Cars

Tesla Desperately Needs a Crossover Hit

Older automakers understand that you have to build many cars on the same platform.

And zero profits.

Photographer: SAUL LOEB/AFP/Getty Images

When Tesla Inc. chief executive officer Elon Musk was asked if his burgeoning collection of startup companies might lead him to step away from the electric automaker, he said he'd stick around as long as he could "positively contribute" to its success. "The most valuable thing I could contribute is product design and technology," he told analysts on the firm's first quarter earnings call on Wednesday. "That's my forte; that's what I like doing."

Under Musk's leadership, Tesla has produced a series of undeniably desirable vehicles that helped it briefly become, on paper anyway, the most valuable automaker in the nation. But is has rolled these cars out in a frantic, iterative, inefficient and nonstrategic manner that shows why mainstream automakers tend to be run by "bean counters" rather than creative visionaries. 

Nothing illustrates this dynamic quite like Tesla's crossovers, the Model X and the forthcoming Model Y. Crossovers are unsexy but highly pragmatic machines that are critical to profitability in the modern car business. With Musk revealing that the Model Y will not share a platform with the mass-market Model 3 sedan, as most analysts had expected, it's becoming clear that the firm still hasn't appreciated basic logic of the crossover market. As Tesla moves into the lower-margin mass market and comes under increasing pressure to show profitability, this unexciting but important lesson will have to be learned.

Decades of tough competition have eroded profit margins on sedans, turning the bulk of the car business's production volume into a commodity product. The industry's answer has been to build roomier, more capable crossovers using the platforms, drive-trains and other internal gubbins from their sedans, thus spreading the development costs of these shared components over more volume and improving margins. Though this strategy has evolved somewhat over the last decade -- with industry leaders moving away from simple platform and component-sharing to more flexible modular "kits" like Toyota's TNGANissan's CMF and VW's MQB -- the underlying logic has only become more fundamental to profits. 

Tesla's first crossover, the Model X, was introduced last year. It was built on the platform of the company's older Model S sedan, but its ambitious design -- including eye-catching double-hinged falcon doors -- made it hard to save costs through part-sharing. “We originally thought the X would have a lot of commonality with the S,” Musk said in 2015, “but maybe 30% of the parts are in common."

As a result of this inefficiency, the Model X has not improved Tesla's gross margins the way a crossover should. On this week's analyst call, Musk admitted that Model X development lacked discipline and its complexity reflected the company's "hubris."

At the same time, Musk's most recent comments about the next-generation Model Y suggest that the company still has not learned the critical crossover lesson. Rather than making a small investment in a new, more spacious crossover body for the Model 3 and charging customers more for it, Musk confirmed that Tesla is developing an entirely new platform for the Model Y.

This means that instead of spreading the Model 3's fixed development costs across more, higher-margin vehicles, Tesla will sink tens (if not hundreds) of millions of dollars into a bespoke platform for its second crossover. For a small-scale automaker, lacking the efficiencies of scale enjoyed by its established manufacturers, Tesla's decision to develop four platforms for its first five vehicles is all but incomprehensible.

Though there are challenges to building crossovers on unmodified sedan platforms -- a fact that gave rise to the industry's modular kits --  it's hard to believe that Tesla is developing a new platform for Model Y just to produce an excellent product for drivers. Instead, it seems that the Model Y's new platform is intertwined with the ambitious new, heavily-automated production system that Musk initially promised for Model 3.

It seems that Tesla was in such a rush to begin producing Model 3 this year that there wasn't time to develop the new automated system, forcing the company to delay it until Model Y production begins in 2019 or 2020. Had Tesla taken a more typical amount of time to develop its first mass-market vehicles, it could have designed the sedan and crossover on the same platform and using the new production system.

Tesla's Silicon Valley-inspired "high-speed iteration" approach to vehicle development has delivered some real advantages that will influence the industry for decades, most notably its game-changing over-the-air software updates. But the Model Y mess also vividly demonstrates why the auto industry has evolved to operate at a more deliberate pace: investing in a new platform before its long-term production system and model strategy is fully baked-in all but guarantees that it will be an inefficient allocation of capital.

Seat-of-the-pants innovation works wonderfully for software, which enjoys strong margins and doesn't require expensive and inflexible tooling to produce each new version, but a botched or half-baked vehicle platform can kill a new model's profitability before the first one is even assembled.

As long as investors are willing to continue subsidizing new platforms, models and production systems, Tesla can continue to pursue its expressive, experimental approach to auto making. Musk is doing exciting things, and it's no surprise that his unique approach to such a calculating and risk-averse industry generates so much excitement.

But novelty never lasts forever, and at a certain point Tesla will need to prove that it can allocate capital efficiently and grind out margins in a competitive business. When that day finally comes, nothing will serve Tesla as well as a boring, efficiently-executed crossover.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Edward Niedermeyer at eniedermeye1@bloomberg.net

    To contact the editor responsible for this story:
    Tobin Harshaw at tharshaw@bloomberg.net

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