#5 Pace of Innovation
When Elon Musk replied to one of my articles last year that “pace of innovation is all that matters in the long run,” he did not say “innovation matters” — he said pace of innovation matters. It’s about how quickly a company is innovating, not the innovation itself. That may sound like a small distinction, but it is indeed huge and the true essence of competitive edge.
Despite everybody talking rightfully about the great and groundbreaking innovations Tesla is making, which is exciting and something I should write an article about too, this chatter often misses the most important part, which is that a fast pace of innovation is what makes your organization bulletproof against all competitors.
With the right pace, you will be the leader in the latest and greatest technology, and with that the leader in demand, gross margin, and profit. You are the master of your own destiny and the actor on stage while others are just reacting, the supernumerary around you.
When I was thinking not long ago about what would be #5 of my 7 article series, my brain picked innovation, but at first I could not explain why and I called myself dumb, but as usual my brain was smarter than me. It turned out it did have good reasons for picking that topic. I will try to explain why.
If you talk about innovation in the time of the crisis, most will say that does not make any difference or competitive edge for any automakers because they are all “in the same boat” and have to cope with the same situation, which is just wrong. Tesla has a much higher and accelerating pace of innovation — and with that, more, faster, and better innovation, which makes all the difference in a crisis.
Many people have listed the moats Tesla has, but they missed the most important part of it all, which is presumably why Elon Musk said moats are lame. What I think he meant is that every moat that you get through an innovation, regardless of how amazing it is, will sooner or later be copied and its competitive advantage equalized.
History shows this to be true, so why innovate at all? The answer is as long as you innovate faster than others you will always be ahead with the greatest and latest, and customers will be willing to pay a premium for your products and services. For that reason, the pace of innovation is indeed much more important than the innovation itself.
That simple logic is hard to comprehend, to truly understand, since everybody quickly gets excited about the next autonomous driving innovation from Tesla, the new Model Y HVAC system that has never been seen before, the never-seen-before large casting process for automobiles, a customer-designed FSD chip technology, and many other things that require separate articles to shed light on their amazing impact on the industry and consumers. But all of that is a static perspective, while our world is as a matter of fact very dynamic.
All of those are amazing accomplishments, but the real one is being faster than others, and faster you can only be if your organization and processes have been built to be faster.
The true innovation of Tesla that people seldom talk about is that the entire company — all of its departments, people, processes, and DNA — have incorporated the ability to innovate with maximum speed and extract the best idea, thought, and paradigm shift that technology can enable. This is a competitive advantage that was installed long before the crisis started and will remain after. It’s an advantage you can only copy if a rare group of people comes together that builds an atmosphere of rewarding people who make mistakes in order to actualize the bold, crazy maverick thought that at first looks completely unachievable.
It’s a 180 degree shift away from what famous German automotive engineering is doing today. German engineering is great, but is never trying the impossible, and with that it’s completely understandable that different aspects of German electric vehicles — like battery technology, centralized operating software architecture, and autonomous driving systems compared to the status of Tesla today — are considered years behind, not months. Now you need to add the accelerating factor of Tesla to this in order to understand the true situation of the incumbent manufacturers. Their best invention in 2020 is behind the Model S delivered in 2012.
To copy an organization and the company’s unknown DNA, or informal organization as it’s often called, is impossible, as it requires that a company “grow into the shape to innovate.” I did see in my career the “me too” approach succeed in technology, but never as a way to invent the next leading technology.
There is no blueprint available or effective book written on how to do this. How to “grow into shape” has a lot to do with attracting the best talent in the market to work for you and go the extra mile. That attraction is usually initiated by the top management of a company, and is one key active ingredient of success. “Smart management” books have been written about it, but if you don’t have a true leader, innovator, and the personification of a fundamental mission, all theory is worthless and a waste of time.
Attraction and appeal multiplies attraction and appeal. Elon Musk made the battery electric vehicle attractive and appealing while without exception all incumbent automakers have literally missed the ship. An electric vehicle can be much sexier and more attractive than a fossil fuel vehicle, and those companies also lose in the attraction battle the best talent, people who are now longing to work for Tesla. You can’t copy in order to be attractive — you have to earn it and deserve it. The true core of innovation is not a physical matter you can touch and appreciate. The organization — its people, relationships, and processes — simply enables it. The true product this brings to life is innovation.
You don’t need just an R&D department that is responsible for doing something better, new, more efficient, lighter, and faster — you need the entire company focused on this. Why use the smart brains of just a few if you could use the smart brains of your entire organization? The ability to innovate is not restricted to people in the R&D department, and if you approach that like all incumbent automakers do, don’t be surprised if you just get the results from those few people, not the full potential that you know you could unlock. With that you get the EV results the incumbent auto industry is getting.
You can claim that all of that is true of the situation of Tesla compared to the rest of the automotive industry and normally a competitive edge, but that it is not an additional advantage in this time of crisis. I believe it is an advantage, though. Allow me to explain why.
In the time of pandemic, a lot of R&D departments are forced to slow down their developments simply because people can’t physically meet like they are used to. The advantage for Tesla is it doesn’t really slow down in this regard.
Having a product that is mainly defined by its software and having a software development organization in place that does not rely on working on valves, gearboxes, nuts, and bolts, but rather bits and bytes, means the people on your team can remotely work from their home offices. This makes a huge difference not because you are faster than before, but because the others are slower. That difference you see expressed in the products and services they push out despite the crisis.
An example of that is the current release of the new autonomous driving feature that allows vehicles to recognize stop signs and lights as well as automatically stop at them, waiting for the driver’s confirmation to go ahead when the car signals it’s ready again because the light is green. The over-the-air update is gradually rolling out for everybody and has some awesome new features included that I already love, that I received for free (without any extra fee), and that I wouldn’t want to miss. This happened while not only in Europe, where I live, but also in California, where Tesla’s HQ is located, people have to stay at home and can’t meet.
That innovation has been created and implemented by the Autopilot team and pushed out to vehicles via a software update, and that creates a financial benefit. It will have an impact on the financial bottom line since it is becoming available for all users where regulators allow it, inspiring more people to buy the Full Self Driving option or buy a Tesla. It’s even more than that in terms of quarterly financials, too. Tesla charges for the functionality either when you purchase the vehicle or if you decide at a later point in time to buy it. Either way, all money collected can’t be accounted for in the balance sheet until the respective functionality is available for the user. That’s an SEC rule in the software industry and nothing unique to Tesla, but it is a huge positive now since Tesla can account for software that it spent years developing and can now be pushed out by OTA updates. The money does not even need to be collected, just finally accounted for. This is, to be clear, not an accounting trick or anything fishy, but a well established conservative accounting practice for many decades and applicable to the entire software industry.
If you sell, for instance, enterprise software to a company, you can only account for it financially and report it in your quarterly earnings release once the software has been received, has been paid for, is fully functional, and has been delivered to your customer. The moment you load the update, it makes a “ping” in the Tesla balance sheet. A Tesla vehicle is rightfully called a “laptop on wheels,” and a huge amount of revenue that Tesla already has in its bank account has not been shown in the earnings reports as revenue yet. Now it will.
In the middle of the crisis, as functionality is enabled, Tesla can account for it and has a financial benefit no one else has because no one has these kinds of over-the-air updates. No one has nearly as compelling software for autonomous driving software. I call this a fundamental and huge differentiator.
If you compare this to the Volkswagen Group, where Board Member Thomas Ulbrich just confirmed that R&D remains a challenge and that they are having large issues with the operating system of the ID.3, you get a sense and feel that the R&D process of Tesla is completely different to that of what other automakers are doing today. I expanded on the R&D processes in my article “Like An Angel Is Pushing You From Behind” and recommend reading it if you want to learn more about my thoughts on why the R&D that Tesla is doing is unique in its structure and organization.
To be able to invent the invention process, you have to be able to think outside the box, you have to allow yourself to imagine the unthinkable. Elon Musk gave a nice example of that in the 3rd Row Tesla podcast when he explained that he had a Model S vehicle as a small model on his desk and was thinking if they cast these tiny small vehicles, why can’t Tesla do it with big ones?
If you would have expressed that thought as a young engineer in an automotive company, they would have likely fired you, but Tesla probably would have given you the opportunity to work on that exciting, wild idea. It’s a thought that may not lead anywhere, but it’s worth investigating in detail since the advantages in effort, time, cost, and space are tremendously exciting for everyone who has worked in mass production before.
Obviously, there are a ton of technical issues around it that no one could solve in the past, which have to do with the alloy as well as available technology or presses, to name just two, and it requires another article to elaborate what that means in detail, but let’s just say there are good reasons why other automakers put the thought quickly to rest.
That did not happen with Tesla. They solved the larger issues to the extent that they could cast a larger portion of the structure than anybody else. They cannot cast the full structure yet, but they continue to strive for a larger casting structure too — to the point that they exchange 70 single parts for 1. Where others would have given up early, Tesla continued and finally succeeded. Don’t let the perfect be the enemy of the good. With that first step, Tesla already achieved a lot of competitive advantage.
Throughout the crisis, the data all Tesla vehicles are collecting is used to continue improving the autonomous driving software and driver assist system, regardless of whether that Autopilot team can meet in a room or not. No one else can do that, because no one else has 1 million vehicles that collect so much data every day on our roads in order to improve algorithms. Although there are of course many fewer miles driven right now since many people are locked down at home, it’s still a significant amount of driving and helps to improve functionality that Tesla can charge for in the crisis or after. That’s a unique competitive edge Tesla has due to innovation.
While I was writing this article, I received an email from Tesla that my free-of-charge premium connectivity for my Model 3 here in Germany will end in the middle of May and I can subscribe to it for €10 a month. I ordered it immediately, as it’s a great functionality to have. The key point is that many others here in Europe will have received the same message and must have done the same. To be clear, I am locked down in my house right now and don’t drive a lot, as we are still requested to stay at home, but in mid-May I plan to go on a 1,000 km trip to my family in the north of Germany and definitely want premium connectivity for the benefit of using some of the provided services. It’s recurring revenue, and for accounting purposes worth much more than one-time revenue since it’s a stable, continuous, reliable revenue flow you can account for and that makes you more independent from larger one-time deals with vehicles that may come in or may not.
The subscription received makes Tesla a software company in the subscription business and gives it a nice additional recurring revenue stream enabled in the middle of the crisis while all other incumbent automakers can’t unlock any revenue. The current approaches of all other auto manufacturers are very much limited in their OTA ability, and therefore in their ability to drive subscriptions. The CEO of Volkswagen Group, Herbert Diess, himself expressed this in April by stating, “We are fighting hard to keep our timeline for the launches to come.”
Meanwhile, Tesla continues to execute on the master plan Elon Musk laid out more than a decade ago. One of its core advantages is pace of innovation. That is true competitive edge.