Electric Carmaker Tesla Downshifts

Funding gaps have put some of the Silicon Valley carmaker's plans on hold
Chairman Musk (with Tesla's Roadster) wants the company to be the Apple of electric cars Thomas Michael Alleman/Wonderful Machine

Since its founding in 2003, Elon Musk's Tesla Motors has been a proud creature of Silicon Valley. That's to say a startup with outsize ambitions and a public disdain for business as usual—or at least as practiced by the dinosaurs in Detroit. On a tight budget, Tesla built an electric car, the Roadster, that's acclaimed for its harmonious balance of greenness, beauty, and performance. Tesla has 1,200 back orders for the $100,000 sports car, mostly from wealthy trendsetters.

But Musk, a software entrepreneur who made millions with PayPal (EBAY), has bigger aspirations: He dreams of one day producing a line of electric vehicles for every purse and purpose. A few weeks ago, Tesla seemed to be on the road to making that happen. Musk had verbal commitments for $100 million in private capital, federal loan guarantees geared at jump-starting development of alternative vehicles, and thoughts of going public next year.


Then the world changed. On Oct. 11 Musk's financial advisers at Goldman Sachs (GS) called with bad news. Investors, fazed by the credit crunch, were suddenly demanding tougher terms. Musk organized bridge financing and poured more of his own money into Tesla. With $55 million-plus at stake, Musk, who is chairman, asked the CEO to step aside, and he took over that role. He began retrenching, laying off 80 of 380 people, cutting costs, and postponing Tesla's second model, the $60,000 Model S sedan. "We're taking action before we're forced to," Musk says.

But delays and tight funds could undercut Musk's long-term vision of selling affordable electric cars to the masses. If oil prices continue their fall and stay below $80 a barrel, Tesla, which currently spends nothing on marketing, could lose some of its buzz. Plus, the startup could lose its first-mover advantage: By 2010, everyone from General Motors (GM) to Toyota Motor (TM), Nissan Motor (NSANY), and Daimler (DAI) expects to launch their own electrified vehicles. James N. Hall, who runs the auto consulting firm 2953 Analytics, sees trouble ahead. "If the market wants [electric cars] in the number Tesla is talking about," he says, "a larger auto company will bury them on cost."

The financing crunch is the second crisis Tesla has endured in the past 12 months. Last year it found that its much hyped $100,000 Roadster was over budget by some $40,000 per car. Tesla had to delay the launch by six months while it looked for a way to make the car profitably. Musk fired founding CEO Martin Eberhard and brought in as interim chief Michael Marks, an executive at electronics maker Flextronics International (FLEX).


The crisis was chastening for the Valleyites. With Marks and Musk more involved, Tesla ditched specialty suppliers, one of which had never made parts for mass-market cars before, and brought in established parts makers, some from Detroit. That cut costs by thousands of dollars per car. (Musk says the Roadster now makes money.)

Marks, who left the interim post in December, also urged Tesla to hire more people with auto industry experience. This summer, Tesla recruited engineering and factory veterans from Chrysler, a finance guy from Ford Motor (F), and a design chief from Mazda Motor (F).

They were to streamline engineering, make Tesla's far-flung manufacturing operations more efficient, and get spending under control.

The Detroit hands had left flailing domestic carmakers for a startup that was promising to reinvent the industry. What they got instead was, well, more of what they were used to back in Motor City. Instead of planning research and development budgets and doling out money to add staff and produce tomorrow's electric cars, Tesla Chief Financial Officer Deepak Ahuja, the former Ford finance guy, has to swing the budget ax and say "no" more often than he thought he would. "I didn't anticipate that," Ahuja says. "We have to react as fast as we can to changing business conditions."

So far the cost cuts are prosaic and piecemeal—moving the shrinking staff into one office, delaying the Model S until the loan guarantees from the Energy Dept. are available and investors loosen up, replacing the transmission handle with a button. But Tesla will need further-reaching structural changes. For example, it gets car bodies and chassis from British sports car builder Lotus, builds electric motors in Taiwan, and does final assembly in California. Given the shipping and exchange rates, the cost per car is "scary," says Musk. He would consider shifting everything to the U.S., but he can't move body production there until 2010, when the Lotus contract expires.

Of course, cost-cutting will take Tesla only so far. Given the array of electric and hybrid vehicles hitting the roads soon, the company needs to find a way to stand out. Musk is focusing on style. He wants to be the Apple of electric vehicles. He's hired Franz von Holzhausen, who, as Mazda's chief designer for North America, had a big hand in that company's celebrated new look. Musk hopes he'll bring a sophisticated, sporty look to Tesla vehicles.

Musk insists Tesla's next models will be irresistible. The Model S will go up against formidable competition—cars such as the Lexus GS 450h hybrid, the diesel Mercedes E-class, and the Chevrolet Volt. Not that those cars feature Tesla's neck-snapping acceleration and running cost of 4 cents a mile. "Our sedan will crush everything out there," Musk says.

You have to give the man marks for confidence. But the challenges are steep—and not just because a recession looms. Past executives say Musk is a micromanager and shares blame for last year's missteps. Marks acknowledges that developing the Roadster for $150 million was a real feat, but notes Musk isn't an auto guy. "They underestimated what it took to get here, and what it takes going ahead."

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