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Monday, March 20, 2017

The Model 3 Won't Ship in July (and that's OK)

TL;DR
Optimistic fans hope Tesla will ship 80,000+ Model 3 this year. Goldman Sachs, on the other hand, downgraded Tesla's stock rating due to Model 3 delivery concerns. The truth is likely between the two. Musk has given many hints to the sources of delay that will likely impact Model 3. We examine his statements and, in light of these, attempt a realistic estimate.

Full Story
Despite the popularly held belief, Tesla will not likely start to ship the Model 3 in volume in July of this year. But if you live on the west coast, you might see yours arrive this year.

There is a lot of concern about the Model 3 and when it will ship. Goldman Sachs recently downgraded Tesla's stock to sell, citing near-term challenges including the launch of the mass-market Model 3.

So when will it ship and what do we know? Tesla provided a lot of information in their earnings call on February 22, 2017. At one point, discussing production risks, Elon Musk said, "I'm just going to tell you everything I know so you can have the same model in your head that I do." Of course, Musk could never convey all that he knows in this realm in one short phone call, but it did provide a glimpse of how he views risk management.

One of the large relevant chunks of information was that Tesla has asked suppliers to deliver 1,000 parts per week starting in July. This is to be followed by 2,000 parts per week in August, then 4,000 per week in September, ramping to 5,000 per week by the end of the year. If all of these parts could be assembled and delivered with a snap of the fingers, Tesla could deliver about 90,000 cars this year. But, this assumes all the suppliers will meet this delivery expectation and those cars magically assemble and deliver themselves. So, for 2017, we'll consider this the "lightspeed" or the impossible to reach upper bound of vehicle delivery.

At a high level, there are three stages: receiving parts, assembly, and delivery. Let's look at each stage and see what obstacles Tesla must overcome in that area.

Stage 1: Receiving Parts 

Supply chain logistics is not as easy as it might seem. Tesla has to deal with dozens of suppliers. The figure below gives you an idea of what they deal with for the Model S.


Model 3 will be a simpler, but it will still depend on dozens of other companies. Tesla can only deliver at the rate of the slowest one. This is the theory of constraints. When you start looking at second and third level suppliers, the list quickly becomes thousands of suppliers. It becomes a web of dependencies. So you must have contingencies and non-correlated alternatives... It takes a lot of planning and management to keep all the parts flowing.

Tesla has told all of their Model 3 parts suppliers to start delivering parts in volume in July. Will all the suppliers be ready and deliver in July and ramp at the rate that Tesla wants them to? The simple answer is 'no'. There will be some that are late. Musk referred to this as the "Term Paper Problem" in the Q4 2016 Results Earnings Call. Here's his quote from the transcript:

We have, what I call, the term paper problem. I was a teaching assistant in college and no matter what date we set for the exam paper, when the term paper was due, there's always some number of people that are late. It's just the way it goes.

Musk goes on to explain that when you have a global supply chain, you inherit "force majeure" risk from around the world. In other words, if there is an unavoidable major disaster that impacts one or more of their suppliers, then it also impacts Tesla's ability to deliver cars. They are taking steps to minimize risk where they can but if you don't know which supplier will be impacted or what will hit them, it is hard to prepare.

At Code Conference 2016, Musk explained this in more detail:

Think of any natural disaster you could care to name—all of those things have happened to our suppliers. A factory has burnt down, there’s been an earthquake, there’s been a tsunami, there’s been massive hail, there’s been a tornado, the ship sank...

These risks don't even have to be a major event. Musk also told the story of trunk carpet that shut down the production line for a few days.

There was a shootout at the Mexican border—no kidding—that delayed trunk carpet. The Border Patrol wouldn’t give us the truck because it had bullet holes in it. We just wanted our trunk carpet... That shut down the production line for several days.

That's right, one of the most technologically advanced things you can buy today was delayed for something as simple as trunk carpet. So, if you assume at least one or more supplier will have some issue and miss the July starting date, then there is the first delay. To address this, Tesla has several options: find another supplier, make it themselves, work with the supplier to address the problem(s).

Key factors: Theory of Constraints, Term Paper Problem, Global Force Majeure.

Let's make the very optimistic assumption that all of these issues can be resolved in three weeks.

Stage 2: Production

Tesla is a manufacturing company. You might think of them as a car company, a design company, or an innovation company. Yes, they have these aspects, but if all they could make was low volume bespoke cars, like the Roadster, then (no matter how great these cars were) they could never reach their mass market goal.

Tesla learned a considerable amount about designing for manufacture with the Model S and X. These cars were designed, for the most part, without much consideration to manufacturing. They are hard to make and they have had delays and issues related to this manufacturing complexity. Tesla has brought their designers into the factory to see these issues as they come up. The designers get to talk to the people on the line and see the issues that their designs are causing. They have applied these learnings to Model 3.

The massive roof opening of the Model 3 might be a cool design feature, but it's there first to allow the robot arms access into the car's interior during manufacturing. Ease of ingress and egress will allow the arms to move faster and allow for multiple operations to occur simultaneously within the body.

Here's Musk from the Q4 2016 Results Earnings Call:
Model 3 is designed for manufacturing. It's considerably simpler than Model S or Model X. Model 3 has 1.5 kilometers of wiring. Model S has 3 kilometers of wiring. A lot of the bells and whistles that are on Model S and X are not present on Model 3. We don't have self-presenting door handles, for example, or falcon-wing doors.

For Model 3, Tesla has turned their attention to "the machine that builds the machine." Musk said that Tesla is applying the rocket equation to manufacturing. The rocket equation considers mass efficiency and rocket velocity; but in a factory, it's volumetric efficiency and the exit rate (velocity) of products. This is a novel approach to manufacturing that only a rocket engineer would conceive.

From the earning call, Musk said "I've refocused most of Tesla engineering, including design engineering into designing the factory. I think in the future, the factory will be a more important product than the car itself," and from Tesla's blog "our factories are so important that we believe they will ultimately deserve an order of magnitude more attention in engineering than what they produce."

Musk has said that ultimately a Tesla factory will look nothing like any factory that has ever existed. He said it will look like an alien dreadnought. The dreadnought changes that they have made will likely pay big dividends when they want to move to 500,000+ vehicles per year, but doing something in a way that has never been done before could have a startup price to pay as they bring the alien dreadnought online for Model 3.

Key factors: New Design, Boot the Dreadnought

Let's assume these factors have a minimal delay of 2-weeks above and beyond the above delay.

Stage 3: Delivery 

Vehicle delivery is that all important final step. Even here, there can be delays. Musk told a story of a cargo ship carrying Teslas that was not allowed to dock due, ironically, to excessive smog in the port.

Tesla will avoid issues with boats by starting delivers to employees near the factory first. This allows them to easily bring the car back in to examine any failure and, if needed, make changes to the production line.

Starting with Tesla and SpaceX employees will mean that non-employee customers will have to wait for these deliveries before they move up in the queue.

Musk from Q4'16 Results call:
The initial cars, sort of Founder Series, actually go to company employees, because it's important to have a good feedback loop on the product we're making. And if there are any issues, bugs, or things that need to be addressed that we can address those before customers experience them.

After the SolarCity merger, Tesla has about 30,000 employees. SpaceX adds about another 5,000. That's 35,000 people that could be in line ahead of the first customer that does not work for Musk. How many of them have ordered a Model 3? It seems likely that at least 2,000 people that work at Tesla/SpaceX would be excited to get one of these cars.

Key factors: Employee deliveries first

This pushes the first delivery to someone outside of the company at least another week.

So When Do I Get My Car?

When pressed in the conference call the Tesla executives consistently said that the product ramp is not possible to predict. There are too many unknowns. But I see no reason for that to stop us from guessing.

We know that parts will start arriving in July. Recapping our potential delays above, there's the Term Paper Problem, Booting the Dreadnought, and Employee Deliveries. Assuming each of these are resolved quickly we could see non-employee deliveries starting in mid-August.

On the pessimistic side, if one of the items hit by the Term Paper Problem is a long lead item, this impact could be much bigger. Then, continuing on the pessimistic track, the employee deliveries could provide feedback that requires tweaks to the car and/or factory. This could further delay the non-employee deliveries until September or October.

Once the cars start shipping, there are several factors that determine your place in line.
Vehicles will go to current Tesla owners that live near the factory that reserved a car on day-one in a Tesla store. Then cars will go to people on the west coast US with the same qualifiers.

Generally, Tesla delivers cars that have a higher price tag first. This allows them to collect money for higher revenue vehicles sooner. This might not be the case for Model 3. E.g., if they are motor constrained, they may opt to deliver single motor cars before dual motor vehicles so they can deliver more cars. Similarly, if they are battery cell constrained, they may opt to deliver more units of the smaller pack vehicles rather than fewer large pack vehicles (assuming there are pack size options). This is unlikely, but possible depending on the constraints that present themselves.

Perspective

What Tesla is trying to do is very hard. They are trying to take a car that is not yet in production and deliver tens of thousands of them in less than half a year. I've seen estimates that Tesla could deliver up to 80,000 Model 3s in 2017. This is nearly impossible (not totally, but nearly). Let me put it into perspective. In 2016, Tesla had an entire year's production and they delivered about 76,000 vehicles (source). Tesla had challenges with Model X production in the first half of the year and they had short-term production challenges in Q4 with the transition to the new Autopilot hardware 2.0. So yes, Tesla has delivered ~80,000 (with production challenges), but this was for the entire year.

For another comparison, in the first 2 months of 2017, GM is only delivering about 1,000 Bolt EVs per month. Tesla wants to get to 5,000 per week.

Model 3 will have start-up pains and less than half a year of production. As we've seen with every EV that has been delivered in the last decade (Tesla's included), the production ramp has been slow. Given this, I estimate that there will only be 20,000 to 40,000 Model 3 vehicles delivered in 2017. This is far fewer than the 80,000 unit prediction that others are making and still fewer even more than the lightspeed 90,000 number would allow. I hope this is woefully low, but given all the unknowns, it seems reasonable.

These 2017 units will be primarily consumed by current Tesla owners and west coast day-one reservation holders.


In 2018, Things Turn Up To Eleven

In 2018, all these production issues should be worked out to allow Tesla to slowly turn the production volume knob up to 11. This will allow all the current reservation holders worldwide to receive their car by end of the year 2018.