Shai Agassi — Lessons From Tesla, Part II

Following up on Shai Agassi’s first post about lessons major auto companies should be taking from Tesla, here’s Part II in his 3-part series on this topic. Well worth a read, imho:

By Shai Agassi

Earlier this week, in Part I of this series, I talked about the fact that the automakers are assuming that the best way to battle Tesla — which is turning out to be a disruptive threat — is by making their own better “Teslas.” Think “threat” is too strong? This a company selling cars people love, at a price that works. The Model-S received the highest score in history for a car from Consumer Reports and added to that a safety record that was just declared to be unprecedented. You could say the company is firing on all cylinders, but, well…

As tempting as it may be to copy Elon Musk, the high-volume car makers should be trying to figure out why Elon Musk is placing the bets he is. What are his assumptions and how to ride them?

I also gave four key takeaways:

1. An electric car is an object of desire
2. An electric car is a modern appliance
3. An electric car is Moore’s Law on wheels
4. An electric car drives — and sells — differently

How do you add up all these lessons? There is no doubt that current volume carmakers, whether the Detroit Big 3 or their global peers in Tokyo and Europe, can all make an “insanely great” electric car. Some of them have done so in the past and the all have every part of the DNA required to make high-volume desirable cars. The key words here are “high volume” – as in millions. All the industry needs to do in order to produce such a car is to think of it like – well, just like a car, not some off-beat experimental vehicle.

Don’t give up on desire due to technical constraints. Challenge the designers to build greatness; ask them to build a better car than any they have ever designed. Allow the thought that an electric car gives you tremendous performance without the cost required to build such performance into combustion engines. Performance sells cars. Design from the battery pack up. In fact, Tesla started by putting wheels on the battery pack and creating a skateboard. The car came after that. Don’t forget to design future upgradability of the key components from the get-go.

But the key here is to design this car to be high volume, from the first moment – use the established parts catalog, borrow as many components from other lines, but don’t lock yourself into an established chassis if it doesn’t fit your battery design. You will be paying more than your savings to live within the constraint of the wrong chassis.

Finally, remember to target a base model at a disruptive price, and add tons of optional add-ons. People who buy a cheaper product than they originally thought possible, have more budget left for accessories.

As you plan, think of the EV battery as a consumable – more like gasoline than the gas tank. Write in big letters on the designers’ walls: The Battery Is Not Part Of The Car’s Costs. Make sure they don’t skimp on the battery to save costs – doing so is counter-productive to both making the EV desired by mainstream consumer and to saving cost. When the designers accept that the battery is an upgradable consumable, the business people will start treating it as an operating cost and not part of the car’s costs.

Let’s understand the cost of the battery “as a consumable:” Most of the industry already negotiated their 2015 contract for EV battery supply. If you divide the cost of the pack by the expected miles the battery will drive (under warranty), their costs are all in the range of $0.03/mile. By the fourth year this amazing new car will be in the market, the 2019 batch of batteries will reach $0.01/mile cost. If we add electricity costs at an additional $0.03/mile the combined operational cost for driving electric will go from $0.06/mile to $0.04/mile over the rest of the decade.

If the industry can’t find fault with this math, they all understand that the biggest liability in car design today is gasoline and its inherent cost per mile. Gasoline is a critical component of operating a car, but the industry has almost no control over its price. Compare that cost we calculated for an electric mile with the cost of driving a super-efficient gasoline sedan – one with real life average mileage (in contrast to imaginary advertised range) of say 35 to 40 mpg as mandated by CAFE standards. At $0.04/mile an electric vehicle has a cost equivalency of $1-$1.60 per gallon (simply multiply $0.04/mile by CAFE’s 40 mpg target to get that comparable cost ). That cost per gallon at the pump reflects a hypothetical global oil price of $25 per barrel. We are a long way away from that price point.

No automotive executive should assume that oil would revert back to those prices within the next decade. If one takes into account European gasoline taxation, you need a negative price for oil to reach comparable levels. As your target market segment, the Twitter generation, would mark the probability for such an event: #NotGoingToHappen .

The entire industry has to come to terms with a calculation, not an assumption, that even after we add battery depreciation as an operational cost, mile for mile — driving a gasoline car will cost 3-4 times more than driving electric! That math, more than any other argument describes the tidal wave approaching the car industry. When we take the cost of the battery off the price of the car and into operational cost, we have to stop assuming that an electric car is bound to cost more than a gasoline car, and seek people willing to pay more to drive less.

A car with “Batteries Not Included,” can be made for a cost that is roughly at parity with a similarly equipped internal combustion engine car. That is the real apple-to-apple comparison, since no one prices upfront the cost of gasoline for life at the purchase of an ICE car. The industry’s marginal cost for a base crossover should be roughly $14,000 – $16,000 before cost of sales, margin and optional add-ons. But if a carmaker is willing to pass through the current EV incentive from the government to consumers, such an EV can actually be offered at a price point below the magical $9,999. Leather seats not included, but performance and desirability will definitely be built in.

An electric crossover starting at $9,999 will succeed not because it is an EV but because it is a great car at an unparalleled price point. Much like the $499 iPad succeeded not because it was a keyboard less tablet, but because it was an amazing computer at an unbelievable price point. And if you ask Apple, the average iPad customer didn’t pay $500 at the Apple Store – More like $800; the average customer left the store with a nice Apple bag full of $300 optional add-ons generating high margins for Apple.

The iPad also spawned a new economy of creators who used it as a platform for their own businesses — think Rovio’s Angry Bird empire — or as a way to disrupt old businesses, as Square is now doing to the point-of-sales machine.

The same will no doubt hold true with electric cars. I’ll explain how, in the next part of this series.

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