Tesla revealed Model 3 plus two innovation secrets

On March 31st 2016, Tesla Motors’ visionary CEO, Elon Musk set foot on stage at the SpaceX headquarters in Los Angeles to unveil Tesla’s revolutionary product, Model 3. In less than one week, 325,000 pre-orders were placed for the car worldwide, meaning the company has far secured almost $14bn worth in sales for a car still over a year away from its release date. 115,000 orders had been placed before the car was even unveiled! This is truly shocking and unprecedented in the car industry. On the same stage, though, Musk also revealed two innovation secrets.

Before getting to those secrets, I need to make it clear why I consider Model 3 a revolutionary innovation. Having known that Tesla Motors itself had previously introduced two fully-electric cars, one may wonder what makes Model 3 revolutionary?

The answer is that Model 3, unlike its two predecessors, will be the first ever high-performing, low-priced, and mass-marketed electric car. Model 3, apart from being fully electric, can go head-to-head with the established big sellers across the whole car manufacturing industry in terms of performance and price. As Musk himself put it: “Model 3 will be 5-star in every category.” The car is quite revolutionary and, of course, has set off the alarms across the auto industry. Customers’ immediate response with a plethora of pre-orders, very much affirms the revolutionary nature of Tesla’s latest innovative product.

Innovation Secret #1:

Musk announced that high-volume production of a high-performing, low-priced electric car –the Model 3- has been his plan since the company's inception. But, what took him so long? Why didn’t Telsa market such a revolutionary car over the past 13 years?

It was surely not an easy endeavor, especially taking into account the size and resources of the company at the time. Tesla’s formula is what Musk referred to as the “Top-Secret Master Plan”. He perfectly described an important innovation secret: “How could Tesla as a tiny company with very few resources make a difference? The only way to do that was to start small. Any new technology takes multiple iterations and economics of scale before you can make it great and affordable.”

Thus, step one for the company was the Tesla Roadster, a high-priced low-volume car.  It intended to show the world that electric vehicles could be compelling and great. Musk added: “Before the Roadster, people thought that an electric car would be slow, ugly, low-ranged and have a bad performance. It was incredibly important to show that, that wasn’t true.” Producing 500 units of Roadster a year was enough to have a huge leverage effect on the whole auto industry. But still a lot of people considered Roadster a nice, yet expensive toy! It was not a car that people could use on an everyday basis or that was capable of competing against combustion-engine sedans.

Step two was the Model S, a mid-volume, not-quite-so-expensive car that proved how practical and good an electric car could be. Since half of the market demanded SUV, Tesla next introduced the Model X SUV, which is regarded by Musk as the step two-and-a-half. This was a critical step for Tesla as the revenue from Model S and Model X was needed to develop Model 3. Producing Model 3 as a very high volume and affordable car needed special capabilities and production facilities that would cost billions of dollars. So Models S and X actually paid for the development of Model 3. They also gave Tesla the brand recognition it needed to support a mass-market car in step 3.

And now Tesla Model 3 is the final step of this innovation trilogy: The first-ever high-volume, low-cost electric car.

Accordingly, Musk made it clear that a revolutionary product should be competitive in every aspect -apart from its innovative features- as compared to the products already on the market. In other words, an electric car could only make a big difference in the market if it were competitive in terms of its performance and price as well. This cannot be achieved by most SMEs in one step, since they normally lack the necessary resources and scale needed. That is why they need to do this step-wise just like what Tesla did; gradually acquiring the ammunition needed to efficiently mass-market its truly innovative product.

I should stress, though, that Tesla’s recipe is not applicable to every innovative SME! As professor David Teece's seminal paper “Profiting from Technological Innovation” (1986) perfectly explains, an innovator may not have the chance to step-by-step acquire or build the required complementary assets on its way to market. This is because it is highly probable that other companies – especially large companies equipped with the needed complementary assets- to profit more from the innovation than the firm first to commercialize it! This is particularly the case when imitation is easy.

In such exceptional cases where the innovator has an iron clad patent protection, he would have more time to build or acquire these complementary assets. This was exactly the case for Tesla. Tesla’s technology was under protection by a total of 655 patents covering around 249 inventions. In other words, Tesla was very much sure about the non-imitability of its innovations along its three-step master plan.

This, in turn, brings us to the second innovation secret revealed on the same stage:

Innovation Secret #2:

Two years ago (On the 12th June 2014), Musk announced in a dramatic statement, “All our patents belong to you.” He said that Tesla was doing so “in the spirit of the open source movement and for the advancement of electric vehicle technology.” This surprising statement attracted a wide range of interest and caused many reactions among IP and innovation experts. Many analysts tried to give their own readings of the timing, motive, and target of that move. But at the SpaceX headquarters, Tesla not only unveiled its revolutionary product, but also implied another innovation secret which perfectly justifies the shocking measure of June 2014.

Tesla, before making that patent policy shift, had become pretty sure that it possessed all the relevant complementary assets needed for profiting from its coming revolutionary innovation- Model 3. Beyond that, I believe the company had managed to develop a co-specialized asset within its boundary, which was extremely difficult for its competitors to develop, at least in the short term; something that gives Tesla a sort of monopoly. This should be something beyond generalized equipment and skills that are available to other car makers. Whatever it was, Tesla felt secured that it got the upper hand and was not anymore worried about its innovation being imitated even without the protection shield of a patent portfolio.

But, what could that co-specialized asset that advantageously positions Tesla relative to all its likely imitators be?

From what Musk said one can deduce that co-specialized asset to be in fact a manufacturing capacity; the Gigafactory which is a giant battery plant appropriately located in Sparks, Nevada. It is larger than 95 football fields and the second largest building in the world. It will only be slightly smaller than the Boeing’s plant in Washington. The Tesla Gigafactory alone will produce more lithium ion batteries than all other factories in the world combined. The giant factory will help Tesla dramatically cut the cost of its batteries by using extreme economies of scale. This lowered cost of the batteries is what enables the company to price its Model 3 at low as $35,000.

If the Gigafactory is in fact the co-specialized asset that Tesla is heavily relying on, to the extent that it opened up all of its patents, one could reasonably expect Tesla’s core innovation to hinge around batteries and charging mechanisms. If so, then most of Tesla’s patents should deal with battery packs and their charging.

Figure 1- The composition of Tesla’s patent portfolio

A close analysis of Tesla’s patent portfolio (by Relecura) fully supports this claim. As figure 1 clearly shows, sixty percent of Tesla’s patent portfolio is related to battery technology (Li-ion), and charging (fast charging). The aforementioned statement shows that the company doesn’t rely anymore, on its patent portfolio to profit from its innovations. Its battery Gigafactory- as a strong co-specialized asset- makes it very difficult for all the rivals in the car industry to produce lithium ion batteries at a competitive price and quality.

Now one could ask, if Tesla’s most important co-specialized asset is its giant battery factory, why didn’t the company just redirect its patenting efforts toward technology areas other than battery and charging? Why did Tesla take a stand against patents all together?   

These are key questions which bring us to another one of Tesla’s innovation secrets which, in my opinion, can be the even more important that the two discussed. I will write about it in my coming post!

In the meantime, please let me know your reflections on this post.