Yesterday will be remembered as the day Germany slipped towards a recession. Yes, there is no way around it, and it will likely be a rather painful one because it strikes at the core of the country’s economic engine and threatens the very essence of what “Made in Germany” means: German cars.
This downturn will also have a name: The Tesla Depression. I’ll explain.
Tesla just scored an epic win
Yesterday, Tesla announced their numbers for Q3 2018. If this was a game, the best characterization would be epic win.
Tesla delivered everything promised and then some: a record $6.8B in revenue, $300M in profit, operating cash flow of $1.4B and $3B in cash and cash equivalents ($731M more than three months ago). Tesla also announced that the Model 3 is the bestselling car in the U.S. in terms of revenue and the fifth bestselling car in terms of volume. The insane part is they achieved this without marketing spend and without any dealer network. As a result, the gross margin is already above 20%.
Tesla’s astronomic rise as well as some underlying trends are at the core of Germany’s economic distress. Ever since a German invented the car more than a century ago, cars have played a central role for Germany’s economic prowess and its national psyche. They still do. And while an American invented mass production, the Germans have stayed ahead and maintained dominance of the luxury car market globally. Until recently.
But in 2012 an audacious startup in California started building cars superior in nearly every aspect. They are faster, safer, and smarter than the best cars of any other manufacturer. Tesla’s cars are also more efficient in their use of energy and more environmentally friendly. They less maintenance, keep their value longer, and are constantly learning new tricks “over the air” (i.e. via wireless software updates).
It looks increasingly likely that Tesla will be to German car manufacturers what Apple was to Nokia: Kryptonite. So, it’s informative to take a look back to make sense of this disruption.
Early signs of trouble for German luxury cars
One of the first signs that Mercedes, Porsche, and their peers might be in trouble cropped up six years ago, six months after the launch of Model S in June 2012.
One Californian started counting new luxury cars around Palo Alto. As unscientific as this was, the fact that all the ones he identified on the streets were Tesla Model S became a news story: “Tesla: 100% Market Share in Silicon Valley”.
And in December 2013, the auto website Edmunds.com confirmed Tesla‘s strong appeal: “Model S is the top-selling vehicle in eight of the nation’s 25 wealthiest ZIP codes.“
When markets go electric
Despite the high price of Model S, Tesla’s impact wasn’t just limited to the luxury segment. In markets with high taxes on ICE cars and a high incentive for electric cars like Norway, Tesla’s luxury cars were able to compete more broadly. Indeed, Tesla Model S outsold all other cars in Norway in March 2014.
Norway will continue to be an interesting market to watch. By the end of 2018, electric cars took the lead and reached a 52% market share. The end of ICE cars is clearly coming in Norway.
Losing the luxury segment to Tesla
Tesla’s successful entry into the luxury segment also didn’t remain a local phenomenon. In 2015, Tesla Model S managed to become the number one large luxury car in the U.S.
And Tesla didn’t stop there. Unlike other U.S. car brands, Tesla’s appeal also proved effective on Europeans. In 2017, Tesla Model S also outsold German luxury stalwarts in Europe.
And the first half of 2018 looks pretty similar. Model S won again. And there’s no end in sight.
Tesla goes mainstream
While Tesla’s success in the luxury segment become a new normal, their overall production stayed limited in size and scale. But that changed dramatically. In the second and third quarter of 2018, Tesla nearly tripled its deliveries from 29,980 in Q1 2018 to 83,500 in Q3.
Selling 83,500 cars in a single quarter catapults Tesla into the mainstream. The company sold more cars globally than Porsche, and more cars in the U.S. than Mercedes.
And in September, Tesla sold more cars in the U.S. than BMW. Are you sitting up yet?
Model 3 became one of the top four cars sold in the U.S. and the one generating the most revenue of all. And all of that happened while production was still limited due to bottlenecks.
Negative sentiment hides epic domination
It’s clear that 2018 is the year electric vehicles reached their tipping point. But when people look back they will be surprised. At the very the moment Tesla accelerated the production and sales of their iconic electric cars, public sentiment about the biggest disruptor in automotive since Henry Ford reached a new low.
The negative coverage about Elon Musk and Tesla approached a fever pitch right around the time Tesla’s success started to seriously hurt established car brands. Casual observers could be fooled into thinking Tesla wasn’t making much progress when, in fact, they were pulling the rug out from under luxury car brands.
While Tesla was gaining massive market share, Mercedes, BMW, Audi, and their peers were losing sales at a brisk pace.
Then suddenly, they win
A day before yesterday, the sentiment turned positive. A prominent Tesla stock shorter publicly changed his mind and went long. Andrew Left of Citron Research is famous for betting against Tesla and seven suing the company. On Tuesday he sounded a different tune: “Plain and simple, Tesla is destroying the competition.” Tesla stock jumped 12% that day.
Yesterday, in after-hours trading after Tesla announced their quarterly numbers, the stock jumped another 12%. And that will probably not be the end of it.
What is in front of us
Tesla is still far away from market saturation. With a Net Promoter score of 96, every car Tesla manages to deliver will likely generate more new sales for Tesla. And that is just the beginning. Tesla hasn’t even started selling the Model 3 in Europe or Asia and only offers a premium version of it. The cheaper entry version of the car, with a proposed sticker price of $35,000, is still not available.
Given Tesla’s outstanding customer satisfaction, their sales will grow further. In Q4 they will likely overtake BMW in addition to Mercedes in the U.S. market. Sales of iconic German car brands like Porsche, Audi, BMW, and Mercedes will decline and public opinion of those brands will suffer.
At some point not too far away, the iconic German car brands — to the great surprise of the German public — will be forced to announce cost reductions and restructuring initiatives. People will wonder how things could turn so badly so quickly. A few months back, everything looked so good and Tesla seemed clearly incompetent. What happened?
When things started to go wrong
When California started pushing for stricter environmental standards to fight the smog in cities like Los Angeles, German car manufacturers had a choice. They could have embraced this development as a chance to use German engineering to differentiate. But they didn’t fully embrace the goal of emission-free transportation. Not a single established vendor took on the challenge and committed to bringing zero-emission vehicles to the market at scale. Instead, we got defeat devices, lobbying, stalling, and a lot of untruthful marketing about “green diesel”.
This breathtaking shortsightedness defies belief. Putting tens of millions of cars with illegal defeat devices on the streets of the world and expecting to not be exposed is a stunning act of hubris. In our highly networked world, one tweet can capture global attention. It was only a matter of time until “Dieselgate” broke and the reputation of these companies destroyed.
Tesla is a challenge on five different levels
And Competing with Tesla is harder than it might seem. It is about much more than building electric cars. We can identify at least four different levels of competitive advantage.
Level 1: Charging stations
Tesla has managed to build up a comparatively dense network of exclusive charging stations in the U.S. and Europe and parts of China. Providing supercharging for customers on road trips is crucial to overcome range anxiety.
German manufacturer have started to join partnerships to build up a comparable infrastructure. But it will take too much time to catch up.
Level 2: The maturity of Tesla’s electric drivetrain, design, tooling, etc.
There is reason to believe that Tesla has a significant head start when it comes to engineering and building electric cars. A good indication is the superb efficiency of their drivetrains. This maturity is the clear result of many years of full dedication to making electric cars work.
It is likely that the engineers of German car manufacturers are well equipped to make fast progress here if their companies fully commit to it.
Level 3: The efficiency and scale of Tesla’s battery production
Bringing down the price and weight of efficient batteries is crucial for electric car manufacturers to succeed. With Gigafactory 1, Tesla brought down the cost while ramping up production to meet the scale of their growing sales.
German car manufacturers will likely emulate Tesla and partner with battery specialists. Again, this seems doable, but it will take time to do it at scale.
Level 4: Over-the-air software
Software is a big one. While all modern cars need a lot of software to work at all, Tesla’s approach to software is fundamentally different. Cars use software for many aspects like the controlling the engine, cooling, exhaust management, navigation, entertainment, diagnostics etc. But until Tesla arrived on the scene, the software in your car was not really designed to be changed. Software was a static thing. It had to be tested diligently because after loading it on a bunch of cars there was no easily affordable way to update it.
This “static stability” of software was good enough in the past when things were pretty stable, and nobody expected their car to learn new tricks every few weeks. Tesla changed that and went for “dynamic stability.” They make updating the whole car then norm. All of its software is updated frequently over the air and at overnight. No need to go to the dealer or pay any maintenance fees.
Dynamic stability is very different. It’s like riding a bike vs. putting it on the side stand. And while riding a bike is pretty stable as long as you are in forward motion, you also get so see much more of the world. That’s what Tesla cars do. They learn new tricks and are constantly improving. In that regard, Tesla cars share many more characteristics with iPhones than with conventional cars.
The problem is, this is a fundamental challenge for German car manufacturers. Their ecosystem was set up to deliver parts and pieces, not holistic software delivered to all cars on the street over the air. Agile software development and delivery also requires a fundamentally different mindset.
Level 5: No dealerships
Tesla copied another pillar of Apple’s strategy, the Apple Store. Instead of selling though independent dealerships, Tesla sell directly to their customers. They maintain a direct relationship with their customers, manage the cars until they get decommissioned and generate loads of data from all the sensors in the cars. The direct sales model will enable Tesla to generate significantly higher gross margins.
This is a tough one for established car manufacturers to match. They are bound to their legacy networks to sell their cars and can’t easily transition to the direct model that Tesla uses.
Level 6: No marketing
Tesla is unique in another way. They don’t do conventional marketing at all. When your CEO sends a Tesla roadster to space and lands rockets on a small barge in the ocean, you have a captivating story that doesn’t require conventional marketing. Add in the idea of saving the world while building the fastest, safest, and most efficient cars in the world, and you might end up with enthusiastic followers. Until recently, Tesla only sold a tiny fraction of the cars of Mercedes, BMW, or Volkswagen. But even then, they received the largest mindshare of the public and people in the industry. Because when Elon Musk tweets the world listens. That might not always be a good thing (especially for him) but it’s hard to compete with.
Being iconic is the most powerful competitive advantage there is. Even with cars that match Tesla’s in many characteristics, there is only one real-world Ironman.