The third quarter of 2021 illustrates the competitive advantage of Tesla due to its integrated business. In the midst of a chip shortage that trims the production of almost all automakers, Tesla still breaks the record in terms of production units. This article is the sequel to talk about Tesla’s economic moat that discussed brand power, direct sales, and low-cost producer.
iPhone of Auto. Again.
Deep Vertical Integration is a Competitive Advantage of Tesla
Some people think that the making of an EV is simple as swapping the internal combustion machine (ICE) with an electronic machine. Sadly, the reality is far more complex than that.
Yes, we hear you. EV design is much simpler. The truth is both of them have their own complexity. This complex topic brings us to a conversation about competitive advantage in business. The most complex part of the ICE (Internal Combustion Engine or the conventional nonelectric car) Vehicle is the engine. The detail is about thermodynamics and fluid mechanics things, to make it simpler for you, the engine has to have the capability to mix fuel, air, and pressure to move the car. Controlling the speed of the car is more about controlling the heat, the pressure, and the sprayed fuel.
Due to its complexity, the conventional carmaker outsources the design, tool up, and manufacture of the engine to the third party. This reminds us a lot about the aircraft industry where Boeing and Airbus outsource their jet engine to the duo GE Aviation and Roll Royce.
And for your information, the competitive advantage aka moat is on the jet engine maker side, not on the Boeing side.
Differ from that, EV complexity is in the battery, speed controller, and motor. Controlling the car is controlling the motor, and it is more about software.
And Tesla – not only has its battery in-house, but it also controls that speed controlling software.
This competitive advantage becomes more apparent when chip shortage comes and hits the entire world. With excel in coding and programming, Tesla could use the old chip or any chip and rewrite the software. Something that any other car company, especially EV carmaker can’t do right now.
So, it is Apple again. Remember M1 and M2 chip that outperforms Intel counterpart. It is a software-hardware company, and so does Tesla.
Investor Note
This vertical integration – battery, motor, and software for Tesla or iOS, macOS, and M chips for Apple – allows the company to deliver a higher profit margin or cut the production cost. Also, it could deliver a better experience for the customer.
Economies of Scale is a Competitive Advantage of Tesla. Behind It.
The truth about Gigafactory.
We start with simple statistics that you can see in the chart below:
Tesla is the largest producer of EVs, and the reason behind it is its Gigafactory.
This gigantic manufacturer is built in 2015, and it is really a painful endeavor. The investment needed is more than 1.5 billion. Not to mention 50 million tax for the factory building. Even Tesla in 2021 – the profitable one – could not bear it.
This is when Tesla’s connection with political power comes into play.
Nevada, the first location of the Gigafactory, provides support.
A total of 1.25 billion incentives are given in the form of sales tax-free for 20 years, free property tax for 10 years, and 195 million in transferable tax credits which gives Tesla the agility to sell for cash.
This support and unfair advantage (compared with the conventional carmaker) is not the first time for Tesla. Since its infant state, the EV maker enjoys some privileges. Before Tesla could reach some economies of scale (making 200,000 units), the federal government help it by providing a federal tax credit of $7,500.
The reason is obviously simple, the conventional carmaker is now seen as an evil side that pollutes the world and makes the earth warmer and warmer while the EV maker – represented by Tesla – is the hero that saves the earth.
According to The L.A. Times, Tesla with Space Exploration Technologies Corp. (SpaceX) has tapped approximately $4.9 billion in government subsidies.
The problem with the incumbent:
When assets become liabilities. Again.
Now you ask, don’t the ICE maker counterpart like GM has the same advantage due to its US “nationality”? Not that easy.
As we have said earlier, the auto industry especially the conventional one is extremely complex. Carmaker usually outsources the component to a third party. They have a long contract to secure the supply of the component. Switching from all-out ICE manufacturing to EV manufacturing means eliminating all the suppliers since the structure of EV and ICE is extremely different. This means the ICE needs to violate the contract which is not feasible.
Not to mention that the conventional need to find new components for its all-new EV which is not abundant as an engine car. Also, the supplier will always prioritize Tesla due to Tesla’s scale.
The complexity becomes more severe due to conventional carmakers greatly depending on ICE sales contribution. Making unprofitable EVs and sacrificing the ICE is suicidal from their perspective.
Investor Note: Moving The Titanic
To put it simply, the legacy carmaker has been headed in the right direction for so long. But now the direction is wrong. Tesla, since its birth, is heading to this. You know, moving the steering board of a large ship like Titanic is never easy.
Final words: Undisputed Champion
The disadvantage of switching cost
To recap, Tesla’s most powerful competitive advantage is its vertical integration along with government support that brings the Gigafactory as a result. The Gigafactory itself strengthens Tesla’s moat in the form of economies of scale. And once again we see how genius is Elon Musk, the brand power he builds brings Federal support. He was treated like an American hero. In the past we had Edison, We have Bill Gates, we have Steve Jobs, and now we have Elon Musk, the poster child of innovation.
America needs to be a leader in every aspect. In smartphones, we have Apple, in e-commerce, we have Amazon, in chips we have Nvidia – Qualcomm – Intel. In EV, tesla is the best choice. Bring back better, says Biden, Makes America great again, said Trump.
Tesla s there. Its position can’t be replaced by another carmaker.
Moreover, the competitive advantage of Tesla is also contributed to the situation faced by conventional carmakers. The industry is heavily interconnected with suppliers, making the company’s strategic move become difficult. Both technically as well and economically.
Also, they are trapped within the stigma that they are the ICE car. It is customer perception that is extremely difficult to change.