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Volume III
Capital Project Management,
Volume III
Evolutionary Forces
Robert N. McGrath
Capital Project Management, Volume III: Evolutionary Forces
10 9 8 7 6 5 4 3 2 1
Keywords
Tesla; Musk; technology s-curves; technological discontinuities; d ominant
design; economy of scale; economy of scope; capital intense; breakeven;
productivity; profitability; competitive advantage; industry life cycle; core
capability; supply chain; vertical integration
Contents
Preface��������������������������������������������������������������������������������������������������ix
in 1996. Now retired after a successful academic career, his interest has
returned to studying EVs, and this book might better be subtitled “what
my 1996 dissertation always wanted to be when it grew up.”
Here, a similar approach was taken: first developing a media item
database, by the systematic collection of well over 1,200 media items
from 2012 to 2018. Out of that database, about 150 items are excerpted
or referenced. While there is plenty of other data that could be assem-
bled, it would be much more haphazard and prone to bias. Truth not-
withstanding, it is only fair to expect any given media company to speak
in terms that its consumers expect. For example, many articles are from
the business media, speaking to that clientele. Thus, while the data that
appeared in the news media are taken at face value, at the same time, to
use Tesla and Elon Musk in order to illustrate any kind of general business
phenomenon should be done anecdotally. Any specific article chosen as
an illustration does not necessarily represent an exemplar but sometimes,
represents an interesting anomaly useful for instructive purposes.
Thus, the author is grateful once again to all who have helped him
along the way since 1996, with special thanks to “the media.” The story
told there, the first draft of history, is our story as it stands. Perhaps this
book constitutes a second draft, but it won’t be the final draft, which
cannot be properly written for years to come.
CHAPTER 1
Introduction
When Tesla first appeared, the “EV industry” was already both very new
and very old. Electric autos had been around since the beginning of
the automotive era, but the new version seemed more promising than
previous efforts mostly due to technological advancements (mostly in
lithium-based electrochemical “batteries”). One might also view it as
an industry within an industry, a new one within an old mature one
based on a revolutionary technology (compared to the standard internal
combustion paradigm). From a pre-introduction period to introduction
(Volume I), industry-wide average profitability was clearly negative, and
sustained firm-specific (quarterly or annual) profit was really out of the
question.
At the time, a disproportionately large amount of impetus was being
generated by just one company, Tesla, and just one founder-visionary,
Elon Musk. This was still a time when the industry could and would
be shaped by clear and individual strategic action, not faceless economic
forces constraining change in traditional, almost deterministic ways. In a
way, Tesla would become an economic force unto itself, sometimes rather
eccentrically challenging many old rules and creating new ones of its own
making.
Key Techonomics Terms in this chapter include:
Profitability and profit
Economic profit and accounting profit
2 Capital Project Management
Some Essentials
A main point of this series is this: accounting profit and economic profitability
are not the same thing.
Economic profitability is first and foremost an enduring or “struc-
tural” characteristic of an industry at large; accounting profit, in contrast,
“the bottom line” on a firm’s income statement, is a calculation, and is
the result of specific managerial decisions over any time period in ques-
tion, usually short. Sustained positive accounting profits should reflect an
organization’s capabilities as they match up against the specific economic
forces that structure an industry, in which case, one may speak of the
sustained profitability of the firm as well.
Economic profit is measured as economic value-added (EVA). If a firm
stands at the top of an industry in this way, this reflects a competitive advan-
tage. See Volumes I and II.
Consider not only the following accomplishment, but also the con-
text of its timing:
But now comes the hard part. Musk & Co. are about to start produc-
tion of the highly anticipated Model 3, Tesla’s first stab at a truly mass
marketed car …
… investors will have to pay a high price to find out. Tesla’s price-to-
sales ratio is six times higher than GM’s, and it doesn’t have a price-
earnings metric since it won’t make a profit anytime soon.
Tesla through 2015: Something Old and Something New 3
The words “most valuable” are important. The value of a firm can
be calculated in several ways for several different purposes (Bierman and
Schmidt 2006), but often the term refers to total market capitalization,
or “market cap” for short. This expression and ideas like corporate value
pop up frequently, but their face value interpretations should not be taken
for granted.
Market cap in business jargon is generally calculated as the number of
shares of common stock that have been sold, times the price of each share
at any specific point in time. Think of it as what the owners of common
stock have actually ponied up out of their own pockets, plus-or-minus
the vicissitudes of market ups and downs in the meantime, that is, capital
appreciation. Unless qualified, this is what the media means by market cap
when used in reference to what the company is “worth,” its “total value,”
and so forth. Market cap means the total investment in stock as the mar-
ket has determined—the “market value” of equity at any one point in
time.
In contrast, the “book value” of equity is what is available for distribu-
tion to shareholders, basically total assets minus total liabilities, preferred
stock, and intangible assets. (Book value was introduced in Volume II in
another context, but otherwise is not important to the present point.)
That said, market cap does not include things that can be important
depending on the conversation; here, the most important being capital
that has been borrowed by selling corporate bonds, called debt. That is
considered capital too, in the sense that it is money borrowed from exter-
nal investors, to be used in the expectation of it being invested profitably
and later all of it returned “with interest” quite literally.
To mention another term now, then, a corporation’s “capital struc-
ture” refers to the total amount of equity and debt a firm is obliged to put
to good use, where the term us used mainly for the purpose of managing
the optimal balance (e.g., the “leverage”) between the two (Volume II).
Capital structure and leverage become important in the Tesla story as it
plays out especially in the later years, but more generally are more inter-
nal, management matters.
Debt is just that—debt, whereas equity or stock represents real, actual
ownership of the corporation with all the rights due to private property
possession.
4 Capital Project Management
The Tesla story begins around 1990 when Elon Musk was not the central
figure, or any figure in the mix for that matter (Baer 2014). Around that
time a friendly collaboration of Silicon Valley engineers—mainly Mal-
com Smith and Martin Eberhard—had worked on consumer gadgets and
related mobility concepts. Soon another friend, named Marc Tarpenning,
joined Eberhard. These latter two fellows and good friends did most of
the “heavy lifting” during the earliest times.
During the late 1990s, the founders-to-be successfully marketed an
electronic book, eventually selling the company for 187 million U.S.
dollars (Baer 2014). Encouraged by their entrepreneurial success, they
wanted to start another company. A little analysis convinced them that
electric vehicles (EVs) had a viable future. With a little looking around
they discovered a firm called ACPropulsion, which was doing work in
California, being enervated by that state’s clean air mandates in the auto-
motive industry (Baer 2014). ACPropulsion already had a vehicle called
the “tzero,” which had impressive acceleration and controllability. It was
enough for them to develop a business plan and to invest in the technol-
ogy—but not in ACPropulsion itself.
Their enthusiasm was partly based on advancements in lithium-ion
battery technology. Lead acid batteries had been standard automotive
technology for most of its history, but simply did not have the natural
potential to become the basis of an EV paradigm. Other battery technol-
ogies were also under research for years, but all had their challenges.
A problem with perceptions was that EVs were something of a joke
(McGrath 1996). Very literally they were often compared to glorified golf
carts and the like, at least by the average mainstream consumer. But tech-
nology enthusiasts were highly interested as were people concerned about
the natural environment. Still, it was difficult to envision a viable—that
is, profitable—market for vehicles, which at the time were so pricey and
underperforming in terms of range—how far a vehicle can travel on one
“fill-up” or here, one recharging.
Range means how far a vehicle can travel on one “fill-up” or here, one
recharging. The explanation is a little technical but not hard to under-
stand. “Energy density” is a technical term about batteries that readily
Tesla through 2015: Something Old and Something New 5
search, the founders decided to build on the Lotus Elise, a small sports
car. Lotus was a well-established design innovator in racing, at least in
Europe. The basic Elise chassis had served similar purposes by other
European and Asian car developers, so there was precedent for success.
Their business terms were attractive to Tesla, and their organization was
already suited to consulting with Tesla. Lotus was used to doing the kind
of things that Tesla needed. This and other key relationships would be the
focus of Tesla’s first vice president of vehicle development, Ian Wright,
only the third member of the formal team.
With that, the timely availability of minimally performing batter-
ies, and a technology license with ACPropulsion, the car design became
clearer. At that point the main problem became financing, a very signif-
icant hurdle. The year 2004 was largely dominated by solving that need.
Tesla had accomplished some financing from personal contacts and small
venture capitalists, but what they really needed was a major investor who
shared their dream. The team was familiar with a man named Elon Musk,
already famous in other circles as being the founder of SpaceX.
Musk was a visionary and long-term thinker yet acted aggressively
in the present. After personal introductions, discussions, offers, and due
diligence, Musk agreed to join the Tesla effort. Musk was particularly
concerned about the natural environment and believed that EVs could
play an important role in any real resolution to climate change. Like the
founders, Musk shared their conviction that any such effect could only
be achieved by large-scale commercial success, not symbolic niche efforts.
Musk led a round of raising 7.5 million U.S. dollars and became the
Chairman of the Board (COB).
Thus, at the outset he held two important roles: Chairman and major/
majority investor.
Tesla’s first real product and basis for business was called the Roadster,
released in 2008. It came in for high praise from sources such as Car
and Driver, beginning a legacy of generally adoring press that would last
for years. With some trouble about safety and reliability issues along the
way, Tesla would enjoy a good public reputation as it concerns product
technology.
Making a car from scratch was more difficult than imagined, and even
using an existing chassis was not straightforward. Because Tesla aimed
Tesla through 2015: Something Old and Something New 7
Tesla made sure the word was spread outside the circles of auto purists
and technology geeks. Positive press appeared in the New York Times, For-
tune, Wired, and the Washington Post. The plan was to begin first deliveries
of the Roadster in 2006 and continue scaling up production until “profit-
ability” was reached in 2008—a sensitive word that will resonate through-
out this story. The Roadster was not ready for first delivery until 2008,
beginning with a problem with production, which would plague Tesla
for years to come. Low cost and headcount across the system was a major
goal, but quickly Tesla found itself managing hundreds of components
rather than just the most value-adding and came to employ 140 people.
The situation also surpassed the experience of the principals who were
more accustomed to the compartmentalized Silicon Valley network way
of doing things.
It is axiomatic that skillsets at the apex of a startup generally evolve, and
“professional managers” eventually take over.
A new CEO was in place in November 2007 who assured that first
Roadster deliveries would begin in the spring of 2008. Sure enough, pro-
duction began in March that year. Boasting that the Roadster was the
only true zero-emissions vehicle in actual production at the time, the next
announced goal was to be producing 100 per month about a year hence,
in early 2009. However, the new CEO lasted only until October 2008,
when Elon Musk essentially took over the company—starting by firing about
a quarter of Tesla employees.
By that time Musk himself had invested about 55 million U.S. dollars
of his own capital, and Tesla was on the verge of collapse by 2008 due
to operational cost overruns (Vance, 2012), Fortunately, Musk was able
to bail himself out in early 2009 with the sale of another earlier venture
of his, Everdream, for 120 million U.S. dollars. We can stop counting
Musk’s roles now, or perhaps boil them all down to one—boss.
repair technicians to customers’ homes to fix the bolts. Still, some of the
glimmer was off the rose, made worse by several high-profile celebrities
announcing their displeasure. Still, Tesla was ready to make perhaps the
biggest move in any firm’s existence—to make the transition to becoming
publicly owned and traded. This event is called IPO, an initial public
offering of stock ownership. The move would give Tesla access to a theo-
retically unlimited pool of capital, but would also expose the company to
public scrutiny by fiduciaries who had good reasons for concern.
The aspiration is not difficult to understand, though. A great deal
of capital would be needed to develop and field their first car past the
Roadster. This would be Model S—a key strategic move not only in its
own right, but where it would eventually stand in the evolution of Tesla
products. However, these two key elements of an overall strategy—one
technological and one financial—were not always in perfect sync, and
other elements of an overall strategy could not help but suffer in the
meantime.
Let’s set the stage at the time Tesla “went public” in 2010.
Commercialized EVs
Three viable autos were already becoming consumer realities, not just
auto-show amusements (BusinessWeek 2010):
General Motors:
Model: Chevy Volt
Technology: Plug-in (Battery-Gasoline) Hybrid (BHEV)
Battery: Lithium-ion
Range: 40 miles in battery mode; 350+ miles on a tank of gasoline,
overall 37 mpg
Price: 40,000 U.S. dollars
Availability: 2010
Years to Develop: 4
Nissan
Model: Leaf
Technology: All-battery-electric (BEV)
Battery: Lithium-ion
10 Capital Project Management
grid. In between the two main coasts for the most part but especially near
the Gulf coast, a revolution in oil exploration (fracking and horizontal
drilling) was already revolutionizing Big Oil and America’s dependence
on oil imports. At the time, low gasoline prices were an impediment
(some calculations said that 6 U.S. dollars/gallon would make EVs via-
ble), but of course could not last forever. Consumers continued to say
that main impediments were sticker price, limited range, and lack of
recharging infrastructure.
J.D. Power projected that in nine years, battery EVs like the Leaf
would sell about 100,000 units in the United States and 1.3 million units
globally, about 1.8 percent of the 71 million cars expected to be sold.
About 3.9 million hybrids and plug-in hybrids would be sold worldwide
in 2020, or a total electric and hybrid market of about 7 percent. In con-
trast, Bloomberg projected that plug-in cars such as the Leaf and the Volt
could make up 9 percent of U.S. sales by 2020 and 22 percent by 2030.
Another poll found that only one-fifth of drivers would consider buying
an electric car, and about half wouldn’t be willing to pay more for either
an EV or the associated infrastructure.
Battery Technology
Nearly 30 years later, and only a month after Toyota followed GM’s
footsteps in abandoning the NUMMI plant, Toyota has made another
surprise decision: A $50 million investment in a small startup called
Tesla, which plans to make electric cars at the NUMMI plant …
(Carney 2010)
• Ford Focus Electric … about the same driving range as the
Nissan Leaf...
• Ford Transit Connect …minivan... aimed at commercial
customers … 80-mile range …
• Mitsubishi I-MiEV … less than $30,000 …the least
expensive battery electric..
• Honda Fit EV … 2012 … the same 100-mile range as
most …
• Tesla Roadster … has a six-figure price tag, so most buyers
are wealthy consumers... helping to establish the Tesla brand
name as the company plots more mainstream models.
• Fisker … Like the Volt, backs up its battery. Like the
Roadster, an exclusive price tag …
Tesla through 2015: Something Old and Something New 15
… the average Volt driver is going 1,000 miles between gasoline fill-
ups. And for the most part, Nissan Leaf owners are perfectly happy to
do without the gas tank altogether …
… Volt owners are getting savvier about maximizing battery use and
minimizing use of the car’s gasoline-powered “range extender” …
The competitive domain (Narayanan 2000) was not only expanding, but
also morphing in character. In traditional economic terms, the argument was
whether EVs were part of the global auto “industry,” or whether EVs had
become a new industry unto itself.
It is not an entirely academic argument, because analyses of things
like “entry barriers” and “substitution” had clear and dramatic practical
implications for strategy.
Threat of Entry
Regardless of whether one speaks of the EV industry, the U.S. auto-
mobile industry, the global auto industry, or anything else for ana-
lytical convenience, it is important to keep in mind that this force
Tesla through 2015: Something Old and Something New 17
The first item in the table is highlighted because it was so critical to the
Tesla story. Inherent economies of scale in auto manufacturing is an endur-
ing “barrier to entry.” From the standpoint of the auto incumbency, it was
a defensible barrier to their existing profitability. From the standpoint of
Tesla, it was something that had to be established, at very great cost, in
order to be competitive in mass markets.
Tesla Motors Inc … won a near-perfect score for its Model S electric
car in an annual owner-satisfaction survey conducted by influential
magazine Consumer Reports …
The results offer a rare piece of good news for Tesla … after three
cars caught fire in less than two months. This week, U.S. regulators
launched a safety probe into the Model S.
“Owners of the Tesla Model S gave it the highest owner-satisfaction
score Consumer Reports has seen in years: 99 out of 100,” the maga-
zine said.
Tesla through 2015: Something Old and Something New 21
(Bullis 7, 2013)
... Even when you factor in … power plants that produce the electric-
ity to power the cars … electric cars produce about 40 percent less
carbon dioxide and ozone than conventional cars.
But … electric cars still are haunted by … high costs and less-than-
optimal batteries.
Those few themes resonated time and again, as they had for over a
century. At any rate, on most fronts, Tesla seemed to be the industry
leader. Its own (with Panasonic) lithium-ion batteries were seen as design
state-of-the art—including safety considerations—and to soon plum-
met in production cost. The Model 3 was already being envisaged, a leap
ahead from even the Model S in being mainstream, as made evident by
the expected price of 35,000 U.S. dollars. Its charging-station approach
22 Capital Project Management
and technology were a good overall model for range extension, cost to
consumers, and technological standardization—a factor that cannot be
underestimated in its importance to survivability if not dominance.
Said the GM CEO, Tesla has “gone from being the quirky little media
darling to being something that is definitely making people in the industry
think” (Bullis 2013).
public perception about a fatality. This was to be a period when the media,
as the voice of the Wall Street investment community, made its concerns
more clearly understood:
… Tesla will need to continue increasing the volume of cars they sell
in order to gain economies of scale to lower their prices. The more
cars Tesla produces, the less it will cost per vehicle for the fixed costs
involved in manufacturing each car…
… but Tesla will need to find ways to reduce their variable costs as well,
in order to reach a price point most consumers can afford, while still
making profit on each sale... the company could be profitable today if
not for its ambitious growth targets.
The difference between gross margin and profit is, mostly, taxes and inter-
est paid on debt. The latter is the major part of the difference between account-
ing profit and EVA:
The words “and to” were inserted in the above article to make clearer
that the accumulation of experience does not lead to an economy of scale.
Accumulation of experience achieves a “learning effect” as well as greater
Tesla through 2015: Something Old and Something New 25
Production and supply chain skills would vie with product development
skills to be the core value-adding capability across the company. This is what
the ILC (Volume 1) would predict, assuming a strategy aimed at mass-markets.
Conclusion
This chapter covered events from Tesla’s beginnings in the late 1990s,
though to incorporation, IPO, and a little beyond. The year 2010 was
particularly pivotal in the life of Tesla as it is for any company that goes
public. The event gave Tesla access to a virtually unlimited amount of
Wall Street capital, but of course exposed the fiduciaries to endless pub-
lic scrutiny and in the present case, media attention. Wall Street specifi-
cally, though not all investor groups across the board, shows a strong bias
toward the short-term and really, quarterly earnings reports and annual
results. Corporate strategists are compelled to think in longer terms, if
for no other reason that capital investments usually take several years to
26 Capital Project Management
Exercises
Define each of the following terms individually, and then compare and
contrast them in the pairs shown:
Profitability and profit
Economic profit and accounting profit
Economic forces and threat of entry
Barrier to entry and economy of scale
Capital (as money, as equipment, as prop-
erty) and capital expenditure
Index
Alphabets ‘e’ and ‘t’ in italics after page number indicate ‘exhibit’ and ‘table’,
respectively
A123, 29 Tesla charging stations, 40
ACPropulsion, 4, 6–7 wireless charging system, 40–41
AC versus DC, 41 See also electric vehicles
Aquion’s batteries, 31 Boeing, 44
asset specificity, 76, 90, 105, 112, 113 Boring Company, 126
Boulder Ionics, 32
bandwagon effects, 38–39 brand capital, 18–19, 38
bargaining powers, 114e–116e breakeven, 96, 150
battery(ies), 108–118 business, global procurement risk,
Aquion’s, 31 146–149
cost of, 24–25, 109, 115 BYD Ltd., 101
lithium-ion, 62
Model S, 29 capital
Tesla’s residential, 49 allocation strategy, 81
decoupling, 13 commitment, 112
design, 28, 113 expenditures, 23, 60, 84
developments, 35 intense, 113, 158, 159
electrochemical, 39 risk, 146
energy density, 5, 57 spending, 23, 60, 84, 138
GM’s decision to outsource, 113 capital-as-equipment, 24
lead-acid, 4, 31 capital-as-money, 24
life, 90 capital risk, cash flow and, 146
lithium-ion, 4, 33–34,44, 111. See cash flow. See free cash flow
also lithium-ion battery China, 29, 107, 113, 129
limitations, 27–50, 37e, 51, 108 global procurement risk and,
manufacturing, 87–88, 90, 93, 99 147–149
Model 3, 15, 28 recharging standards, 151
parameter, 110 redefines mass market, 100–103
recharging, 32, 43, 69, 151 VW in, 79, 99
replacing, 144 Cobalt, 98, 113, 114, 143
reverse, 42 competitive advantage, 2, 24, 39, 70,
size, 111 87, 107, 112, 157
solid state technology, 111, 154 competitive domain, 16, 127, 157
stored power, 118–121 Consumer Reports, 71–72
technological discontinuities, contracting risk, 151–154
35–36 core capability, 92
technology, 11 corporate commitments, 39, 53
and packaging, 109 corporate cash flow, 146
development in, 34–38 corporate portfolio, 91, 108
176 Index
supply chain, 25, 58, 76, 99, 121, Model Y, 129, 132
128n production difficulties, 68–70
capacities, 128 production rate of Model 3, 132
development, 101 productivity, 159
global strategy and, 149, 154 professional management, 143–145
latent profitability, 159 profitability, 137–140
lithium, 113 regulations, 10–11, 124–125
production technology and, 66 and Roadster, 4–8
strategic consistency in, importance sales performance, 80
of, 92 scaling up for mass production,
Tesla’s, 19 127–128
vertical integration and, 116e shares, 132–135
SWOT analysis, 17e strategic change, 60
strategies, 22–25
technology/technological supply chain, 19, 25, 58, 66
breakthrough, 35e, 110, 145, 154, technical limitations, 64
158 technology risk, 149–151
convergence, 71, 93 threatening financial position, 126
discontinuities, 35e–36e time-consuming, 70
innovation, 25, 55e–57e, 120–121,
value proposition, 48–49
158
vs. information technology, 92
maturity, 144
and VW, 99–100
risk, 149–151
warranty expenses, 65
S-curves, 35e
Tesla Motor Inc. See Tesla
uncertainties, 27–38
Tesla Semi, 121–124
Tesla, 1, 4–8
agenda for 2017, 75 threat of entry, 16e–18e
Autopilot hardware system, 92 threat of substitution, 55e–57e
battery technology, 11 time-consuming, Tesla’s, 19, 70
beyond IPO, 18–22 time-of use rates, 63
brand capital, 19 Toyota, 10, 13, 43, 92
capital expenditures, 60
charging stations, 40 value proposition, Tesla’s, 48–49
debt situation, 93 vertical integration, 116e
facts and figures, 145–146 Volkswagen, 10, 30, 78, 89, 90, 94,
free cash flow, 77, 81, 84–85, 93, 98, 102, 150–153
96 Volvo, 10, 102, 153
future perceptions of, 83
initial public offering and, 12–16 Washington Post, 8
lithium-ion battery and, 47–48 Wired, 8
mass production, 91 Wireless charging system, 40–41
Model 3, 64–68, 130 wireless versus plug-in, 41
Model D, 22–23 Wright, Ian, 6
Model S, 8–11, 20–21, 45, 131
Model X, 18, 53, 131 zero-emissions vehicles, 78