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Tesla has a strategy car incumbents can't beat, but they may be too slow

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Tesla Motors is following up its well-reviewed, ridiculously expensive Model S by releasing the Model X, an all-electric SUV that is … even more expensive, with vehicles starting at a mind-blowing $132,000. This isn't an unprecedentedly high price for a car, but even luxury automakers like BMW and Mercedes offer entry-level products for a quarter the price of a Model X.

Musk is, of course, aware that his vehicles are far too expensive to be mass-market successes. He has signaled that cheaper versions of the Model X will be "coming later," and promises that by 2017 there will be a car — the Model 3 — in the $35,000 range. But Tesla has missed deadlines before, so there is some reason to doubt that it will be able to deliver on that target.

But even more, the whole idea of starting with an incredibly expensive, incredibly high-end product flies in the face of a lot of emerging conventional wisdom about the process of technological disruption and the desirability of shipping "minimum viable products" that improve iteratively over time.

Yet there's a method to the madness. In some ways, the actual car is the least of the obstacles to creating a mass-market electric car. Under the circumstances, the focus on high-end products as a support system for the infrastructure Tesla needs to make a mass-market product makes perfect sense. And so far, the strategy is working. But it does have one potentially fatal flaw — it's slow, and leaves Tesla potentially vulnerable to having its legs swept by another new entrant.

Electric cars' chicken-and-egg problem

If electric cars were widely owned and nobody had a gasoline-fueled car, nobody would buy one. Getting regulatory approval to cruise past people's houses with such a noisy and toxic device would be a nightmare, of course, but it would also be really inconvenient. Where would you refuel?

In the real world, of course, the shoe is on the other foot: People with conventional cars can easily find a gas station, while electric car charging stations are few and far between.

Regardless of the price of gas, the volume of subsidy, or one's personal commitment to the environment, it just makes an awful lot of practical sense to buy a car that uses the same fuel as everyone else's car. Tesla is aware of this and has a solution in the form of a growing network of "Supercharger" stations that, when complete, would make electric cars a reasonable thing for a typical family to consider.

The Model S (and Model X) is priced to appeal to people who don't need to worry too much about the practical aspects of car ownership. And they offer gross margins high enough to subsidize the buildout of the charger network.

Similar logic applies to the costly batteries that are the heart of an electric car. Tesla is building a "Gigafactory" that it says will reduce unit costs of its batteries by 30 percent. This is the kind of breakthrough you need in order to make an affordable electric car. The early expensive cars provide the funds necessary to build the factory, as well as practical experience with integrating batteries into cars that would be necessary to actually take advantage of it.

Disruption from above

Like any good disruptive business strategy, Tesla's has the virtue of being essentially impossible for incumbent automakers to compete with. Companies that are already making money selling internal combustion engines aren't going to invest in a broad infrastructure that would make gasoline obsolete. Nor are they going to attempt to engineer a manufacturing breakthrough that would have the same impact.

The incumbents aren't dumb. They can (and do) make electric cars. But they make EVs that are designed to live in a world dominated by conventional cars — semi-affordable small cars useful for daily local driving by people with an eccentric interest in green living.

By contrast, Tesla, by simply accepting the reality that its early cars will be too expensive for the vast majority of people to even consider, has achieved something really impressive: near-universal acclaim for the quality of its products, including a determination from Consumer Reports that the P85 D variant of the Model S is so good that it broke the quality scale.* This is a kind of free marketing campaign for the eventual Model 3 that money can't buy.

Tesla's Achilles heel is speed

The strategy of starting from the top and then working down, though alien to the software-heavy business models that dominate the startup sector these days, makes perfect sense for the infrastructure-intense car industry. The real risk for Tesla is that its roadmap may be unfolding too slowly. The Model X was originally supposed to have shipped in 2013, and even with delivery of preordered vehicles beginning this week it doesn't think new orders will be fulfilled until the back half of 2016. In other words, Tesla is evidently facing significant production bottlenecks that make it difficult for the company to make cars in large quantities.

That's another good reason for the company to charge high prices, but it adds up to significant reason to doubt that it will really have a mass-market Model 3 ready in 2017. Tesla would need to develop the car, obviously, which is difficult. But it would also need to develop a process by which the cars can actually roll off assembly lines at mass scale. There's no point in selling a car that normal people would consider buying if you can't actually get them built.

This isn't a huge problem if you view the competitive set as legacy carmakers. A year or three, more or less, doesn't really change anything.

The problem is that other new entrants could attempt a similar strategy, and despite Tesla's years-long lead, the company's slow pace of execution means they're not un-catchable. Companies like Google and Apple that are known to be interested in the car market have much more free cash flow available from their existing businesses than Tesla can obtain by selling high-end cars. If they can manage to build a good car (admittedly a big if), then these companies have the ability to leapfrog Tesla in terms of capital investments in manufacturing and vehicle charging facilities with ease. To stave off that kind of competition, Tesla needs to rely on its actual expertise in building cars. And so far even though the cars it's built have been extremely well-regarded, it hasn't actually demonstrated the ability to make them at the kind of scale that a successful car company needs.

Correction: An earlier version of this article said it was the Model X, rather than the P85D, that broke Consumer Reports' quality ratings scale.

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