Tesla’s real innovation is its business practices, not its electric cars.

Tesla’s Real Innovation Isn’t the Electric Car

Tesla’s Real Innovation Isn’t the Electric Car

A Closer Look at the New Energy Economy
April 11 2016 9:54 AM

Tesla’s Real Innovation Isn’t the Electric Car

It’s the company’s business practices—and they should make a lot of industries very, very nervous.

A Tesla Motors mass-market Model 3 electric car from Tesla Motors on March 31, 2016.
So innovative. Let’s count the ways.

Handout/Reuters

It’s hard to overstate the economic impact of automobile manufacturing. Autos are both the biggest manufacturing sector and the biggest retail sector. And these sectors spread revenues to a huge number of other parties: suppliers, auto dealers, gas stations, media. A whole host of business models rest on the traditional avenues of car manufacturing, sales, and ownership. Which is why Tesla’s rise and continued success—last week it staged a coup by garnering more than 325,000 reservations for its new Model 3—is so interesting, and so potentially disruptive.

Tesla’s great innovation isn’t the way its cars get around. The concept of using electricity to power cars isn’t exactly a new one, after all, and several other automakers produce electric vehicles. Rather, the company’s most meaningful innovation lies in its business practices, which differ significantly from those of other car manufacturers. As a result, Tesla’s impact will extend far beyond the company’s bottom line. Should its vehicles become commonplace and truly mass-produced, as the company hopes will be the case with the Model 3, and if the company can do it while turning a profit (it lost $717 million on its operations in 2015), it will mean a big shift in revenues throughout the economy—far beyond the $13.4 billion in sales those 325,000 reservations might lead to. For Tesla and its car owners simply don’t spend their money on things that much of the rest of the industry and their customers do.

Advertisement

Let’s count the ways. Every Tesla vehicle that hits the road will cut into sales of petroleum. The company has already sold 107,000 cars, and none of them use gas. Let’s say, for the sake of argument, that there are 100,000 electric cars on the road, each of which travels 10,000 miles per year. A similar petroleum-fueled car getting 25 miles per gallon would consume 400 gallons annually. For every 100,000 Teslas on the road, that’s 40 million gallons of gasoline not sold—or about $100 million not spent annually at gas stations. (Of course, some of that spending is diverted to increased payments for electricity.)

Next, take advertising. Startups often spend disproportionately on advertising to get noticed in a crowded field. But Tesla is an outlier among startups, and among the auto industry. I have yet to see a Tesla television advertisement, and it has managed to rack up significant sales without airing 30-second spots during the Super Bowl. That spells bad news for the advertising business. In 2015, three of the top 10 advertisers in the U.S. were car companies: General Motors (No. 3, $3.1 billion), Ford (No. 6, $2.5 billion), and Fiat/Chrysler (No. 8, $2.2 billion). Nor does Tesla engage in much of the expensive marketing efforts that the rest of the industry does, like sponsoring sports teams. Car companies spend tons of money to appear at auto shows, paying for spokesmodels, displays, rides, and other events. Tesla didn’t bother to show up to the New York Auto Show.

The auto companies also spend a lot of time and effort wooing and coddling their vast networks of dealers. These are, in a way, their chief customers, since they actually purchase the cars and are the sole path for reaching retail customers. Tesla doesn’t have dealers and sells directly to consumers through retail stores that it owns. Every sale of a Tesla vehicle, then, represents a loss of margin for a car dealer—and a threat to a century-old structure in which vehicles are sold through dealers who maintain large lots and inventory.

Car companies spend a lot of money on incentives. That is to say, they discount, throw in features, option packages, and cash rewards to help move vehicles off the lot. Last November, for example, the average incentive paid per car sold was $3,108. By contrast, Tesla has constructed a business model in which it generally charges full freight. And to the extent that there are incentives on its vehicles, somebody else is paying them—the American taxpayer. People who buy all-electric cars are entitled to a $7,500 federal tax credit. (Tesla buyers will stop getting the full $7,500 credit once the company sells 200,000 cars.)

And then there’s Wall Street. Tesla has been quite active in the financial markets; last year, it sold $500 million in stock to the public. But one of the unique things about its business model, from the beginning, was that Tesla takes customer deposits up front—a year, two years, three years in advance of production and delivery. Other car companies don’t do that. And all those deposits add up. Deposits are a liability, of course: Once you accept a deposit, you are obliged to make the car. But they are essentially no-interest loans, or free money. At the end of last year, Tesla was sitting on $283 million of customer deposits. And with 325,000 people signing up and paying $1,000 each for Model 3 reservations, the company just Hoovered up another $325 million—without paying a dime in Wall Street underwriting fees.

Some analysts have argued that Tesla’s quirks would get ironed out as the company gained scale and strove to adapt from a purely luxury brand into a mainstream one. As Tesla matured and targeted different price points, it would surely have to act more like a typical American car company, right? But so far, it’s not. It has managed to score 325,000 orders for a more affordable car without running advertisements or showing up at the auto shows, and without building up a dealer network. And that’s the real threat it poses to the establishment. It’s creating an alternate business model—and an alternate business ecosystem.