In the first article in a series on strategic innovation, Tony Grundy explores how existing business models are being thrown up in the air and landing in quite a different shape
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This article was first published in the May 2016 international edition of Accounting and Business magazine.
A recent episode in a Sky documentary series looked at nuclear energy. Heat and light from the sun reaches Earth, it explained, heats the planet up and nurtures life. Plants then generate chemical energy, which over millions of years is compressed into oil, which is then burnt and so turned into heat.
Next the programme cut from the sun, via solar panels, to an electric car whose cells are recharged by solar energy. An astrophysics professor jumped behind the wheel – in this case, a US-manufactured Tesla – and set off noiselessly, reaching 60 miles per hour in 3.9 seconds, gliding almost silently past noisy sports cars spouting emissions.
Electric/solar-powered cars such as the Tesla are a supreme example of a disruptive technology that is revolutionising a sector that has embraced the same paradigm for decades.
Ahead of his time
Nikola Tesla was a brilliant Serbian-American physicist and engineer who came up with a stream of trailblazing inventions. He was so prolific that alien theorists contend that he must have been in contact with species from elsewhere in the universe. He was also ahead of his time: one of his most significant inventions was an electric motor, which he conceived in 1882. But to date electric motors have lagged their petrol-powered rivals due to the abundance of oil at affordable prices and a lack of understanding about the environmental effects of carbon emissions.
As long ago as 1996 I saw an electric car at the Epcot Center in Florida, US, which even then achieved reasonable performance but was just too costly. Two decades ago, there was far less pressure to think and behave ecologically and no obvious reason why the automotive industry should put itself through the unnecessary turmoil of substituting petrol for electricity. The mindset and commercial drive was just not there.
The obvious thing to do would have been to sell electric cars at a loss and push volumes up so that with the cumulative experience the unit cost would fall. This is called ‘the experience curve’ and is most easily observable in the history of microchip costs.
Cue Tesla Motors, an automotive company founded in California in 2003 by Martin Eberhard and Marc Tarpenning with a vision of making an electric sports car. After starting up on seed capital and later venture funds, Tesla came close to bankruptcy in 2008 and was in effect the object of a management buy-in when Elon Musk took over the reins. One of his crucial actions was the acquisition of around US$465m in relatively cheap loan finance from the US department of energy.
Tesla’s pricing model followed very closely that of the experience curve exploited to great effect in many industries in Japan. Prices have gone down sharply, in line with a move towards more affordable - if less dazzling - models. In 2010 the Roadster cost US$109,000, the later Model S US$57,400, and the first mass-market model, the Model 3, due out in 2017, just US$35,000.
Further finance was secured through rounds of private equity and through an initial public offering in 2010 and, despite stuttering profitability, the future prize of economic value hovers like a strategic, financial umbrella over the company, enabling it to attract new funds to fuel its expansion. In 2015 planned capital expenditure was US$1.5bn, and operating costs were projected to rise from 45% of sales to 50%.
Obviously Tesla must be mindful of not growing too fast. There is a fine line to be managed in its growth trajectory: too slow and rival entrants will be encouraged; too fast and the business may overheat, like an economy given too much stimulus by government.
And there is more to Tesla’s strategy. It is planning a car buy-back scheme guaranteeing a return of a percentage of the initial price pro rata to the decline in price of another high-quality car such as a BMW. It is also said to have a complex ‘coordination model’, with closely integrated and mutually supportive technologies that are hard to imitate.
Tesla has stated its intention to produce electric motors for other applications, transcending the automotive sector and defining itself through its distinctive competences rather than through its markets. It has also announced that it plans to sell electric power plants to other car companies. Maybe it was felt that this would enable it to go even faster along the experience curve, building ever-bigger entry barriers to competitors – rather like getting into a party first and locking the doors so that you can feast. It is also an interesting example of blurring the distinction between competitor and strategic ally.
But how durable is a strategy such as Tesla’s, and how might it pan out culturally and in the face of changes in management over time? Alliances are like long-term relationships: after the honeymoon period wears off, how do you transition to a more mature but evolving relationship and manage through times that require adjustment?
Getting the economic value out of a strategy like Tesla’s requires a thorough implementation plan to keep the operation on the road. The sheer pace of growth in employees could be an issue: employee numbers have doubled to 12,000 in the last 18 months. For a company that hasn’t been through this before, compound growth rates of over 50% can be very hard to assimilate and could well lead to indigestion.
Dr Tony Grundy is an independent consultant and trainer, and lectures at Henley Business School
CPD technical article
"Tesla’s pricing model followed very closely that of the experience curve exploited to brilliant effect by Japanese companies"