Case study on Tesla car

The Tesla comes under few companies have attracted as much

scorn and adoration as Tesla. When Tesla launches a product
like the Cybertruck, the reception tends to be divisive: critics see
it as further evidence that founder Elon Musk is out of touch and
doomed to fail, while supporters buy in — within a month Tesla
received 200,000 preorders for the new vehicle. Compare that
to the Ford-150, the world’s best-selling car in 2018, which sold
just over 1 million vehicles that year. Disagreements aside, there
is no question that the company has shifted the auto industry
toward electric vehicles and achieved consistently growing
revenues (passing $20 billion in 2019). At the start of 2020,
Tesla was the highest performing automaker in terms of total
return, sales growth and long-term shareholder value. Surely,
there is a method to what seems like madness to so many [1].
Tesla’s recent breakout market performance is proving some of
its skeptics wrong. In mid-January of 2020, Tesla’s market
capitalization had reached $107 billion, and it surged past the
giant German automaker Volkswagen to become the world’s
second most valuable auto company behind Toyota. Tesla’s
valuation now exceeds that of Ford and GM combined. [2]
Are certain industries so difficult to enter that they are destined
for lower levels of entrepreneurship and innovation? If one looks
at Porter’s five forces analysis, industries like the automobile
industry seem especially immune to the threat of new entry and
upstart competitors. Numerous factors that Porter identifies,
including economies of scale, learning curves, access to
distribution channels, patents, unrecoverable up-front R&D
expenditures, and other capital requirements can serve as
barriers to entry, and all of them seem to be present in the auto
industry. Thirty-five years ago, Porter wrote, “In the auto
industry economies of scale increased enormously with post-
World War II automation and vertical integration — virtually
stopping successful new entry.”[3] At that time, General Motors,
Ford, Chrysler (plus AMC/ Jeep), Honda, Nissan, and Toyota
constituted six of the seven top-selling car companies in the
United States, and the same is true today. [4]

The high costs of entry in the auto market have led many to
speculate that even if a better product existed, incumbents could
successfully keep it off the market. A prime example is the
electric car, which has long been a dream of those seeking to
reduce auto emissions but a product that many considered as
too difficult to introduce. Electric cars benefit everyone by
reducing emissions and improving air quality and are “a winner
for consumers.” However, it says that electric cars “are a threat
to the profitability of the conventional gas-powered auto
industry” so “economics and corporate power stopped
California’s electric car program in its tracks.”[5] Compared to
gas powered vehicles, electric cars lack a refueling infrastructure
and a distribution and service network. To frame the problems
using the language of potential market failure, introducing an
electric vehicle means facing network externalities associated
with electric cars (such as the need for new charging stations
compared with the fueling stations that gas-powered vehicles
already have) and high barriers to entry (such as the high fixed
costs of introducing new technology and building the production
capacity that incumbents already have).

Although innovation in an industry does not necessarily require

new entrants (incumbents will and frequently do innovate
whenever they can), [6] new entrants often view industries in a
totally different way and embrace such change. Yet entering
certain industries is more difficult and that has the potential to
affect outcomes in an industry. In 2011, one observer stated,
“The higher the capital requirements, the higher the barriers to
entry…When there are high barriers to entry, then you don’t see
new entrants, and you don’t see innovation. It’s really that new
entrants are what drives innovation.” This observer was Silicon
Valley entrepreneur Elon Musk, Tesla’s initial investor, co-
founder, and CEO, who viewed all of the barriers in the auto
industry as ones that could be overcome [7]. As Musk explains,
“Our goal when we created Tesla a decade ago was the same as it
is today: to drive the world’s transition to electric mobility by
bringing a full range of increasingly affordable electric cars to
market.”[8] Tesla’s long-run success, with or without current
preferential tax treatment, is to be determined. Nevertheless,
within twelve years, Tesla has created one of the top-selling full-
sized luxury cars in the United States and Tesla’s Model S has
won multiple car of the year awards and earned an all-time top
rating from Consumer Reports.

In an industry with many challenges, including large fixed costs,

network effects, and incumbents that might prefer to preserve
the status quo, Tesla is showing that a Silicon Valley startup can
overcome many seemingly insurmountable economic problems.
Tesla also has relied heavily on alliances, allowing Tesla to
leverage expertise and infrastructure of other firms rather than
having to constantly reinvent the wheel [9].

Musk noticed that companies like General Motors were not

developing electric cars as effectively as they could and that led
him to enter that space. According to Musk, “the single largest
macro problem that humanity faces this century is solving the
sustainable energy problem — that is, the sustainable
production and consumption of energy,” but rather than waiting
for a solution, Musk states, “the only way I could think to
address that was with innovation.”[10] Although electric cars do
not necessarily reduce the consumption of fossil fuels or
emissions overall, they have the potential to, especially if lower
emission power sources like nuclear become more widespread.
The “well to wheels” emissions equivalents for electrics vary
based on how electricity is generated and when one draws from
a grid, and electric car battery storage also has the potential to
draw from the grid at non-peak hours or more effectively utilize
intermittent energy sources such as wind or solar. [11] Musk
states that it is tempting to reason by analogy and infer that the
market will be similar to how it exists now. However,
entrepreneurs are capable of bringing products to market that
others have not envisioned. As another Silicon Valley
entrepreneur, Steve Blank, has stated, “Capitalism is an
evolutionary process where new industries and new companies
continually emerge to knock out the old.” Following
Schumpeter, Blank explains how “entry by entrepreneurs was
the disruptive force that sustained economic growth even as it
destroyed the value of established companies.”[12] Despite the
fact that many thought that electric cars could never compete
with gas-powered vehicles, Tesla has shown that Silicon Valley
style thinking can help overcome entry barriers even in the most
established of industries.

Theoretical underpinnings of Tesla, Inc: Disruptive

innovation & High-end encroachment

Disruptive innovation theory was originally published by

Christensen [13]. A disruptive innovation is defined as “a
product or service that displaces an incumbent product or
service”. Danneels [14] defined disruptive innovation as “A
Technology that changes the bases of competition, changing the
performance metrics along which firms compete”. The most
recent definition was by Gilbert [15] who defines it as “A new
technology is that which unexpectedly displaces an established
one”. A 2013 study by the authors of this paper undertook a
review of the theory and discovered that disruptive innovations
are more expensive than existing technologies, the new
technology will be less developed than the incumbent but the
disruptive technology will possess added value features. It was
also found that disruptive innovations will firstly fill niches
towards the top of the market, and will then diffuse downwards
into the more competitive mass-market levels [16]. Disruptive
innovations initially enter niches that are not attractive to
incumbent firms [17]. These markets are unappealing mainly
due to low volume sales potential, and because they demand
specialized products that could not be produced at an
economically viable price. This means that incumbent firms
cannot produce a product that will maintain existing profit
margins. This makes it easier for the disruptive innovation to
enter these markets, as there will be no existing competition. In
these niches the new technologies are not seen as a threat to
incumbents [16]. However once unit sales are increased and
costs reduced they can diffuse down the market, it is as this
stage that they become actually disruptive to the market leaders
sales and profits. Christensen did not include high-end
encroachment in the original definition of disruptive innovation
[17]. However much subsequent literature [17] does present a
good case for including high-end encroachment into the theory.
Additionally the mobile phone, which is an example of high- end
encroachment, is classified as a disruptive innovation by
Christensen [13, 1]. The effects of high-end encroachment on the
market can be immediate and significant, meaning that
innovations that enter markets via high-end encroachment are
disruptive [20].

There are three types of high-end encroachment. These are New

Market, New Attribute and Immediate High-End
Encroachment. The type of high-end encroachment depends
upon the level of Core Attribute and Ancillary Attribute
Performance changes compared to the incumbent innovation
[19] as shown in Figure 1. The first customers who purchase
high end innovations are typically innovators, as based on
Rogers [21] theory. These innovators typically place a higher
value on the performance advancements of the high-end
innovations, more than low end customers would [22]. New
Market encroachment depends upon the highest level of core
attribute improvements along with strong ancillary attribute
improvements. The innovations will also be high priced; these
innovations open up new markets at the top of a market [23].
This is usually the first stage of a market entry strategy and the
innovations will generally diffuse down from this high-end
market to progressively lower markets as cost reductions are
achieved. This is the market entry approach that Tesla Motors
have used, their first model the Tesla Roadster was targeted to
high-end customers in a new market space at the top of the
electric vehicle market. New Attribute high-end encroachment is
where core attributes are improved to a similar extent as new
market encroachment. With this strategy ancillary attributes are
only moderately improved compared to incumbent technologies.
These innovations have higher costs than incumbent
technologies, but the difference in cost is less significant than
with new market innovations. These innovations enter the top of
existing markets, they do not open new markets, and the
innovations then diffuse to lower market levels [23].
Innovations in the automotive sector that fit this pattern include
hybrid vehicles where ancillary attributes are moderately
improved but core attributes are often much improved over
comparable Internal Combustion Engines (ICE) vehicles. On
market introduction hybrid vehicles were more expensive than
ICE vehicles but less so than the Tesla Roadster or Tesla Model
S. Both Fuel Cell Vehicles (FCVs) and Battery Electric Vehicles
(BEVs) are disruptive innovations. They are both automotive
technologies entering a highly competitive market. They share a
number of characteristics such as zero tailpipe emissions, silent
operation, electric drivetrain, smooth acceleration and high
torque figures. They also have some shared barriers to market
entry, they are disruptive innovations, costing more than
incumbent ICE vehicles, and both suffer from poor
infrastructure access at present. The higher than average prices
of Tesla vehicles makes the comparison especially useful, this is
because BEVs are expected to cost significantly more than
conventional ICE vehicles due to the novel materials used and
initial lack of economies of scale. It should be acknowledged that
for disruptive innovations high-end encroachment is not the
only appropriate market entry strategy. Low end encroachment
where technologies enter at the bottom of the market in low
value applications is also possible [24]. Low-end encroachment
is not being explored for BEVs because this market entry
strategy would not be possible. The high prices inherent with
BEVs mean they would not be able to compete with incumbent
ICE vehicles on price. According to Van Van Orden et al., 2011
[19] there are 6 types of encroachment patterns, 3 high-end

Source:medium.com