Tesla Tackled By “Real Automaker” Problems

Tesla stock is falling as it deals with recalls, layoffs, cost-cutting and other old-fashioned auto manufacturer challenges.

Elon Musk once called Tesla a “technology velociraptor,” but the more appropriate animal comparison might be a shark: if Tesla isn’t moving forward, it’s struggling for breath. Bringing the high-growth venture capital-fueled startup mentality to the auto industry is great when you have new models coming out and new ideas to hype, but once the company settles into the unsexy long-term grind of cost-cutting and efficiency improvement where car companies earn their keep it tends to remind “disruption”-happy hypergrowth investors that Tesla really is just an auto manufacturer after all. With a recall, layoffs and belt-tightening all hitting Tesla at the same time, it’s becoming harder and harder not to see Tesla for what it’s always been.

First up, Tesla has to deal with one of the problems that’s caused the most headaches in the auto industry over the past few years: Takata airbags. With some 50 million of the now-defunct Japanese suppliers airbags in some 37 million vehicles, almost every automaker on earth has had to deal with the fallout from Takata’s too-good-to-be-true prices, and Tesla has been replacing airbags in its cars since 2017. China’s State Administration for Market Regulation posted a notice saying Tesla would start recalling some 14,000 cars made with Takata airbags between 2014 and 2016 according to the SCMP, which Tesla’s latest Takata-related update suggests is in line with its NHTSA recall schedule. Apparently Tesla has been waiting on replacement parts, which are in short supply, but “are expected to be available by Spring 2019.”

Meanwhile, Tesla is tightening the belt again as it works toward lowering the cost of the Model 3, laying off some 7% of its workforce. In a “company update” email posted online and filed with the SEC, Musk notes that “last year was the most challenging in Tesla’s history” and that 

“We face an extremely difficult challenge: making our cars, batteries and solar products cost-competitive with fossil fuels. While we have made great progress, our products are still too expensive for most people. Tesla has only been producing cars for about a decade and we’re up against massive, entrenched competitors. The net effect is that Tesla must work much harder than other manufacturers to survive while building affordable, sustainable products.”

Elon Musk

Musk went on to call Tesla’s 3rd quarter profit “our first meaningful profit in the 15 years since we created Tesla,” but admits that it was only possible due to sales of higher-priced Model 3 in North America and that a smaller projected Q4 profit would depend on similar high-spec sales to Europe and Asia. With the US tax credit sundowning and inventory levels building, Musk seems to agree that the perennial question about Tesla’s demand come down to the company’s ability to cut costs. 

“Starting around May, we will need to deliver at least the mid-range Model 3 variant in all markets, as we need to reach more customers who can afford our vehicles. Moreover, we need to continue making progress towards lower priced variants of Model 3. Right now, our most affordable offering is the mid-range (264 mile) Model 3 with premium sound and interior at $44k. The need for a lower priced variants of Model 3 becomes even greater on July 1, when the US tax credit again drops in half, making our car $1,875 more expensive, and again at the end of the year when it goes away entirely…

As a result of the above, we unfortunately have no choice but to reduce full-time employee headcount by approximately 7% (we grew by 30% last year, which is more than we can support) and retain only the most critical temps and contractors. Tesla will need to make these cuts while increasing the Model 3 production rate and making many manufacturing engineering improvements in the coming months. Higher volume and manufacturing design improvements are crucial for Tesla to achieve the economies of scale required to manufacture the standard range (220 mile), standard interior Model 3 at $35k and still be a viable company. There isn’t any other way.”

Elon Musk

As time goes on it’s looking increasingly clear that a significant percentage of Tesla’s massive Model 3 order book is for the lower-cost versions of the car, which is unsurprising given that the headlines coming out of the Model 3 reveal were all focused entirely on the fact that an “affordable” Tesla was finally coming. That’s been a challenge for all the reasons Musk mentions in the latest update, and in an email he sent late last November he admitted that Tesla still needed to beat $3,000 per vehicle out of the base-cost car just to hit a zero gross margin at the much-hyped $35,000 price point. Tesla’s real problem is that a lot of the traditional methods for cutting those costs have been tapped already: Tesla hit up suppliers for cost retroactive reductions last summer, it cut 9% of its workforce, and it’s talked about increasing production throughput to 7,000 units per week but still seems to be stuck below that rate. 

Further workforce cuts suggest that the kinds of efficiencies he talked about late last year, asking employees to “focus on simplification and reducing cycle time” and explaining that “finding cost efficiencies is a game of pennies,” hasn’t yielded the needed results. That’s not surprising, given the magnitude of the cost reductions Tesla is looking for. Musk is right that cost-cutting is a game of pennies, which is why you don’t want to find yourself having to pull $3,000 or more worth of pennies out of a car whose raison d’etre is its affordable price point… especially when that base price version is supposed to become available in about six months. Beating 300,000 pennies out of a bill of materials and production process over six months while the car is already in production, rather than in the design or development phase, is every bit as ambitious as the Tesla’s Ford Model T-rivaling production ramp plan that instead turned into a year of “production hell” and slowing volume growth.

With the entire auto industry bracing for a down-cycle after a decade of strong growth, trade wars raging, EV tax credits expiring, and (perhaps most surprising) Tesla unwilling or unable to keep raising cash to fund growth, the company that has soared on the strength of high-tech hype is going to have to prove that it can grind out profits on the strength of its operational efficiency. That’s not an area where Tesla has a track record of excellence, and with the expiration of its referral program which helped keep its hype story bubbling among unscrupulous media outlets, fanatical fan blogs and social media accounts, Tesla’s actions are going to have to speak louder than the “hypergrowth” story that has sustained it so far. 

Having kept a skeptical eye on Tesla for years, that’s the one thing I haven’t seen from the company: consistently executing substance over style and “the story.” If they can grit out the next nine months, make those dramatic Model 3 cost reductions and finally get down to a mass-market price point, this company may have what it takes to go the distance. But let’s be clear: as impressive as Tesla’s gutsy survival has been, it hasn’t been due to executing on car company fundamentals. Tesla’s latest challenge is uncharted territory, but it’s also the same fundamental challenge it’s been avoiding ever since Elon Musk wrote a blog post signaling Tesla’s intention to enter the mass market all the way back in 2006.