Elon Musk

Elon Musk, CEO of Tesla, is a peculiar billionaire. He seems to have an aversion to markets. Given the choice between buying something and making it, he chooses the latter. While other car-makers outsource, he insources.

Tesla was designed with an enormous footprint.  It built, and owns, the factory where its batteries are made. It runs its own dealer network. Because its cars are pioneering and unique it must run its own Tesla-branded fueling stations and service centres.

But it did not stop there. Tesla bought a solar panel company, which itself expanded into making solar roofs. It cancelled a contract with outside seat-makers and embarked on making its own seats. It also ditched its alliance with autonomous driving company Mobileye to build an autonomous driving system from scratch. The great continued in late 2017 as Tesla bought Perbix, the company that makes the machines it uses in its factories. One commonly held estimate is that Tesla makes 80% of its own inputs.

It is a peculiar quirk of our capitalist system that the larger a company gets, the fewer of its economic relationships are market relationships. Nobel-winning economist Ronald Coase first addressed this in a 1937 paper, The Nature Of the Firm.

The scale of firms is defined by the number of relationships they can control more efficiently than a market. This is the insight that drives consultants to urge firms to focus on their core competencies and sell off business units that fell outside that banner. Many firms have become extremely successful by focusing on those few relationships they are very good at and outsourcing the rest.

Apple products for example, are designed in California. But their component parts are sourced globally and the production is run by the Taiwanese company, Foxconn.

Tesla has chosen a different path. Its approach is more than a few mergers and begins to look like full vertical integration, where a company owns its upstream suppliers and its downstream distributors.

Vertical integration is normally a feature of extremely well-established and rich companies. Like Royal Dutch Shell, which owns every step from oil rigs to petrol stations. Start-ups like Tesla normally try to keep their capital needs modest and their management focused on their key points of difference.

Of course, constant fiddling is at odds with mass production, which is about doing the same thing over and over. This may explain the lengthening delays Tesla is experiencing in getting production of its Model 3 electric cars up to scale.

Loose money

Confidence, genius and innovation are one explanation for Tesla’s phenomenal taste for in-housing. But they may not be a sufficient one.

Perhaps the reappearance of a large, vertically integrated company at this juncture in history ought not surprise us. We sit at the end of an era of very loose monetary policy. Since 2009 central banks have been pumping the global economy full of cash. Those funds are sloshing around, desperately seeking somewhere to go. Loose money has blown up house prices across the world, primed sharemarkets to record highs, sent bond markets into an impossible frenzy, driven interest rates below zero in multiple jurisdictions, and conjured billionaires in extremely unexpected asset classes like Bitcoin. Compared to some of those bets, making lots of money available to a genius inventor with a compelling vision makes a lot of sense.

Tight capital management was in vogue in the 1980s and 1990s. The lessons hung over too long, remaining influential even after capital became dirt cheap. It should be unsurprising a firm can surge ahead by unlearning those lessons.

This, mind you, is not so much genius as luck.  Tesla was meant to be self-funding. Musk described his original master plan as:

  • Create a low volume car, which would necessarily be expensive;
  • Use that money to develop a medium volume car at a lower price; and
  • Use that money to create an affordable, high volume car.

“I feel confident saying that Tesla does not need to ever raise another funding round,” said Musk in 2011.

Luckily, the next time Tesla needed more capital it was available. As it was the seven times after that. Tesla has raised billions of dollars in debt and billions by issuing shares and may yet raise more. Tesla lucked into being capital hungry at the exact right moment.

But what comes next?

US interest rates are rising, and the US Federal Reserve is eyeing the $4 trillion in assets it bought during the quantitative easing era nervously. The Bank of Japan is also rumoured to be looking at tightening policy. This is not the end of the era of loose money. But it may be the beginning of the end.  And that will eventually force changes.

Should it survive and thrive into the next decade, the lessons of how Tesla succeeded will be folklore. Imitators will also attempt to do everything in house. But the foundations will be shifting.

Tesla may one day need to divest business units rather than raising capital to buy them, and it may need to lean heavily on top-notch suppliers. If he is truly cleverer than the rest Mr Musk may be able to beat his competitors again by embracing the joys and challenges of buying what you need from others.

Peter Fray

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