It has been a rough week for Silicon Valley electric-car maker Tesla Motors (Nasdaq: TSLA ) , and it's not even Friday yet.
First, the company cut its third-quarter outlook sharply after hitting snags as it ramped up production of its new Model S sedan. Then came word, buried deep in a regulatory filing, that over a thousand people who had put down deposits on a Model S had subsequently cancelled their orders.
It sure sounds brutal, and investors weren't happy: Tesla's stock was down almost 10% on Tuesday.
Are the wheels coming off of every gadget geek's favorite carmaker?
Much ado about a predictable snag
I've been plenty critical of Tesla in the past, but I think the news reports -- and the market's reaction on Tuesday -- were both a bit overblown. To understand why, let's take a step back and look at the gist of what's really happening.
Back in late July, Tesla CEO Elon Musk said that the company was on track to deliver 5,000 examples of the Model S to customers by the end of 2012. But he was also very clear that the company was ramping up production slowly, as it worked to fine-tune production processes and, importantly, quality.
At the time, Tesla was making just two cars a day. That was double the rate it had started at in June, and Musk expected the factory gradually to ramp up to 80 cars a day by the end of the year.
What Tesla is saying now is that it's ramping up a little less quickly than it initially had anticipated. Some of its suppliers are having trouble meeting Tesla's goals -- not a surprise with a new company and an ambitious design. Tesla also emphasized that it's making an all-new product "with new employees using new equipment," which will understandably take some time to get up to speed.
The upshot? Fewer cars made during the third quarter than expected, fewer deliveries than expected, and thus less revenue coming in; hence, the sharply trimmed outlook. But, assuming that the customers who have already placed deposits mostly hang in there (and despite the thousand-plus cancellations, Tesla's total number of "reservations" is still north of 10,000 and still going up), that money will come in eventually.
Long story short, production of the Model S is having some teething troubles. As a seasoned auto-industry watcher, here's my take on that: I'm not the least bit surprised, you shouldn't be either, and it might even be a good thing in the long run.
Making cars is hard, folks. Really hard.
Making cars isn't like making cell phones. It's hard -- really hard -- to build cars to the level of fit and finish and durability required to compete with mass-market giants like Toyota (NYSE: TM ) and Ford (NYSE: F ) . Think of how much trouble a giant like General Motors (NYSE: GM ) has had trying to up its game in recent years. Now think of all of the challenges involved in doing that with a start-up.
It's especially hard when, like Tesla, your product is competing head-on with cars like Audis and BMWs that pretty much set the global standard for things like ride quality and interior fit and finish. And it's double-extra hard when you don't have the massive financial and engineering resources and depth of experience that the global giants can draw on.
Elon Musk is being exceptionally picky about the quality of the cars Tesla is producing, say reports. That's a good thing, an essential thing. He has to be, or this thing isn't going to work.
Tesla's having no trouble selling cars to its core enthusiasts, the gadget geek early adopters who were happy to plunk down deposits before they'd even sat in a Model S. But to "cross the chasm" from there to the mass market means being able to sell a Model S to someone who owns, say, a Mercedes-Benz E-Class and is basically happy with it.
To pull that off, Tesla's cars have to be more than technical marvels. They have to be really, really good. I remain skeptical that the company can pull it off, but it looks like Musk and his minions are really, really serious about trying. Tesla investors should be happy about that.
Tesla's execution remains impressive, but its long-term prospects remain cloudy. How will the company preserve its margins once better-funded competitors take aim at its niche? Even as I admire Tesla's achievements to date, I'm not high on its chances of long-term success. But while Tesla Motors is a recommendation of the Fool's Rule Breakers newsletter service, there's a different multibagger that has the growth-stock service's attention these days. Find out what that stock is with a free report.