Friday, March 21, 2014

Why Tesla Motors can't (and won't) sell its cars through franchise dealerships

California icon Tesla Motors began selling cars in 2008 with the release of the revolutionary Tesla Roadster. It was the first fully electric car that didn't have to make apologies for its performance. The Roadster's zero-to-sixty time, as quick as 3.7 seconds, put it head-to-head with the fastest cars made by Ferrari and Porsche, and it was faster than any other car made in America. What's more, the Roadster has a range of 240 miles—triple the range of any previous electric car.

What prompted the creation of the Roadster—and the birth of Tesla Motors—was the realization that lithium ion batteries had finally reached a level of energy density that could make an electric sports car a practical reality. The batteries were light enough and powerful enough to offer the kind of performance found in high performance gasoline cars, while also providing a useable driving range of over 200 miles. A similar inflection point occurred at Apple when Mitsubishi began producing a hard drive the size of a quarter. Mitsubishi's engineers had no specific application in mind when they designed the tiny hard drive, but when Apple's engineers saw it they immediately realized it was the missing piece to a new product—and the iPod was born.

While the Tesla Roadster's performance is spectacular, something else kept the car from becoming a mass market success: the lithium cells were expensive, and the Roadster's battery pack contains 6,831 of them. These lithium cells are similar to the type used in laptop computers and rechargeable power tools. In one sense, Tesla made a brilliant decision by designing their battery pack around a common lithium cell, but it also resulted in a car with a very high manufacturing cost. If you took that cost and factored in an industry standard 15% profit margin for Tesla, plus a 20% profit for a third-party dealership, the Roadster's base price would have been in the neighborhood of $130,000. Even with its great performance, the Roadster would have been a tough sell at that price.

More importantly, however, Tesla believed that third party dealerships wouldn't be the best advocates for electric cars, especially if they sold gasoline powered cars out of the same dealership. By promoting electric cars, they'd be undermining their existing business. Furthermore, electric cars require a fraction of the routine service required for a gasoline car, and service is where car dealerships generate most of their profit. Where would the incentive be for a dealership to get behind this new technology?

So Tesla set up its own showrooms and began selling cars directly to the public. By eliminating the middleman, they were able to offer the Roadster at a somewhat more realistic $109,000. Between 2008 and 2012, Tesla sold about 2,600 of them. Car dealers and dealer associations barely took notice.

Then Tesla released the extraordinary Model S sedan in 2012. Right away, this car began winning practically every car award on the planet. Consumer Reports called it the best car they'd ever tested. Motor Trend Magazine named it their 2013 Car of the Year. Sales climbed from about 2,000 at the end of 2012, to 25,000 at the end of 2013. Through manufacturing efficiencies, Tesla was able to get the base price down to $70,000. And after a federal income tax credit for electric cars, consumers paid only $62,400. The auto industry began to wake up.

Drawing from its experience with the Roadster, Tesla pushed ahead with its revolutionary sales & service model. Tesla took a cue from Apple and redefined the automobile showroom by placing them in upscale shopping malls. The highly trained sales staff is there to educate, not to sell. There are no sales incentives or commissions, and every customer pays the same price.

Bottom line: the consumer pays Tesla roughly the same amount as they would for an equivalent gasoline car, but gets a lot more car for the money.

Think of it this way: when you buy a Tesla, you are essentially making a down payment on 10 years of fuel—in the form of the car's battery. Of course you'll also be paying for electricity to charge the battery, but that electricity will be costing you only 20 to 25% of what you'd otherwise be paying for gasoline. The EPA estimates that I'll save $9,100 in fuel cost during 5 years of driving in my Model S, when compared to a similar gasoline powered car. Now imagine if every Audi A8 or Mercedes S Class came with a gas card worth $9,000. A Tesla simply has more intrinsic value built into it.

Tesla plans to build a massive new battery factory that will help bring battery costs down further, enabling them to offer a $35,000 car with a 200 mile range. But their cars will continue to be expensive to manufacture relative to their gasoline powered cousins. Selling directly to the consumer allows Tesla to offer its cars at realistic prices while also providing added value.