Tesla's Secret Weapon

Some CEO’s make things look easy and appear to enjoy their work. CEO’s like Richard Branson and Warren Buffet come to mind. These are guys that clearly enjoy what they are doing and, as a result, make everything they do look effortless and fun.

Tesla’s Chairman and CEO, Elon Musk, is another one of these types. There is an impishness in his communication of the company’s performance that conveys the overwhelming impression that no matter how bleak or dangerous the financial circumstances of his company may look, he has a plan that will ensure that everything works out fine for investors and customers alike.

Musk’s blithe spirit derives from his direct ownership of the customer relationship.

Tesla reported earnings last week. It is safe to say that financial analysts viewed those results as falling somewhere on a spectrum between disappointing and disastrous. But Musk skillfully evinced sanguinity.

Analysts had expected a small profit, but instead were told of a tripling of the company’s net loss to $320.4M with an operating loss of $113.9M for the company’s 2015 fourth quarter. Tesla says it can achieve a net profit within 12 months.

Tesla’s fourth quarter sales rose 27% to $1.21B relative to the year-ago period. The company’s full year net loss was $889M on sales of $4.05B. Tesla said it sees deliveries of Model S sedans and Model X SUVs reaching between 80,000 and 90,000 in 2016, with Model X weekly production expected to peak at around 1,000 a week in the second quarter.

Musk’s serenity derives from a fundamental advantage he holds over the entire automotive industry. Tesla owns and controls its customer relationships directly.

The power of this control is manifest in the over-the-air software update strategy that Tesla has pioneered and perfected. While the rest of the automotive industry wrestles with dealer franchise agreements that limit the ability to directly update vehicle software, Tesla is able to nimbly plunge ahead with added features and functions long after the vehicle sale.

In fact, Tesla has been able to avoid vehicle recalls and has been able to charge thousands of dollars for performance upgrades, such as Autopilot, delivered via over-the-air software updates. Competing incumbent automakers have mastered this technology, but have been constrained in deploying it by dealer agreements which generally require that software updates be performed by the dealers.

Of course, owning the customer relationship has even greater implications in the context of Tesla building wireless connections into all of its cars. Tesla is mastering the process of continuous improvement of its existing cars while working on new cars.

In the earnings call last week Musk noted that the company continues to identify approximately 20 Model S enhancements every week. “Mostly, these are little tiny nuance things that most people wouldn't notice,” said Musk (as transcribed by SeekingAlpha - https://tinyurl.com/zkhum82). “But, it is a continuous improvement process. That's why I say, when people say, when should they buy Model S? Like what model year? It's like, we don't really have model years. We keep improving the car. If you want to wait until the car stops improving, you'll be waiting forever.”

Reliability is improving steadily as well. In his letter to investors, Musk wrote: “The cost of first year repair claims for cars produced in 2015 was at about half the level of cars produced in 2014, and about one quarter the level of cars produced in 2012.”

Of course, the theme of constant improvement was reflected throughout the earnings call with emphasis on cost reductions targeted at improving overall profit margins. It is clear that unambiguous customer ownership facilitates data collection and analysis – giving Musk a fundamental market advantage.

Competing car makers must guess or depend on third-party survey organizations to determine whether they are achieving improvements in reliability and customer satisfaction. Tesla owners, on the contrary, feel a direct link to Musk himself. He is speaking directly to them, even if his audience is financial analysts on an earnings call.

The data collection engine that underpins Tesla’s product development and customer and vehicle relationships is reflected in the Autopilot launch. In the investor letter Musk noted: “Our customers are now driving over 107,000 Tesla vehicles in 42 countries and have traveled nearly two billion miles. Tesla’s Autopilot (which is not present in all 107,000 vehicles) is learning at the rate of over a million real world miles per day.”

The dealer-centric world of incumbent automakers is not only hampered by the customer ownership conflict (Who owns the customer? The dealer or the car maker?) it is also driven by the demands of sales, marketing, incentives and advertising.

Traditional car dealers have to move the metal. With vehicles sales hitting record levels in the U.S., these demands have only increased.

Tesla doesn’t advertise and its prices are fixed.  Nevertheless, Tesla is outselling all cars in its class with the smallest dealer network, no advertising and no haggling.

In fact, the demand-driven nature of Tesla’s sales is reflected in Tesla’s limiting of access to the Model X for test drives while the company was sorting out kinks in the production process. The message to analysts: Tesla did its best to tamp down interest in the car rather than stimulating demand. “There’s no channel to stuff,” said Musk, speaking more generally, “because there is no channel.”

Constant improvement, customer ownership, data collection and analysis are all hallmarks of the not-so-secret weapon of vehicle connectivity deployed by Tesla. Whether or not Tesla can build, sell and maintain cars profitably remains to be seen, but Tesla has mastered the customer relationship fundamentals.

Competitors know that customer ownership is a much bigger hill to climb than power density. Tesla is gradually converting that hill into an impenetrable wall as it prepares for a 2017 launch of the Model 3.