learning Curves: Forming Partnerships, Leveraging Other Firms’ Capital and Quickly Bringing Products to Market

Consider some of Tesla’s specific steps. Even though Tesla eventually hopes to produce mass-market electric cars, spending years in the design room and the preproduction phase for a large scale could have ended in a disaster in many ways. Instead, Tesla started small with what can be considered a minimum viable product with their low-volume roadster [55]. Without a pipeline of products about to be released, a huge amount of capital, and the luxury of spending as much as many of their competitors, timing was important. In 2006, Tesla co-founder Martin Eberhard stated their goal was to bring their first car “to the market quickly and efficiently” and they did so through partnerships with existing firms. In 2004, Tesla approached Lotus to discuss a partnership and over the next couple of years formed a relationship where Lotus would help with design, engineering, and technology and be the contract assembler of Tesla’s first vehicle. Eberhard stated, “Much as I love cars, I am the first to admit that neither I, my co-founder, Marc Tarpenning, nor our original investor (and chairman of our board), Elon Musk, is an automotive engineer.” [57]. Lotus Engineering assisted with analysis and supply chain and starting with Lotus Elise licensed technology, and Tesla’s U.K.-based engineering team designed the chassis. Tesla was able to “save time and money” by heavily relying on Lotus for issues related to structure and safety. Having shared safety components let Tesla buy windshields, airbags, and automatic braking systems from the same suppliers. Such modular relationships let Tesla incorporate relatively complicated components without having to design them anew. Various authors have talked about how modular relationships common in the technology industry let firms get into and out of new areas with relative ease, and partnerships let firms leverage the knowledge and infrastructure of existing firms. [6] Lotus assembled the car and about 6 percent of Roadster parts overlapped with those of its British relative. Automobile Magazine likely underestimated the Roadster’s novelty, describing the cars as: “Lotus Elise’s [converted] to run on batteries….everything else about the $100,000 Roadster felt like the $50,000 Lotus Elise on which it was based.” Yet the product turned out well and had a range and performance competitive with many high-end gas vehicles. The Roadster had a 245-mile range, 0 to 60 miles per hour acceleration of 3.6 seconds, and a top speed of 130 miles per hour. Eberhard stated, “Just about three years from the day Marc and I started Tesla, we saw our first real Roadster from the assembly line.” Development of the Roadster cost more and took longer than they anticipated and Musk now states he wishes Tesla had done more in house. However, Tesla produced 2,500 Roadsters in its four years of production and that car enabled Tesla to move toward its next stage. Musk states it was “the beachhead of the technology. It’s the introductory product (that) allows us to refine the technology and make (it) more affordable over time.”[57] Tesla was then able to plan for the larger-scale production Model S and got there through partnerships with Daimler, Panasonic, and Toyota. In 2009, Daimler invested $50 million and subsequently formed an agreement for Tesla to supply drivetrains to Daimler’s Smart and Mercedes, and in 2010, Panasonic invested $30 million and created an agreement to develop batteries with Tesla. Some of Tesla’s most important transactions were with Toyota, which in 2010 invested $50 million for shares in Tesla’s IPO and sold Tesla its New United Motor Manufacturing, Inc. (NUMMI) plant in Fremont, California, for $42 million.

Problems with mass market entry

A key aspect in the market entry of BEVs like Tesla is customer identification. When target customers are being discussed within the literature, key themes arise, which is that early adopters of BEVs are highly educated, environmental conscious and have oil supplies concerns [58, 59]. Most studies overlook the need for BEV users to have higher incomes due to the high prices of BEVs, some studies do acknowledge this, though [60]. It is clear that they are more expensive than a comparable ICE vehicle, and have shorter ranges. This is a major hurdle for mass market low-end encroachment market entry [61].

Price and payback times

Whilst BEV sales are increasing [24], market uptake is still low. A study found that intent to purchase a BEV is still very low [58]. Prospective customers see the main advantage of a BEV as potential fuel savings, however the initial purchase price of BEVs, compared to a similar conventional vehicle is too high to justify these fuel savings. Payback times are found to be unacceptably long [58]. A comparison can be seen in Figure 13 showing the running costs of a Nissan Leaf with 4 similar rival vehicles. Figure 13 shows that the Nissan Leaf does not become the cheapest vehicle type almost 4 years of ownership. However, when the battery is leased (£70 per month) the Leaf is the lowest cost option from year 0, due to the reduced purchase price, but becomes more expensive than a Hybrid after 8 years and a Diesel ICE after 10 years due high battery lease costs. It is important to consider that these findings are based on a £5000 UK government grant available for plug-in vehicles. A cost comparison in the absence of these running costs can be seen in Figure 14. The information in Figure 14 suggests that the Leaf’s does not become the cheapest vehicle type until more than 10 years when compared to a hybrid vehicle or an efficient diesel vehicle. BEV grants are not available in all nations meaning ICE vehicles are still often cost effective due to unacceptably long pay back periods. To suggest to consumer that mass market BEVs can save you money, on the basis of lower fuel costs alone, would be misleading and untrue according to these findings.

Figure 13: Running costs per year of the Nissan Leaf Compared to its rival hybrid, ICE and diesel cars. Based on purchase price, fuel costs and road tax (including Government grant) [84]

Figure 14: Running costs per year of the Nissan Leaf Compared to its rival hybrid, ICE and diesel cars. Based on purchase price, fuel costs and road tax (excluding Government grant) [84]

Range

For consumers limited range is an issue, and a preventative factor when purchasing a BEV. Ranges of mass market BEVs are around 87 to 124 miles [24]. Ranges are limited due to cost reductions. For many customers this limited range wouldn’t be an issue; Pearre et al. [63] suggested that 75% of the US population could substitute an ICE for a BEV with limited disruption due to range. However, drivers still perceive the range as an issue. Daily, many people don’t drive further than the range of a BEV (87- 124 miles), but on a monthly or annual basis journeys exceeding these ranges are common. This raises the issue of high income being important in the adoption of BEVs. BEVs would form part of a multi-vehicle fleet, with a second ICE vehicle being available for journeys exceeding the BEVs range [64].

Core & ancillary attributes

In addition to mass market BEVs having lower ranges compared to ICE vehicles there are other core attributes with lower performance values. Mass market BEVs have slower 0- 60 mph acceleration times, and lower top speeds. This means that vehicles have core attributes that are worse than the incumbents, and many core attributes, such as the visual appearance of the vehicle and the level of equipment (satnav, radio, air conditioning etc.) remain unchanged. All of this would lead to a logical suggestion that these types of BEVs should be entering markets via low-end encroachment, but their high prices prevent this from being a possibility. As a result they are marketed at higher prices than ICEVs despite them not having improved core or ancillary attributes.

Consumer perceptions

Often the image of a technology or product is developed over a long period of time and their perception is based on previous experience and exposure. This is problematic for BEVs since current BEVs are much more advanced than previous ones. However, people may base their perceptions of BEVs based on previous prevailing opinions. In the UK it is suggested that buyers’ perceptions of BEVs are negative because of previous experiences & observations of Milk Floats, Electric Golf carts and Quadricycle BEVs such as the G-wiz [65]. As a result of this, consumer’s opinion of the core attributes of a BEV are even lower than the actual core values. There is a need to change these views in order to increase market uptake. Garling & Thøgersen stated in 2001 that “Higher prices, limited ranges, less loading capacities and lower top speeds are not a desirable package” Whilst this statement was made in 2001 it still remains true today. Compared to their most direct rivals electric vehicles do fall short in these areas. Because of these inadequacies, it was suggested that BEVs should enter markets with low introductory prices and that drivers of high-end cars are unlikely to purchase a BEV over an ICE vehicle [66]. As a result of statements such as these many automotive manufactures have gone down the route of cost minimization for mass market BEVs, but this leads to the core values of the technology being inferior to incumbent vehicles, and this causes the negative views of BEVs to continue. And indeed costs have not been able to be reduced to a level that makes them cost competitive compared to ICEVs. There is an additional consequence of introducing poor quality products into to the market. Not only will initial market uptake be low, it can harm future diffusion rates. The first people to adopt new technologies are innovators & early adopters [21]. These people are often opinion leaders and are an important source of information for groups of later adopters [21]. Word of mouth marketing is important in the spread of new technologies [68] and the views of opinion leaders will either drive of halt market uptake. If the first adopters view BEVs as inferior they are unlikely to recommend the vehicles to others in their network, thus stifling their market uptake. The high-end encroachment strategy reduces the risk of this occurring.

Outline of problems with Mass market entry

With the BEV cost minimization is not the answer, a market entry route that concentrates on improving core and ancillary attributes through developing a high quality product is more relevant. The poor core attributes of BEVs discussed here are only present in BEVs for mass markets, such as the Nissan Leaf, Peugeot iOn, Mitsubishi i-MiEV, and Smart electric. As we shall see, Tesla has produced BEVs with none of the disadvantages of these BEVs and superior core and ancillary attributes compared to ICEVs. Tesla has developed a high value BEV without shortcomings of mass market BEVs. This high-end encroachment market entry approach has long been used within the automotive sector and indeed many other market sectors. However with BEVs & FCVs it has been neglected by many automotive organizations, with most companies seeking a route of mass-market entry first. Some of these companies have seen success thanks to government incentives, especially Nissan with the Leaf; however this case study is less relevant for BEVs due to the lower purchase price of the Leaf. The price point of the Leaf is currently unattainable for BEVs and so this low cost market entry route is not appropriate for BEVs. This is the reason for the Leaf or any other BEV not being the subject of this study.

Methods adopted by Tesla to defy the shortcomings of mass market entry by Electric Vehicle manufacturers

Supercharger network

Many innovative and disruptive technologies require new infrastructure, with BEVs requiring electric recharging infrastructure. BEVs can be charged with standard mains supply electricity but this results in slow charge rates. Tesla is developing a network of supercharging stations. These stations can charge the Model S’s batteries by 50% in 30 min [69]. This high speed charging is achieved using 120 kW max charge rates and with batteries that have a lower taper point than other batteries [16]. The supercharger network is free to use forever, when the option is purchased with the vehicle or comes as standard with the vehicle. In 2015 the Supercharger network covered 98% of the population in the US. There are currently 16,585 superchargers at 1870 stations around the world (March, 2020). The purpose of this network is so that Tesla can show that it is possible to drive long distances in BEVs. A team from Tesla completed a coast-to-coast road trip in the Model S to prove this. The network does not support the old Tesla Roadster due to technological incompatibility [16]. Tesla has also began development of the Supercharger network in Europe, development began in Norway, which already has one of the highest concentrations of BEVs in Europe [33] and the first Model S to be sold in Europe were sold in Norway [71], with 500 being delivered to customers between August and September 2013 [72]. In addition to Norway, Supercharger stations are now in Germany, The Netherlands, Austria, Switzerland and the UK [73].

Sales model

Many innovative and disruptive technologies do not enter markets via traditional sales channels. Tesla did not follow the traditional model of franchises that mainstream automotive companies follow. Tesla sold the Roadster though its own sales channels. Disruptive technologies can be complex; keeping the sales in-house prevents misinformation developing around a product. Poor sales and marketing advice in the early days of a market entry can potentially be damaging. By owning their own sales channels Tesla is able to offer customers compelling customer service. Tesla’s sales channels achieve higher efficiencies and higher sales capture over traditional franchise models [74]. Currently this model is being battled by US OEMs who have been successful banning Tesla from selling vehicles directly to the public in the state of Texas [75]. Tesla takes advantage of increased revenue share from vehicles sold; by selling the products directly, margins can be made smaller, this can lead to the purchase price of the technology being marginally lowered making the product more competitive in the market.

Threats

Tesla is experiencing some resistance from incumbents in the automotive sector. Currently in the US the National Automotive Dealers Association (NADA) and many state dealer associations are attempting to block Tesla’s direct sales approach. The NADA are using State Legislation and Courts to block Tesla. They have been successful in the State of Texas and are making progress in two more states [16]. It is unclear if the intentions of these blockages are really to prevent direct sales or if they are to prevent Tesla from selling BEVs in these states. What is clear is that this will be damaging to Tesla. An additional threat is competition from other manufactures. As is common with new products other manufactures are now looking to enter the same market that Tesla operates in Ref. [19] with BMW recently entering the BEV sector with its i3 and i8 vehicles. US Company Detroit Electric is also looking to launch a high performance BEV Roadster [77].

Overcoming Network Externalities: Expanding Markets with Charging Stations, Distribution, and Service

Tesla used knowledge from Silicon Valley to reduce potential barriers to entry, and Tesla is also using knowledge from Silicon Valley thinking to deal with network effects, or network externalities, in the auto industry. A network effect is present when the value of a good depends on how many other consumers use the good. For example, being the only person in the world with a telephone or an Internet server would be of little value. From payment processing to software systems and social media, the value of many networked products depends on the number of users. More traditional products like cars can also have network effects when the number of users and service centers in an area matter.[78] Although some forms of network externalities will forever be present, firms can overcome and internalize network externalities by owning and subsidizing parts of a network to increase the number of users.

Consider, for example, the strategy of one of Musk’s first co-founded companies, PayPal, which gave new users and their referral a $10 bonus for each person who signed up. This promotion was costly, but it helped increase the number of users from 1,000 in October 1999 to 1 million in April 2000 to 40 million when eBay bought the company for $1.5 billion in 2002. Other tech firms also subsidize different parts of a network to expand the number of users and increase the value of the product line. The “hardware-software paradigm” theory in economics describes how a hardware (or software) producer that receives spillover benefits from complementary software (or hardware) on its network may want to subsidize the production of the complementary product or vertically integrate to produce both [79]. Hardware producers, such as video game console manufacturer Sony, benefit from having more designers and customers on their network, so they often initially sell consoles below cost or subsidize early software production on the hardware’s platform. With other arrangements, the subsidization can go in the opposite direction from software to hardware producers. Microsoft used to subsidize phone hardware producer Nokia to expand the amount of people with a Windows Phone. When capturing the benefits through such an arrangement is difficult, a third option for a producer is to become integrated and produce the hardware and software in a way that maximizes the value of both. Microsoft ended up choosing this route when it purchased Nokia’s handset business in 2013, and Apple’s phone business has been more vertically integrated all along. The optimal arrangement is not set in stone, but firms will seek to maximize the joint value of the hardware and software and that can include subsidizing parts of the ownership experience.

Tesla faces many of these dilemmas where cars can be considered the hardware and the technology, service, and charging considered the software. Musk even describes the car as “a very sophisticated computer on wheels,” and states, “Tesla is a software company as much as it is a hardware company. A huge part of what Tesla is, is a Silicon Valley software company. We view this the same as updating your phone or your laptop.” Like other Silicon Valley firms, Tesla has recognized the need to provide certain parts of the consumer experience at zero cost to the consumer. Consider the growing charging network that Tesla is subsidizing. In 2013, Consumer Reports stated it did not give the Model S a perfect score because of potential issues with range and access to charging. Although Tesla owners can charge their cars using any 120-volt outlet, faster charging requires a 240-volt outlet like those used for home appliances, and even that takes hours. The more parking spaces that have 240-volt outlets and the more special charging stations there are, the more valuable Tesla cars become. One step that Tesla is taking is creating a Destination Charging program that subsidizes the installation of the $750 Tesla Wall Connectors at participating hotels, resorts, and restaurants. Another important step that Tesla is taking is building a network of much faster charging stations that give Tesla owners electricity for 170 miles in a 30-minute charge. As of March 2020, Tesla has built 1870 charging stations (with 16,585 Superchargers) that charge at marginal cost to the user. Spending $500,000 per station and not charging users anything is costly, but when viewing a charging network as equivalent to software in the “hardware-software paradigm,” one can understand why Tesla provides this complementary product at zero marginal cost. Tesla is also working with other potential charging-station companies and encouraging them to get into the space.

Another network effect that Tesla faces compared with established firms is a dealership, distribution, and service network. Tesla reports that one of the most common customer questions is about servicing the cars, and to address this concern, Tesla has built and is expanding Tesla owned-and-operated service centers. Tesla currently has fifty that operate with the following instructions from Musk: “What I’ve told the Tesla Service Division is their job is never to make a profit.” Here the firm is not acting altruistically, but working to increase Tesla’s profits overall by helping “quell fears about buying and maintaining an electric car and boost sales of the Tesla in the long run.”[80] By subsidizing one aspect of the ownership experience (and pricing it into the car), Tesla is working to maximize the value of hardware and software and to internalize those benefits.

One of Tesla’s most interesting moves to deal with network effects was to free all of its patents into the public domain. As of March, 2020 Tesla had hundreds of patents, yet they decided to make all of their patents open to the public to encourage other firms to enter the electric car space. As Musk states: “Our true competition is not the small trickle of non-Tesla electric cars being produced, but rather the enormous flood of gasoline cars pouring out of the world’s factories every day. We believe that Tesla, other companies making electric cars, and the world would all benefit from a common, rapidly evolving technology platform. Technology leadership is not defined by patents, which history has repeatedly shown to be small protection indeed against a determined competitor, but rather by the ability of a company to attract and motivate the world’s most talented engineers. We believe that applying the open source philosophy to our patents will strengthen rather than diminish Tesla’s position in this regard.”[81]

Tesla has benefited from the existing technology and manufacturing infrastructure of other car companies like Daimler, Lotus and Toyota, and it sees the benefits of having more companies and engineers working on electric vehicles. Although Tesla has paid research and development costs that other firms will not, it may benefit from having more participants in the electric car network.

Tesla’s approach flies in the face of theories that assume that businesses must rely on restrictions to protect their market position. Bahrami and Evans describe how Silicon Valley firms often rely on cross-pollination and adaption of others’ ideas and how much of their success can be attributed to the ecosystem that facilitates both competition and collaboration. The personal computer industry led by IBM, Microsoft, and Intel turned out much bigger because the large firms had many smaller firms contributing to their relatively open and modular product ecosystem [82]. Being a key player in a large product infrastructure can be better than having complete control over a proprietary but small one. More recently Google has gained 85 percent of the smartphone operating system by making much of its Android operating system open source and Microsoft is now making some of its products open source as well. Tesla seems to have gone a step further and is the largest company that we know of to make all of its intellectual property open source. By working to increase the size of the electric car market, Tesla has the potential to be in an important position in an increasingly large segment. The move may have other benefits too according to Musk: “Open sourcing the patents does have the advantage of making Tesla a more attractive place for the world’s best engineers to work. And it builds goodwill, which I believe will be important.”[83]

Reflections on the future of the Automobile

The Tesla story suggests that barriers to entry for the automobile industry are coming down. Tesla’s big break came with securing the NUMMI plant for a fraction of its replacement cost and securing favorable DOE loans. New entrants in the automobile sector can take advantage of contract manufacturing (CM), to reduce their upfront capital costs. For example, Valmet Automotive has manufactured cars for large OEMs for decades, and currently makes the Mercedes GLC in Finland. New entrants have already used the services of contract manufacturers such as Valmet to produce their cars. In addition, given the overcapacity in manufacturing they may be able to buy an existing plant as Tesla did with NUMMI. GM shut its last plant in Australia and a British EV entrepreneurs is in talks to buy the assets [85]. In the future dynamics of the auto sector, substantial value migration could occur to new entrants that focus on critical aspects of the auto industry value chain (as shown in Figure 15) or on niche markets in the electromobility age. These critical elements are likely to be dominated by sensors, specialized computer hardware (i.e., video recognition), communication and control software. For example, the platform operating system that is used to control the car and communicate between the car and its surroundings, could become a critical battleground over which new entrants and incumbent OEMs fight to obtain, or retain, a dominant position in the industry.

Figure 15: Porter’s Value Chain of Tesla Motors

Connectivity via vehicle-to-vehicle and vehicle-to-infrastructure communications will require standards. Could the players developing the platform operating systems become the kingpins in the future auto industry, setting standards and forcing other actors in the auto ecosystem to adopt them [85]?

The current three big players in this space are Google, Apple, and Microsoft. Each have already adapted operating systems for the car (Android, iOS, and Windows Embedded Automotive, respectively). In China, Baidu and Alibaba are actively working on similar systems. While the early generations of these products have focused on smart phone connectivity etc., to enhance phone operations and music playing, these platforms could readily form the basis of future features such as advanced driving navigation, partial and fully autonomous driving and communication and connectivity to manage traffic flows. Apple is known to be working on car applications and autonomous vehicle technology. Already, driving navigation tools leverage online mapping and big data in real time to provide guidance of how to avoid traffic jams. In future, the same systems could manage traffic flows automatically if a sufficient portion of the traffic is connected to the one system.

The large IT companies such as Google, Apple, Microsoft and their Chinese counter-parts Alibaba, Baidu, and Tencent have the financial capacity and technical capabilities to repeat the Tesla journey, or even, to buy an OEM outright. Apple for example is sitting on US $250 billion in cash and its stock value is 15 times as large as GM (US $ billion 900 versus 60 billion). If large IT companies decide that it does not make sense for them to become system integrators outright, then they could focus on capturing value by developing platform technologies that become installed in the cars produced by the OEMs through alliances. Companies such as NVidia and Intel are currently adopting this approach. For IT companies, this strategy would leverage their existing competitive advantage in hardware, software, smart phones, big data, artificial intelligence and cloud services infrastructure (e.g., see for example Sangameswaran & Nagarajan [87]. For B2C firms such as Apple, the aim could be to develop ecosystems which seamlessly integrate a user’s smart phone, their connected ‘smart’ home and the ‘smart’ car; for B2B firms such as Intel, the aim could be to develop an IT vehicle platform that multiple OEMs install in each car. It is conceivable that in the long term controlling the automotive IT platforms may become more valuable than making the car itself, especially if individual ownership substantially declines, reducing the value of automotive aesthetics. This is precisely what happened with the PC three decades ago, when a large portion of the sector value migrated to the producers of the critical components, being the CPU (Intel) and operating system (Microsoft) [85].

Thus, competition in the auto market is increasing, driven by a convergence of trends including electrification of the powertrain, greater use of ride-sharing and the future prospects for autonomous vehicles. New companies are being formed in an attempt to take advantage of the lower barriers to entry, while IT companies are vying to enter the sector directly or develop standards and platforms so they can become kingpins and control the emerging ecosystem(s).

As barriers to entry have come down, competition in the EV space has changed dramatically since the Model S was launched in 2012. New entrants such as the Chinese company Qiantu are attempting to repeat Tesla’s success in China and have announced a luxury EV sports car with the intention of developing more models in future [87]. Established companies such as BYD of China already have a range of EV and PHEV cars on sale. Over the coming 3 to 5 years all major OEMs will have hybrid EVs and battery EVs across most major market segments and will be delivering those products at scale. What will be the ramifications for new entrants and even Tesla? Although Tesla, has a current market capitalization greater than both GM and Ford, it still needs to ramp up production of the Model 3 and compete against rivals such as the Chevy Bolt and forthcoming compact luxury EVs from European and Japanese manufacturers.

In China, the government is backing the development of a local EV industry with substantial funding and tariffs on imported autos. While China’s strategy to become a leading manufacturer of ICE automobiles hasn’t been fulfilled, the electric vehicle market is less mature and may offer a second opportunity for Chinese manufacturers to develop products which could compete globally. And in China, so called new energy vehicles, are expected to capture most of the auto sales growth in the country over the next 8 years. A plethora of new entrants have already started manufacturing everything from electric motorbikes and electric delivery vans to electric sports cars. Global start-up NIO (2017), with backing from Baidu, Tencent and several Silicon Valley venture capital firms has developed an electric super-car and announced plans to introduce an all-electric SUV in China in 2018. BYD has become the world’s second largest manufacturer of plug-in hybrid vehicles (behind Nissan) with cumulative production of more than 170,000 units. BYD already produces over 8 GWh of batteries per annum, compared to less than 1 GWh by Tesla. Chinese internet companies Baidu, Alibaba, and Tencent are investing in autonomous driving technologies, start-up electric car companies and joint ventures with OEMs. Baidu has established an autonomous vehicle division and invested into NIO. Tencent has a 5% stake in Tesla, while Alibaba has a cooperation agreement with SAIC and is actively developing internet connected cars [89]. Given government support, it seems likely that the Chinese internet giants will be in a good position to develop and potentially dictate the autonomous driving platforms used in China.

Emerging manufacturers like Tesla are seeking to become significant OEMs while new IT entrants are working on everything from mapping technologies and smartphone connectivity through to new automobile operating systems and autonomous vehicles. In light of our analysis of Tesla’s development, large IT companies could enter automobile manufacturing directly in the next few years. Clearly they do not have to because they can participate in the new automobile ecosystem in many different ways. The automotive industry is now facing its greatest transformation since Edison and Ford argued over whether gasoline combustion or lead-acid batteries should power the automobile a century ago [89].

For management scholars, the success of Tesla, the emergence of new automobile OEMs in China, and the strategic moves by IT companies to establish themselves in new segments of the industry raises important questions whether the future of automobiles will look very different than its past. If one thing is for sure, it is that the success of Tesla has heralded a new era in the automobile industry. As innovation and competition in the automotive sector increases, consumers will be the big winners. There is more choice than ever and new cars are more efficient, safer and have more features than those which came before.

Up until 150 years ago, whale oil was the preferred fuel for lamps, but that changed with the invention of kerosene, a cheaper alternative that could power the masses. Tesla is now offering an equivalent innovation that has the potential to reduce auto emissions, and let cars be powered by all types of energy, including nuclear and solar. One cannot predict what products or companies will reign supreme in the future, but the entrepreneurial process allows for innovation and the replacing of old ways of doing things. Even if Tesla is ultimately outcompeted, its high market capitalization has already benefited its investors and acted as a signal and attracted more investment into the electric car industry. When General Motors and Chrysler veered toward bankruptcy, the market was signaling that the incumbents were doing something wrong, and as the value of Tesla rose, the market is signaling that Tesla is doing something right. Currently, Audi, BMW, Mercedes, and Porsche have plans to compete in the electric car market. Even if they are more successful or take over the market, Tesla will have helped pave the way for a new technology in much the same way that now-defunct or purchased firms such as RCA, Zenith, Magnavox, Kodak, Polaroid, Commodore, Amiga, and Atari helped paved the way for modern stereos, television, photography, computers, and home entertainment. The entrepreneurial process constantly encourages firms to come up with better products and, in the process, disrupt existing market structures for the ultimate benefit of consumers.

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