Tesla’s electric cars will remain just a niche

By | January 22, 2014

Elon Musk, Tesla, and luxury electric cars have been the most eye-catching keywords of the past few months. The entrepreneurial experience of the legendary Elon Musk has set off a raging tide of electric cars in the lifeless U.S. auto sector, at the same time the U.S. government is trying to reshape the competitiveness of the U.S. manufacturing sector. He has even been touted as the next Steve Jobs. In 2013, 21,500 Tesla cars were sold worldwide. In the 40-year history of modern electric cars, this was the first breakeven performance achieved by any electric car manufacturer. The world cheered, and Tesla’s share price soared five-fold in just a few months. Will Tesla, which originated in Silicon Valley and broke into the market with luxury electric cars, rewrite the history of the auto sector and become the gravedigger for the auto giants?

As a representative of luxury electric cars, Tesla enters our field of vision with a brand new look. In fact, the real competitive edge of luxury electric cars is not their R&D capabilities. Nor is it the technological barriers to entry they have established. Instead, it is their accurate market positioning. Tesla’s investment in technology as well as its imagination and creativity are worthy of respect. We do not intend to refute the media’s admiration of the business genius of Musk. But luxury electric cars are actually a story about ‘doing little but achieving a lot’. They have resolved the difficulties faced by electric cars during their development over the past 40 years, but they have not really resolved electric cars’ fundamental problem of practicality.

Although the technology at this stage is sufficient to enable electric cars to become commercialised and gradually become a means of transport, they offer far less value for money compared to cars powered by conventional internal combustion engines.The irreconcilable contradiction between mileage and manufacturing cost is an insurmountable difficulty encountered by electric cars: to run far, there must be enough energy, which would require enough battery power. However, inlcuding sufficient enough battery power in the vehicle means the cost of electric cars becomes uncontrollable.In order to satisfy both the cost and mileage issues, electric cars have so far become smaller. For example, the Nissan Leaf, Mitsubishi MiEV, and GM Volt currently on the market are all small electric cars.Though their final prices have been contained at about US$20,000, the practicality, comfort, safety, and driving pleasure they offer are not on a par with similarly priced midsize sedans. As a result, electric cars are still marking time after four decades of development.When oil prices rise, electric cars become a media darling and electric car-related concept stocks become well sought after; but when oil prices come down, they are ignored.

A luxury car should have three features: speedy acceleration, a quiet ride, and high speed. Electric cars are born with luxury genes – speedy acceleration and low noise are a natural gift as electric cars work in a different way from gasoline-fired cars. Once positioned as a luxury car, price is no longer a problem, and the restraint on manufacturing costs will be less important. The seemingly irreconcilable conflict among costs, range, and safety is thus solved.

Simply by piling up more batteries, Tesla may achieve an unprecedented range of 300km, basically meeting the requirements of general consumers. However, too many batteries implies an overly heavy car body and could be extremely dangerous in case of a collision. However, Tesla can easily solve this issue by raising prices – it is currently using the best electronic control system to improve battery efficiency and use lighter but harder materials to produce the car body.

Electric cars cannot overturn the conventional auto industry!

Oil prices have risen around five-fold in the past four decades, while battery energy intensity has increased about four-fold with the technological breakthroughs from lead and nickel batteries to lithium batteries. However, electric cars’ market share has gradually declined compared to when GE launched the modern electric car for the very first time. The fundamental reason lies in the fact that internal combustion engines have achieved substantial improvements during this period, while electric cars still fall behind cars equipped with traditional internal combustion engines.

Some basic judgments on the electric car industry: 1) current battery technologies and electronic control systems are adequate for commercialization of electric cars; 2) I believe electric cars still will not be able to compete with internal combustion engine cars in terms of price/performance ratio in the next decade, based on my estimates of possible evolution paths for battery and electronic control technologies; 3) it is unrealistic to rely on consumers’ change in consumption habits and voluntary purchases of ‘expensive and difficult to use’ electric cars to drive electric car growth; 4) there will be considerable obstacles for the government in promoting the use of electric cars in the future, and as a result I am cautious about the development of electric cars.

If it is unrealistic to expect consumers to change their driving habits, and expecting them to pay for environmental protection is nothing but a daydream. It might be cruel to say, but reality is cruel – and ironic. Consumers’ aspirations are very simple, they always want easier-to-use or cheaper products. The iPhone is a good (and successful) example of ‘easier-to-use’, which consumers are willing to pay a premium for. Copycat (or ‘Shanzhai’) cell phones win the game because they are ‘cheaper’. Consumers are ready to tolerate low quality to some degree, but they are understandably reluctant to buy electric cars, which are both expensive and not so easy to use.

Then can electric car development only be driven by the government? I think the government may pave the way through the promulgation of laws and regulations, but it cannot solve the problems that the market fails to solve, especially the long-term feasibility issue. The reasons could be:

  • Economic issues. The government can provide startup capital to risky industries like venture capitalists, and can also provide manufacturing and consumption subsidies. However, government subsidies have a certain ceiling – thousands of cars? Yes. Millions? Definitely no.
  • Scientific issues. I believe electric cars do not necessarily generate less pollution than traditional internal combustion engine cars. We need to focus on the carbon footprint of the entire industry chain (from wellhead to wheels) instead of carbon emissions from driving (from fuel tank to wheels). If only the latter is considered, undoubtedly electric cars are more environmental friendly. But if we take battery production and recycling into consideration, carbon emissions in the electric car industry chain are just marginally lower than that of internal combustion engine cars. In China, where power generation mainly relies on coal, electric cars do not have any particular environmental advantages as the recycling of electric cars/batteries still involves carbon emissions. Just think about the law of conservation of energy.
  • Political issues. A nation needs to align the interests of multiple parties, e.g., state-owned enterprises, private enterprises, consumers, and local governments if it intends to drive the development of the electric car industry. One example would be the postponement of the implementation of China IV standards, which can be largely attributed to the difficulty in aligning the various interests. The electric car industry involves many interested parties, making any interest alignment more difficult. I believe the government may invest equal effort into initiatives with less resistance, e.g., public transit development, which is also a way to considerably reduce carbon emissions and improve people’s transport experience.

Some believe economies of scale can reduce the manufacturing costs of electric cars and eventually reach an optimal balance between price and performance, sweeping away the obstacles to mass production of electric cars. The so-called economies of scale refer to the sharing of fixed costs via an increase in unit production. Of course, when production rises, manufacturers will have strong bargaining power against both upstream and downstream players, resulting in lower procurement and marketing costs. The auto industry is a typical example for economies of scale, as raw material costs only account for c10% of the total manufacturing cost. In other words, auto manufacturing is a highly value-added process. For electric cars, however, batteries account for 40% of the cost. The battery industry has a rather short industry chain, with raw materials accounting for over 50% of production costs and lithium accounting for around 30% of total costs. It is difficult for raw material costs to decline with the rise of production scale – just the opposite, raw material prices may soar with rising demand. Lithium prices are likely to rise if demand increases as lithium mines are limited in number, and this may constitute a restraint on future demand for electric cars.

The electric car fervor will continue for a while as a new niche market has been found with growing economies of scale. But it is naive to believe luxury electric sports cars will lead the trend and overturn the conventional auto industry, unless they have the same price/performance ratio as a Honda Civic.

How will the high-end electric car market evolve in the future? Will high-end electric cars overturn the traditional auto industry, just as Apple forced Nokia/Motorola into a quagmire?

First, we need to discuss the potential market size for high-end electric sports cars. Take the US market as an example, around 2 million luxury cars (sedans and SUVs combined) are sold each year, including about 500,000 luxury sport sedans. High-end electric sports cars (represented by Tesla) fit in these niche markets, but they have a fatal weakness compared with traditional sport sedans – their top speed is much less than same-class cars equipped with internal combustion engines. Traditional sports sedans include the Ford Mustang, Chevy Corvette,Porsche 911, BMW M4, and so on, and the 911 can reach a top speed of 302km/h. In contrast, most EVs have a top speed of 120km/h, and high-end electric sport cars can only attain 200km/h after major improvements. Top speed is the Achilles’ heel for EVs, and it is something that is difficult to change via technology enhancement, just like their natural advantages. According to media reports, Tesla buyers are mostly environmentalists, fashion pursuers, and ‘fake’ racing car drivers – I happen to be the third type of buyer. Back when I lived in the U.S., I drove a 500HP Ford Mustang, but never exceeded 120km/h. I still enjoyed driving the Mustang, for the vigor it added to the quiet urban life with its cool contour and roaring engine.

In fact, a market scale of 500,000-600,000 units is large enough. However, we believe the competition in this niche market may intensify soon. When a niche market becomes profitable, there surely will be new entrants wanting to grab a slice. BMW will soon launch its own high-end EV models, the i3 and i8, making it a highly competitive market. By the way, BMW’s single-year R&D expense is higher than Tesla’s annual revenue.

Nevertheless, just as the media and consumers have raved about, high-end electric cars, represented by Tesla, have ripped open the frozen EV market and found a fulcrum for the EV industry with its colorful imagination. I certainly believe luxury electric cars will stay in the headlines for quite a while.

One thought on “Tesla’s electric cars will remain just a niche

  1. Pingback: Tesla transitions to non-GAAP EBBS reporting - Equity-Research.com

Leave a Reply

Your email address will not be published. Required fields are marked *