Tesla Sets Itself Up for Trouble — Again

Although plenty of major institutional investors still hold shares in Tesla, several of them were savvy enough to know that the stock price peak would accompany the Model 3 launch. The launch exposed the failure of Musk’s belief that Tesla could eliminate the production prototype phase and go straight to final assembly, which was overly dependent on robots to do tasks that only humans can perform. 

The idea of more losses from moonshot ideas like robo-taxis was not credible enough to keep the likes of T. Rowe and Fidelity engaged. Like other companies where costs exceeded revenues, the rather quaint idea of actually making a profit has to be Tesla’s priority because yet another improbable idea isn't going to reverse the skepticism surrounding the stock — only selling more cars and increasing margins will do that. Increasingly, the idea that Tesla was more than an auto manufacturer is being challenged, and with that, the sky-high valuation it enjoyed as a “unicorn” is disappearing. While the stock still has its champions, the bond market now rates Tesla debt with junk bond ratings, making it more expensive to fund capital investments with debt.

The flaws in Tesla’s business model were always there and harken back to the time when it boldly announced a fantastic car, but also a supposedly lower cost production system as well as a customer experience that controlled the purchase process along with all aspects of ownership. The lessons learned by traditional automakers about the challenges of managing a high fixed-cost, capital-intensive business that depends upon fickle buyer preferences were ignored in favor of disruptive ideas that would revolutionize both production and distribution.  The fact that Tesla deliberately did not tap the expertise and institutional knowledge within incumbent auto companies speaks for itself.

Tesla’s fundamental mistake was the assumption that it would always have an overflowing order bank, so it would be the first automaker to successfully implement “build to order” assembly. It would sell its cars at fixed prices without having to discount them and would never have excess parts inventory, idle employees, or finished goods parked around an assembly plant.  This allowed Tesla to hypothesize superior production and distribution economics more than incumbent automakers.

In recent months, Tesla has behaved very much like a traditional automaker in trying to stoke sales and margins. Standardizing features like the auto pilot on the Model 3 and effectively eliminating the base model are standard automaker margin-grabbing practices. Signaling future price hikes to pull demand forward is another. Numerous blogs and reports in the press suggest that customers are being offered  discounts while being upsold to higher margin vehicles.  Restricting a Model 3 lease so that the customer could not purchase at lease maturity makes no sense on many levels, but the most obvious is that Tesla would have to carry depreciating assets on its balance sheet along with the expense of maintaining that fleet. It already owns plenty of off-lease S and X models that it is responsible for retailing.

The popularity and demand for every make and model fluctuates, and, in Tesla’s case, has been dependent on the largess of government incentives here and in Europe. This will only get worse for Tesla when the federal tax credit drops to $1,875 (from $7,500) on July 1st and disappears entirely at year-end. Tesla should have chosen a traditional franchise dealer model because it is now discovering that build-to-order production is not possible in the highly competitive and cyclical automotive industry. Every other automaker would force its dealers to take extra inventory while it slowed production, and the dealers would find the market-clearing price for the inventory. Although Model 3 owners love the car, many have experienced delivery problems because of inadequate logistics and delivery support that’s needed for high volume sales. And the lack of service capacity has only gotten worse with the Model 3’s arrival.

Tesla’s production and liquidity woes need a believable strategy that establishes financial credibility. With the Model 3 order book apparently satisfied in the U.S., Tesla has no choice but to attack costs, especially those related to excessive production, which not only include high fixed costs but also lower labor productivity than is typical of other automakers.

Maryann Keller is principal of Maryann Keller & Associates, an automotive research and consulting firm.