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How Tesla Plans to Revolutionize the Electric Car

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This interview was June 12, and all prices and dates reflect that date.

Tesla Motors (TSLA) headquarters is a stark contrast to other auto manufacturers. Its design and layout is more like that of a tech startup, than an automotive giant like Ford (F) or General Motors (GM).

Perhaps that's why Tesla, which cites Apple (AAPL) as part of the inspiration for its retail experience, is attempting to turn the car industry on its head, similar to Apple in the smartphone and tablet markets.

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I recently had a chance to sit down with Deepak Ahuja, Tesla's CFO, to discuss a wide array of initiatives. These included Tesla's chances of selling more than 20,000 Model S vehicles next year, the state of the electric vehicle market, the falling oil prices, the company's power train deals, as well as several other topics.

Chris Ciaccia: How achievable is a 20,000 unit run rate by 2013? Is there anything that could prevent this, whether it be macro headwinds, or poor product response by the customer?

Deepak Ahuja, Tesla CFO: As you know from your experience in the automotive industry, a 20,000 unit target that we have set for ourselves is quite modest. It represents 1%, or even less than 1% share of the premium vehicle market in that price range. I think we have set for ourselves, even before we started getting all of these reservations, our target was 20,000 units and we have tried to make it modest in our minds. The reservations we've been continuing to receive, we have over 10,000 at this point without a single test drive.

We feel very confident that the car [Model S] is going to be awesome from every aspect. The functionality, the design, the power train performance, and the fact that it's an electric vehicle. So, I'm pretty confident that we should be able to achieve 20,000 units in sales, and hopefully do better. But at this point, we'll stick with 20,000 units.

Ciaccia: Tesla's vehicles do not have an internal combustion engine and oil prices have dropped from around $110 per barrel to around $85 per barrel. Have you seen any push back from customers perhaps canceling because they don't see the benefit of having an electric vehicle anymore? If oil prices continue to decline, does that materially hurt Tesla's business?

Ahuja: I think there are many ways to look at that issue. Firstly, the car we want to bring to market, we want to make an aspirational car on its own merit, beyond the fact that it's an EV [electric vehicle]. We want people to buy this car because it has amazing innovation, terrific user interface, awesome driving characteristics and dynamics.

We don't want people just to buy this car necessarily because of the savings on a cost of ownership basis. Having said that, we also want to offer a very good value for our customers where the cost of ownership helps them. At present price of gasoline, the savings against some of the competitors can be as much as $2,500, or $2,400 per year, in terms of gasoline, versus the cost of charging. That's very significant. Sure, the price of gasoline may drop short-term, may go up, it's very hard to predict.

We still think the savings are substantial the customer is receiving, and this is in addition to being green, and using less emissions for people who look at all aspects. We don't see a direct correlation coming to the bottom line between the price of gas and flow through into reservations, or cancellations, right away. I think there's a bigger picture, and a bigger story here.



Ciaccia: You touched on the cost of charging. How does that work? Is the consumer paying for the cost of electricity at a charging station, or is that built into the price of the vehicle?

Ahuja: We expect most people will charge their vehicles at their home. Typically overnight, after they've used the car. Tesla vehicles have a much longer range than any other product so far on the market, per charge. It's pretty convenient to drive throughout the day and still have a lot of charge left and top it off every night.

Typically in many cities, there's a discount when you charge at night. For example, the neighborhoods here, if you charge past 1 a.m., your rates fall pretty dramatically. You can in fact program your car to start charging at specific times to take advantage of those lower rates. Some of those lower rates can fall as low as $0.06 per kilowatt hour (kWh). But even if we look at $0.10 kWh or $0.11 kWh, which is the national average, and we look at the national average price for gasoline, the savings are about $2,400.

Ciaccia: What happens to the EV market if government subsidies are cut because of austerity measures? We started to see it in Europe with solar panels. Does that materially affect Tesla's business?

Ahuja: That's a great question. The core of our strategy has been not to rely on the subsidies to develop a robust business model for Tesla. The main subsidies in our case is the $7,500 tax credit. We've known from the beginning that this is limited to 200,000 cars per manufacturer. Clearly, there's an end in sight, and it could be that this gets changed. You never know what the political environment is, but at this point, it's 200,000 vehicles. We know very well, that when we go to our next product, which is generation three cars, we cannot rely on these tax credits to get us to affordable price points. Our goal is to get our costs down in a way that offers good value to our customers.

Ciaccia : How does Tesla do that? You build on an as-needed basis, as opposed to another auto manufacturer who builds on an assembly line, and cranks out hundreds of thousands of vehicles per year. You're building as needed. How do you cut costs and try to improve the bottom line?

Ahuja: I would certainly link the two. Certainly, the business model that we have of building only to order is possible given that we have lower volumes. I think 20 [thousand], maybe even 50 [thousand], we could be there. As we go to 100 [thousand]-plus or even four or five hundred [thousand], we may have a combination model.

There may be some cars that we might put at our facilities and have people come in and buy the car because they don't want to wait. We want to start offering that feature. So there's a cost of manufacturing, and there's a cost of selling. Clearly, our model optimizes and makes our cost of selling extremely efficient, because we have less assets and less working capital in our selling strategy. On the cost of manufacturing, on the efficiencies we are getting, are across every part of our bill of material. Of course, the electric power train is a very expensive part of the car, and we are working on every element of it, starting with the cell itself. We are working with our key strategic partners in Asia to make sure we have the lowest cost per kWh on the cell. The battery pack that the cells go into, our engineers and our design really allows us to get the best in class cost per kWh for the pack.



Ciaccia: Do you think that battery costs can come down markedly over the next five years?

Ahuja: I think that in past experience, typically, it averages to about 8% annually. It doesn't necessarily happen every year - there are step functions. The cumulative annual effect is 8%. The product development cycle that we see at these cell manufacturers are these cost reductions will continue in the future at roughly the same rate.

Ciaccia: You touched on power trains before. Tesla does a lot of other work for Toyota (TM) and Daimler Benz (DDAIF). What kind of relationships do you have with the two of them, and do you foresee any kind of expansion with other manufacturers to make electric vehicles more than just a niche market?

Ahuja: Our relationship with both Toyota and Daimler,  I would say, has been extremely constructive and growing. Clearly they have taken a bigger picture approach as well, since they have decided to invest in Tesla in addition to being our commercial partners. The two are fairly diligent in dealing with commercial decisions in an ongoing basis.

We see a growing opportunity at both Toyota and Daimler, and clearly we've continued to announce the progression of those partnerships, with Daimler, including the recent program where they announcedtheMercedes Benz vehicle. We'll provide the entire electric power train, not just the battery pack as we have in the past.

For Toyota, we already are providing the entire electric power train, and I think that's going to be an amazing product in the market. Those relationships, I would say have been mutually beneficial. Not only have we provided the power trains, we've learned a lot from them. It's also helped our own supply chain, getting access to cheap parts, and parts that are being purchased at high volumes by Toyota and Daimler, so we get the economies of scale from them. Beyond Toyota and Daimler, we certainly are in conversations with folks. It's a balance between our requirements and our resources required on our vehicles. As it becomes appropriate to announce something, we will.

Ciaccia: How important are the international markets to Tesla? China is consuming an astronomical amount of natural resources. Does Tesla have any plans to educate those consumers on the benefits of having an electric vehicle versus having an internal combustion engine? In terms of a revenue percentage, how do Tesla's revenues break down, domestic, versus international?

Ahuja: We've always considered the international markets important. Roughly half of our stores are located internationally, in Europe and Asia. The Roadsters we've sold in 30 countries, as you may have read. The Roadster has really helped us learn how to be an international company and create a presence in these countries. It serves as a terrific foundation for us as we launch the Model S internationally. The international markets are therefore important in our minds for Model S. We expect to get into Europe and Asia next year with the Model S.

China, as you said, is a huge market. There's also significant price premiums in China, because customers are willing to pay for premium products. We are exploring China, and we definitely expect to be there sometime, I would say, in the 2013 time-frame. I would say the process of getting into China is longer, given the local governments. It's hard to predict exactly when we'll be in China.

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