Even the old, large car companies that were initially reluctant are now acknowledging that the future of automotive transport is electric and autonomous. Research reports by RethinkX and ARK Invest agree that by 2030 the overwhelming majority of miles travelled in passenger vehicles will be autonomous. If these forecasts are even approximately accurate, the landscape of the automotive market will be completely transformed over the next 13 years.

What makes companies successful in the current automotive market is not what will make them successful in the new automotive market. I find that many industry analysts extrapolate future success from past success far too linearly, not accounting for how the competitive dynamics of the market will change. Incumbent car companies are well-designed for the market that existed up until about 2010, but not for the market that will exist in 2030 and onward.

Source: ARK Invest.

Tesla (TSLA), on the other hand, is designed almost perfectly for the market to come. As a pure electric car company, its incentives and distribution model are aligned toward making electric cars. So is its experience, competence, and intellectual property. As a Silicon Valley-based software company, it has the talent and culture for developing software for self-driving cars. That culture also leads it to push forward on new technology faster than auto industry incumbents, and to prize frequent iterations of hardware and software.

1. Tesla has unique, structural advantages in the electric car market thanks to its exclusive focus on electric cars.

These two advantages are 1) asymmetric motivation and 2) a direct sales model.

By asymmetric motivation, I mean that Tesla is incentivized to allocate 100% of its resources to electric cars. Incumbent car companies, on the other hand, are torn between profitable and familiar gasoline cars and capital-intensive, initially lower-margin electric cars that they have to learn how to make.

Tesla’s direct sales model is an advantage due to an intrinsic feature of electric powertrain technology. With 1% of the moving parts of an internal combustion engine according to one estimate, electric cars require much less maintenance than gasoline cars. Car dealerships are highly reliant on maintenance revenue. It accounts for 47% of their gross profit, compared to just 28% for new car sales.

Source: The Wall Street Journal.

At least in the United States, the world’s second largest car market behind China, incumbent automakers are locked into the dealership models. State laws prevent manufacturers from competing with their own dealerships.

There is no easy answer for incumbents. Their distribution model is ill-suited to electric cars, and they can’t abandon their distribution model. Reform of car dealerships seems to me like one path forward, but it seems likely to create an oppositional relationship between manufacturers and dealers. An alternative would be lobbying state legislatures to change the laws.

2. Tesla leads the self-driving car market in driving data to train the neural networks that operate the cars.

Whereas competitors like Waymo (GOOG, GOOGL), GM (GM), Mobileye (INTC), and Uber (UBER) have test fleets numbering in the hundreds, Tesla has around 70,000 in its customer-owned fleet of cars with full self-driving hardware, with another 2,000 cars added every week. This is by a factor of more than 100 the largest self-driving test fleet in the world. Since data is so crucial for machine learning, Tesla is empowered to develop self-driving software at a pace much faster than any other company.

Tesla is planning to ramp up Model 3 production from a handful per day currently to 5,000 per week by the end of the year and 10,000 per week by the end of next year. This is in addition to the 2,000 Model S and X cars that are sold per week. So Tesla’s fleet should grow 10x by mid-2019 at the latest. This will put Tesla at more than 1,000x where its competitors are currently.

Competitors will surely scale up their test fleets over that same span of time. However, only installing full self-driving hardware on production cars will allow these fleets to come close to Tesla’s. Currently no car manufacturer has yet announced plans to do so before 2020, with several targeting 2021 or later.

Tesla demonstrates its production self-driving hardware. Source: Tesla.

By that time, Tesla may have already launched its autonomous ride-hailing service, The Tesla Network. At TED, Tesla CEO Elon Musk said that Tesla would complete development of its full self-driving software in 2019. If Tesla can launch the Tesla Network that year or in 2020, it will beat competitors to the punch and gain the first mover advantage.

There are two important caveats here. First, Musk is known for setting aggressive timelines that his companies don’t always meet. Moreover, developing software to solve an unsolved AI problem has some amount of inherent unpredictability. Second, regulatory approval is a factor that Tesla doesn’t control.

3. Unlike any competitor, Tesla is both a software company and a car manufacturer.

Tesla is a Silicon Valley-based company whose CEO is Elon Musk, a successful software entrepreneur. A 2015 report by Morgan Stanley found that 60% of its employees work in software, versus the industry norm of 2%. Tesla has software in its DNA. The company excels at software, whether it’s the car’s user interface, Autopilot, or the power management software for its battery packs. Other car companies, by contrast, can’t even develop a navigation system that most people want to use.  

This software-centric culture will serve Tesla well going forward. Venture capitalist Marc Andreessen, known for his thesis that software is eating the world, argues that “in 10 years, the winning car company will be the car company that makes the best software.” Right now, that company is Tesla.

Conclusion

While there is uncertainty and risk on the horizon for Tesla, there is also immense opportunity. Analysts don’t talk much, if at all, about the competitive advantages described in the article, meaning that in the aggregate they fail to see Tesla’s full potential. Although things could take a wrong turn for Tesla, in my personal evaluation the balance of risk and reward is attractive enough for me to invest in the company, and even to recommend it to my friends, family, and readers.