Tesla is today the most valuable automaker in the world by market capitalization beating
out industry giants like General Motors, Ford, Volkswagen group, and even Toyota.
It has achieved this impressive feet despite a short operating history, a limited product
lineup and even relatively modest sales figures compared to these much more established entities.
In spite of all of these indicators, investors are willing to pay more than
five times as much for the same stake in tesla as compared to the more traditional automakers.
So what is going on here?
What do investors see in Tesla that a rational person may not?
What is the companies vision to truly justify being valued this highly?
and could this all be a charismatic CEO taking a pool of naive investors for a ride.
And before we start answering these questions we need to give
the standard disclaimer that we do for all company videos and that is that nobody on
the Economics Explained team currently owns any tesla shares or stock options,
so even though we would want to remain impartial either way now you know.
Toyota by most metrics is the largest car company in the world,
they produce the most cars, they make the most revenue,
employ the most people and have a long-tenured history with brand recognition, and a base
of loyal customers that probably spans even further than they would actually like it to.
By comparison, Tesla sells one-thirtieth as many cars,
makes less than 10% of the revenue, and oh yeah hemorrhages money every year it operates.
2019 was actually considered a good year as far as finances go because it only lost 862 million
dollars which was an improvement from the 1 billion dollars it lost in the year before.
Despite this Toyota has a market capitalization of just under 200 billion dollars, whereas Tesla
is more than double this runner up sitting at a valuation of over $400 billion dollars.
The first thing to know here is that market capitalizations are sometimes a bit
misleading. This number is calculated by taking the market price of a stock,
and then multiplying it by the total amount of stocks.
There are currently just under 1 billion tesla shares in existence,
so if we multiply that by the $430 market price, we get our market capitalization figure.
Now market price is something that can jump around quiet alot for any number of reasons
that are completely divorced from the underlying fundamentals of the company.
ameture investor hype, stock buybacks, easy access to capital, price manipulating tweets,
all of that good stuff can push a share price up
without actually making the company they reflect any larger or more prosperous.
All of these factors are common criticisms leveled at Tesla, but supporters will point
to the fact that building cars is just one small part of scaling up the
Tesla Empire
One fo the most telling insights into the difference between tesla
and regular automakers is to look at their subsidiaries.
Regular automakers have grown their influence by buying up other car brands.
Volkswagen is a great example of this Volkswagen group is not only
responsible for the people’s car but they also own part of or all of, Bentley, Audi, Bugatti,
Porsche, Seat, Lamborghini, Skoda as well as a collection of commercial vehicle manufacturers.
Tesla, by contrast, is a company that still owns other companies
but it takes a slightly different approach to it’s mergers and acquisitions.
Instead of buying up competitors, it owns companies within its own supply chain,
which allows it to not only be a car manufacturer but also a component supplier,
dealership, fuel station, energy generator and maybe even one-day transport provider all in one.
Now these two different approaches all hope to achieve the same two things,
increase revenue and decrease costs, which results in increased profits.
business 101 right, but here is how they do it.
A company like Volkswagen is investing in what is called horizontal integration,
IE they are investing in businesses on the same level of the production process as their own.
Porsche and Volkswagen are companies that technically do the same thing they take raw
materials and components turn them into cars before selling them off to dealership networks.
Now just because all these car companies
do the same thing doesn’t mean that their arent huge advantages to teaming up.
Companies like volkswagen will build cars on similar platforms and share them between
all of their brands. The Volkswagen Tiguain, Audi Q7, Porsche Cayenne, Bentley Bentayga,
and even the Lamborghini Urus all share the same basic chassis and components.
This does the two things the the business wanted to do.
It increases revenue because suddenly the manufacturer can appeal to all manner of different
buyers with the same car, an average family gets the base model Volkswagen, a wealthier family will
buy a porsche or Audi, and for the people that want a truely ostentatious display of wealth,
there are the Bentleys and Lamborghini’s that cost 6 times as much for effectively the same car.
This means that Volkswagen will draw revenue from buyers that wouldn’t have even considered a car
from either end of their product spectrum, either because it was far too expensive or far too povo.
This technique also reduces costs because research and development as well as manufacturing overheads
are shared between all of the brands. It would be cost-prohibitive for a boutique manufacturer
like Bentley to invest the same amount of money into developing a new drivetrain.
Modern cars requirer huge teams of engineers, designers, and lawyers to make sure cars comply
with all of the various road laws around the world, while you know also being a good car.
And yes yes I know there are boutique manufacturers that do pull this off without being
beholden to some corporate overlord, but just remeber those cars tend to be extremely expensive
even by Lamborghini and Bentley standards, and they probably lack the day to day reliability
as well. I mean I dunno... Patreon dot com so maybe one day I can find out.
Now Tesla takes this concept and turns it on it’s head, literally,
it does what is called vertical integration, where instead of buying up competitors in the same step
of the production process it buy’s up or creates businesses that cover other parts of the process.
tesla’s largest investments have not been in the cars themselves but rather in component
manufacturing, recharging station and owning their own dealership networks. All steps in
the process of selling a car that traditional manufacturers have left to other companies.
This still achieves the same 2 goals.
It reduces expenses because you don’t have to
include profit markups for all of the different steps of the process.
For example, if Audi sells a car to a dealership they are going to sell
it at a wholesale price and then that dealer will add a markup to the consumer
to make their own profits. By owning this entire process tesla can cut out those middlemen.
It also increases revenue by offering additional revenue sources.
Tesla really only makes 3 cars at the moment. The model S, model 3, and the model X we have
just seen that the Volkswagen group has a wider selection of products within just one chassis.
But in the same way that Volkwagen increased revenue by offering lots of
different types of cars to lots of different types of people,
tesla is offering lots of different services to the same types of people.
If you buy a new porsche and then go fill it up down the road, volkswagen is not seeing
any revenue from the sale of that gasoline, whereas if you buy a new tesla
and go charge it on the companies supercharger network they will.
The same is true for a lot of other area’s as well, a by-product of making electric cars
with an emphasis on vertical integration is that tesla has become really good at making batteries.
The same tree-hugging tech bro that will inevitably buy a new Tesla
may very well buy a house battery pack as well, meaning that again they have made
money outside of just being one of the many moving parts in the auto industry.
Increase revenues, and decrease costs to make more profit, simple formula with two very
different approaches from established automakers and tesla respectively.
The only problem is that as innovative as teslas fresh new approach may seem,
it hasn’t really worked, they haven’t made any profit. To the contrary they are loosing money,
but maybe that’s ok because they haven’t yet achieved the magic solution to all business woe’s
Economies of scale
Economies of scale is a phenomena in production
where the unit cost of goods trends downwards as more items are made.
The term tends to get thrown around pretty loosely
but its actually a little bit more complex than what you may think.
There are three main reasons why this effect happens.
Mitigation of fixed costs, efficiency in scale, and negotiating power.
Say you were tasked with building just 1 car, if push came to shove you could probably do
it. But most of you watchingwould need to go to school to learn how to put a car together,
and you would also need to buy a whole lot of equipment actually manufacture the car.
This education and a workshop full of tools could cost
hundreds of thousands of dollars and take years of time to put together.
If you were to turn around and sell that car at a price that was commensurate with your outlay and
effort it would be astranomically expensive, easily hundreds of thousands of dollars.
But now lets say you were tasked with building two cars, well you wouldnt need to go back to
school to learn to build another car, and you could use the same tools all over again.
In this example the tools and education are the fixed costs, no matter how many cars are made
you don’t need to spend any more on these, and as more and more cars are produced they reflect
a smaller and smaller fraction of the total cost involved in making a single car.
The next big step is scale,
hand tools and a garage workshop is great, but even with the most skilled mechanic in
the world it is going to struggle to put a car together from scratch in less than a month.
A full-on assembly line on the other hand well that’s a different beast. Now tasks can be broken
down into very easy very repetitive actions that might not require any education at all.
What’s more, is if you do the exact same thing day in and day out you get very good at it,
inherently making production more efficient.
Finally if you are ordering in a single piece of every component that goes into a car,
you are going to pay retail price for those parts, but if you are ordering hundreds of
thousands of components at a time, or even better still manufacturing the components in
house your are going to pay much less for them, this lowers the variable costs of production.
All in all looking like a pretty big win for economies of scale,
it mitigates fixed costs, increases output, and reduces variable costs, what’s not to love.
It’s pretty easy to graph out this process and see that cost competitiveness will naturally
favor those who produce the mosts. So sure, maybe tesla’s are a bit too expensive for most
consumers today, but as we saw earlier they only make 1/30th the number of cars that Toyota does.
As soon as they expand into making a few million cars a year
they will have the magic economies of scale and be super profitable right?
Well, maybe, but probably not.
As fantastic as the economies of scale effect looks it has a dark side,
you see this chart here is not actually complete, it is supposed to look like this.
In typical manufacturing after a certain point producing more goods starts to cost more and more.
This is caused by the reverse of the reasons that it all gets cheaper in the first place.
Those fixed costs for starters, either a would be manufacturer is going to have to try and squeeze
more and more out of their existing factory or workshop or whatever, or they are going to need
to open a second location to keep on making more cars. This is a huge jump in fixed costs
that will need to be shared amongst the costs associated with each individual car after that.
The same thing happens with breaking down processes into smaller and smaller tasks.
One man building an entire car by hand is efficient,
a team working on set steps is efficient, but a huge team of thousands of people each
responsible for one single screw or weld each is just as inefficient as having one person
doing the whole thing. Eventually, people will just be getting in each other’s way.
And finally that bulk discount turns into clearing out entire markets.
If you want to buy 10,000 glass windows you get a bulk discount.
If you buy 10 million you force up demand so much that prices increase.
Call it a personal vendetta of mine but, the loose way that people throw around the
idea of economies of scale being the secret ingredient to every business
is potentially harmful in choosing good quality companies to invest in.
This should probably be the key takeaway of the video,
but nobody will click on a thumbnail called the negative marginal cost minimization in
high output production. So you know haha, I tricked you into learning.
But maybe we have been a bit too cynical here and missed the point of tesla entirely.
Most institutional investors agree that a 400 billion dollar valuation for a car company
even with all of it’s vertical integration is ludicrous,
especially considering all of the factors we have already explored. But maybe tesla is
Not a car company at all
I mean sure, it builds cars, but not many of them,
and they really are only a means to an end of efficiently getting from place to place.
What is much more exciting is the final step of the companies’ plan to control
everything related to road-based transport. The idea of car ownership.
Tesla is quiet famously developing systems for self-driving cars, these systems act as
cool party tricks right now but have some much more serious long term potentials.
It could become their very own transport network.
Taxi companies and uber drivers make money by purchasing vehicles
and using them to transport passengers, which means there is more money in moving people about
than in simply selling a car as a one-time transaction.
Even a range-topping tesla model x sells for under $100,000 in the US today,
which is obviously a lot of money but that same car if let loose to act as
it’s very own uber driver could make hundreds of thousands of dollars before being retired.
Elon Musk has already spoken quite freely about a future
where nobody owns a car, which would be unusual rhetoric for a
car company CEO had it not been for this holistic approach to a transport solution.
Now for investors this positions tesla more as a tech company that just so happens to make cars,
rather than a car company that has some cool tech.
Technology has the advantage of being able to achieve the aforementioned economies of scale
far more effectively than other business types like retail,
oil and gas, healthcare, pharmaceuticals, and yes of course even auto manufacturing.
That is why today 7 of the 10 most valuable companies in the world are tech companies.
So the cynical analyst are right. Tesla the car manufacturer is not worth even a fraction of
their 400 billion dollar valuation. But a company that proposes to be the world leader in renewable
energy storage, a replacement to gas companies, and a cheaper alternative to uber all in one?
Well, that’s a more intriguing proposition.
Especially when considering that well yeah they do make really cool cars and I definitely want one.