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Tesla Motors in 2018: Will the New Model 3 Save the Company?

Arthur A. Thompson The University of Alabama

Tesla Motors began assembling the first mod-els of its new “affordably-priced” entry-level Model 3 electric car in May 2017 and delivered the first units the last week of July, with a goal of gradually ramping up production to a total of 1,500 units by the end of September. The first production vehicles, delivered to employees who had placed pre- production reservations over a year earlier, were pre- configured with rear-wheel drive and a long-range battery; had a range of 310 miles and 0 to 60 mph acceleration time of 5.1 seconds; and a sticker price starting at $44,000 with premium upgrades available for an additional $5,000. Deliveries of the standard Model 3, with a base price of $35,000, 220 miles of range, and a 0 to 60 mph acceleration time of 5.6 sec- onds, were expected to begin in the United States in November 2017. Dual motor all-wheel drive configu- rations were scheduled to be available in early 2018. Plans called for international deliveries of the Model 3 to begin in late 2018, contingent upon regulatory approvals, starting with left-hand drive markets and followed by right-hand drive markets in 2019.

Tesla had unveiled six drivable prototypes of the Model 3 for public viewing and a limited number of test drives on the evening of March 31, 2016. Buyer reaction was overwhelmingly positive. Over the next two weeks, some 350,000 individuals paid a $1,000 deposit to reserve a place in line to obtain a Model 3; reportedly, the number of reservations grew to nearly 400,000 units over the next several months. Because of the tremendous amount of interest in the Model 3, Tesla Chairman and CEO Elon Musk announced in May 2016 that Tesla was advancing its schedule to begin producing the Model 3 from late 2017 to mid- 2017 and further that it was going to accelerate its

efforts to expand production capacity of the Model 3, with a goal of getting to a production run rate of 500,000 units annually by year-end 2018 instead of year-end 2020.

In early August 2017, in a letter updating share- holders on the company’s second quarter 2017 results, Musk said:

Based on our preparedness at this time, we are confi- dent we can produce just over 1,500 [Model 3] vehicles in Q3 and achieve a run rate of 5,000 vehicles per week by the end of 2017. We also continue to plan on increas- ing Model 3 production to 10,000 vehicles per week at some point in 2018.1

But in his third quarter 2017 update on November 1, 2017, Musk related a host of produc- tion bottlenecks and challenges that were blocking the ramp-up of Model 3 production and delaying deliveries, saying, “this makes it difficult to predict exactly how long it will take for all bottlenecks to be cleared or when new ones will appear. Based on what we know now, we currently expect to achieve a pro- duction rate of 5,000 Model 3 vehicles per week by late Q1 2018.”2

But Tesla’s “production hell” with the Model 3 continued to haunt the company in early 2018. Many analysts believed Tesla’s problems stemmed from having taken huge shortcuts in the parts approval process, production line validation, and full beta test- ing of the Model 3 in order to begin early assembly and production ramp-up. There were other reasons, including ongoing parts bottlenecks and inconsis- tent manufacturing quality. Production line employ- ees interviewed by reporters indicated significant

CASE 18

Copyright ©2019 by Arthur A. Thompson. All rights reserved.

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numbers of units coming off the assembly line had quality problems involving malfunctioning parts/ components and/or faulty installation issues that required reworking. A big parking lot just outside the assembly plant in Fremont, California, was said to be full of Model 3s awaiting corrective attention; a few were even being junked because of the high cost of restoring them to a condition that would pass final pre-delivery inspection. On February 7, 2018, Musk reported:

We continue to target weekly Model 3 production rates of 2,500 by the end of Q1 and 5,000 by the end of Q2. It is important to note that while these are the levels we are focused on hitting and we have plans in place to achieve them, our prior experience on the Model 3 ramp has demonstrated the difficulty of accurately forecasting specific production rates at specific points in time. What we can say with confidence is that we are taking many actions to systematically address bottlenecks and add capacity in places like the battery module line where we have experienced constraints, and these actions should result in our production rate significantly increasing dur- ing the rest of Q1 and through Q2.

Despite the delays that we experienced in our pro- duction ramp, Model 3 net reservations remained stable in Q4. In recent weeks, they have continued to grow as Model 3 has arrived in select Tesla stores and received numerous positive reviews, including Automobile maga- zine’s 2018 Design of the Year award.3

A week or so later, Tesla shut down the Model 3 assembly line for four days to address some of the assembly problems being encountered. Nonetheless, in early March 2018, there were reports from mul- tiple sources that Tesla had not been able to consis- tently achieve a production run rate of 800 units per week. So Musk’s target of a weekly production rate of 2,500 Models 3 by the end of March seemed very much in jeopardy.

In addition, there were accumulating reports from the owners of Model 3s relating to touch- screen issues—one related to the audio system vol- ume suddenly blasting higher without the screen having been touched; another related to drivers returning to their parked Model 3 and discovering the touchscreen on and the audio sound blaring; still another related to “phantom” inputs along the edges of the touchscreen when certain apps were opened. In some instances, Tesla had replaced the touchscreens; in others, it promised a software solu- tion would soon be forthcoming. A second reported problem, in which the battery capacity decreased

noticeably while the car was parked in the sun on a hot day for several hours, had been reported by a number of Model 3 owners and, to a lesser extent, by a few Model S and Model X owners. It appeared that battery drain problems often occurred in Model 3 vehicles experiencing touchscreen issues. A cou- ple of Model 3 owners with technical backgrounds had speculated the problem related to touchscreens being mounted on a large metal pedestal such that large temperature differentials between a vehicle’s hot interior and its cooler exterior caused the touch- screen and plastic touchpad to warp and produce other anomalies as the metal pedestal absorbed heat from inside the vehicle. As of March 27, 2018, the cause had not been pinpointed, but if the problem did relate to a faulty pedestal design, then correct- ing the design problem could cause further delays in ramping up Model 3 production and drive up war- ranty costs for Model 3s already delivered. During the last week of March, Elon Musk tweeted that he had taken over the role of supervising Model 3 pro- duction for the time being.

The first week of April 2018, Tesla reported that it produced 34,494 vehicles in the first quarter of 2018. Tesla’s Q1 deliveries were 29,980 vehicles, of which 11,730 were Model S; 10,070, were Model X; and 8,180 were Model 3; as of March 31, 4,060 Model S and Model X vehicles and 2,040 Model 3 vehicles were in transit to customers. Tesla also reported that after shifting some production resources away from Model S and Model X production over to production and assembly of the Model 3 during the last week of March, it was able to produce 2,020 Models 3s in the last seven days leading up to April 3. In its produc- tion and delivery announcement, the company fur- ther said:

Given the progress made thus far and upcoming actions for further capacity improvement, we expect that the Model 3 production rate will climb rapidly through Q2. Tesla continues to target a production rate of approxi- mately 5,000 units per week in about three months.

Finally, we would like to share two additional points about Model 3:

• The quality of Model 3 coming out of production is at the highest level we have seen across all our prod- ucts. This is reflected in the overwhelming delight experienced by our customers with their Model 3s. Our initial customer satisfaction score for Model 3 quality is above 93 percent, which is the highest score in Tesla’s history.

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features. Retail sticker prices in 2018 ranged from a base price of $80,700 to $97,000 for a well-equipped Model X to $140,000 for a fully loaded model. Both the Model S and Model X were being sold in North America, Europe, and Asia in 2017 and 2018.

The Model S was the most-awarded car of 2013, including Motor Trend’s 2013 Car of the Year award and Automobile magazine’s 2013 Car of the Year award. The National Highway Traffic Safety Administration (NTSHA) in 2013, 2014, and 2015 awarded the Tesla Model S a 5-star safety rating, both overall and in every subcategory (a score achieved by approximately 1 percent of all cars tested by the NHTSA). Consumer Reports gave the Model S a score of 99 out of 100 points in 2013, 2014, and 2015, saying it was “better than anything we’ve ever tested.” However, the Tesla Model S did not make the Consumer Reports list of the “10 Top Picks” in 2016, 2017, and 2018, but the Model S did earn a perfect 100 score on the 2018 road test drive.

The sleek styling and politically correct power source of Tesla’s Model S and Model X were thought to explain why thousands of wealthy individuals in countries where the two models were being sold— anxious to be a part of the migration from gasoline- powered vehicles to electric-powered vehicles and to publicly display support for a cleaner environment— had become early purchasers and advocates for Tesla’s vehicles. Indeed, word-of-mouth praise among current owners and glowing articles in the media were so pervasive that Tesla had not yet spent any money on advertising to boost customer traffic in its showrooms. In a presentation to investors, a Tesla officer said “Tesla owners are our best salespeople.”5

As Tesla’s current chairman and CEO, Elon Musk’s strategic vision for the automotive segment of Tesla’s operations featured three major elements:

1. Bring a full-range of affordable electric-powered vehicles to market and become the world’s foremost manufacturer of premium quality, high- performance electric vehicles.

2. Convince motor vehicle owners worldwide that electric-powered motor vehicles were an appealing alternative to gasoline-powered vehicles.

3. Accelerate the world’s transition from carbon- producing, gasoline-powered motor vehicles to zero emission electric vehicles.

At one point, Musk’s stated near-term strate- gic objective was for Tesla to achieve sales of about

• Net Model 3 reservations remained stable through Q1. The reasons for order cancellation are almost entirely due to delays in production in general and delays in availability of certain planned options, particularly dual motor AWD and the smaller battery pack.4

Despite the difficulties being experienced with the Model 3, production and sales of the company’s trailblazing Model S sedan (introduced in 2012) and Model X sports utility vehicle (introduced in late 2015) were proceeding largely on plan. Combined sales of these two models reached nearly 101,500 units in 2017 (see Exhibit 1). The Model S was a fully electric, four-door, five-passenger luxury sedan with an all-glass panoramic roof, high definition backup camera, a 17-inch touchscreen that controlled most of the car’s functions, keyless entry, xenon head- lights, dual USB ports, tire pressure monitoring, and numerous other features that were standard in most luxury vehicles. The cheapest Model S had a base price of $75,700 in 2018 and, when equipped with options frequented selected by customers, carried a retail sticker price ranging from $95,000 to $136,000. The Model X was the longest range all-electric pro- duction sport utility vehicle in the world; it could seat up to seven adults and incorporated a unique falcon wing door system for easy access to the second and third seating rows. The Model X had an all-wheel drive dual motor system and autopilot capabilities, along with a full assortment of standard and optional

EXHIBIT 1 Tesla’s Deliveries of the Model s, Model X, and Model 3 to Customers, 2012 through the First Quarter of 2018

Period Model S

Deliveries

Model S plus Model X

Deliveries

Model 3 Deliveries

2012 2,653

2013 22,477

2014 31,655

2015 50,332

2016 76,230

2017 101,420 1,734

Q1 2018 21,815 8,182

Source: Company 10K reports and press releases.

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enable them to compete head-on with the Model S, Model X, and Model 3. Several vehicle makers were also pursuing the development of electric-powered semi trucks for commercial uses.

3. Tesla had yet to prove it could boost operating efficiency and lower costs enough to be both price competitive and attractively profitable in producing and marketing its vehicle models. It reported both a loss from operations and a net loss each of the past five years, despite growing its automotive sales and leasing revenues from $2.61 billion in 2013 to $9.64 billion in 2017—see Exhibit 2. In February 2018, the company did say it expected to generate a positive quarterly oper- ating income before the end of 2018 (but not a positive operating income for the year). While Tesla’s ongoing operating losses and net losses were partly, or perhaps largely, due to the sizable new product development costs associated with the Model X and Model 3 and to the required accounting treatments for both leased vehicles and Tesla’s generous stock compensation plan, it was nonetheless disconcerting that Tesla’s oper- ating loss of $1.63 billion in 2017 was the largest in the company’s history—an outcome that had to be reversed soon. The extent of Tesla’s growing operating losses was illustrated by the fact that in the first quarter of 2017 General Motors reported an operating profit of $1,418 for every vehicle it sold around the world and Ford’s reported oper- ating profit per vehicle sold was $1,174—in com- parison, Tesla’s operating profit per vehicle was −$15,855.6

A possible fourth challenge seemed to be gath- ering steam on the Tesla message boards. People with Model 3 reservations who, because of all the production problems and delivery delays they had been hearing about, had posted concerns about tak- ing delivery of the Model 3 they had ordered. In one anecdotal case, a poster told of when he went to the Tesla delivery location to take delivery of a black Model 3, he could clearly see paint swirls on the hood; when told by the delivery person that the service department had done the best job it could to buff out the swirls and that the car would be sold “as is,” the poster refused delivery. But after further conversation with the delivery person he said he then agreed to pay an extra $1,000 for a red Model 3

500,000 electric vehicles annually by year-end 2018, but the difficulties in ramping up production of the Model 3 has pushed achievement of this objective out to the end of 2019 at the earliest and more probably the end of 2020, assuming sales of the Model 3 took off as expected. Musk planned for the company to begin deliveries of the Tesla Semi truck in late 2019 and a new version of the Tesla Roadster in 2020. His strategic intent was for Tesla to be the world’s big- gest and most highly-regarded producer of electric- powered motor vehicles, dramatically increasing the share of electric vehicles on roads across the world and causing global use of gasoline-powered motor vehicles to fall into permanent long-term decline.

At its core, therefore, Tesla’s strategy was aimed squarely at utilizing the company’s battery and elec- tric drivetrain technology to disrupt the world auto- motive industry in ways that were sweeping and transformative. If Tesla’s strategy proved to be as suc- cessful as Elon Musk believed it would be, industry observers expected that the Tesla’s competitive posi- tion and market standing vis-à-vis the world’s best- known automotive manufacturers would be vastly stronger in 2025 than it was in 2018.

But in 2018 there were three challenges with the potential to imperil Musk’s vision for Tesla Motors:

1. Gasoline prices across much of the world had dropped significantly from 2015 to early 2017 and were expected by many knowledgeable observ- ers to remain permanently “low” (below $80 or even lower) because the abundance of shale oil and the sharply-lower costs of extracting oil from shale deposits. Affordable gasoline prices made the purchase of electric vehicles less attractive, given that (1) electric vehicles were higher priced than vehicles with gasoline engines, (2) electric vehicles so far were limited to an upper range of about 300 miles on a single battery charge, and (3) new vehicles powered by gasoline engines were getting more miles per gallon (due to government- mandated mileage-efficiency requirements).

2. Tesla was facing the prospect of much more formida- ble competition from virtually all of the world’s major motor vehicle manufacturers (BMW, Mercedes, Jaguar, Volkswagen-Audi, Toyota, Honda, Nissan, General Motors, and Ford) that were rushing to introduce affordable and high-end electric vehicles with features and engine configurations that would

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CAse 18 Tesla Motors in 2018: Will the New Model 3 Save the Company? C-195

positive in Q3 and Q4.”7 The company also reported significant increases in energy storage deployments for utilities and other commercial enterprises and record deliveries of Powerwall systems for residences, resulting in Q1 revenues for energy generation and storage of $410.0 million, versus $213.9 million in the first quarter of 2017. Musk believed the company would generate positive cash in Q3 and Q4.

On the negative side, however, Tesla reported its largest quarterly net loss ever—$784.6 million, a loss from operations of $597.0 million, a negative cash flow from operations of $398.4 million, and a net decrease in cash and cash equivalents of $745.3 million. It was unclear whether, given expected capital expenditures of almost $3 billion, the company would need to raise additional capital to get through the year; the com- pany ended Q1 with a cash balance of $2.67 billion. Despite all the uncertainties, in May 2018 Musk had pledged no capital raise would be needed in 2018. This pledge baffled many Wall Street analysts, most all of the company’s critics and skeptics, and other keen observers because Musk, during the May 2, 2018 conference call with analysts to discuss Tesla’s Q1 2018 financial results, expressed his appreciation to the Chinese government for its announcement that foreign companies would henceforth be allowed to have 100 percent ownership of manufacturing facili- ties in China and said Tesla could have a Gigafactory capable of vehicle production in China “not later than the fourth quarter” of 2018.8

Exhibit 2 presents selected financial statement data for Tesla for 2013 through2017.

COMPANY BACKGROUND Tesla Motors was incorporated in July 2003 by Martin Eberhard and Marc Tarpenning, two Silicon Valley engineers who believed it was feasible to pro- duce an “awesome” electric vehicle. Tesla’s name- sake was the genius Nikola Tesla (1856–1943), an electrical engineer and scientist known for his impressive inventions (of which more than 700 were patented) and his contributions to the design of modern alternating-current (AC) power transmis- sion systems and electric motors. Tesla’s first vehicle, the Tesla Roadster (an all-electric sports car) intro- duced in early 2008, was powered by an AC motor that descended directly from Nikola Tesla’s original 1882 design.

after being promised by the delivery person it would be ready for pickup in one week—after 10 days, the poster said he had received no notification to come pick up the red Model 3. There were also message board posts from some Model S and Model X own- ers about the repair problems they were experiencing with their vehicles. There was one extreme example where an unhappy Model S owner reported having to take his vehicle to the Tesla service center for repairs six times in the past five months. Then in late March 2018 Tesla announced it was recalling about 123,000 Model S sedans globally after discovering that cer- tain corroding bolts in cold weather climates could lead to a power-steering failure.

However, when Tesla announced its finan- cial and operating results for the first quarter of 2018 ending March 31, the outcomes were in some respects better than many investors and Wall Street analysts expected. Tesla reported delivery of 8,182 Model 3s during the quarter and after having imple- mented numerous adjustments in assembly methods and correcting problems with faulty and improperly designed parts it was now able to sustain a produc- tion rate of 3,000 Model 3s per week. Elon Musk said that continued refinements of the assembly process and improved operational uptime of the associated machinery should lead to a production rate of “well over 5,000” vehicles per week by the end of June or beginning of July. Musk admitted that he had been wrong in mandating use of so many robots along the assembly line, and that now the assembly line had been and was still being greatly simplified, with more use being made of semi-automated and manual assembly to perform certain tasks until the com- pany had enough time to perfect the use of robots and enable full automation to resume. Musk con- fidently predicted that the Model 3 would become the best-selling medium-sized premium sedan in the United States before year end—the company had over 450,000 Model 3 reservations at the end of Quarter 1. Musk indicated that if Tesla executed according to plan the company would achieve positive cash flows and positive net income (excluding non-cash stock- based compensation) in both the third and fourth quarters of 2018. According to Musk, this was “pri- marily based on our ability to reach Model 3 pro- duction volume of 5,000 units per week and to grow Model 3 gross margin from slightly negative in Q1 2018 to close to breakeven in Q2 and then to highly

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EXHIBIT 2 selected Financial Data for Tesla, Inc., 2013–2017 (in millions, except share and per share data)

Years Ended December 31

2017 2016 2015 2014 2013

Income Statement Data:

Revenues:

Automotive sales $ 8,534.8 $ $5,589.0 $ 3,431.6 $ 2,874.4 $ 1,921.9

Automotive leasing 1,106.5 761.8 309.4 132.6

Total automotive revenues 9,641.3 6,350.8 3,741.0 3,741.0

Energy generation and storage 1,116.3 181.4 14.5 4.2

Services and other 1,001.2 468.0 290.6 191.3 91.6

Total revenues 11,758.8 7,000.1 4,046.0 3,198.4 2,013.5

Cost of revenues:

Automotive sales 6,724.5 4,268.1 2,639.9 2,058.3 1,483.3

Automotive leasing 708.2 482.0 183.4 87.4

Total automotive cost of revenues 7,432.7 4,750.1 2,823.3 2,145.7

Energy generation and storage 874.5 178.3 12.3 4.0

Services and other 1,229.0 472.5 286.9 166.9 73.9

Total cost of revenues 9,536.3 5,400.9 3,122.5 2,316.7 1,557.2

Gross profit (loss) 2,222.5 1,599.3 923.5 881.7 456.3

Operating expenses:

Research and development 1,378.1 834.4 717.9 464.7 232.0

Selling, general and administrative 2,476.5 1,432.2 922.2 603.7 285.6

Total operating expenses 3.854.6 2,266.6 1,640.1 1,068.4 517.5

Loss from operations (1,632.1) (667.3) (716.6) (186.7) (61.3)

Interest income 19.7 8.5 1.5 1,126 189

Interest expense (471.3) (198.8) (118.9) (100.9 (32.9

Other income (expense), net (125.4) 111.3 (41.7) 1.8 22.6

Loss before income taxes (2,209.0) (875,624) (875.6) (284.6) (71.4)

Provision for income taxes 31.5 13,039 13.3 9.4 2.6

Net loss $ (2,240.6) $ (773.0) $ (888.7) $ (294.0) $ (74.0)

Net loss attributable to noncontrolling interests and subsidiaries

(279.1) (98.1) — — —

Net loss attributable to common shareholders

$ (1,961.4) (674.9) $ (888.7) $ (294.0) $ (74.0)

Net loss per share of common stock, basic and diluted

$ (11.83) $ (4.68) $ (6.93) $ (2.36) $ (0.62)

Weighted average shares used in computing net loss per share of common stock, basic and diluted

165.8 144.2 128.2 124.5 119.4

Balance Sheet Data:

Cash and cash equivalents $ 3,367.9 $ 1,196,908 $ 1,196.9 $ 1,905.7 $ 845.9

Inventory 2,263.5 2,067.5 1,277.8 953.7 340.4

Total current assets 6,570.5 6,259.8 2,791.4 3,198.7 1,265.9

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S and $100 million for a powertrain manufacturing plant employing about 650 people that would supply all-electric powertrain solutions to other automakers and help accelerate the availability of relatively low- cost, mass-market electric vehicles.

In June 2010, Tesla Motors became a public com- pany, raising $226 million with an initial public offering of common stock. It was the first American car com- pany to go public since Ford Motor Company in 1956.

Management Changes at Tesla In August 2007, with the company plagued by delays in getting its first model—the Tesla Roadster—into production, co-founder Martin Eberhard was ousted as Tesla’s chief executive officer (CEO). While his successor managed to get the Tesla Roadster into production in March 2008 and begin delivering Roadsters to customers in October 2008, internal turmoil in the executive ranks prompted Elon Musk to decide it made more sense for him to take on the role as Tesla’s chief executive officer—while continu- ing to serve as chairman of the board—because he was making all the major decisions anyway.

Elon Musk Elon Musk was born in South Africa, taught him- self computer programming and, at age 12, made

Financing Early Operations Eberhard and Tarpenning financed the company until Tesla’s first round of investor funding in February 2004. Elon Musk contributed $6.35 million of the $6.5 million in initial funding and, as the company’s majority investor, assumed the position of Chairman of the company’s board of directors. Martin Eberhard put up $75,000 of the initial $6.5 million, with two private equity investment groups and a number of private investors contributing the remainder.9 Several rounds of investor funding ensued, with Elon Musk emerging as the company’s biggest shareholder. Other notable investors included Google co-founders Sergey Brin and Larry Page, for- mer eBay President Jeff Skoll, and Hyatt heir Nick Pritzker. In 2009, Germany’s Daimler AG, the maker of Mercedes vehicles, acquired an equity stake of almost 10 percent in Tesla for a reported $50 mil- lion.10 Daimler’s investment was motivated by a desire to partner with Tesla to accelerate the devel- opment of Tesla’s lithium-ion battery technology and electric drive train technology and to collaborate on electric cars being developed at Mercedes. Later in 2009, Tesla was awarded a $465 million low-interest loan by the U.S. Department of Energy to acceler- ate the production of affordable, fuel-efficient elec- tric vehicles; Tesla used $365 million for production engineering and assembly of its forthcoming Model

Property, plant, and equipment, net 10,027.5 5,983.0 3,403.3 1,829.3 738.5

Total assets 28,655.4 22,644.1 8,092.5 5,849.3 2,416.9

Total current liabilities 7,674.7 5,827.0 2,816.3 2,107.2 675.2

Long-term debt and capital leases, net of current portion

9,415.7 5,860.0 2,040.4 1,818.8 599.0

Total stockholders’ equity 4,237.2 4,752.9 1,088.9 911.7 667.1

Cash Flow Data:

Cash flows from operating activities $ (2,240.6) $ (773.0) $ (888.7) $ (57.3) $ 263.8

Proceeds from issuance of common stock in public offerings

400.2 1,701.7 730.0 — 360.0

Purchases of property and equipment excluding capital leases

(3,414.8) (1,280.8) (1,634.9 (970.0) (264.2)

Net cash used in investing activities (4,419.0) (1,416.4) (1,673.6) (990.4 (249.4)

Net cash provided by financing activities 4,414.9 3,744.0 1,523.5 2,143.1 635.4

Sources: Company 10-K reports for 2014, 2015, and 2017.

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a man on Mars in 10 years.15 In May 2012, a SpaceX Dragon cargo capsule powered by a SpaceX Falcon Rocket completed a near flawless test flight to and from the International Space Station; since then, under contracts with NASA, the SpaceX Dragon had delivered cargo to and from the Space Station multiple times. Going into 2018, SpaceX secured contracts of over $12 billion to conduct over 100 missions. Currently, SpaceX was working toward developing fully and rapidly reusable rockets and test launching its new Falcon Heavy rocket, said to the world’s most powerful rocket. The company was said to be both profitable and cash-flow positive in 2013 to 2017. Headquartered in Hawthorne, California, SpaceX had 5,000 employees and was owned by management, employees, and private equity firms; Elon Musk was the company’s CEO and largest stockholder.

Another of Elon Musk’s business ventures was SolarCity Inc., a full-service provider of solar system design, financing, solar panel installation, and ongo- ing system monitoring for homeowners, municipali- ties, businesses (including Intel, Walmart, Walgreens, and eBay), universities, nonprofit organizations, and military bases. Going into 2016, SolarCity managed more solar systems for homes than any other solar company in the United States. While Solar City had installed many solar energy systems, it had never been profitable or cash flow positive due to its busi- ness model of recovering the capital and operating costs of the installed systems through leasing fees and power purchase agreements. In November 2016, to rescue Solar City from probable bankruptcy, Tesla acquired the company and continued its operations as a new division named Tesla Energy. However, the business model was changed to one where custom- ers financed their new solar power installations with cash and loans, thus producing a healthier mix of upfront and recurring revenue; moreover, the costs of installing solar-powered installations were expected to decline, partly because of improvements in solar technology, greater efficiencies in manufacturing solar-generation systems, and cost savings achieved by operating Tesla’s automotive and energy divisions as sister companies.

In August 2013, Musk published a blog post detailing his design for a solar-powered, city-to-city elevated transit system called the Hyperloop that could take passengers and cars from Los Angeles

$500 by selling the computer code for a video game he invented.11 In 1992, after spending two years at Queen’s University in Ontario, Canada, Musk trans- ferred to the University of Pennsylvania where he earned an undergraduate degree in business and a second degree in physics. During his college days, Musk spent some time thinking about two impor- tant matters that he thought merited his time and attention later in his career: one was that the world needed an environmentally clean method of trans- portation; the other was that it would be good if humans could colonize another planet.12 After graduating from the University of Pennsylvania, he decided to move to California and pursue a PhD in applied physics at Stanford; however, he left the program after two days to pursue his entrepreneur- ial aspirations instead.

Musk’s first entrepreneurial venture was to join up with his brother, Kimbal, and establish Zip2, an Internet software company that developed, hosted, and maintained some 200 websites involving “city guides” for media companies. In 1999 Zip2 was sold to a wholly-owned subsidiary of Compaq Computer for $307 million in cash and $34 million in stock options—Musk received a reported $22 million from the sale.13

In March 1999, Musk co-founded X.com, a Silicon Valley online financial services and e-mail payment company. One year later, X.com acquired Confinity, which operated a subsidiary called PayPal. Musk was instrumental in the development of the person-to-person payment platform and, seeing big market opportunity for such an online payment plat- form, decided to rename X.com as PayPal. Musk pocketed about $150 million in eBay shares when PayPal was acquired by eBay for $1.5 billion in eBay stock in October 2002.

In June 2002, Elon Musk with an investment of $100 million of his own money founded his third company, Space Exploration Technologies (SpaceX), to develop and manufacture space launch vehicles, with a goal of revolutionizing the state of rocket technology and ultimately enabling people to live on other planets. Upon hearing of Musk’s new venture into the space flight business, David Sacks, one of Musk’s former colleagues at PayPal, said, “Elon thinks bigger than just about anyone else I’ve ever met. He sets lofty goals and sets out to achieve them with great speed.”14 In 2011, Musk vowed to put

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really understand it’s do or die but if we work hard and pull through, there’s going to be a great outcome, peo- ple will give it everything they’ve got.

Asked if he relied more on information or instinct in making key decisions, Musk said he made no bright-line distinction between the two.

Data informs the instinct. Generally, I wait until the data and my instincts are in alignment. And if either the data or my instincts are out of alignment, then I sort of keep working the issue until they are in align- ment, either positive or negative.19

Musk was widely regarded as being an inspiring and visionary entrepreneur with astronomical ambi- tion and willingness to invest his own money in risky and highly problematic business ventures. He set stretch performance targets and high product quality standards, and he pushed hard for their achievement. He exhibited perseverance, dedication, and an excep- tionally strong work ethic—he typically worked 85 to 90 hours a week. Most weeks, Musk split his time between SpaceX and Tesla.

In 2017, Elon Musk’s base salary as Tesla’s CEO was $49,920, an amount required by California’s minimum wage law; however, he was accepting only $1 in salary. The company’s Board of Directors in 2017 established an executive compensation plan for Musk tied to Tesla’s performance on various metrics; compensation was in the form of stock option awards subject to various vesting conditions. Musk con- trolled 37.8 million shares of Tesla common stock (worth some $13 billion in March 2018); his share- holdings gave him 21.9 percent of total shareholder voting power in Tesla.

TesLA IN 2018 Following the acquisition of Solar City, Tesla described its business in the following way:

We design, develop, manufacture and sell high- performance fully electric vehicles, and energy genera- tion and storage systems, and also install and maintain such systems and sell solar electricity. We are the world’s only vertically integrated sustainable energy company, offering end-to-end clean energy products, including generation, storage and consumption. We have estab- lished and continue to grow a global network of stores, vehicle service centers and Supercharger stations to accelerate the widespread adoption of our products, and

to San Francisco (a distance of 380 miles) in 30 minutes. He then held a press call to go over the details. In Musk’s vision, the Hyperloop would transport people via aluminum pods enclosed inside of steel tubes. He described the design as looking like a shotgun with the tubes running side by side for most of the route and closing the loop at either end.16 The tubes would be mounted on columns 50 to 100 yards apart, and the pods inside would travel up to 800 miles per hour. The pods could be small to carry just people or enlarged to allow people to drive a car into a pod and depart. Musk estimated that a Los Angeles-to-San Francisco Hyperloop, with 70 pods departing every 30 sec- onds and spaced 5 miles apart, could be built for $6 billion with people-only pods, or $10 billion for the larger pods capable of holding cars with people inside. Musk claimed his Hyperloop alternative would be four times as fast as California’s proposed $70 billion high-speed train, have a pleasant and super-smooth ride, and be “much cheaper” than air travel. Musk announced that he would not form a company to build Hyperloop systems; rather he was releasing his design in hopes that others would take on such projects. As of 2018, there were several Hyperloop projects under development and others being formally considered.

Since 2008, many business articles had been written about Musk’s brilliant entrepreneurship in creating companies with revolutionary products that either spawned new industries or disruptively trans- formed existing industries. In a 2012 Success maga- zine article, Musk indicated that his commitments to his spacecraft, electric car, and solar panel busi- nesses were long term and deeply felt.17 The author quoted Musk as saying, “I never expect to sort of sell them off and do something else. I expect to be with those companies as far into the future as I can imag- ine.” Musk indicated he was involved in SolarCity and Tesla Motors “because I’m concerned about the environment,” while “SpaceX is about trying to help us work toward extending life beyond Earth on a permanent basis and becoming a multiplanetary spe- cies.” The same writer described Musk’s approach to a business as one of rallying employees and inves- tors without creating false hope.18 The article quoted Musk as saying:

You’ve got to communicate, particularly within the company, the true state of the company. When people

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common stock, other types of long-term debt, and issues of new common stock to provide funding for research and development (R&D), the development of new models, expanded production capabilities, an ever-growing network of recharging stations, and opening retail showrooms and Tesla service centers. Tesla’s long-term debt and contractual capital lease obligations grew from $600 million at year-end 2013 to $9.4 billion at year-end 2017, and the number of shares of common stock outstanding rose from 119 million to nearly 166 million during the same period. In the most recent four years, Tesla had burned through cash at a torrid pace because of the heavy expenses it was incurring for design and engineering, gearing up to produce certain parts and component systems internally, constructing new facilities, equipping vehicle assembly lines with robotics technology, tools, and other machinery, and adding over 31,000 new employees to the almost 6,000 employees it had at year-end 2013.

Tesla ended 2017 with $3.4 billion in cash and cash equivalents. Executive management expected that the company’s capital expenditures in 2018 would total about $800 million.

TesLA’s sTRATeGY TO BeCOMe THe WORLD’s BIGGesT AND MOsT HIGHLY ReGARDeD PRODUCeR OF eLeCTRIC VeHICLes In 2018, Tesla’s strategy was focused on gearing up production of the Model 3 and expanding the compa- ny’s production capacity, finishing the construction of its $5 billion Gigafactory 1 near Reno, Nevada, to produce batteries and battery packs for Tesla’s vehicles, and adding sales galleries, service centers, and Supercharger stations in the United States, much of Europe, China, and Australia. At the Tesla Energy division, efforts were underway to (1) begin manu- facturing of photovoltaic cells and a new Solar Roof product at Gigafactory 2 in Buffalo, New York; (2) begin to grow the sales of its energy storage products currently being manufactured at Gigafactory 1; and (3) introduce the first-of-its-kind Solar Roof for com- mercial and residential applications. Tesla’s near- term objective was to triple its sales of energy storage products in 2018.

we continue to develop self-driving capability in order to improve vehicle safety. Our sustainable energy products, engineering expertise, intense focus to accelerate the world’s transition to sustainable energy, and business model differentiate us from other companies.

We currently produce and sell three fully electric vehicles, the Model S sedan, the Model X sport util- ity vehicle (“SUV”) and the Model 3 sedan. . . . We also intend to bring additional vehicles to market in the future, including trucks and an all-new sports car. . . .We sell our vehicles through our own sales and ser- vice network which we are continuing to grow globally. The benefits we receive from distribution ownership enable us to improve the overall customer experience, the speed of product development, and the capital efficiency of our business. We are also continuing to build our network of Superchargers and Destination Chargers in North America, Europe, and Asia to pro- vide both fast charging that enables convenient long distance travel.

. . .In addition, we are leveraging our technological expertise in batteries, power electronics, and integrated systems to manufacture and sell energy storage prod- ucts. In late 2016, we began production and deliver- ies of our latest generation energy storage products, Powerwall 2 and Powerpack 2. Powerwall 2 is a home battery. . . . Powerpack 2 is an energy storage system for commercial, industrial, and utility applications.

Finally, we sell and lease solar systems (with or without accompanying energy storage systems) to resi- dential and commercial customers and sell renewable energy to residential and commercial customers at prices that are typically below utility rates. Since 2006, we have installed solar energy systems for hundreds of thousands of customers. Our long-term lease and power purchase agreements with our customers gener- ate recurring payments and create a portfolio of high- quality receivables that we leverage to further reduce the cost of making the switch to solar energy. The elec- tricity produced by our solar installations represents a very small fraction of total U.S. electricity generation. With tens of millions of single-family homes and busi- nesses in our primary service territories, and many more in other locations, we have a large opportunity to expand and grow this business.

We manufacture our vehicle products primar- ily at our facilities in Fremont, California, Lathrop, California, Tilburg, Netherlands and at our Gigafactory 1 near Reno, Nevada. We manufacture our energy stor- age products at Gigafactory 1 and our solar products at our factories in Fremont, California and Buffalo, New York (Gigafactory 2).20

During 2014-2017, Tesla raised billions of dol- lars via the sale of senior notes convertible into

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Tesla’s Second Vehicle—The Model S Customer deliveries of Tesla’s second vehicle—the sleek, eye- catching Model S sedan—began in July 2012. Tesla introduced several new options for the Model S in 2013, including a sub-zero weather package, parking sensors, upgraded leather interior, several new wheel options, and a yacht-style center console. Xenon headlights and a high definition backup camera were made standard equipment on all Model S cars. In 2014 an all-wheel drive powertrain was introduced to provide buyers with four powertrain options. The Model S powertrain options were further modified several times. In March 2018, the Model S was being offered with three powertrains options:

• 75D—all-wheel drive, 75 kWh battery pack, 259 mile driving range, 0 to 60 mph in 4.2 sec- onds, with a standard price of $74,500

• 100D—all-wheel drive, 100 kWh battery pack, 335 mile driving range, 0 to 60 mph in 4.1 sec- onds, with a standard price of $94,000 (which included Smart Air Suspension)

• P100D—maximum performance all-wheel drive with dual front and rear motors (mounted on the front and rear axles), 100 kWh battery pack, 315 mile driving range, 0 to 60 mph in 2.5 seconds, with a standard price of $135,000 (which included the best interior and other premium upgrades)

Popular options included enhanced autopi- lot software ($5,000); full self-driving capability— subject to further software validation and regulatory approval ($3,000); and third-row, rear-facing seating ($4,000). From time to time, Tesla sent software updates to all Model S vehicles previously delivered to customers that included new and updated features. In 2018, all Model S vehicles had a standard software feature called “Range Assurance,” an always-running application within the car’s navigation system that kept tabs on the vehicle’s battery charge-level and the locations of Tesla Supercharging stations and parking-spot chargers in the vicinity. When the vehi- cle’s battery began running low, an alert appeared on the navigation screen, along with a list of nearby Tesla Supercharger stations and public charging facil- ities; a second warning appeared when the vehicle was about to go beyond the radius of nearby char- gers without enough juice to get to the next facility, at which point drivers were directed to the nearest charge point. There was also a Trip Planner feature that enabled drivers to plan long-distance trips based

Product Line Strategy A key element of Tesla’s long-term strategy was offer vehicle buyers a full line of electric vehicle options. So far Tesla had introduced four models—the Tesla Roadster, Model S, Model X, and Model 3. But plans were already in place to introduce the Tesla Semi truck (prototypes were being tested in March 2018), a crossover compact SUV (tentatively called the Model Y) based on a third-generation platform more advanced and production-efficient than the Model 3 (designs were to be publicly released in late 2018), a new Roadster 2 model, and a pick-up truck.

Tesla’s First Vehicle—The Tesla Roadster Following Tesla’s initial funding in 2004, Musk took an active role within the company. Although he was not involved in day-to-day business operations, he none- theless exerted strong influence in the design of the Tesla Roadster, a two-seat convertible that could accelerate from 0 to 60 miles per hour in as little as 3.7 seconds, had a maximum speed of about 120 miles per hour, could travel about 245 miles on a sin- gle charge, and had a base price of $109,000. Musk insisted from the beginning that the Roadster have a lightweight, high-strength carbon fiber body, and he influenced the design of components of the Roadster ranging from the power electronics module to the headlamps and other styling features.21 Prototypes of the Roadster were introduced to the public in July 2006. The first “Signature One Hundred” set of fully equipped Roadsters sold out in less than three weeks; the second hundred sold out by October 2007. General production began in March 2008. New mod- els of the Roadster were introduced in July 2009 (including the Roadster Sport with a base price of $128,500) and in July 2010. Sales of Roadster mod- els to countries in Europe and Asia began in 2010. From 2008 through 2012, Tesla sold more than 2,450 Roadsters in 31 countries.22 Sales of Roadster models ended in December 2012 so that the company could concentrate exclusively on producing and market- ing the Model S. However, Tesla announced in early 2015 that Roadster owners would be able to obtain a Roadster 3.0 package that enabled a 40 to 50 percent improvement in driving range to as much as 400 miles on a single charge; management indicated additional updates for Roadsters would be forthcoming. In 2017, Tesla announced it would re-introduce a new version of the Roadster in 2020 (after it began deliveries of the Tesla Semi truck and Model Y).

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$35,000, the range of available upgrades and options could up the price to $55,000 or more. The average selling price of the Model 3 was expected to be around $42,500.

By most estimates, going into 2018, at least 300,000 people had paid $1,000 to reserve a Model 3 and were waiting in line for delivery. From the outset, the Model 3 had been designed to enable efficient, high-volume production. However, the Model 3 still posed a much tougher production cost challenge than the three previous models, all of which had prices in the $80,000 to $130,000 range. The Model 3’s profit- ability hinged on being able to drive production costs per unit down more than 50 percent below what had been achieved with prior models. Of particular con- cern was the lithium-ion battery pack, the single big- gest cost component in the Model S and Model X, which had an estimated cost of $209 per kilowatt- hour as of December 2017.23 Part of the solution was equipping the Model 3 with less powerful electric motors, but a host of other cost-saving efficiencies had to be achieved as well—the cost-profit outcome was uncertain and speculative as of March 2018.

One factor likely to prove problematic for many prospective Model 3 buyers in the United States was a provision stating that once the cumulative sales vol- ume of a manufacturer’s zero emission vehicles in the United States reached 200,000 vehicles, the size of the $7,500 federal tax credit entered a one-year phase-out period where buyers of qualifying vehicles were “eligible for 50 percent of the credit if acquired in the first two quarters of the phase-out period and 25 percent of the credit if acquired in the third or fourth quarter of the phase-out period.”24 Purchasers of that manufacturer’s vehicles were not eligible for any federal tax credit after the phase-out period. Tesla’s cumulative sales in the United States would almost certainly exceed 200,000 vehicles sometime in 2018 (probably sometime before July 1), mean- ing that a hefty percentage of people with Model 3 reservations would qualify for only some or none of the $7,500 tax credit—buyers who leased a Tesla were not eligible for the tax credit (the credit went to the company offering the lease; the tax credits were also based on the size of the battery). Some states also offered tax credit for the purchases of plug-in electric vehicles. There were also a variety of tax credits offered by states. The governments of China, Japan, Norway, United Kingdom, and several other European countries offered tax incentives for electric

on the best locations for recharging both en route and at the destination; during travel, the software was programmed to pull in new data about every 30 seconds, updating to show which charging facili- ties had vacancies or were full. Autopilot software features were updated and upgraded as fast as they were developed and tested.

In the United States, customers who purchased a Model S (or any other Tesla model) were eligible for a federal tax credit of up to $7,500. A number of states also offered rebates on electric vehicle pur- chases, with states like California and New York offering rebates as high as $7,500. Customers who leased a Model S were not entitled to rebates.

Tesla’s Third Vehicle—The Model X Crossover SUV  To reduce the development costs of the Model X, Tesla had designed the Model X so that it could share about 60 percent of the Model S platform. The Model X had seating for 7 adults, dual electric motors that powered an all-wheel drive system, and a driving range of about 260 miles per charge. The Model X’s distinctive “falcon-wing doors” provided easy access to the second and third seating rows, resulting in a profile that resembled a sedan more than an SUV. The three drive train options for the Model X in 2018 were the same as for the Model S, but the driving ranges and acceleration times for the Model X were different from those of the Model S. In 2018, the standard price for the Model X with a 75D drive train was $79,500; the standard price for 100D Model X was $96,000 (which included Smart Air Suspension); and the standard price for a P100D Model X was $140,000 (which included the best inte- rior and other premium upgrades). The Model X was the first SUV ever to achieve a 5-star safety rating in every category and sub-category; it had both the low- est probability of occupant injury and a rollover risk half that of any SUV on the road. Over-the-Internet software updates were standard.

Tesla’s Fourth Vehicle—The Model 3 The idea behind the Model 3 was to incorporate all the company had learned from the development and production of the Roadster, Model S, and Model X to create the world’s first mass market electric vehicle priced on par with its gasoline-powered equivalents. The Model 3 was attractively styled, with seating for five adults, a driv- ing range of 210 to 310 miles depending on drive train selection, and 0 to 60 mph acceleration capability of less than 6 seconds. While the stated base price was

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say the company had about 2,000 reservations for the Semi. Observers speculated that near-term plans for the Semi had moved to the back burner tempo- rarily due to Tesla’s lack of capital to fund further development and build a new production facility for the Semi.

Model Y In In 2017, Elon Musk announced that Tesla had launched plans for the development and 2020 production of an all-electric crossover SUV that would be built on the same platform as the Model 3. The Model Y was expected to be a smaller version of the Model X and carry price tags comparable to the Model 3. Industry observers speculated that that Tesla would show prototypes of the Model Y in the second half of 2018, after hearing Musk say in May 2018 that the company would announce no later than the fourth quarter of 2018 where a production facil- ity for the Model Y would be located. Because Musk was aiming for production of one million Model Ys annually, a second Model Y facility was expected to be established in China in 2021. Musk also said, “I think the Model Y is going to be a manufacturing revolution.” However, it seemed doubtful that Tesla could get the Model Y into the marketplace by the end of 2020, given the 24 to 36 months it usually took to build a new vehicle production facility, equip it, staff it, and build out the supply chain. Some observers speculated that Tesla might purchase an existing plant from an automaker, since sedan pro- duction in the United States was dropping rapidly due to an accelerating shift in buyer preferences away from sedans and toward SUVs and light trucks. Ford Motor had just announced it would cease production of four of its slow-selling traditional passenger cars (Taurus, Fusion, Focus, and Fiesta) by 2020; General Motors was expected to cease production of its Chevrolet Cruze compact and possibly its Chevrolet Sonic and Impala sedans at the end of their current product cycles. Fiat Chrysler has already killed its Dodge Dart and Chrysler 200 sedan models.

Distribution Strategy: A Company- Owned and Operated Network of Retail Stores and Service Centers Tesla sold its vehicles directly to buyers and also provided them with after-sale service through a net- work of company-owned sales galleries and service centers. This contrasted sharply with the strategy of

vehicle purchases as well. In 2018, Canada discon- tinued the use of incentives for electric vehicles with a manufacturer’s suggested list price of price greater than C$75,000 (US$58,500).

The Tesla Semi-Truck Mention was made of a semi-truck in Tesla’s 2016 master plan. But behind the scenes Tesla had moved swiftly to come up with not only a design but also prototypes. The Semi was unveiled with much fanfare at a press conference on November 16, 2017. The company described the Semi as a Class 8 semi-trailer truck prototype that would be powered by 4 electric motors of the type used in the Model 3; have Tesla Autopilot, which per- mitted semi-autonomous driving, as standard equip- ment; and have a driving range of up to a range of 500 miles (805 km) on a full charge. Elon Musk said the 500-mile version, equipped with Tesla’s latest battery design, would be able to run for 400 miles (640 km) after an 80 percent charge in 30 minutes using a solar-powered Tesla Megacharger charging station. He also said the Semi would be able to accel- erate from 0 to 60 mph in 5 seconds unloaded and in 20 seconds fully loaded. Tesla expected to offer a warranty for a million miles and said maintenance would be simpler than for a diesel truck. Production of the Semi was scheduled to begin in 2019. A week later, Musk said that the regular production versions for the 300-mile range version of the Semi would be priced at $150,000 and the 500-mile range version would be priced at $180,000; the company also said it planned to offer a Founder’s Series Semi at $200,000. Scores of companies, including Wal-Mart, United Parcel Service, Anheuser-Busch, J.B. Hunt Trucking Co, and PepsiCo, immediately lined up to place pre- orders for 5 to 150 Semis (at an initial reservation price of $5,000, which was quickly raised to $20,000 per reservation) so they could conduct tests of how well the Semi would perform in their operations. In March 2018, Tesla began testing the Semi with real cargo, hauling battery packs from Gigafactory 1 in Nevada to the Tesla Factory in Fremont, California. Pictures of the Semi being loaded with cargo at the Nevada Gigafactory and traveling on the highways were immediately publicized in the media and posted on the Internet and social media.

In Elon Musk’s Q1 2018 Update Letter to Shareholders on May 2, 2018, no mention was made of the Tesla Semi; however, in a later conference call with Wall Street analysts that same day, Musk did

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key source of revenue and profit for the dealer but where warranty-related costs were typically a sub- stantial expense for the vehicle manufacturer.

Tesla Sales Galleries and Showrooms Currently, all of Tesla’s sales galleries and showrooms were in or near major metropolitan areas; some were in prominent regional shopping malls and others were on highly visible sites along busy thoroughfares. Most sales locations had only several vehicles in stock which were available for immediate sale. The vast majority of Tesla buyers, however, preferred to customize their vehicle by placing an order via the Internet, either while in a sales gallery or at home.

In years past, Tesla had aggressively expanded its network of sales galleries and service centers to broaden its geographical presence and to provide bet- ter maintenance and repair service in areas with a high concentration of Tesla owners. In 2013, Tesla began combining its sales and service activities at a single location (rather than having separate locations, as earlier had been the case); experience indicated that combination sales and service locations were more cost-efficient and facilitated faster expansion of the company’s retail footprint. At the end of 2017, Tesla had 338 sales and service locations around the world; an unspecified number of new openings were planned for 2018. Tesla’s goal was to have sufficient service locations to ensure that after-sale services were available to owners when and where needed.

However, in the United States, there was a lurk- ing problem with Tesla’s strategy to bypass distribut- ing through franchised Tesla dealers and sell directly to consumers. Going back many years, franchised automobile dealers in the United States had feared that automotive manufacturers might one day decide to integrate forward into selling and servicing the vehicles they produced. To foreclose any attempts by manufacturers to compete directly against their fran- chised dealers, automobile dealers in every state in the United States had formed statewide franchised dealer associations to lobby for legislation blocking motor vehicle manufacturers from becoming retailers of new and used cars and providing maintenance and repair services to vehicle owners. Legislation either forbid- ding or severely restricting the ability of automakers to sell vehicles directly to the public had been passed in 48 states; these laws had been in effect for many years, and franchised dealer associations were diligent in pushing for strict enforcement of these laws.

rival motor vehicle manufacturers, all of whom sold vehicles and replacement parts at wholesale prices to their networks of franchised dealerships that in turn handled retail sales, maintenance and service, and warranty repairs. Management believed that inte- grating forward into the business of traditional auto- mobile dealers and operating its own retail sales and service network had three important advantages:

1. The ability to create and control its own version of a compelling buying customer experience, one that was differentiated from the buying experience consumers had with sales and service locations of franchised automobile dealers. Having customers deal directly with Tesla-employed sales and service personnel enabled Tesla to (a) engage and inform potential customers about electric vehicles in gen- eral and the advantages of owning a Tesla in par- ticular and (b) build a more personal relationship with customers and, hopefully, instill a lasting and favorable impression of Tesla Motors, its mission, and the caliber and performance of its vehicles.

2. The ability to achieve greater operating economies in performing sales and service activities. Management believed that a company-operated sales and ser- vice network offered substantial opportunities to better control inventory costs of both vehicles and replacement parts, manage warranty service and pricing, maintain and strengthen the Tesla brand, and obtain rapid customer feedback.

3. The opportunity to capture the sales and service rev- enues of traditional automobile dealerships. Rival motor vehicle manufacturers sold vehicles and replacement parts at wholesale prices to their networks of franchised dealerships that in turn handled retail sales, maintenance and service, and warranty repairs. But when Tesla buyers purchased a vehicle at a Tesla-owned sales gallery, Tesla cap- tured the full retail sales price, roughly 10 percent greater than the wholesale price realized by vehi- cle manufacturers selling through franchised deal- ers. And, by operating its own service centers, it captured service revenues not available to vehicle manufacturers who relied upon their franchised dealers to provide needed maintenance and repairs. Furthermore, Tesla management believed that company-owned service centers avoided the conflict of interest between vehicle manufactur- ers and their franchised dealers where the sale of warranty parts and repairs by a dealer were a

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Vehicle Limited Warranty. Mobile service pricing was based on a per visit, per vehicle basis; there was a $100 minimum charge per visit. Tesla’s mobile ser- vice fleet consisted of 230 vehicles in February 2018, with coverage of all of North America. Going into 2018, the company’s mobile service fleet in North America was completing 30 percent of all service jobs at a cost below the average fees charged at its service centers.

Prepaid Maintenance Program Tesla recommended that Model S and Model X owners have an inspection every 12 months or 12,500 miles, whichever came first. Owners could purchase plans covering prepaid mainte- nance for three years or four years; these involved sim- ply prepaying for service inspections at a discounted rate. All Model S or Model X vehicles were protected by a 4 year or 50,000 miles (whichever came first) New Vehicle Limited Warranty and an 8 year or unlim- ited miles Battery and Drive Unit Limited Warranty. These warranties covered the repair or replacement necessary to correct defects in materials or workman- ship of any parts manufactured or supplied by Tesla. Owners could also purchase an Extended Service Agreement for 2 years (or 25,000 miles) or four years or 50,000 miles, whichever came first.

Tesla’s Supercharger Network: Providing Recharging Services to Owners on Long Distance Trips A major component of Tesla’s strategy to build rapidly-growing long-term demand for its vehicles was to make battery recharging while driving long distances convenient and worry-free for all Tesla vehicle owners. Tesla’s solution to providing owners with ample and conve- nient recharging opportunities was to establish an extensive geographic network of recharging stations. Tesla’s Supercharger stations were strategically placed along major highways connecting city centers, usually at locations with such nearby amenities as roadside diners, cafes, and shopping centers that enabled own- ers to have a brief rest stop or get a quick meal during the recharging process—about 90 percent of Model S and Model X buyers opted to have their vehicle equipped with supercharging capability when they ordered their vehicle. All Model S and Model X own- ers were entitled to free supercharging service at any of Tesla’s Supercharging stations; Model 3 owners had to pay a recharging fee. In March 2018, Tesla announced price increases for its Supercharging stations to about $0.25 per kwh. Tesla owners charged their vehicles

As sales of the Model S rose briskly from 2013 to 2015 and Tesla continued opening more sales gal- leries and service centers, both franchised dealers and statewide dealer associations became increas- ingly anxious about “the Tesla problem” and what actions might need to be taken. Dealers and dealer trade association in a number of states were openly vocal about their concerns and actively began lobby- ing state legislatures to consider either enforcement actions against Tesla or amendments to existing leg- islation that would bring a halt to Tesla’s efforts to sell vehicles at company-owned showrooms. A host of skirmishes ensued in 12 states. In several cases, settlements were reached that allowed Tesla to open a select few sales locations, but the numbers were capped. In states where manufacturer direct sales to consumers were expressly prohibited, Tesla was allowed to have sales galleries, service centers, and Supercharger locations—but was prevented from using its sales galleries to take orders, conduct test drives, deliver cars, or discuss pricing with potential buyers. Buyers in these states could place an order via the Internet, specify when would like the car to arrive, and then either have it delivered to a nearby Tesla service center for pickup or have it delivered directly to their home or business location. As of March 2018, the prevailing state restrictions on Tesla sales galleries did not seem to be limiting Tesla’s sales in a meaningful way.

Tesla Service Centers Tesla Roadster owners could upload data from their vehicle and send it to a service center on a memory card; all other Tesla owners had an on-board system that could communicate directly with a service center, allowing service technicians to diagnose and remedy many problems before ever looking at the vehicle. When maintenance or service was required, a customer could schedule service by contacting a Tesla service center. Some service loca- tions offered valet service, where the owner’s car was picked up, replaced with a very well-equipped Model S loaner car, and then returned when the service was completed—there was no additional charge for valet service. In some locations, owners could opt to have service performed at their home, office, or other remote location by a Tesla Mobile Service technician who had the capability to perform a variety of ser- vices that did not require a vehicle lift. Mobile service technicians could perform most warranty repairs, but the cost of their visit was not covered under the New

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moving parts than the powertrains of traditional gasoline-powered vehicles, a feature that enabled Tesla to implement powertrain enhancements and improvements as fast as they could be identified, designed, and tested. Tesla had incorporated its latest powertrain technology into its three current models and was planning to use much of this technology in producing its forthcoming electric vehicles.

Although Tesla had more than 500 patents and pending patent applications domestically and inter- nationally in a broad range of areas, in 2014, Tesla announced a patent policy whereby it irrevocably pledged the company would not initiate a lawsuit against any party for infringing Tesla’s patents through activity relating to electric vehicles or related equip- ment so long as the party was acting in good faith. Elon Musk said the company made this pledge in order to encourage the advancement of a common, rapidly- evolving platform for electric vehicles, thereby benefit- ing itself, other companies making electric vehicles, and the world. Investor reaction to this announcement was largely negative on grounds that it would negate any technology-based competitive advantage over rival manufacturers of electric vehicles.

Battery Pack In prior years, Tesla had tested hun- dreds of battery cells of different chemistries and performance features. It had an internal battery cell testing lab and had assembled an extensive perfor- mance database of the many available lithium-ion cell vendors and chemistry types. Based on this evaluation, it had elected to use “18650 form factor” lithium-ion battery cells, chiefly because a battery pack containing 18,650 cells offered two to three times the driving range of the lithium-ion cells used by other makers of electric vehicles. Management believed that the company’s accumulated experience and expertise had produced a core competence in designing battery packs that were safe, reliable, and had long lives. At the same time, it had pioneered the development of advanced manufacturing techniques that enabled mass production of high quality bat- tery packs at low cost. Ongoing improvement of its production methods had allowed the Tesla to reduce the costs and improve the performance of its batter- ies over time. Management believed Tesla’s current battery pack design gave it the ability to change bat- tery cell chemistries and form factor if needed and, also, to capitalize on the advancements in battery cell technology being made globally. Going forward,

at home more than 90 percent of the time and used Supercharger stations mainly for trips or when they needed extra range. A 50 percent recharge took 20 minutes, an 80 percent recharge took 40 minutes, and a 100 percent recharge took 75 minutes. As of year-end 2017, Tesla had a total of 1,128 Supercharger stations globally; most Tesla stations had between 6 and 20 charging spaces, but newer stations in high- traffic corridors had as many as 40 spaces, a customer lounge, and a café. About 300 new Supercharger loca- tions were planned for 2018.

Tesla executives never expected that Supercharger stations would become a profit center for the company; rather, they believed that the ben- efits of rapidly growing the size of the company’s Supercharger network came from (1) relieving the “range anxiety” electric vehicle owners suffered when driving on a long-distance trip and (2) reducing the inconvenience to travelers of having to deviate from the shortest direct route and detour to the closest Supercharger station for needed recharging.

Technology and Product Development Strategy Headed into 2018, Tesla had spent over $4.1 billion on R&D activities to design, develop, test, and refine the components and systems needed to produce top quality electric vehicles and, further, to design and develop prototypes of the Tesla Roadster, Model S, Model X, Model 3, and Tesla Semi vehicles (see Exhibit 1 for R&D spending from 2013 to 2017). Tesla executives believed its R&D activities had produced core competencies in powertrain and vehicle engineering and innovative manufacturing techniques. The company’s core intellectual property was contained in its electric powertrain technology— the battery pack, power electronics, induction motor, gearbox, and control software that enabled these key components to operate as a system. Tesla personnel had designed each of these major elements for the Tesla Roadster and Model S; much of this technol- ogy had been used in the powertrain systems that Tesla previously had built for other manufacturers (mainly Toyota and Mercedes) and had been fur- ther improved and refined in the powertrain systems being used in the Model X, Model 3, and the proto- types for the Tesla Semi.

The powertrain used in Tesla vehicles in 2018 was a compact, modular system with far fewer

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Control Software The battery pack and the perfor- mance and safety systems of Tesla vehicles required the use of numerous microprocessors and sophisti- cated software. For example, computer-driven soft- ware monitored the charge state of each of the cells of the battery pack and managed all of the safety sys- tems. The flow of electricity between the battery pack and the motor had to be tightly controlled in order to deliver the best possible performance and driv- ing experience. There were software algorithms that enabled the vehicle to mimic the “creep” feeling that drivers expected from an internal combustion engine vehicle without having to apply pressure on the accel- erator. Other algorithms were used to control traction, vehicle stability, acceleration, and regenerative brak- ing. Drivers used the vehicle’s information systems to optimize performance and charging modes and times. In addition to the vehicle control software, Tesla had developed software for the infotainment systems of the Model S, Model X, and Model 3. Almost all of the software programs had been developed and written by Tesla personnel. Starting in 2014, Tesla began devot- ing progressively larger fractions of its programming resources and expertise to developing and enhancing its software for vehicle autopilot functionality, includ- ing such features as auto-steering, traffic aware cruise control, automated lane changing, automated parking, driver warning systems, automated braking, object detection, and self-driving. In October 2016, Tesla began equipping all models with hardware needed for full self-driving capability, including cameras that provided 360-degree visibility, updated ultrasonic sen- sors for object detection, a forward-facing radar with enhanced processing, and a powerful onboard com- puter. Wireless software updates periodically sent to the microprocessors on board each Tesla owner’s vehicle, together with field data feedback loops from the onboard camera, radar, ultrasonic sensors, and GPS, enabled the autopilot system in Tesla vehicles to continually learn and improve its performance. In March 2018, Elon Musk said he expected Tesla’s auto- pilot software to be able to handle all modes of driving by the end of 2019 and that Tesla’s autopilot system would safer than human drivers within two years.

Vehicle Design and Engineering Tesla had devoted considerable effort to creating significant in-house capabilities related to designing and engineering portions of its vehicles, and it had

Tesla believed it had the capabilities to quickly incor- porate the latest advancements in battery technology and continue to optimize battery pack system perfor- mance and cost for its future vehicles.

Power Electronics The power electronics in Tesla’s powertrain system had two primary functions—the control of torque generation in the motor while driving and the control of energy delivery back into the battery pack while charging. The first function was accomplished through the drive inverter, which converted direct current from the battery pack into alternating current to drive the induction motors, provide acceleration, and enhance the overall driving performance of the vehicle. The second function was to capture kinetic energy from the wheels being in motion but being slowed down by applying the brakes and reverse the flow of energy to help recharge the battery pack—a technology called “regenerative brak- ing.” (When brakes are applied in gasoline-powered vehicles, the brake pads clamp down on the wheels to slow the vehicle (letting the kinetic energy escape as heat); but in electric vehicles (and most hybrid vehicles), the regenerative braking systems slow the vehicle by reversing the flow of electricity to the electric motors powering the wheels, while also cap- turing the heat from the kinetic energy to generate electrical energy for partially recharging the battery pack.) When the electric vehicle was parked, battery recharging was accomplished by the vehicle’s charger, which converted alternating current (usually from a wall outlet or other electricity source) into direct cur- rent which could be accepted by the battery.

Owners could use any available source of power to charge a Tesla’s battery pack. A standard 12 amp/110-volt wall outlet could recharge a mostly discharged battery pack to full capacity in about 21 hours. Tesla recommended that owners install at least a 24 amp/240-volt outlet in their garage or carport (the same voltage used by many electric ovens and clothes dryers), which permitted charging at the rate of 34 miles of range per hour of charg- ing time. But owners who installed a more power- ful 60-amp/240-volt wall connector outlet could charge a 75 kWh battery that had been driven 300 miles in 8 hours and 42 minutes; installation of a 90 amp/240 volt circuit breaker enabled charging a 100 kWh battery in 5 hours and 47 minutes. On a road trip, a 120 kW Supercharger could recharge a battery driven 300 miles in 75 minutes.

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In May 2010, Tesla purchased the major por- tion of a recently closed automobile plant in Fremont, California, for $42 million; months later, Tesla purchased some of the plant’s equipment for $17 million. The facility—formerly a General Motors manufacturing plant (1960–1982), then operated as joint venture between General Motors and Toyota (1984–2010)—was closed in 2010. Tesla execu- tives viewed the facility as one of the largest, most advanced, and cleanest automotive production plants in the world. The 5.3 million square feet of manu- facturing and office space was deemed sufficient for Tesla to produce about 500,000 vehicles annually (approximately 1 percent of the total worldwide car production), thus giving Tesla room to grow its out- put of electric vehicles to 500,000 or more vehicles annually. The Fremont plant’s location in the north- ern section of Silicon Valley facilitated hiring tal- ented engineers already residing nearby and because the short distance between Fremont and Tesla’s Palo Alto headquarters ensured “a tight feedback loop between vehicle engineering, manufacturing, and other divisions within the company.”25 Tesla offi- cially took possession of the 370-acre site in October 2010, renamed it the Tesla Factory, and immediately launched efforts to get a portion of the massive facil- ity ready to begin manufacturing components and assembling the Model S in 2012. In late 2015, Tesla completed construction of a new high-volume paint shop and a new body shop line capable of turning out 3,500 Model S and Model X bodies per week (enough for 175,000 vehicles annually). In 2016 and 2017, Tesla made significant additional investments at the Tesla Factory, including a new body shop with space and equipment for Model 3 final assembly. Tesla expected the Fremont facility, together with a neighboring 500,000-square-foot building that Tesla had leased, would be expanded to 10 million square feet in the coming years. However, there were strong rumors in 2018 that Tesla was actively looking for additional production sites—one in the United States, one in China, and one in Europe.

In December 2012, Tesla opened a new 60,000 square-foot facility in Tilburg, Netherlands, about 50 miles from the port of Rotterdam, to serve as the final assembly and distribution point for all Tesla vehi- cles sold in Europe and Scandinavia. The facility, called the Tilburg Assembly Plant, received nearly complete vehicles shipped from the Tesla Factory, performed certain final assembly activities, conducted final

become knowledgeable about the design and engi- neering of those parts, components, and systems that it purchased from suppliers. Tesla personnel had designed and engineered the body, chassis, and interior of its current models. As a matter of neces- sity, Tesla was forced to redesign the heating, cool- ing, and ventilation system for its electric vehicles to operate without the energy generated from an internal combustion engine and to integrate with its own battery-powered thermal management system. In addition, the low voltage electric system which powered the radio, power windows, and heated seats had to be designed specifically for use in an electric vehicle. Tesla had developed expertise in integrat- ing these components with the high-voltage power source in its vehicles and in designing components that significantly reduced their load on the vehicle’s battery pack, so as to maximize the available driv- ing range. All Tesla vehicles incorporated the latest advances in mobile computing, sensing, displays, and connectivity.

Tesla personnel had accumulated considerable expertise in lightweight materials, since an electric vehicle’s driving range was heavily impacted by the vehicle’s weight and mass. The Tesla Roadster had been built with an in-house designed carbon fiber body to provide a good balance of strength and mass. The Model S and Model X had a lightweight alumi- num body and a chassis that incorporated a variety of materials and production methods to help optimize vehicle weight, strength, safety, and performance. Weight reduction was an important factor in the design of the Model 3. In addition, top management believed that the company’s design and engineer- ing team had core competencies in computer-aided design and crash test simulations; this expertise was had reduced the development time for the Model 3 and the Tesla Semi prototypes.

Manufacturing Strategy Tesla had contracted with Lotus Cars, Ltd. to pro- duce Tesla Roadster “gliders” (a complete vehicle minus the electric powertrain) at a Lotus factory in Hethel, England. The Tesla gliders were then shipped to a Tesla facility in Menlo Park, California, where the battery pack, induction motors, and other pow- ertrain components were installed as part of the final assembly process. The production of Roadster glid- ers ceased in January 2012.

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production, higher prices for component parts dur- ing the first several months of production runs, and higher logistics costs associated with the immaturity of Tesla’s supply chain. However, as Tesla engineers redesigned various elements of the Model S for greater ease of manufacturing, supply chain improve- ments were instituted, and manufacturing efficiency rose, the costs of some parts decreased, and overall production costs the Model S trended downward.

Tesla had encountered a number of unexpected quality problems in the first two to three months of manufacturing the Model X. Getting the complicated hinges on the falcon-wing doors to function properly proved to be particularly troublesome. Customers who received the first wave of Model X deliveries also reported problems with the front doors and windows and with the 17-inch dashboard touchscreen freezing (a major problem because so many functions were controlled from this screen). Most of these problems were largely resolved by mid-2016, although Model X owners rated the reliability of their vehicles signifi- cantly lower than Model S owners—the chief culprit was the falcon-wing doors, which reportedly had generated significant warranty claims and warranty costs. Weekly production volumes of the Model X rose steadily in over the next three months.

Further manufacturing efficiency gains were made in producing the Model S and Model through the first half of 2017. Major gains in production effi- ciency were expected in the second half of 2018 and beyond as production of the Model X ramped up.

Tesla’s “Gigafactory 1” In February 2014, Tesla announced that it and various partners, principally Panasonic—Tesla’s supplier of lithium-ion batter- ies since 2010—would invest $4 to 5 billion through 2020 in a “gigafactory” capable of producing enough lithium-ion batteries to make battery packs for 500,000 vehicles (plus Tesla’s recently-developed energy stor- age products for both businesses and homeowners); the planned output of the battery factory in 2020 exceeded the total global production of lithium bat- teries in 2013. Tesla’s direct investment in the project was scheduled to be $2 billion. Tesla expected the new plant (named the Tesla Gigafactory) to reduce the company’s battery pack cost by more than 30 percent— to around $200 per kWh by some estimates (from the current estimated level of about $300 per kWh).

In September 2014, Tesla announced that the Tesla Gigafactory would be located on a site in an

vehicle testing, and handled the delivery to customers across. It also functioned as Tesla’s European service and parts headquarters. Tilburg’s central location and its excellent rail and highway network to all major markets on the European continent allowed Tesla to distribute to anywhere across the continent in about 12 hours. The Tilburg operation had been expanded to over 200,000 square feet in order to accommodate a parts distribution warehouse for service centers throughout Europe, a center for remanufacturing work, and a customer service center. A nearby facil- ity in Amsterdam provided corporate oversight for European sales, service, and administrative functions.

Tesla’s manufacturing strategy was to source a number of parts and components from outside suppli- ers but to design, develop, and manufacture in-house those key components where it had considerable intellectual property and core competencies (namely lithium-ion battery packs, electric motors, gearboxes, and other powertrain components) and to perform all assembly-related activities itself. In 2018, the Tesla Factory contained several production-related activi- ties, including stamping, machining, casting, plastics molding, drive unit production, robotics-assisted body assembly, paint operations, final vehicle assem- bly, and end-of-line quality testing. In addition, the Tesla Factory manufactured lithium-ion battery packs, electric motors, gearboxes, and certain other components for its vehicles. In addition, Tesla manu- factured lithium-ion battery packs, electric motors, gearboxes and components for Model S and Model X at the Tesla Factory. While some major vehicle component systems were purchased from suppli- ers, there was a high level of vertical integration in the manufacturing processes at the Tesla Factory in 2018. From 2016 to 2018, efforts to expand pro- duction capacity at the Tesla Factory were ongoing to accommodate growing sales of the Model S and Model X and to enable production of the Model 3 to reach 10,000 units per week.

In 2014, Tesla began producing and machining various aluminum components at a 431,000 square- foot facility in Lathrop, CA; an aluminum castings operation was added in 2016. Aluminum parts and components were used extensively to help reduce the weight of Tesla vehicles.

Initially, production costs for the Model S were adversely impacted by an assortment of start-up costs at the Tesla Factory, manufacturing inefficien- cies associated with inexperience and low-volume

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convertible senior notes due 2019 carrying an inter- est rate of 0.25 percent and $1.38 billion in convert- ible senior notes due 2021 carrying an interest rate of 1.25 percent. The senior notes due 2019 were convert- ible into cash, shares of Tesla’s common stock, or a combination thereof, at Tesla’s election. The convert- ible senior notes due 2021 were convertible into cash and, if applicable, shares of Tesla’s common stock (subject to Tesla’s right to deliver cash in lieu of shares of common stock). To protect existing shareholders against ownership dilution that might result from the senior notes being converted into additional shares of Tesla stock, Tesla immediately entered into convert- ible note hedge transactions and warrant transactions at an approximate cost of $186 million that manage- ment expected would reduce potential dilution of existing shareholder interests and/or offset cash pay- ments that Tesla was required to make in excess of the principal amounts of the 2019 notes and 2021 notes.

Supply Chain Strategy Tesla’s Model S and Model X used thousands of purchased parts and compo- nents sourced globally from hundreds of suppliers, the majority of whom were currently single-source suppliers. It was the company’s practice to obtain the needed parts and components from multiple sources whenever feasible, and Tesla was trying to secure alternate sources of supply for many single sourced components. So far, success had been limited, which had prompted the company to produce more parts and components internally within a year or two. However, qualifying alternate suppliers for certain highly customized components—or producing them internally—was thought to be both time consuming and costly, perhaps even requiring modifications to a vehicle’s design.

While Tesla had developed close relationships with the suppliers of lithium-ion battery cells and cer- tain other key system parts, it typically did not have long-term agreements with them with the exception of the relationship it had with Panasonic. However, Tesla was working to fully qualify additional battery cells from other manufacturers.

Marketing Strategy From 2014 to 2017, Tesla’s principal marketing goals and functions were to:

• Generate demand for the company’s vehicles and drive sales leads to personnel in the Tesla’s show- rooms and sales galleries.

industrial park east of Reno, Nevada. The Nevada site was thought to be chosen partly because the state of Nevada offered Tesla a lucrative incentive package said to be worth $1.25 billion over 20 years and partly because the only commercially active lithium mining operation in the United States was in a nearby Nevada county (this county was reputed to have the fifth largest deposits of lithium in the world). Construction began immediately. The facility was being built in phases, with the final phase scheduled for completion in 2020.

As of 2017, some 5.5 million square-feet of space, powered by wind and solar generating facilities located nearby, was operational or nearly so. Battery cell pro- duction began in early 2017; the plan called for Tesla to work closely with Panasonic and other partners to inte- grate battery material, cell, module, and battery pack production in one location. The battery packs manu- factured at the Gigafactory (now called Gigafactory 1) were used for all Tesla vehicles and for the company’s two primary energy storage products (Powerwall and Powerpack). In 2018, Tesla was also using space at Gigafactory 1 to manufacture Model 3 drive units.

In 2018, Tesla expected Gigafactory 1 would pro- duce 35 Gigawatt hours of lithium-ion battery cells (a Gigawatt is a unit of electric power equal to 1 billion watts or 1000 megawatts), nearly as much as the rest of the world’s entire battery production combined. Plans were in already place to expand the battery-making capacity at Gigafactory 1 well beyond the amount needed for 500,000 vehicles per year and for Tesla’s energy storage products. As many as 10,000 work- ers were expected to be employed at Gigafactory 1 in 2020. Because Tesla had recently discovered ways to build an improved lithium-ion battery that would be larger, safer, and require fewer individual batteries per battery pack, Tesla executives were confident the company would achieve a significant reduction in the unit cost of producing battery packs once the Model 3 reached high-volume production. At present, Tesla believed its ownership of Gigafactory 1 and partner- ship with Panasonic gave the company sole access to the highest-volume and lowest-cost source of lithium- ion batteries in the world. However, in March 2018 Volkswagen indicated it had just signed agreements with battery-makers to supply the company with bat- teries for its forthcoming electric vehicles at a cost of about $115 kWh, significantly below the $200 per kWh cost Tesla was targeting for Gigafactory 1 in 2018.

Less than a month after announcing its intent to build the Gigafactory, Tesla sold $920 million of

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United States, Germany, Canada, and Great Britain. Tesla management intended to broaden its financial services offerings during the next several years.

Some of Tesla’s current financing programs out- side of North America provided customers with a resale value guarantee under which those customers had the option of selling their vehicle back to Tesla at a preset future date, generally at the end of the term of the applicable loan or financing program, for a pre-determined resale value. In certain markets, Tesla also offered vehicle buyback guarantees to finan- cial institutions that could obligate Tesla to repur- chase the vehicles for a predetermined price. These programs, when first introduced in 2015 and 2016 had been widely publicized and attracted numer- ous buyers, but Tesla determined in late 2016 and 2017 to back away from these offers in most coun- tries because they were proving unprofitable, had unattractive accounting requirements, and exposed Tesla to the risk that the vehicles’ resale value could be lower than its estimates and also to the risk that the volume of vehicles sold back to Tesla at the guar- anteed resale price might be higher than the com- pany’s estimates—such risks had to be accounted for by establishing a contingent liability (in the current liabilities section of the balance sheet) deemed suf- ficient to cover these risks.

Sales of Regulatory Credits to Other Automotive Manufacturers Because Tesla’s electric vehicles had no tailpipe emis- sions of greenhouse gases or other pollutants, Tesla earned zero emission vehicle (ZEV) and greenhouse gas (GHG) credits on each vehicle sold in the United States. Moreover, it also earned corporate average fuel economy (CAFE) credits on its sales of vehicles because of their high equivalent miles per gallon rat- ings. All three of these types of regulatory credits had significant market value because the manufacturers of traditional gasoline-powered vehicles were subject to assorted emission and mileage requirements set by the U.S. Environmental Protection Agency (EPA) and by certain state agencies charged with protect- ing the environment within their borders; automo- tive manufacturers whose vehicle sales did not meet prevailing emission and mileage requirements were allowed to achieve compliance by purchasing credits earned by other automotive manufacturers. Tesla had entered into contracts for the sale of ZEV and GHG

• Build long-term brand awareness and manage the company’s image and reputation.

• Manage the existing customer base to create brand loyalty and generate customer referrals.

• Obtain feedback from the owners of Tesla vehicles and make sure their experiences and suggestions for improvement were communicated to Tesla personnel engaged in designing, developing, and/ or improving the company’s current and future vehicles.

As the first company to commercially produce a federally-compliant, fully electric vehicle that achieved market-leading range on a single charge, Tesla had been able to generate significant media cov- erage of the company and its vehicles. Management expected this would continue to be the case for some time to come. So far, the extensive media coverage, largely favorable reviews in motor vehicle publica- tions and Consumer Reports, praise from owners of Tesla vehicles and admiring car enthusiasts (which enlarged Tesla’s sales force at zero cost), and the deci- sions of many green-minded affluent individuals to help lead the movement away from gasoline-powered vehicles had all combined to drive good traffic flows at Tesla’s sales galleries and create a flow of orders and pre-production reservations. As a consequence, during 2012-2017, Tesla had achieved a growing vol- ume of sales without traditional advertising and at relatively low marketing costs. Nonetheless, Tesla did make use of pay-per-click advertisements on websites and mobile applications relevant to its target clien- tele. It also displayed and demonstrated its vehicles at such widely attended public events as the Detroit, Los Angeles, and Frankfurt auto shows.

In early 2018, Tesla negotiated marketing agree- ments with both Home Depot and Lowe’s to stock and help promote its innovative Solar Roof tiles for residential and commercial roof applications.

Tesla’s Leasing Activities Tesla, in partnership with various financial institu- tions, began leasing vehicles to customers in 2014; the number and percentage of customers opting to lease Model S vehicles increased substantially in 2015. By year-end 2015, Tesla was not only offering loans and leases in North America, Europe, and Asia through its various partner financial institutions, but it was also offering loans and leases directly through its own captive finance subsidiaries in certain areas of the

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additional features. In 2018, these two energy stor- age products were being used for backup power, independence from utility grids, peak demand reduc- tion, demand response, reducing intermittency of renewable generation, and wholesale electric market services.

When Solar Energy was merged into Tesla, the company arranged to lease a facility, called Gigafactory 2, in Buffalo, New York, to produce (1) solar energy systems sold to residential and commer- cial customers and (2) its freshly-developed Solar Roof, which used aesthetically pleasing and durable glass roofing tiles designed to complement the archi- tecture of homes and commercial buildings, to turn sunlight into electricity that was being marketed in 2018 with distribution partners Home Depot and Lowe’s.

Tesla Energy’s solar energy systems included solar panels that converted sunlight into electri- cal current, inverters that converted the electrical output from the panels to a usable current compat- ible with the electric grid, racking that attached the solar panels to the roof or ground, electrical hard- ware that connected the solar energy system to the electric grid, and a monitoring device. The majority of the components were purchased from vendors; the company maintained multiple sources for each major component to ensure competitive pricing and adequate supplies.

Tesla Energy had an in-house engineering team that designed its energy storage products and cre- ated customized energy storage solutions and solar energy systems for customers. In the United States, it used its national sales organization, channel partner network, and customer referral program to market and sell its residential solar and energy storage sys- tems. Outside the United States, Tesla Energy used its international sales organization and a network of channel partners to market and sell Powerwall 2, and it had recently launched pilot programs for the sale of residential solar products in certain countries. It also sold Powerwall 2 directly to utilities, who then installed the product in customer homes.

In December 2017, Tesla completed installation of a 100-megawatt lithium-ion battery hooked into the electricity grid in South Australia to relieve power shortages created by a tornado in 2016. Elon Musk had promised that once the contract was signed, Tesla would complete the project in 100 days or it would be furnished free of charge—Tesla completed

credits with several automotive manufacturers, and it also routinely sold its CAFE credits. Tesla’s sales of ZEV, GHG, and CAFE credits produced revenues of $360.3 million in 2017, $302.3 million in 2016, $168.7 million in 2015, $216.3 million in 2014, and $194.4 million in 2013. In Exhibit 2, these amounts were included on Tesla’s income statement in the rev- enue category labeled “Automotive sales”; without these revenues, as frequently noted by Wall Street analysts, Tesla’s losses in 2013 through 2017 would have been significantly higher.

TesLA eNeRGY IN 2018 In 2015, Tesla formed Tesla Energy, a new subsidiary that would begin producing and selling two energy storage products in 2016—Powerwall for homeowners and Powerpack for industrial, commercial, and util- ity customers. Powerwall was a lithium-ion battery charged either by electricity generated from a home’s solar panels or from power company sources when electric rates were low. Tesla saw Powerwall as prin- cipally a product that energy-conscious homeowners with a rooftop solar system could use to lower their monthly electric bills by programming Powerwall to power their homes during certain hours when local power company rates were high and then recharging the battery during the late-night hours when rates were low. However, Powerwall home batteries could also be used as a backup power source in case of unexpected power outages. Powerpack models were 100 kW lithium-ion batteries that industrial, com- mercial, and utility enterprises could use for energy storage or backup power.

In the first week after announcing its new Powerwall and Powerpack products, Tesla received 38,000 reservations for Powerwall (residential buyers could place a reservation with no money down) and requests from 2,500 companies indicating interest in installing or distributing Powerpack batteries. Tesla moved swiftly to prepare its supply chain and produc- tion teams to begin volume builds on both products. Production began at the Tesla Factory in Fremont and then shifted to the Gigafactory in the last part of 2015. In early 2016, both Powerwall and Powerpack production was operating smoothly and expand- ing at the Gigafactory. Production and deliveries of Powerwall 2 and Powerpack 2 began in late 2016. Both products had the capability to receive over- the-air firmware and software updates that enabled

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when the vehicle’s battery pack (rechargeable only from an external plug-in source) was depleted, usu- ally after a distance of 20 to 50 miles. Hybrid vehi- cles were jointly powered by an internal combustion engine and an electric motor that ran on batteries charged by regenerative braking and the internal combustion engine; the batteries in a hybrid vehicle could not be restored to a full charge by connecting a plug to an external power source. Exhibit 3 shows the 10 best-selling plug-in electric vehicles in the United States from 2013 through 2017.

There was no question in 2018 and beyond that Tesla was faced with intensifying competition in the global marketplace for electric-powered vehicles. Virtually every motor vehicle manufacturer in the world was developing new battery-powered electric vehicles, most with driving ranges of 200 miles or more. In 2018 and 2019, models with 200+ mile driving ranges were scheduled to be introduced by Audi, Jaguar, Mercedes, Kia, Volvo, General Motors, and Hyundai. Models from Porsche, Aston Martin, Nissan, Audi, Volkswagen, BMW, General Motors, and Ford were scheduled for 2020. Sales of a second- generation Nissan Leaf with a driving range of up to 150 miles began in January 2018.

In 2018 Volkswagen announced plans to equip 16 factories to produce electric vehicles by the end of 2022, compared with three currently, and to build as many as 3 million electric cars per year by 2025. In December 2017, Toyota said by around 2025, every Toyota and Lexus model sold around the world would be available either as a dedicated electrified model or have an electrified option. Additionally, Toyota expected to have annual sales of more than 5.5 million electrified vehicles by 2030 (including more than one million zero-emission vehicles totally powered by either batteries or fuel cells) and to halt all production of gasoline-powered vehicles by 2040. In 2018, the government of Germany launched a campaign to put one million electric cars on its roads by 2020 and to have 40 percent electric cars on its roads by 2035.

• In late 2013, BMW began selling its all-new i3 series electric car models that had a lightweight, carbon fiber reinforced plastic body, lithium-ion batteries with a driving range of 80 to 100 miles on a single charge, a 170 horsepower electric motor, and a base price of $41,350; customers could also get the BMW i3 with a range extender package

the installation in 60 days. According to Musk, the battery was three times more powerful than the world’s next biggest battery.

Tesla’s revenues from energy generation and storage products topped $1 billion in 2017 (refer to Exhibit 2). Elon Musk was very optimistic about the growth opportunities for Tesla Energy:

2018 will see major growth in Tesla energy storage deployments, as the production ramp of our storage products is just as steep as with Model 3. This year, we aim to deploy at least three times the storage capacity we deployed in 2017 . . . . With more electric utilities and governments around the world recognizing the reli- ability, environmental, and economic benefits of this product, it’s clear that there is a huge opportunity for us in large scale energy storage. Powerwall demand for home energy storage remains exceptionally high, with orders consistently above production levels. We are increasingly promoting our energy products in Tesla stores and in non-Tesla retail locations. There is a sig- nificant cross-selling potential between Powerwall and our solar products, as evidenced by the fact that a vast majority of the customers who have ordered Solar Roof have also ordered at least one Powerwall.

As Solar Roof is truly the first-of-its-kind and there is significant complexity in both its manufacturing and installation, we are deliberately ramping production at a gradual pace. When fully scaled, Gigafactory 2 will be able to produce enough solar cells to add more than 150,000 new residential solar installations every year. As we ramp production, a portion of the output will be dedicated for Solar Roof tiles with the balance used in our proprietary high-efficiency retrofit solar panels. With demand outpacing production, we expect our backlog to remain in excess of one year for the next several quarters.26

THe eLeCTRIC VeHICLe seGMeNT OF THe GLOBAL AUTOMOTIVe INDUsTRY Global sales of passenger cars and SUVs in 2017 were roughly 81 million. Sales of other types of vehi- cles (light or pickup trucks, heavy or cargo- carrying trucks, recreational vehicles, buses, and minibuses) totaled just over 26 million. In 2017, global sales of plug-in electric vehicles totaled 1.22 million units —plug-in vehicles included both battery-only vehi- cles and so-called plug-in hybrid electric vehicles equipped with a gasoline or diesel engine for use

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C-214 PART 2 Cases in Crafting and Executing Strategy

EXHIBIT 3 sales of Best-selling Plug-in electric Vehicles in the United states, 2013–2017

Best-Selling Models 2013 2014 2015 2016 2017

Tesla Model S 17,650 17,300 25,202 28,896 27,060

Chevrolet Bolt VE 579 23,297

Tesla Model X 214 18,223 21,315

Toyota Prius PHV/Prime 12,088 13,264 4,191 2,474 20,963

Chevrolet Volt 23,094 18,805 15,393 24,739 20,349

Nissan Leaf 22,610 30,200 17,269 14,006 11,230

Ford Fusion Energi 6,089 11,550 9,750 15,938 9,632

Ford C-Max Energi 7,154 8,433 7,591 7,957 8,140

BMW i3 — 6,092 11,024 7,625 6,276

Fiat 500e 2,310 5,132 6,194 5,330 5,380

All Others 4,260 12,243 19,532 32,847 46,184

United States Total 95,642 123,049 116,099 158,614 199,826

Worldwide Not available 320,713 550,297 777,497 1,227,117

Source: Inside EVs, “Monthly Plug-in Sales Scorecard,” www.insideevs.com, accessed March 5, 2018.

(base price of $45,200) that included a 34 horse- power motor used only to maintain the charge of the of the lithium-ion battery at an approximate 5 percent charge and extend the driving range to 160 to 180 miles per charge. BMW sold more than 16,000 i3s in 2014 and 25,000 i3s in 2015. In mid-2014, BMW began selling a super-premium sporty, high-tech electric vehicle called the i8 that had a three-cylinder electric motor, a supple- mental gasoline engine for higher speeds, scissor doors, flamboyant aerodynamic flourishes, and an electric-only driving range of about 22-miles. Global sales of the i8 were 1,741 units in 2014 and close to 5,000 units in 2015; the 2015 base price of BMW’s i8 was $137,450.

• Mercedes-Benz launched sales of its premium compact B-Class electric vehicle in the United States in mid-2014; the 4-door, 5-passenger vehicle (base price of $41,450) was built on an entirely new platform compared to other B-Class mod- els with traditional gasoline engines, had an estimated driving range of 115 miles on a single charge, accelerated from 0 to 60 miles per hour in less than 10 seconds, delivered 174 horsepower, had a top speed of 100 miles per hour, utilized an electric powertrain system custom-designed and

produced by Tesla, and was loaded with safety features. Mercedes B-Class electric vehicles with a range extender package were also available. The new electric B-Class models competed directly with BMW’s i3 series electric car.

• While a number of automakers had a near-term focus on hybrids with a very short battery-only range, media reports indicated that Mercedes, BMW, Porsche, and Audi were working on produc- ing fully-electric vehicles with a 300+ mile driving range on a single charge by 2018. The new version of the Volt would likely be introduced in Fall 2016.

• In late 2015, both Cadillac and Audi intro- duced new plug-in hybrid luxury sedans (the Cadillac CT6 and the Audi A6L eTron) with an electric-only range of just over 60 miles on a single charge. Initially, both models were only being pro- duced and sold in China. However, Cadillac was expected to begin selling the hybrid plug-in ver- sion of the CT6 in North America and elsewhere in late 2016 or early 2017.

• Executives at GM were acutely aware that cures were needed for the disappointingly small sales volume of the much ballyhooed Chevrolet Volt. GM was rumored to be nearing production of a next-generation compact electric car that could

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CAse 18 Tesla Motors in 2018: Will the New Model 3 Save the Company? C-215

sharing some of its fuel-cell technology patents for free with other automotive companies in an effort to spur whether there was merit in installing fuel cells and building out a hydrogen charging network. Audi, Honda, Toyota, Mercedes-Benz, and Hyundai had recently introduced first-generation models powered by hydrogen fuel cells.27

Hydrogen fuel cells could be refueled with hydro- gen in 3 to 5 minutes. California and several states in the northeastern United States already had a num- ber of hydrogen refueling stations. Existing gasoline stations could add hydrogen refueling capability at a cost of about $1.5 million. A full tank of hydrogen provided vehicles with a driving range of about 310 miles. While battery-powered vehicles were currently cheaper than fuel-cell powered vehicles, experts expected that cheaper materials, more efficient fuel cells, and scale economies would in upcoming years enable producers of fuel-cell vehicles to match the prices of battery-powered electric vehicles.

go 200 miles on a single charge, be equipped with a generator for battery charging, and have a base price close to $30,000.

• At the 2016 Geneva International Motor Show, automakers pushing new electric models and/ or plans for forthcoming models included Opel (a subsidiary of General Motors), PSA Peugeot Citroen, BMW, Mercedes-Benz, Hyundai, Honda, and Volkswagen.

Hydrogen Fuel Cells: An Alternative to Electric Batteries Many of the world’s major automotive manufac- turers, while actively working on next-generation battery-powered electric vehicles, were nonetheless hedging their bets by also pursuing the develop- ment of hydrogen fuel cells as an alternative means of powering future vehicles. Toyota was considered the leader in developing hydrogen fuel cells and was

eNDNOTes 11 Josh Friedman, “Entrepreneur Tries His Midas Touch in Space,” Los Angeles Times, April 23, 2003, www.latimes.com (accessed on September 16, 2013). 12 David Kestenbaum, “Making a Mark with Rockets and Roadsters,” National Public Radio, August 9, 2007, www.npr.org (accessed on September 17, 2013). 13 David Kestenbaum, “Making a Mark with Rockets and Roadsters,” National Public Radio, August 9, 2007, www.npr.org (accessed on September 17, 2013). 14 David Kestenbaum, “Making a Mark with Rockets and Roadsters,” National Public Radio, August 9, 2007, www.npr.org (accessed on September 17, 2013). 15 Video interview with Alan Murray, “Elon Musk: I’ll Put a Man on Mars in 10 Years,” Market Watch (New York: The Wall Street Journal), December 1, 2011 (accessed on September 16, 2013). 16 Ashlee Vance, “Revealed: Elon Musk Explains the Hyperloop, the Solar- Powered High-Speed Future of Inter-City Transportation,” Bloomberg BusinessWeek, August 12, 2013, www.businessweek.com (accessed on September 25, 2013).

1 Tesla Second Quarter 2017 Shareholder Letter, August 2, 2017. 2 Tesla Third Quarter 2017 Shareholder Letter, November 1, 2017. 3 Tesla Fourth Quarter 2017 Shareholder Letter, February 7, 2018. 4 Company press release, April 3, 2018. 5 Jeff Evanson, Tesla Motors Investor Presentation, September 14, 2013, www.teslamotors.com (accessed November 29, 2013). 6 As reported in Autoweek, “Tesla Has to Turn Potential into Real Profits,” May 5, 2017, www.autoweek.com (accessed March 7, 2018). 7 Tesla First Quarter 2018 Shareholder Letter, May 2, 2018. 8 Tesla Q1 2018 Results—Earnings Call Transcript, May 2, 2018, www.seekingalpha .com, (accessed May 9, 2018). 9 John Reed, “Elon Musk’s Groundbreaking Electric Car,” FT Magazine, July 24, 2009, www.ft.com, accessed September 26, 2013. 10 Tesla press release, and Michael Arrington, “Tesla Worth More Than Half a Billion After Daimler Investment,” May 19, 2009, www.techcrunch.com (accessed September 30, 2013).

17 Mike Seemuth, “From the Corner Office— Elon Musk,” Success, April 10, 2011, www .success.com (accessed September 25, 2013). 18 Mike Seemuth, “From the Corner Office— Elon Musk,” Success, April 10, 2011, www .success.com (accessed September 25, 2013). 19 Mike Seemuth, “From the Corner Office— Elon Musk,” Success, April 10, 2011, www .success.com (accessed September 25, 2013). 20 Company 10-K report for 2017, pp 1–2. 21 According to information in Martin Eberhard’s blog titled “Lotus Position,” July 25, 2006, www.teslamotors.com/blog/ lotus-position (accessed September 17, 2013). 22 2013 10-K Report, p. 4. 23 Mark Stevenson, “Lithium-ion Battery Packs Now $209 per kwh, Will Fall to $100 by 2025: Bloomberg Analysis,” Green Car Reports, December 11, 2017, www.greencarreports .com (accessed March 7, 2018). 24 Company documents. 25 Company press release May 20, 2010. 26 Tesla Fourth Quarter 2017 Shareholder Letter, February 7, 2018. 27 George Ghanem, “Avoid Tesla Because Hydrogen Is the New Electric,” March 6, 2016, www.seekingalpha.com, (accessed March 7, 2016).

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