Elon Musk Demonstrates The Benefits Of Being Considered Foolish

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This XSeed blog was written by Executive-in-Residence, Mike Hoefflinger, and originally appeared on Forbes.

Will Elon Musk’s navigation from near-bankruptcy to becoming the first new public American car company started in nearly a hundred years end with Model 3?

Recap

In a previous post, I introduced the “Clever-Foolish 2×2” behind Silicon Valley-style breakout innovation. It makes this essential point: If you have a clever idea that is generally considered clever, you are probably in for a food fight.  If you have a clever idea that is generally considered foolish, you have a tremendous opportunity to win big – as companies like Amazon, Google, Netflix, Facebook and Uber have been proving.

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Understanding Elon Musk

Clever-Foolish stories usually have at their center a visionary, autocratic founder-CEO with the will to act. With Tesla’s pursuit of a post-hydrocarbon economy, SpaceX’s mission of a multi-planetary society (using delightfully clever-foolish approaches like re-usable rockets), and the willpower required to move himself, SpaceX and Tesla from being within hours of bankruptcy in late 2008 to double-digit billion dollar successes, Tesla CEO Elon Musk is one of the great examples of the species.

His exploits are made all the more impressive because both Tesla and SpaceX engage in a ground-breaking amount of US-based, large-scale, vertically integrated manufacturing which Silicon Valley notoriously shies away from.

The relentless, endearingly awkward South African-born grandchild of the first people to fly from South Africa to Australia in a single-engine plane leaves even incisive arbiters of personalities like Stephen Colbert wondering whether he is superhero or supervillain.

Tesla’s Beginning: Hiding In Plain Sight

At the time of its founding in July 2003 (Musk joined as chairman in February 2004, but is credited as a founder), it was easy to dismiss Tesla as very foolish. It had been roughly a century since the last set of public-to-be American car companies were founded (Ford in 1903, Maxwell Motor Company—which would become Chrysler—in 1904, General Motors in 1908) and the fledgling team aimed to build all-electric vehicles, the history of which was littered with lack of mainstream success.

Still, Musk, in a move mirroring Babe Ruth’s “called shot”, could not have been more clear in his 2006 blog post about what would turn out to be their 10-year strategy: “Build sports car [Roadster]… use that money to build an affordable car [Model S]… use that money to build an even more affordable car [Model 3].”

The “sports car” he referred to was less about the car than its innards. Most especially the integration of 6,831 standard lithium-ion battery cells into the breakthrough battery pack that essentially made the car a giant laptop with seats and wheels, and required significant cooling and fire-protection innovation for the notoriously dangerous cells.

It was the team’s progress on the battery pack—the early internal signal so important for clever-foolish companies—that gave them the confidence that they were indeed clever while the market thought them foolish. A knowledge imbalance captured best by none other than Bob Lutz—vice-chairman of GM, America’s biggest car company—in a 2009 New Yorker article: “All the geniuses here at General Motors kept saying lithium-ion is 10 years away, and Toyota agreed with us—and boom, along comes Tesla.”

In fairness, Tesla skated so close to the foolish line that even Gene Berdichevsky, who was Tesla employee #7 and worked on the power train and battery pack, is quoted in Ashley Vance’s Musk biography as saying that “only now do I realize how insane it was”.

Model S: Mission (Seemingly) Impossible

Having produced a mere 200-300 Roadsters, and barely skirted bankruptcy, Tesla introduced a prototype of the Model S in March of 2009.

While Musk, in his signature preternaturally confident way, positioned Model S as a natural follow-on to the Roadster, there were a myriad of foolish elements in the plan that hoped to combine a handful of advancements each of which individually would have been the entire extent of generational innovation from other car companies:

* All new battery pack: With 50% greater energy density than the Roadster.
* All new power train: With 2x the power density of the Roadster.
* All new design and manufacturing: The only US car with 98% of its body out of aluminum.
* All new user interfaces: A 17” touch display first shown ahead of even Apple’s iPad.
* All new software and updates: First-of-its-kind ability for the car to update itself overnight.

As if that were not difficult enough, they would also look to significantly grow their direct-to-consumer sales approach that to this day encounters significant protectionist resistance in the US from state legislators influenced by car dealership special interests.

No wonder detractors were lining up around the block to bet against Musk and Tesla with the press widely deriding them (including a premature eulogy from the Huffington Post) and the stock market holding as much as 62.5% of Tesla’s public float as short.

Against all naysayers, Tesla proved to be very clever. And the Model S is very popular.

Tesla had not just built a no-compromise electric car. Not just the best car in its class. But, arguably the best production car ever. A Motor Trend and Automobile Magazine Car of the Year. The highest-ever rated car by Consumer Reports. The safest car ever tested by the US National Highway Transportation Safety Administration.

But, most importantly, Model S outsold all other electric cars at any price point as well as each of its competitors in the luxury class (Mercedes Benz S-class, BMW 7 series, Lexus LS, Audi A8 and Porsche Panamera) as it went from 2,650 units delivered in 2012 to 31,655 in 2014.

Threading The Needle In Step “3”

As impressive as it is to deliver tens of thousands of Model S vehicles, Musk’s vision for Tesla can only begin to be fulfilled (and its stock market valuation justified) if Tesla delivers many hundreds of thousands of Model 3 vehicles. That will require them to build a car with an entry cost much closer to $30,000 than $70,000.

Tesla’s new battery Gigafactories (Gigafactory 1 near Sparks, NV is merely the first even though by itself it will be larger than all current global Li-ion plants put together) is rooted in this pressure. But, harrowing as this undertaking will be, it won’t get Tesla to the answer.

Contrary to popular discussion, the battery cost won’t be the difference-maker for Model 3. It will be something even harder, more elusive and much more foolish: marketing.

Here’s the math: Tesla CTO JB Straubel told the MIT Technology Review in 2013 that Model S batteries cost less than a quarter of the car’s average price (mostly still the 85 kWh version costing roughly $100,000). Assuming a 20% improvement in cost in the last two years, we can estimate today’s battery cost to be about $230/kWh. Assuming another 30% improvement when the Gigafactory comes online, it will be $165/kWh by 2017. That means savings in the battery between today’s low-end 70 kWh $70,000 Model S and 2017’s 60 kWh Model 3 (a lighter and shorter range car) will only be about $6,000. Assuming another $15,000 of savings (the difference, for example, in the MSRP of the BMW 5 and 3 series) due to the smaller Model 3 frame and fewer options, we’re still only at about $50,000.

This matters because as Tesla aims for the volume market, they will be exposed to tough price sensitivities: Daniel Fishana’s analysis at Torque News projects that in the US the difference in sales volume for a car costing $30,000 and a car costing $50,000 could be the difference between 600,000 units and 200,000 units.

The camp that still considers Tesla foolish—short interest in Tesla stock is still at about 25% of the public float—is betting that Musk will be undone by his historical achilles heel: the tendency to deliver late and over budget. To prove them wrong, Musk and Tesla will have to find another $7,000 of savings through big profit sacrifices in the first few years of Model 3 production.

And then they’ll have to thread a needle they have never faced.

While Tesla will continue to benefit disproportionately from US Electric Vehicle rebates in the near term ($7,500 per vehicle, which brings the car to the magical $35,000), the next resident of the White House will likely come under pressure to eliminate those subsidies as crude oil prices which have dropped to levels we’ve not seen in a decade make EV hand-outs harder to justify.

The entirety of Tesla’s future will depend on their ability—similar to Apple’s reality distortion field—to defy price-based sales volume predictions by creating demand for its brand and products at 10x their current levels. Model 3 will have to outsell less expensive cars at similar ratios as Model S has outsold lower-priced competitors to-date (see Fishana’s models).

Nobody said the clever-foolish life was easy, but Tesla and Musk have had an impressive 12-year run. It’s entirely possible that the only real threat to Tesla dominating the category they invented could be the entry of fellow clever-foolish expert—and world’s most valuable company—Apple (you can find my take on that in this article at VentureBeat).

(Photo of Tesla Model S by Steve Jurvetson, licensed under Creative Commons)