Adding on to Shai Agassi’s first three articles on how a major auto manufacturer could learn from Tesla (and Apple) to really disrupt the gasmobile market with electric cars, here’s his fourth and final article in the series (a real grand finale). Definitely worth a read. If you missed the first three articles, they are here: one, two, three.
by Shai Agassi
In the previous three parts of this series we have looked at the lessons the auto industry can learn from Tesla. I identified four key takeaways all carmakers should use as the foundation for their electric vehicle plans. The lessons all add up to the following principle:
Design a desirable Electric car that is upgradable over the years. Separate between car ownership and the battery, since batteries continue to improve exponentially. Finally, don’t force this new category of product through a mixed channel selling both ICE cars and EVs.
The recommendation to mass volume carmakers, those making more than 1 million cars per year, was not to try and beat Tesla in the category it created and dominates – Luxury electric cars. Tesla predicts it will make 21,000 cars this year – Nothing in the scale these massive carmakers operate enables to make any meaningful profit when they make a model at such low volume.
Instead, my recommendation was to make a desirable electric crossover, with space and power, then equip it with enough of a battery to get great range – say 150 to 200 miles. Most crucially of all – do not sell that battery. Instead, partner with an operator that owns the batteries, the one you buy with the car, the ones available on the road, and the ones drivers will use over the life of the car. The operator will package batteries together with electricity and offer those as “electric-miles” offered for a fixed monthly fee. For the sake of argument, let’s make that monthly fee equal to the cost of a weekly stop at the gas station today – roughly $300 a month.
Picture a great car serviced through an energy model that allows you to drive it unlimited miles but pay a flat monthly fee as you do so. #Like
The last remaining question was the price point that will make this electric crossover so disruptive as to drive demand through the roof. We pegged “infinite demand” at the imaginary market size of 1M cars worldwide. Mind you, that is only 1% of cars sold each year.
The final claim of Part III was:
If the market leader priced such a car starting at $9,999 after all incentives, without the cost of the battery (remember there is an operator that owns that battery) – a new category will be born, with demand far surpassing any imagination.
The metaphor I used was the iPad. At launch the first iPad was priced at $499, far below the price point for a powerful laptop. Compare that with Windows’ TabletPCs that asked for a premium above the price of a laptop, due to the “Tablet features”, such as touch. The result – TabletPC was always considered a niche segment where meaningless numbers were sold over the first 5-10 years in the market. Apple’s genius pricing of its first iPad at sub $500, combined with the fact that it was “an object of desire” disrupted the laptop market and shifted non-buyers (people who didn’t consider the need for a tablet before) into “Tablet devices”.
The product-price combination created a whole new category that did not exist before iPads – a blue ocean. It was a desirable product at the price of a “cheap weak laptop” (just as the Netbook category was losing appeal). Despite the official starting price point of $499, consumers ended up paying more for iPad options, such as additional memory and 3G capabilities. They also bought 3 party add-ons and apps that created a thriving industry around the new iPad.
Two questions were raised immediately from readers:
- Can anyone make a desirable EV, and offer it at this magical price point of sub-$10K, while making profit?
- When does magic happen? Do we have to set the target price so low? What will happen at $14,999 or even $19,999? In other words, what are the price points where significant market segments shift their interest (and allocated personal budgets) from ICE cars towards an electric car?
So, after this long introduction, lets examine both points in more detail.
$9,999 – Fact or Fiction?
Let’s make a few assumptions that one can validate rather easily:
- An electric drivetrain and its supporting parts (power electronics, charger, inverter, but without the battery) will cost the same as a basic gasoline drivetrain with its supporting parts (including gear, pumps and hundreds of parts) – given the right volume (say, greater than 100K cars of the same model). Even better, the electric components keep getting cheaper, faster than any mechanical parts do.
- Once you need to alter the gasoline drivetrain to get better efficiency and lower emissions (e.g. to support CAFÉ), such a gasoline drivetrain gets more expensive than the electric components. Everyone in the industry is quoting different costs, so let’s accept that “efficiency cost differential” is in the range of an additional $5,000 due to high cost of hybridization.
- The electric drivetrain provides at least 50% more power for that same cost (called torque, or “oomph” for laymen). Reason is simple, electric motors provide their power immediately, while gasoline engines need to “rev up” to get to max power.
- The rest of the car: seats, metal, glass and the origami that makes them into a car, cost the same regardless of the drive train.
- The current baseline gasoline crossover (e.g. Nissan Juke or Honda CR-V) cost about $15,000 to make. That cost includes all allocations, before sales and marketing costs.
- That price point may differ between carmakers, mostly depending what options are included in the baseline version vs. sold as optional “add-ons”.
Infrastructure costs, whether charging or battery swapping, are actually accounted for by the operator, not the carmakers. Hence they do not add up any cost to the car’s BOM. That is not the case with range extenders or other hybrid approaches that add significant cost to the car in order to “avoid infrastructure needs”. Current attempts are to make EVs rely on the same infrastructure that drives ICE cars – gas stations and the oil industry’s infrastructure to drive today. Nothing is harder to change than a century old fixation.
Put it all together, and imagine our target car for the CAFÉ era: A zero emission electric crossover, which should cost $5,000 less to make than its comparable ICE version. Batteries and Infrastructure owned by the electric mile operator, offered at lower operating cost than gasoline. The factory gate price for that mass-produced EV of $14,000 (without battery) may be aggressive, but most carmakers will tell you that they can hit that price point depending on what goes into the car and what they leave as optional. Leather seats, and sport accessories will cost more, but remember that you do get that 50% power boost for free – simply by going electric.
This is where the automotive-industry game of “cost allocations” gets complicated. A car program, in particular a new car platform, needs to recover the “program costs” invested in making the model. That requires the financial department allocating internal costs based on association with specific car models. In some cases, these allocations go back to past research programs. The opposite extreme is to only account for modifications made to an existing car platform in the process of making its electric version. As a result, such “program allocations” can range anywhere between $100M to $1B per model. Divide the program cost, by the expected volume and you get an additional cost item that is added to ever car from the first one onwards. Beat the volume projection and you get extra margin, miss them…well, we have seen what happened when demand went down across the entire industry.
So the real art of such allocation is the internal assessment of whether the specific model will sell 10K, 100K or 1M cars over its life. The Leaf and Volt are both reaching 100K cars over lifetime. Tesla’s Model-S and its SUV sibling, the Model-X, will most likely reach and cross the 100K threshold. Most other EV programs are struggling to even reach the 10K lifetime sales goal.
At $100M program cost, a carmaker needs to allocate $10,000 per car if they believe volumes will only reach 10K. That kind of cost allocation would double the cost of making the car – making our target price impossible to attain, and the car less desirable (that’s part of the chicken and egg problem). On the other hand, if the carmaker believes that the model will sell 100K cars, that same program allocation is now reduced to $1,000 per car. Such program cost is material but does not change the overall target price – $15,000 plus or minus $1,000 is still in the same cost range as before. Finally, a blockbuster model that can reach 1M cars over its lifetime get a miniscule program cost allocation of $100 per car – practically nothing.
Based on the government loan Tesla applied for from the US Government, the Model-S had a declared program cost of roughly $500M. That amount was used to design, develop and tool a factory for the kind of volume the company is shipping right now. Tons of innovation had been included in that development cost, and the US government was gracious enough to provide that cost as a loan – which Tesla repaid earlier than originally mandated. Every one of the Big-3 carmakers has access to the same loan program, and if they would commit to deliver a sub $10K electric crossover, I am sure the DOE will jump on the opportunity to finance such a program.
Getting to $9,999 – Operator cross-subsidy
So, how do I get from a crossover that costs $15,000 out of factory to a $9,999 asking price? The answer is simple – The government is currently offering a $7,500 incentive to any EV buyer. The original intent was to help early adopters who would otherwise be deterred by costs – and let’s be honest, these are not really Tesla’s owners’ crowd. If, on the other hand, our new target segment is the $10,000 car buyer – a government incentive of $7,500 per car makes a world of difference for them.
This electric crossover we discussed (less the current government incentive) would cost $7,500 out of the factory. If a carmaker offers it to the public at $9,999 they should not need lots of sales and marketing efforts to push sales. Especially if early adopters knew that sooner or later the cost of said cars would push up, once the government reduced the incentive programs. It does require that carmakers do not take any part of the incentive into their own pockets. The essence of this pricing scheme is to pick a strategy of high volume over short-term margins.
What happens when incentives start to shrink? Let’s assume an incentive scheme the scales back from today’s $7,500 down to $5,000, then $2,500 and finally completely eliminated. How do we keep the price of the cars at that sub-$10K disruptive price? That’s where our energy-operator concept comes to the aid of carmakers. Let me explain how:
- We have already established (in part II) the fact that battery costs will continue their current price decrease of 8% year over year, while their life expectancy continues to improve.
- The original cost of the battery pack, the one the operator buys in 2015, is roughly $10,000.
- Let’s assume the government will reduce its incentive level by $2,500 every 4 years (election cycles tend to have an amazing effect on congress allocations).
- Compounding four years of 8% cost reduction, ends up reducing battery pack costs by an average of $2,500 over every 4-year period, more in early years, less over time.
- The operators, once they were able to recover their infrastructure costs, will pass through the $2,500 savings on the battery pack over to the carmakers – in order to continue driving the consumer price down and volumes high.
That is the beauty of the symbiotic carmaker & operator model. Operators are required in order to make EVs seem cheap to buy and simple to operate. Since the operator has to invest up front capital to get the network going across a region, they rely on continuous supply of high car volumes in order to monetize their network investment. From the moment the two parties are in the market, both share an interest in driving high volumes.
As you try to envision the relationship between carmaker and operator, think about how Apple and AT&T collaborated. They both wanted to drive higher usage for their combination of smart-phone & data network. One would not have much use without the other. The Apple iPhone would not sell that well without AT&T’s subsidy, in a market that was used to cheap and even free baseline products from the likes of Nokia.
Then, after a few years of interlocked symbiotic relationship, both Apple and AT&T opened up to alternative offerings, and the subsidies were reduced or eliminated in certain markets. But it was the close relationship and cross subsidy that allowed both of them secure and recover the early investments required for market entry.
This model allows the carmaker to focus on making and selling cars, at a cheaper cost:
- It allows the carmakers not to pass the entire cost structure, in particular the expensive battery, to the driver – such high costs deter buyers.
- It allows the operator to focus on infrastructure and service, providing a financial model that monetizes infrastructure and batteries over a much longer period of time.
- Each party remains within their corporate-DNA, accelerating innovation and adoption. Both parties have a cost and revenue structure that fits their P&L, capital return metrics, and investor expectations.
Customers who were in the market for a new $20,000+ ICE car, but opt for an electric crossover offered at $9,999, find themselves with a lot of “spare budget”.Such buyers will end up buying more optional after-sales items than people who bought a $20,000 car today. Carmakers make higher margin on these “dealership options” than they do on the cars themselves. That’s what dealerships live from – with a hefty contribution from the service and parts department thrown in of course.
So, Imagine the equivalent experience to what you see at an Apple-Store. People who queue for the $9,999 EV, and sales people with portable configurators helping them add options onto the car. Take it a step further, imagine people doing the configuration on their iPads, and simply shipping the configuration to their closest “delivery store”. That is what a successful dealership will look like.
What’s the magic with “starting at $9,999” – why not more?
Unlike other consumer electronic devices, which have become effectively throwaway products, very few people would buy a car if they assumed the car would be worthless 3 to 5 years later in the used car market. In effect, we leverage the car’s projected residual value as a critical element in our purchase decision. Future residual value is most visible in leasing and financing contracts. When financing a new car, we pay only for the “lost usage value” and cost of capital, not the entire cost of that new car.
Buying the average ICE car today includes an assessed residual value loss of about 50% over its first 4 years on the road. For the average family car, that value differential is almost than $15,000, since the average US car sold in 2012 cost $30,750. An electric crossover offered at a price point between $9,999 and $14,999 inevitably loses less value than an ICE car that is expected to lose $15,000 over its first four years. That statement is true even if the EV market actually falls flat for whatever reason during that time period . Such ‘peace of mind’ eliminates one of the biggest risks for new buyers – unknown residual value – and assists in creating a competitive financing package for EVs. #noFear
How about a new EV for the price of used ICE?
This sub-$10K price point has a much greater effect on a class of non-buyers: People who would love to buy a new car – but simply can’t afford one. Reality is that most used car buyers would love to buy that same car new, they just can’t afford to lose so much value over their ownership period. So, the car market for used cars is full of potential EV buyers – If only they could afford a new EV. These guys are considered non-buyers, simply because carmakers don’t see them in the market for a NEW car.
Try and offer a brand new electric crossover at $9,999 and a massive segment of the market will tip from buying used ICE car to buying new EVs; not because they are electric, just because they are affordable and new. In fact, these buyers are in a very different market segment than any targeted by carmakers with EVs these days. No one even surveys these EV non-buyers if they would like to buy a cheaper EV. The surveys (and the consumers) simply assume no such option will exist. These are the same surveys that missed the iPad wave because they didn’t ask cheap NetBook buyers if they want to get a “bigger touch screen tablet that wouldn’t run windows but was really cool looking for $499”. When consumers saw the iPad, they immediately knew that they wanted one. Now.
The second hand buyer market is very interesting for a multitude of reasons:
- Used car buyers do not expect to buy a car at a dealership. As a matter of fact, they buy used cars on the web, at eBay and other used car sites. Cost of sales: close to nothing.
- Used car buyers do not expect to get zero cost 3-year warranty. Offer them such a warranty and they would pay another $500-$1,000 for it. Much like they would do with a new appliance at BestBuy or AppleCare. Margin to carmaker: very high.
- Used car buyers do not compare EV’s operational costs to the latest mpg figures of new models, they compare costs with the reality of what the market had to offer 5 years ago. Not only that, used cars operate at lower efficiency and higher costs than they did when they were brand new. Saving for customer: significant and recurring.
- Used car buyers do not expect desirability, cool and configurations when they purchase a used car. They end up buying the closest approximation to the car they wanted that is available. New car smell: priceless…
The distribution channel that opens up when these customers are willing to pick up a car through the likes of eBay is huge. eBay changes drastically the economics of car distribution. Enable eBay as a channel for new desirable competitively priced EVs, and you open up a massive distribution channel. But on eBay, competition is used cars, and the price needs to compete with $10,000 not with $19,999. That channel will not materialize at all with a $19,999 price tag.
Any price point between $9,999 and $14,999 is probably going to create a lot of excitement. So we are trying to solve an equation with two unknowns: What is the highest price point that generates more than enough demand. If we look at the used car buyer segment, we can check on the Kelley Blue Book to understand more viscerally the difference between $15,000 and $10,000 car buyers: used cars offered at $15,000 are 3 year old sedans or 4-5 year old SUVs; take the price down to $10,000 and you compare against cars that are 6-10 years on the road.
The average car driving on the US road is now more than 8 years of age. In other words, 150M people are driving used cars that are worth $10,000 or more right now. This price point will effectively provide an option to every one of these drivers – switch your used car for a brand new EV and get some money back. Throw in a fixed monthly fee contract (equal to what they pay for gasoline today) that allows them to drive any distance they want at no extra and see their reaction.
So let’s change the question which has been on every EV survey the industry is quoting from “Would you pay more to drive an electric car?” to –
“Would you prefer an 8-year-old used gasoline car or a brand new electric crossover, if they were offered at the same price?”
and see what answer you will get from people who don’t have the ability to pay more than $20,000 for their car. The demand is there for electric cars; just price the car right for the segment.
The right answer is not a single number – rather a range of models. The baseline model should start at $9,999, with other models coming on top in various shapes and trims. There is room for 3 or 4 levels going up from that baseline probably all the way up to $18,999. Much like iPads are priced from $499 to $849 and find a market segment for each one. Regardless of the price point, all the cars need to be extremely desirable, and offer great value for that money. Every driver should become a force multiplier as a roaming sales force.
The magic feedback loop
When a car can be distributed electronically, the strategic planners in charge of pricing can cut downstream distribution costs out of their sticker price. To do so, the car itself needs to be so desirable it effectively generates demand on its own – since an on-line channel does not generate demand it only fulfills it. Customers need to be so thrilled that they become sales multipliers – they are the effective sales force that demonstrates the product on the road, and make their friends want one too.
As long as demand for the car is strong, a low cost (on-line) channel allows carmakers to keep the price at such low level. Keeping the price point so low on a desirable car ensures that demand outpaces supply – which generates great residual value, and financing packages faster. Such a product is also best suited for consumers to pick online – remember how Amazon is your preferred site for products that Toys-R-Us keep missing during Christmas time.
The Store morphs into an experience and service center. It is a place where interested prospects feel safe to ask questions and it becomes the physical meeting place for your local community. It is not the location where high-cost sales people pressure you into buying a car that doesn’t fit your life style. Can you imagine a car dealership experience at an Apple Store? How funny would it be to haggle over price with one of those 22 year old blue-shirt-wearing-Apple-salespeople?
Looking at the fundamental lessons we have started with:
- If the car is not desirable, even $9,999 price tag will not create disruptive demand in the millions of cars
- If the car will not be upgradable, consumers will always wait for “the next and better version” even if the price is right.
- If batteries are not offered separately from the car, the price point moves up by $10K-$15K, making the same car carry a price tag of $25K. Such a product will not be sold online, it needs a dealer experience, and it does not serve the used car non-buyers.
- Adding dealers and marketing adds roughly $5K-$7K to keep everyone paid.
Add it all up and you get a slightly improved Nissan Leaf. We tried that experiment – it did not end up with 1M cars sold.
Putting it all together, the price point is essential. Most of this plan may work at some higher price, but will probably not be as disruptive. In any case, carmakers can control how much margin is left for them at this price point by shifting parts of the offering into the baseline package or choosing to leave them out and price them as optional items sold at an additional cost.
The first volume carmaker that will hit this magic price will really set the bar for the entire car industry. Fast followers, hanging around to see the market materialize first may find out that they are indeed chasing a very rapid car, which is not easy to catch up anymore.
Let me know what you think…