Supply and demand are two sides of the same coin, and although they look different, you cannot separate the two. They are like twins always moving together.
You can’t measure true supply without having excess demand and you can’t measure true demand without excess supply. They influence each other and are actually the same looked at from two different perspectives.
Demand is a mystery you can read about in my article from May 2019, “The Mystery of Tesla Model 3 Demand.” Demand is an idea that only gets real once supply is provided.
What does that mean in the time of the corona crisis, and how could Tesla possibly be better off with demand and supply than the competition, as boldly claimed in my two previous articles and videos?
Isn’t my prediction of Tesla achieving 500,000 units in 2020 despite all odds an overly optimistic point of view, while in reality it should be discussed if Tesla will survive at all? Let’s take a step back and look at what we know today and how the situation may play out in the future.
It’s much easier to justify the claim of a competitive edge for safety and diversification, but since the entire auto industry is locked down, uncertainty and fear about the future is causing demand to fall off a cliff for the auto industry, and how can Tesla possibly be better off? Also, production in Fremont, Sparks, and Buffalo has been down for weeks.
A good way to start on this topic is to assess the latest supply and delivery numbers from Q1 2020 that came in as a surprise for the market. Those numbers give us a good picture why I am convinced Tesla has been better off than the competition in terms of demand and supply, and also give us a glimpse into the present and the future.
Let’s start with the past. When the corona crisis hit the economy in late Q1, it hit the auto industry hard, as a vehicle is a huge investment and many can push it off or cancel it to mitigate risk. That’s what people are trying to do these days — mitigate our health and financial risks. All automakers stopped production, first in China and later in Europe and the US, with disrupted supply chains as well. However, Tesla has advantages not many talk about. One of them is missing the dealership ecosystem as a buffer or finished goods inventory stage.
While automakers usually deliver vehicles to dealers who sell them to customers, Tesla sells vehicles online and delivers them without any dealers, directly to its customers. That structure has been fought against legally and politically by dealer associations in the USA, but it turns out to be a huge net positive in the crisis. It’s been called an Amazon- or Apple-like structure that works for small goods but not for vehicles that people want to touch and sit in first before they buy. That had been my opinion too until the moment I bought my Model 3 online without even scheduling a test drive.
Tesla can take online orders that auto dealerships don’t offer, and can perform touchless test drives as well and touchless deliveries without the risk of any physical contact with humans.
Every salesman knows an unclosed sale is a lost sale that does not come back. Therefore, every order Tesla can collect in these days is one order more than the competition has. This is due to the unique software architecture that in the past has often been seen as only relevant for techies. Now we see some of the broad strengths of the vehicles’ IT infrastructure, the online sales model, and the lack of dealerships.
All incumbent dealerships had to close their stores because of their old-fashioned offline business, while Tesla could continue to deliver vehicles in Q2 and showed delivery numbers that have for most been an unexpected surprise, achieving the best Q1 P&D numbers Tesla ever achieved while all other automakers had unprecedented decreases in Q1. And we can predict it won’t look better in Q2.
It’s even worse. Since dealerships are privately owned businesses, a large wave of business closures and bankruptcies is unfortunately not only expected but quite certain to happen. If dealers go out of business, who is taking orders if there is no online order model?
Some automakers have online order platforms as well, but the usage is rather awkward, with complex product and service bundles that confuse interested buyers rather than convince them. Incumbents are not known for online sales, and consumers are used to talking to a physical person in a store.
Trust is key for any sale, and consumers need time to build trust in an online ordering process. When I placed my online order, it felt strange at first transferring money without having talked to anyone, but it helped a lot to know this is the way everybody does it. With incumbents, everybody places their orders in a dealership, so people are more likely to wait with their orders than trial with an online ordering process.
Even if Tesla doesn’t look bad on the demand end, what about supply? They don’t produce right now in the US, and without manufacturing there will be no delivery and no sale.
Q2 deliveries for Europe have been put on ships, like every quarter in the first part of the quarter, in order to arrive on time to be delivered at the end of the quarter. Enough supply was in transit already before the production halt came into effect on March 23rd, and demand was seemingly not yet negatively impacted either.
For that reason, and because of the touchless delivery system as well as the flexibility to even deliver vehicles directly from trailers to houses of new owners, Tesla has impressively good delivery numbers in Q1.
In terms of demand, there should be no mistake that many will have had second thoughts about whether it is a good idea to buy a car going into a recession and broad economic uncertainty, but that demand decrease would come out of a huge pile of backlog demand and may, given still constrained supply, not even be felt much or at all in most sales regions.
On top of those points, the total cost of ownership an electric vehicle is much lower than for a comparable gas/diesel vehicle. Plus, you can charge it safely and relaxed at home.
But what about production?
While production started again in Q1 in China, with Gigafactory Shanghai having strict protective measures in place, people did receive vehicles at a time when Europe and North American infection peaks were still not visible and there was much fear about what would come. Stronger than expected P&D numbers in China will have helped to overcome production shortages in particular in the US. This may be partly due to successful efforts to localize supply of parts and systems in China based on a strong partnership between Tesla and China.
The company’s high level of vertical integration is another plus helping Tesla to have more control itself over parts needed compared to other automakers, which have to rely more on external suppliers and their ability to produce.
For all of those reasons and more, Q1 was a record first quarter for Tesla in terms of supply as well demand, but let’s assess what that means for both now and the future.
In Q2, all the bad implications of the crisis will hit the auto industry, and with it also Tesla. That is what most believe, but give me the opportunity to explain why I believe Tesla will suffer in Q2 but not anywhere near as much as other automakers will suffer.
First of all, as outlined in my previous article and video about the diversified structure of Tesla in terms of products and services, there are a lot of other products that are not negatively impacted on the demand end, and likely not even on the supply end — for instance, the Tesla battery business. Utilities, communities, and other large energy transmission and supply organizations plan large-scale projects over the course of years and don’t cancel or even postpone them if a crisis like the one we have right now emerges.
If they are in the construction phase, batteries are likely already assigned, and if they are still in the planning process they will still place an order if they consider Tesla to be the right vendor, regardless of whether there is a pandemic happening or not. Those companies are agnostic to short-term changes in business. The solar business will surely see a large decline in demand as well as supply, but that may be only in the short term.
Let’s continue to talk about the auto business, though, which is without a doubt the larger portion of Tesla’s business today.
Since Gigafactory Shanghai continues to ramp up production faster than expected, as confirmed in the Q1 P&D report and the latest March China sales report, we can expect this to continue in Q2, which will help to mitigate the production stop in the US.
Also, the construction phase of the Model Y production line in Shanghai continues going rapidly, and we may see an earlier than expected production start for the highly anticipated crossover/SUV in China. Originally the plan was to start production of Model Y in China at the end of 2020, but given the amazing success China achieved already with the Model 3 production lines, we should expect the Model Y line to be ready early.
Overlooked by most, Gigafactory Berlin-Brandenburg in Germany is on schedule, with just a week’s delay, and will likely be able to start production as planned in mid 2021. At that time, Gigafactory Shanghai will be running on all lines with high volumes, which means the added production capacity in 2021 for Tesla will be significant. High utilization of invested capacity will bring the costs down and allow Tesla, if required, to lower prices again, which drives more demand.
For Q2 2020, the biggest concern in terms of supply is the Fremont factory, which as we learned from a leaked internal letter is intended to be back into production on May 4th 2020, which means a full 6 week production loss. Sparks and Buffalo are included in the facility language they used, which is key to ramping up business in all segments.
But 6 weeks is still a significant amount of time and can’t be easily compensated, right?
On an annual basis, every automaker has production lines down for about 2 weeks for retooling and maintenance work over the course of a year. That’s business as usual and Tesla has done it before too. As we learned from a tweet from Elon Musk, Tesla intends to implement productivity increases in these weeks as well. Since initial deliveries of the Model Y have begin already, it can be assumed that after the 6 week shutdown is over, we will likely see a step change in output and productivity as we have seen in the past with the Model 3 line. That incremental output will help to compensate for a portion of the 6 week downtime that in terms of annualized production is now only a net 4 weeks of interruption or downtime.
That 4 weeks represent an annualized production loss in Fremont of about 7.5%. What is different from other automakers is that Tesla is in an exponential production ramp situation with higher demand than it can deliver. The question for Tesla is how much the exponential growth will be reduced, not if P&D is declining, a situation all other incumbents are facing today.
In May, most of the production from Fremont will likely be shipped to Europe, as it takes 2–4 weeks for vehicles to arrive. It also should be taken into consideration that production in Q1 was higher than deliveries and a good number of vehicles are already available in Europe as inventory and will be sold as well if demand is there. That will help provide better than expected deliveries in Europe if enough supply can be shipped to Europe in May.
In June, it’s fair to assume that the Fremont factory will produce just for US demand, to focus on deliveries with short distances to customers. That will allow Tesla to reduce inventory and deliver most of what is produced in that month. If all of these assumptions turn out to be accurate, I would expect lower deliveries in Q2 than what we have seen in Q1, but higher deliveries than in Q2 2019. In fact, looking at the March sales numbers in China, there is even a small chance to grow deliveries in Q2 globally versus Q1, which would be stunning given all the downtime and difficult odds to overcome. Since I do expect further productivity increases in Q3 and Q4, it’s my expectation that Tesla can deliver on its annual guidance of 500,000 vehicles in 2020. In the aftermath of the crisis, I think it will be seen as severe for all automakers except for Tesla. That’s based on my napkin calculations, including the latest information that Tesla in China sold more than 10,000 units in March alone (a new record), which confirms my conclusions.
For the entire year, I do expect dramatic volume decreases for all other automakers while Tesla is likely able to meet the guidance made for 2020 and have a stronger financial position and ability to execute by the end of 2020 versus at the start. The ability to benefit from the large financial aid programs most Western countries have put in place will add to this.
Model Y production starting and ramping in 2020 and the ability to overcome demand weaknesses other automakers feel strongly will give Tesla a strong competitive edge against incumbents with regards to supply and demand.
If you read my previous articles and have seen my videos, you will know now why I believe Tesla has a competitive edge in regards to safety, diversification, and supply & demand. In the 4th episode of this series, I will talk and write about vertical integration in the time of the corona crisis and why it’s a huge competitive edge that only Tesla has.
These are 4 aspects that help Tesla through the crisis, but they are all together more that the summary of their parts and Tesla has built a holistic experience that is hard to compete against. Tesla will succeed in the crisis because the company focuses on that holistic experience of its customers and not on the physical product alone.
You can delay, postpone, or cancel the purchase of a great product, but you will always try to repeat a great experience that you had.
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