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Saturday, March 31, 2018

Moats: Why Tesla Can Do What Other Car Companies Only Dream About

A moat surrounds a medieval castle to protect from attackers
Castel of Brede, photo by Lionel Lourdel 
In modern business parlance, a moat is something that protects a business from competition or gives it an advantage. A moat could be a trade secret, patented product or process, or an asset that represents a significant capital investment. A moat could be a partnership, an exclusive license, a government granted limited-monopoly, or any barrier to a resource or market. The term was popularized by Warren Buffett. He covers moats in his book Buffett Beyond Value and says that he doesn't invest in businesses unless they have one or more moats; otherwise, it's a quick race to the bottom.

"In business, I look for economic castles protected by unbreachable moats." ~Warren Buffett

This story is about Tesla's moats, but I don't mean to imply that Buffett would invest in Tesla. Tesla is far from the value investments of the Berkshire Hathaway portfolio. Rather, Buffett's comments are to demonstrate the importance of moats. Morningstar even has a guide called Why Moats Matter. Understanding the moats a business employs is clearly important to understanding the business and its future. 

In no particular order, here's a list of Tesla's moats: mall stores, direct sales, Supercharger network, brand loyalty, EV mindshare, mission-driven, Tesla Energy, Panasonic partnership, rockstar status CEO, electric motor technology & manufacturing, battery technology & manufacturing, software development, connected cars, AI, talent magnet, fleet learning, SpaceX, vertical integration, over-the-air updates, mobile ranger service, Gigafactory, investor expectations, first mover advantage.

These moats enable Tesla to do things that other automakers cannot even consider. Some of these moats are wider than others. Let's group them and look at them in more detail. If you know of any Tesla moats missing from the list, let me know below.

Stores & Direct Sales

When you buy a Tesla product, you buy it from, well, Tesla. This might seem like a silly statement, but that is not how most car companies operate. Traditional automakers have dealerships. Dealerships are not owned by the manufacturer, they're locally owned businesses. In most states, the automakers are legally forbidden from owning a dealership. Dealerships are middlemen. This means that when you pay for a car, you must pay a price that allows both the manufacturer and the dealership to make a profit on the sale.

Tesla has stores in shopping malls. This allows you see their cars in a familiar and comfortable place. The Tesla employees in the store are not commissioned salespeople. They are there to answer questions, not to "get you into a deal today". There is no haggling; the cars have a Hobson's Choice price: Take it, or leave it. You pay the same price as Elon Musk's mom would pay, the same price as any Tesla board member would pay. This matches well with the online shopping model that Gen Y and younger are accustomed to.

Additionally, Tesla can sell their cars, solar, and energy storage products all under one roof. There's likely to be significant overlap in customers for these products.

* Moats: Mall Stores, Direct Sales

Connected Cars & Over-the-Air Updates

All of Tesla's cars have wireless service. The original cars had 3G, today they have 4G LTE, and when 5G is the standard they'll come equipped with that (or maybe something better). This connectivity allows the navigation system to have up-to-date maps and real-time traffic. Every smartphone has had this feature for over a decade, but in cars, this is still a rarity. In other cars, maps could be years out of date and/or cost hundreds of dollars to update.

The maps and traffic data are nice, but the real advantage of a connected car is software updates. Tesla is constantly improving their software (more on software later) and when a new version is released, after a couple taps on the screen, your car is updated to the latest and greatest. This keeps the ownership experience exciting. You can recapture a bit of the "new car smell" when a new feature or easter egg is added.

* Moats: Connected Cars, OTA Updates, Refreshed SW keeps cars relevant

No Dealerships

A dealership's agenda might not be the same as the manufacturer's and it is not likely the same as yours.

We just discussed over-the-air updates. These are an example where a dealership might have a different interest than you or the manufacturer. Over-the-air updates are convenient for owners; you just wake up to a vehicle with updated software. Well, dealerships in many states could prevent a manufacturer from implementing this feature in their cars. Why? Because that is considered "servicing the vehicle" and the dealership agreement guarantees that all manufacturer service is contracted to the dealership. The dealerships want you to bring your car in often so they have a chance to upsell you on service or to a newer car. If a manufacturer pushes updates over-the-air, they might find themselves in a lawsuit or two with the dealership associations as Tesla has been, albeit for different reasons.

Dealerships make most of their money from service. Anything that prevents a car from coming into the shop is a missed opportunity for them to profit from the customer. Electric vehicles already require far less maintenance than gas cars, if wireless software updates were allowed too then there would be even fewer reasons for the car to visit the dealership on a regular basis.

With Tesla owning their own stores and service centers, Tesla is able to set their own direction without a complex web of multi-state dealership agreements. This gives them flexibility and allows them to define the ownership experience for their vehicles.

* Moat: Ownership of customer experience, No margin sharing

Panasonic Partnership

Tesla and Panasonic are partners in battery and solar technology and manufacturing.

Panasonic announced it would invest more than  $1.6B into the Tesla Gigafactory 1 battery plant. Gigafactory 1 supplies the battery cells for Tesla Model 3, Powerwall, and Powerpack products. Panasonic directly manufactures the 18650 cells that are used in the Model S and X.

Panasonic is also a partner in Gigafactory 2 for solar roof production.

Tesla currently has a hot brand and they are shipping a lot of Panasonic technologies. Panasonic certainly is looking at Tesla as a growth area for their products. Many other automakers are using LG Chem batteries. This means that Panasonic has a vested interest in seeing Tesla survive and grow. This could mean that Panasonic would be willing to invest more into Tesla if cash infusions are needed as Tesla hits bumps in the road getting to mass market production.

* Moats: Strong technology and financial partnership with a behemoth

EV Mindshare

It seems like nearly all headlines about electric cars (any electric car) mentions Tesla. The car being reviewed is either a "Tesla Killer" or "How Does Car X Compare To The Tesla ..."  This was true for the new Leaf, the Jaguar iPace, the Porsche Mission E, and nearly any other new EV coming to market.

This is no different than hybrids and the Toyota Prius. Any new hybrid that comes out is compared to the Prius, because Prius is the benchmark for hybrids. Similarly, Tesla is the benchmark for electric cars. Over the next decade, many automakers will make EVs and they will all be compared to Tesla (range, price, styling, performance...).

As more automakers bring EVs to market, they will be playing the game on Tesla's court.

* Moats: First Mover Advantage, home field advantage, de facto standard

Mission-Driven, Brand, & Rabid Fans

Tesla has a fanbase that other car companies dream about. They have Apple-like devotion with people lining up to buy Tesla's first affordable mass production vehicle. Why does Tesla have such devoted fans? There are as many reasons as there are fans. However, I'll suggest one important reason: Tesla is mission-driven. They are an uncompromised pure-play.

Tesla is not reluctantly making EVs just to meet a state mandate. They didn't recall and crush EVs from the late 90s. They don't have a 100-year history of making gas-burning cars that have put billions of metric tons of CO2 into our atmosphere. They haven't participated in a conspiracy to shut down public transportation. They were not caught cheating on emissions tests.

Tesla makes exciting cars that are fun to drive!

They also make solar panels that can charge the car with energy from the giant fusion reactor in the sky known as the Sun. They make storage batteries so the stored solar energy can power your house after the sun goes down.

People are inspired by Tesla. Their many many fans give them free advertising. Fans make ad videos, write blogs, record Tesla podcasts and YouTube channels. Tesla held a competition for the best fan ad and there were hundreds of submissions. One couple loves Tesla so much, they had a Tesla-themed wedding. Few brands have such devotion.

* Moats: Devoted fan base, dedicated brand, free from historic stains, free fan-based marketing

SpaceX 

SpaceX is not part of Tesla, but Elon Musk is at the helm of both companies and they have more cross-over than is initially apparent. Their cross-overs include aluminum fabrication and AutoPilot as well as less direct connections too.

When the engineers at Tesla run into a tough problem, they can literally call rocket scientists. “That’s cross-fertilization of knowledge from the rocket and space industry to auto, back and forth; as I think it’s really been quite valuable,” Musk said on a Tesla earnings call.

Aluminum Fabrication: When you are making rockets, you want them light and strong. Seams are generally weak points. SpaceX uses a specific friction stir welding process that fuses metal parts together without melting them. The end result is stronger and lighter than a traditional aluminum weld, with just 10% waste metal.

AutoPilot: SpaceX's rockets have to operate autonomously for much of their flights, including landing on drone ships at sea. This is very different than navigating city streets, but both of them need to interpret the data from the sensors. Raw data from radar and sonar are very noisy and false positives are common. Decoding these signals is tricky and vitally important. Sharing hard-learned lessons here improves both systems.

Marketing: SpaceX launched a Tesla Roadster into space. This was a huge marketing success. Most aerospace companies would have just used a dummy-load for this type of test launch. So for just the small cost of a used Roadster and a mannequin, Tesla and SpaceX had the most talked about launch in the last decade. According to Reuters, Apple's and Google's corporate brands dropped in an annual survey while... Tesla's rocketed higher after sending a red Roadster into space.

Starlink: Starlink is a satellite broadband communication project by SpaceX. It is to provide low-cost, high-performance satellite-based internet connectivity. SpaceX has just launched the first of the low-earth orbit satellites and plans to put nearly 12,000 of them into orbit by the mid-2020s. The first obvious customer for this service is Tesla. Today, Tesla has to pay for the LTE connection in each of their vehicles. After Starlink is up and running, Tesla can use this network for all of their connected car activities. The service wouldn't be free to Tesla, but it would be one of Musk's companies paying another one of Musk's companies.

Mapping is an important part of autonomous car tech. There are no publicly announced plans, but it's possible that SpaceX satellites could help provide some of this information to Tesla.

* Moats: Access to SpaceX's advanced materials scientists. Access to cross promotions. Possible highly affordable connected car internet service.

Recruiting Talent

If you were fresh out of school and wanted a job at a car company, would you rather work at one of the legacy car companies or at Tesla? Tesla is an innovative Silicon Valley company that makes sexy fast cars. If you want to work in battery tech, AI, automation, or many other fields, Tesla is the place that is treading new ground.

In March of 2018, Tesla was on LinkedIn’s list of top companies that American professionals want to work for, placing 5th and outranking Apple and Disney. Tesla is listed along with tech companies, not automakers. They are (and they are perceived as) a tech company that makes cars, rather than just a car company.

Over 500,000 people applied for jobs at Tesla in 2017. With this many candidates, Tesla is able to hire the cream of the crop. To do things that have never been done before, you have to hire highly skilled people.

* Moat: Desirable employer

Vertical Integration

Most car companies today are predominantly assembly and branding companies. Other than the internal combustion engine, they do very little of the engineering. Instead, they rely on their suppliers. In many cases, even the car designs are outsourced. This means legacy automakers are buying parts and buying others' innovations. Cars generally have 15% or less margin at wholesale, whereas the component suppliers may have 50% margins.

Tesla certainly has suppliers too, but they manufacture far more of their car's components than other automakers. Tesla designs and manufactures their own electric motors and they have vastly improved upon the AC Propulsion motor they started with a decade ago. By controlling the manufacturing of their parts -- especially batteries -- from start to finish, Tesla could create a significant cost advantage.

* Moats: Vehicle design, vehicle engineering, product margin

Software

Tesla's cars are often described as "computers on wheels". They are software controlled. This allows new features to be added, upgrades, improved user interfaces, voice control, and more. The big screen is central to the car and not a de minimis afterthought. Tesla has a large in-house software team to deliver these features that are vital to the driving and ownership experience of Tesla.

Other automakers contract their software to outside firms for various tasks. This means that the navigation “look and feel” may be different from the entertainment system’s.

* Moats: Talented in-house software engineering (see recruiting talent above)

Fleet Learning & AI 

All of Tesla's cars have their full AutoPilot sensor suite of cameras, radar, and sonar. As we discussed above, Tesla's vehicles are connected cars. This means they can receive new software over-the-air. This allows Tesla to test their AutoPilot updates in shadow mode on hundreds of thousands of cars driving millions of miles before rolling them out to customers. Even cars that don't have enhanced AutoPilot or self-driving features enabled are helping to contribute to Tesla's validation efforts. Tesla has more than 300,000 cars on the road around the world gathering valuable feedback for their AI.

Compare this to the autonomous drive efforts of any other company. Other companies have a couple dozen cars on the road with engineers or safety drivers behind the wheel. It takes a long time to get a million+ miles of validation under those conditions. Then the software gets an update and the validation effort has to start all over.

* Moats: Massive fleet of fully instrumented cars

Supercharger Network

One of the drawbacks to EV driving is the difficulty of locating charging facilities while on road trips. Tesla has solved this problem. In most regions where they sell the cars, there is a vast Supercharger network. You simply type the address in for your destination and the car will plot a route for you, showing you each stop that you'll need to make along the way. You can drive from Seattle to Miami or LA to Portland, Maine using Tesla Superchargers all along the route to recharge your car.

Today, there is no other plug-in car that can make such a claim. CHAdeMO and CCS charging stations are clumped in urban areas on the coasts with a large charging wasteland betwixt and between.

Additionally, Tesla's Supercharger network is reliable and easy to use. With other networks, you have to join and carry a card, fob, or app that you have to tap, scan, or activate. With Tesla's network, you just plug in. The protocol for determining who you are and what, if any, fees apply happens automatically when the car is connected.

Reliability and availability are vital to a charging network. If you show up at a location near empty, expecting to charge, only to find the charging station broken down or occupied, this can ruin your trip. Tesla Supercharger stations generally have 6 or more charging stalls. Most have 10+ and a few have as many as 50 charging stalls. So if a stall or two are down for repair, there are still plenty of spots where you can charge. If you're curious about a Tesla Supercharger location along your route, you can tap on it in the car and it will show you how many stalls are there, how many are operational, and how many are occupied. Other networks generally only have 1 charging stall per location. If it is not working or blocked, you're out of luck.

Other automakers are generally not investing in charging networks. They see themselves as automakers, not fuel suppliers. Since their business is not dependent on selling EVs, they are content to let this remain as someone else's problem.

Tesla, on the other hand, is growing a vast network of Superchargers around the globe where they will be able to sell energy above the local residential rate (while still cheaper than gasoline). Tesla has said that charging will not be a profit center for the company, but the revenue will certainly help to pay for expansions of the Supercharger network. Tesla has more than 1200 locations where you can fast charge, with more location coming online every week.

* Moats: Building thousands of Supercharging locations is both time and capital intensive. Network ease of use & reliability. Revenue stream from 'fueling' vehicles.

Workplace & Destination Charging

While we're on the topic of charging, it is important to mention destination charging. There are hotels, bed & breakfasts, wineries, restaurants, ski lodges, malls, and other places that have Level 2 charging for Tesla vehicles. These are often a free amenity at these locations for patrons. These locations want well-heeled Tesla drivers to visit their establishment.

Tesla recently expanded this program and is now offering Level 2 chargers free to employers too.

Other car companies are far behind in providing charging support at this level.

* Moats: Vast network of workplace and destination charging stations

Gigafactory

Tesla has a giant battery factory in Nevada. By footprint, it is one of the largest buildings in the world. When it is in full operation, this one factory will make more batteries annually than all of the world's combined factories made in 2013. Tesla has plans for similar factories in Asia and Europe as well.

These factories require a massive outlay of capital. They require a commitment to battery-powered cars as the next generation of personal transportation. Other automakers are only tepidly dabbling in EVs. They are making low-volume "compliance" cars and some are still working on fuel-cells or hail-mary internal combustion solutions.

* Moats: Biggest battery factory in the world, with more coming. Significant capital expenditure.

Investor Expectations 

Why is it that Tesla can spend billions of dollars on battery factories and global Supercharger networks? Whereas, if other automaker CEOs hemorrhaged cash at this rate, they'd be fired faster than a Tesla in Ludicrous mode. The simple answer is the expectation of the board of directors and the shareholders. People who invested in legacy automakers bought into a stable business that pays regular dividends.

Tesla investors, on the other hand, bought into a growth company. They are not looking for Tesla to be profitable today, or anytime soon. Tesla's investors are looking for top-line growth rather than bottom-line profits. Today, Tesla has about 20% of the luxury car market. If they can expand into affordable cars, semis, small crossovers, performance cars, pickup trucks, and who know what else with a similar market share, Tesla could be one of the most valuable companies in the world. And as we discussed above, owing to direct sales and vertical integration, Tesla has the ability to sell cars with better profit margin than any other automaker can. Or so goes the hope of people (like me) who are invested in Tesla.

Amazon is a good comparison. For years Amazon sank their revenue back into their growth rather than paying out dividends to investors. In May 1997, Amazon went public at $18 per share. As I write this, the stock is nearly $1500 per share. And that's after 3 stock splits. Amazon investors were looking for growth, not profits and dividends. Today, Tesla investors have the same growth mentality. As market darlings, Tesla can raise capital by issuing shares, bonds, or taking loans. This allows them to pursue big efforts as long as they are delivering growth.

* Moats: Investor expectation of growth rather than quarterly profits

Rockstar CEO

Love him or hate him, Musk is by far the most widely known CEO of a car company since Henry Ford. This fame and fandom allow Musk to put out a message and have it echoed through his social media presence. When he tweets, it is news. The Boring Company, another of Musk’s ventures, has sold hats, flamethrowers, fire extinguishers, and now lifesize LEGO-like interlocking bricks made from tunneling rock. Fans have bought and will buy these because they are fans and want to signal their devotion to the Musk tribe.

This media attention can be a double-edged sword. When Tesla misses a deadline or a Tesla vehicle is in a crash, it gets as much media attention as Tesla's successes do. But for a company, the only thing worse than too much media attention... is *no* media attention.

Musk's past accomplishments, circle of friends, and current status allow him to raise money. This is important until Tesla's vehicle production is at a volume that would allow them to be consistently profitable (about 1 year from now by our estimation).

* Moats: Media attention, Ability to raise capital

Dreadnaught

In addition to trying to reinvent personal transportation, auto sales methods, and home energy, Tesla is trying to reinvent the way that cars are manufactured. This is "the machine that builds the machine".

In 2016, Tesla acquired German automation company, Grohmann Engineering. This was one step to reinvent the auto factory. Musk has said that their factory will look so radically different from traditional factories that it would seem like an alien dreadnaught. Staying true to Tesla's Silicon Valley root Musk said, "It might look like a giant chip pick-and-place machine...".

Musk has said that if you look at the rate that cars come off the end of the line in today's auto factories, it's slower than "grandma with a walker". Musk would like his factory to move at least at a jogging pace. He wants the robots to be moving so fast that air drag is a relevant factor.

Musk has even talked about Tesla selling their factory designs as a product.

Today, however, companies like GM, Ford, and Toyota are not impressed with the speed or quality of Tesla's manufacturing and have no intention of trading in their factories for a Tesla Dreadnaught.

The results of the current version 0.5 Dreadnaught are not Earth-shattering, but that does not mean that it won't eventually be revolutionary. For example, when Nicolaus Copernicus first introduced his heliocentric system, it was not well received. In fact, initially, it did a worse job at predicting the movements of the planets than the existing Earth-centric Ptolemaic system. That was because the Ptolemaic system had been refined for 1400 years and it had been finely tuned to account for all of the perturbations in the night sky.

Today Toyota's Kaizen method is vastly superior to Tesla's Dreadnaught. The modern car manufacturing process is a big improvement over the assembly line that Ford used, but it is an evolution of that same 100-year-old method. The question is, once refined, will Dreadnaught be the system that replaces it?

The modern assembly line was designed around people operating it. Robots have replaced many of the people on the line, but the robots are retrofitted into a system made for people. Dreadnaught, on the other hand, is a system that is designed around robots. This is not all that different from the clean slate design of Tesla's cars. They are not gas cars retrofitted with batteries and motors. They were designed from the beginning to be electric.

Dreadnaught could be the system that allows manufacturing to make a leap forward, or it could be an expensive failed experiment. Time will tell.

* Moats: None yet, but maybe Dreadnaught 3.0 will make the manufacturing world take notice.

Summary

Tesla has looked at all the objections that someone may have to buying an electric car and they have done their best to resolve them. They have made EVs that are cool, fast, and fun. They have made road trips possible. They have made home and destination charging convenient. They are working on battery and vehicle manufacturing to increase the volume and bring down the cost. They have allowed you to "drive on sunshine". Tesla has created a compelling narrative that is far beyond just the vehicles they sell.

In the process of resolving the objections to electric vehicles, Tesla has created a long list of moats. Tesla's moats are not unbreachable, but some of them are far outside the culture of the traditional automakers or beyond the template that the investors impose upon them. Even the automakers that are making EVs are trying to compete with the car's features or price. They don't even know how to compete with the Tesla narrative. It seems Tesla will stand apart from the crowd for many years, even after the legacy automakers become fully committed to electric cars.

Disclosure: I'm long Tesla
http://ts.la/patrick7819