Tesla often evokes strong reactions: positive and negative. Its challenger status, battling the entrenched motor vehicle industry to drive the transition to electric vehicles (EV’s) is a strong positive. Its heady valuation draws a lot of negative press. At ca. $650B (plus) market cap Tesla’s market cap exceeds the combined market cap of the seven largest auto players. We will discuss both issues over this two-part blog. And apologies at the outset … each part is longer than my usual blogs. I hope you find it worth the additional investment.
The auto industry has long been a case study in ‘barriers to entry’: large up front R&D costs; capital cost of manufacturing facilities; economies of scale; brand and marketing spend; dealer relationships. Overlaying this, the industry economics should have deterred even the most optimistic investor. Tesla’s audacity to imagine it could overcome these massive barriers to entry was extraordinary.
But has Tesla now established a sustainable competitive advantage? Why can’t the incumbents simply out-compete Tesla using their scale and experience? Is Tesla genuinely disruptive?
To answer these questions, we need to understand how the changing product architecture of the electric vehicle alters the competitive dynamics. Tesla is much more than simply a new challenger brand.
Christensen et al (2001) observed patterns that occur during a product’s evolution: viz.
“In the early stages, when the product’s functionality does not yet meet the needs of key customers, companies compete on the basis of product performance … later, as the underlying technology improves and mainstream customers needs are met, companies are forced to compete on the basis of convenience, customisation, price and flexibility”
Some fundamental organisational consequences flow from this pattern. In the early stages, when the products aren’t yet ‘good enough’, the engineers must push right up against the technology frontiers. But they can’t do that with off the shelf components with standard interfaces. Companies need to adopt ‘interdependent, proprietary product architectures’ during this phase.
But as the industry moves into the next phase of competition, the focus shifts to speed to market, customisation, segmentation, and cost. To compete on these dimensions, companies must design modular products in which there are clear interfaces between the components and sub-systems.
Both phases of this pattern are evident now.
The traditional auto players have long been locked into the modular, speed and cost, competitive dynamic. The head of software at VW observed:
“Over the past 20 years the auto industry became more integrators than developers ... software is written by suppliers. This was good for a while because it drives costs down, but you lose control”
By contrast, EV’s are clearly in the ‘not yet good enough’ phase. With the shift to electric, Tesla has put computing at the heart of the vehicle, with the central processing unit managing not just the electric motor and battery, but all the ancillary functions, including brakes, lights, entertainment, heating and other critical systems. This represents a substantive shift in product architecture.
As Nvidia’s auto specialist observed:
“The key here is taking [the] distributed system in the car, dozens if not hundreds of applications, and centralizing everything … this is very complex”
Tesla’s organisational response reflects what Christensen observed 20 years ago. Most of the parts inside the Tesla are designed and manufactured by Tesla. Tesla developed its own chips, designed to optimise the interface with their software, for their integrated control unit, which is the centre piece of their design. This allows Tesla to control the development of all the key technologies.
The initial response of the incumbents to the EV transition has been to ‘shoehorn’ an electric drive train into a vehicle originally meant for an internal combustion engine (eg. e-Golf). Or BMW’s early e-vehicle:
“The i3 was designed so as not to cannibalise their profitable car lines. This mentality naturally permeates all of the car manufacturers”
The result is that the incumbents locked themselves into overly constrained design choices.
For years it has been assumed that when the big players got serious they would have Tesla’s measure. Volkswagen has been the most aggressive of the majors, outspending its peers in seeking to beat Tesla. Their ID.3 was their first vehicle designed from the ground up to be fully battery electric vehicle. It turned out VW’s five years and $50B investment to out-compete Tesla failed: their ID.3, launched in 2020 with much fanfare, didn’t work as advertised.
As the Wall Street Journal reported:
“now the Germans have finally come, and they’re not as good as Tesla”
Arguably, the incumbents fell victim to a form of ‘architectural innovation’. Architectural innovation refers to the reconfiguration of an established system to link together existing components in a new way.
The challenge of architectural innovation is that on the surface the core concepts of the design remain untouched. The organisation mistakenly believes it understands the new technology. But they are relying outdated patterns embedded in the old architecture (Henderson & Clark, 1990): viz.
“The focus of active problem solving becomes the elaboration and refinement of knowledge about existing components within a framework of stable architectural knowledge … it can be encoded in the operation of [communication] channels, information filters and strategies … The fact that they may be talking about the wrong things may only become apparent after there are significant failures or unexpected problems”
The Wall Street Journal opines that the incumbents didn’t consider EV’s are more about software than hardware. A senior engineer at VW recognised they have underestimated this shift:
“maybe we [VW] underestimated how much work is involved and how little we could actually rely on legacy software”
Another VW insider observed:
“In the middle of success it’s not easy to understand why you need to change now … the biggest challenge isn’t the technology, it is the mind-set of the people – their reluctance to embrace radical change until circumstances force them to”
Even once an incumbent realises the gap, the pathway to success takes time. One of the sources of sustainable competitive advantage is ‘path dependence’: competitive advantage is built through cumulative investments over time. This is the Tesla advantage. It is simply not possible for the incumbents to rapidly overcome what is arguably a 5-10 year advantage of cumulative experience and knowledge.
Are there other factors at play?
The obvious one is the disruption that the EV industry will impose upon the incumbents’ business model. One of the core competencies of the major auto makers is their highly integrated supply chain. Tesla’s vehicles reportedly have around 20 parts versus the 2,000 in internal combustion engines. According to the Nikkei Asian Review:
After a tear down of the Tesla 3, a “stunned engineer from a major Japanese car maker declared ‘we cannot do it … it will render obsolete the parts supply chain they have cultivated over decades
Tesla is so far ahead of more established peers that its technology could end the auto supply chain as we know it”.
This is the very essence of ‘competence destroying’ disruption.
Advantage Tesla.
Sources:
Christensen’s (2001) HBR paper (with co-authors) Skate to where the money will be. It is a play on a famous Wayne Gretsky quote: “skate to where the puck is going, not where it’s been”
Wall St Journal (2021). How Volkswagen's $50 Billion plan to beat Tesla short-circuited.
Forbes (2020). Can Volkswagen’s ID.3 save the German car industry from Tesla?
Thomas and Maine (2019). Market entry strategies for electric vehicle start-ups in the automotive sector – lessons from Tesla Motors
WSJ (Jan 2021): How Volkswagen’s $50B plan to beat Tesla short circuited
I hesitate to call it competitive advantage: the paucity of the economic returns to the auto sector suggest none of the majors have real competitive advantage
This is not Christensen style disruption, but it is disruption as articulated by a number of other prominent theorists.
