Teslas High End Disruption Gamble

Author

Jeff Dyer, Contributor and Nathan Furr, Contributor

August 21, 2015

By Jeff Dyer, David Bryce

For adherents of classic disruptive innovation theory, Tesla’s potential as a market disruptor is minimal. After all, the company doesn’t go after low-end, price-sensitive customers who are over-served by current vehicles; they don’t pursue “non-consumption” (customers who don’t currently drive cars); and the technology didn’t start out as inferior (Tesla now produces the fastest 0-60 mph time of any four-door production automobile on the planet (2.7 seconds in “ludicrous” mode).  Tesla automobiles look and drive much like other cars, utilize established infrastructure like roads, and confine much of the product innovation to only one aspect – the power system.  These facts simply do not fit the required mold for successful disruption as originally described by disruption guru Clayton Christensen.  Indeed, a recent article in Harvard Business Review titled: “Tesla is not as disruptive as you might think” was largely informed with analysis by Tom Bartman, Christensen’s research associate assigned to analyze whether Tesla will be a disruptor.    “It’s [Tesla] a classic sustaining innovation,” says Bartman. “Disruptive theory is all about the disrupter being better suited for people who use it early on and then improving over time.”[i]

But Tesla’s strategy does not follow the common disruptive mold because it doesn’t have to.  Instead, Elon Musk pursues what we call a “high-end” disruption strategy, an approach that can be just as troublesome for incumbents. High-end disruption is about producing innovations that are “leap frog” in nature making them difficult for incumbents to rapidly imitate.  Then, instead of using technology to improve performance over time, they use technology to lower costs per unit of performance over time.    Our 5 years of research on the phenomenon indicates that Tesla could become a textbook case (for more information about our research visit learn.innovatorsdna.com).[ii]  In stark contrast to the low-end variety, high-end disruptive innovations outperform existing products on key performance dimensions at introduction; they sell for a premium price rather than a discount; and they target incumbent’s most profitable customers, often going after the most discriminating and least price-sensitive buyers before spreading to mainstream markets.  History provides sharp examples: Apple’s iPod outplays the Sony Walkman; Starbucks’ high end coffee drinks and atmosphere drowns out local coffee shops; flash drives zoom past zip drives and floppy disks; Garmin’s GPS golf watches have taken much of the business from range finders; and Dyson’s vacuum cleaners have dropped prices from $3000 to $300 and continue to grow market share.  The incumbents didn’t react fast enough and the high-end disruptors successfully invaded their markets.  The big question facing incumbent automakers protecting over $1 trillion in sales: Will Tesla’s strategy work? It appears to be playing out well so far, as evidenced by Tesla’s recent debut at the number one spot on our Most Innovative Companies List this year and discussed in more depth in the article Decoding Tesla’s Secret Formula.

Let’s examine the question considering the conditions that favor high end disruptors.  First, high end disruptors are more likely to succeed when their offering is based on processes, technologies, or a business model that are difficult for incumbents to imitate.  For example, when Apple launched iPod into mainstream markets, Sony and Panasonic were the world leaders in portable music players. iPod was an architectural innovation—a new combination of software and computer hardware—that was familiar to computer firms but not to makers of traditional music players.  Panasonic had little experience with those technologies and never entered; Sony took almost five years to imitate iPod but could never imitate the full business model with iTunes.  In the case of Tesla, at first glance incumbent imitation of the battery technology that powers a Tesla shouldn’t be difficult, especially considering the fact that Musk has offered to open Tesla’s patents to competitors.  But even with access to the patents, incumbents will find imitation difficult because Tesla’s cars also represent an architectural innovation.   If you peeled the skin off a Tesla and compared it to a comparable combustion engine vehicle or electric vehicle like the Nissan Leaf, you would see that the car’s architecture is completely different because the systems and drive train are engineered from the ground up around the battery.  In stark contrast, other automakers simply insert the battery as a module into a standard platform (See Figure 1 comparing the Tesla S and the Nissan Leaf).  Moreover, some of the car’s subsystems, like traction control, are based on completely different technologies than a standard car.

Moreover, Tesla has improved the performance of the lithium ion batteries by developing its own techniques for linking the battery cells together and cooling them.  The battery cells have been designed to vent heat in a very particular way, and there’s coolant running through the entire battery pack.[i]  While Tesla may share its patents, it’s unlikely it will share its trade secrets with regard to battery technology.  Indeed, battery packs are assembled at the Tesla factory in an area hidden from visitors.

In addition, Teslas are manufactured differently in highly vertically integrated and automated plants with extensive use of ten-foot-tall red robots, reminiscent of Transformers.  While typical auto factory robots perform only one function, Tesla’s robots perform up to four tasks on multiple models: welding, riveting, bonding, and installing a component.  “From the manufacturing standpoint, the way we assemble this car is essentially different from any other car,” says Gilbert Passin who is VP of Manufacturing at Tesla and a 23 year industry veteran.[ii]  Finally, incumbents in catch-up mode may have difficulty imitating elements of Tesla’s business model including their network of supercharging stations that only work with a Tesla and their “no dealer” distribution method (incumbents are locked into dealer agreements). Advantage Tesla.

Second, high end disruptors are more likely to succeed if they can gain a significant share of the market before incumbents are able to offer a “me too” product (our research suggests at least 5 percent).  Share is critical as high end disruptors move down market because it provides the new entrant the volume necessary to mitigate the scale and cost advantages of incumbents.  Nobel prize-winning scientist Godfrey Hounsfield, developer of the first CT scanner, learned this the hard way when he launched his innovative scanner to the healthcare market.  GE responded by putting its significant R&D resources into developing a comparable product and successfully launched a CT scanner within 2 years, well before Hounsfield’s company, EMI, had generated significant volume.  It then leveraged its 300 person healthcare salesforce (compared to EMI’s five person salesforce) and 1200 person customer service organization to become the market leader.  Tesla is not even close to five percent share in key mass market segments and incumbents have not yet released pure electric, Tesla-like vehicles that compete head to head going 275 miles on a charge.  To get close to 5 percent share of the U.S. market Tesla will have to get to Musk’s goal of 500,000 vehicles per year.   That means Tesla’s model 3, a $35,000 sedan scheduled to launch in 2018, will have to be a massive hit.   But if it is anything like the Tesla Model S—which was Motor Trend’s only unanimous choice for car of the year and the highest rated car in Consumer Reports history—then Tesla has a real chance.   Time will tell, but Tesla’s Model 3 may get it to 500,000 vehicles before getting serious electric-vehicle competition from incumbents.   No advantage to either incumbents or Tesla here yet.

Third, to get customers to adopt a high end innovation, the new entrant must quickly build or access the assets required for widespread commercialization and adoption (via acquisition or alliance), and they must do so before incumbents catch on.  The CT scanner case demonstrated the importance of quickly building key commercialization assets.  These commercialization assets include plants and manufacturing know-how, distribution assets, trained sales forces, marketing know-how, and service networks. The entrant’s speed hinges in part on whether the required assets are specialized.  If so, they are more difficult to access and take much longer to build. Many of the assets required by Tesla are specialized to electric cars, including super-charging stations.  This should slow Tesla down in a big way, giving a huge advantage to incumbents.

But even in this area Tesla does not appear to be disadvantaged.  The reason is that Tesla has a secret weapon: Elon Musk.  Because of Musk, Tesla has been able to access the massive financial resources needed to assemble all of the assets—even specialized ones—required for commercialization.   Tesla has already built over 450 supercharging stations and the number is growing rapidly.  The central console in the car is a computer with constantly updated navigation to you nearest charging station.  Moreover, Musk has already raised the $5 billion required to build Tesla’s new battery Gigafactory, due to come online in 2017, which will bring the cost of the battery (the most expensive component in the car) down by 30 percent.

This brings us to the final factor influencing the success of a high end disruptor: rapid improvements in technology combined with increases in scale that steadily and significantly lower the cost per unit of performance.   When two of Tesla’s founders, Mark Eberhard and Marc Tarpenning decided to start a car company, they chose lithium ion batteries as the energy source for a very specific reason.  “One of the things we kept running across was these articles that would say the reason why electric cars will never succeed is that battery technology has not improved in a hundred years,” Tarpenning said. “Literally, articles would say that, and it’s true of lead acid batteries.”   Yet it’s not true of lithium-ion batteries.   “They get better, on average, at around 7% a year,” says Tarpenning. “It goes in fits and starts as they roll out new chemistries … They get cheaper and better.”[iii]    So while the crucial role of technology in low end disruption is to improve product performance, the crucial role of technology with high end disruption is to lower the cost of already existing high performance.  If Tesla can continue to bring down the cost of electric cars at a faster rate than combustion engines improve then Tesla’s chance of disruptive success goes way up.

Whether Tesla can successfully move down to mainstream markets and generate high volumes is still uncertain.  However, to see a new entrant compete against incumbents in a well-guarded industry mostly on their terms is to witness a modern marvel.  It is as unusual as it is remarkable. Yet Elon Musk, by his force of will and ability to command large investments has so far been able to move forward fast enough that incumbents have not yet effectively responded to his offering.   But if we had to bet, our money is on Tesla.  Customers are clamoring for its cars and up to this point incumbents seem unable or unwilling to match the offering.   It very well may be that they don’t want to do anything to validate Tesla’s business model because they are worried that it will lead to their own disruption.  However, as Tesla builds scale, offers new cheaper models, and makes charging more convenient with its stations, the company should be able to follow the path of other successful high-end disruptors. Musk has said all along that his strategy was to break in to the industry with super-luxury vehicles, then move down-market.   He’s told competitors his strategy…now we’ll see if they can respond.

Of course, Tesla could end up just being a successful niche player—offering battery powered vehicles with superior performance and styling that don’t force real change upon Toyota, GM, and Ford.  But if Tesla can move down market with an offering and business model that has broad appeal and continues to resist effective imitation—then Toyota, GM, and Ford really can’t continue to do business as usual.  And they will be in Tesla’s rear view mirror.  And ultimately, that’s the definition of disruption.

Jeff Dyer is Horace Beesley Professor of Strategy at BYU and co-author of The Innovator’s DNA and The Innovator’s Method.  David Bryce, professor of Strategy, at Brigham Young University

[i] Vance, Ashlee. 2015.    “Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic Future.”  New York, NY: HarperCollins Publishers.

[ii] http://seekingalpha.com/article/2604485-teslas-highly-scalable-model

[iii] http://www.businessinsider.com/tesla-the-origin-story-2014-10

[iv] Tesla’s Not as Disruptive as You Might Think.  Harvard Business Review, May issue 2015. https://hbr.org/2015/05/teslas-not-as-disruptive-as-you-might-think

[v] See  Bryce, David J. and Jeffrey H. Dyer.   “High End Disruption.”  Working Paper, October 10, 2014.

This article was written by Nathan Furr and Jeff Dyer from Forbes and was legally licensed through the NewsCred publisher network.


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