- The global auto industry is ruthlessly evaluating weak markets and killing off unpopular products while Tesla is expanding in China.
- Tesla doesn’t have much of a choice – if it doesn’t take the risk now, it won’t be able to dive in amid a global auto sales downturn.
- The contrast highlight the biggest difference between Tesla’s immature business and car companies that are over a hundred years old.
The contrast was telling: The same week that Tesla CEO Elon Musk attended a groundbreaking ceremony for a new Gigafactory in Shanghai, China, Ford announced that it would substantially restructure its European operations and, ominously, review its situation in Russia, implying that it might follow General Motors in exiting that market.
There was also continuing chatter around a possible Ford-VW alliance – although some of the prospective bloom of such a partnership was diminished by the ongoing incarceration in Japan of former Nissan Chairman Carlos Ghosn, disgraced architect of the Renault-Nissan-Mitsubishi alliance.
The global auto industry is preparing to play defence. In the US, sales topped 17 million new vehicles in 2018 for an unprecedented fourth straight year, and although there are no major signs of a big downturn in 2019, carmakers are getting ready. The lessons of the financial crisis, when a bloated GM and a crippled Chrysler both went bankrupt, have been learned.
Before 2009, big car companies would count on brief recessions and robust recoveries, reliably stalling on difficult strategic decisions. But no more. GM has left Russia and Europe, ended production in Australia, and streamlined in South Korea, and it’s now winding down underperforming passenger cars in the US and preparing to idle factories. Fiat Chrysler Automobiles got out of passenger cars to focus on SUVs and pickup two years ago. And Ford ousted CEO Mark Fields in 2017, bringing on Jim Hackett, who has concentrated on improving what he calls Ford’s business “fitness.”
Make the tough calls when times are good
The arguments in favour of these moves aren’t complicated: when times are good and profits are rolling in, as they have been for years, make the tough calls. Then batten down the hatches when the bad weather sets in, as it always does in the highly cyclical car business.
Automakers might be overreacting, but they are gazing out at alarming developments. The biggest of these is an economic slowdown in China, where GM, for example, is now selling more cars than in the US. The China market has grown so rapidly that it’s now the world’s largest – but it hasn’t really endured a major decline of the sort that car companies in the US and Europe have negotiated many times over a hundred-plus years.
So Ford, GM, Fiat-Chrysler, the Japanese, and the Germans, and the South Koreans are all wisely de-risking.
Tesla, meanwhile, is performing its traditional role – if a 15-year-old company can have traditions – of gobbling up risk, front-running it while the rest of the industry is happy to sit on the sidelines.
The Shanghai Gigafactory is a perfect example. It will be the first plant built by a Western carmaker that won’t be a joint venture with a Chinese carmaker. China has required foreign automakers to enter joint ventures since the 1990s, and while that might sound bad, in practice it’s been extremely effective for both sides and has provided massive risk mitigation for US and European companies.
Think about it: You trade half the ownership for a 50% reduction in overall risk. Not a bad deal.
Shanghai could be a turning point for Tesla
Musk and Tesla aren’t into sharing, so their Shanghai factory will be wholly Tesla-owned. This is possible because China has carved out a joint-venture exception for all-electric automakers. And, of course, Tesla sees what everybody else does: a growing China market versus a tapped-out Western one. Geopolitics – tariffs and the vagaries of global shipping costs – makes for extreme price instability for Teslas delivered in China, so the company wants to build where it sells.
On one hand, the Shanghai factory could signal a maturation turning point for Tesla. For starters, the company will likely pay for it with debt – a big positive, as the factory will be built with expensive 2019 money (Ford continues to operate plants that were built with relatively cheap early-20th-century money), but that investment will be discounted over the decades thanks to the magic power of inflation.
Tesla might also learn from the debacle of its Model 3 roll-out – an exercise in frustrated wheel-reinventing – and adopt a standard production system in Shanghai, aiming to deliver vehicles rather than undertake yet another experiment in manufacturing. The latter would obviously layer on the already risky move of building a new factory when the rest of the industry is closing them.
For some time now, I’ve argued that although Tesla makes some fantastic vehicles, its real product is risk. The traditional car business doesn’t create risk (it does stumble into it every few decades, but that is due largely to the requirement that carmakers serve gigantic, marginally profitable worldwide transportation demand). That’s why Tesla has a bigger market cap than GM while selling over nine million fewer cars in 2018. For investors, risk equals payout, and that applies to longs and short-sellers.
Now, you could step back from all this and maintain that Tesla is making a dumb move by committing billions to a new factory. What the company should do is consolidate its gains and stabilise the core business.
Unfortunately, Tesla can’t really afford to wait out a downturn anddefer=”defer”its expansion. If and when the China market starts to grow robustly again, Tesla wants to be well-established in the country. The lesson for carmakers that have tried to play catch-up in China is that it’s both costly and time-consuming.
Besides, where would Tesla be without risk? You have to be true to your principles – and risk is what’s made Tesla the first successful new car company to arrive in decades.
Business Insider Emails & Alerts
Site highlights each day to your inbox.