Why Tesla Patent Release Is Good for Humanity, But Bad for Business

The company's CEO has made the odd move of allowing competitors to use its patents.

Jun 17, 2014 at 5:47AM

Tesla Motors (NASDAQ:TSLA) CEO Elon Musk's decision to make the company's patents available to "anyone who, in good faith, wants to use our technology" might be good for mankind but it could mean the end of the electric car pioneer.

Musk made the move, according to a statement, because he believes that patents can stifle progress. He also believes that the company has a bigger goal than its own success. 

"Tesla Motors was created to accelerate the advent of sustainable transport," he said. "If we clear a path to the creation of compelling electric vehicles, but then lay intellectual property landmines behind us to inhibit others, we are acting in a manner contrary to that goal."

That may be true, but allowing your much bigger competitors with dramatically more resources at their disposal access to your research is foolhardy. Musk is upset -- as a human being -- that the big automakers aren't doing more to build electric cars.

At Tesla, however, we felt compelled to create patents out of concern that the big car companies would copy our technology and then use their massive manufacturing, sales and marketing power to overwhelm Tesla. We couldn't have been more wrong. The unfortunate reality is the opposite: electric car programs (or programs for any vehicle that doesn't burn hydrocarbons) at the major manufacturers are small to non-existent, constituting an average of far less than 1% of their total vehicle sales.

He's right. The big automakers have only played in the fringes of electric vehicles. Toyota (NYSE:TM) has had some success with its hybrid Prius line. But the 51 miles per gallon that car gets pales in comparison to the 265 miles a Tesla Model S can go using no gas. Of course, a Prius starts around $24,000 while the Model S starts around $71,000.

That lack of interest and innovation are an advantage for Tesla. The company has the ability -- thanks to its proprietary technology -- to make pure electric vehicles that the major players can't. 

Tesla has found a niche that the big boys have ignored -- largely because the economics don't make sense as a volume play. Protecting that niche while growing the company would give the electric car maker the best chance of sustainable success. Sharing its research and intellectual property with the competition makes it likely that one or more competitors will find a way to make electric cars cheaper than Tesla.

Some might argue that there's a business benefit for Tesla if more companies are building more EV cars -- a critical mass would lead to more rapid growth of the charging infrastructure. And indeed, more accessibility to charging stations would benefit all players. And sure, building a better world is an admirable goal.

But the risks to the company far outweigh the costs, and the move strikes me as irresponsible.

What is Tesla facing?

Just because the auto industry at large has ignored electric cars does not mean it will forever.

If one of the auto giants decides to compete then it should have the resources to eliminate Tesla, which lacks the scope to fight off larger competitors. 

Even if Musk had not made the bold move of opening up the company's patents for use by competitors, Tesla faced an uphill fight. Innovators often create a category and build a market before being wiped out when established players in adjacent markets decide to compete.

Remember Handspring? That company essentially created the personal digital assistant market only to fall quickly once Apple took an interest. The same thing is happening now to Pandora and Spotify -- the companies that pioneered digital streaming (while not being able to make money on it). There was room for innovation and small players, but once the market grows big enough, larger companies can overwhelm the companies that did the hard work in creating the market.

This can happen under the best of circumstances. If a company makes it easier for its competitors by giving away the patents that protect its intellectual property, it becomes easier ... even inevitable.

How is Tesla doing?

Annual vehicle production across all automakers around the globe is nearing 100 million. Tesla represents a teeny tiny part of that. In the first quarter of 2014 the company produced a "record" 7,535 Model S vehicles for global delivery. It also delivered 6,457 cars -- slightly more than it had expected. Production capacity is growing and the company, according to a release, expects to be able to make 1,000 vehicles per week by the end of 2014 -- up from 700 now. 

To put things in perspective that's a max production capacity of 52,00 vehicles in a 100 million vehicle marketplace. If things go well then next year Tesla can control about one half of one tenth of 1% of the total market.

Tesla had $713 million in first quarter revenue up from $621 million a year ago. The company made a slim $17 million profit on those sales.

Tesla also spent way more than it made -- $82 million -- on research and development, money its competitors now won't have to spend if they decide to destroy the minor player that Tesla currently is.

A rising tide lifts all boats

While it seems likely that sharing proprietary technology will simply help Tesla's competitors overtake it, it's also possible that a move into all-electric vehicles by one of the major players will create more demand -- much like Toyota's Prius has done for hybrids. Toyota, General Motors (NYSE:GM)Honda (NYSE:HMC), and Ford (NYSE:F) in some ways lack prestige because of their size. Those brands could bring lower-priced electric cars to the masses while Tesla remains a premium brand at a premium price. It's possible that Tesla could become the Porsche (NASDAQOTH: POAHF) of electric cars.

Under this scenario a certain part of the buying community would be drawn to electric cars but would not want to give up the cache of owning a high-end brand. Tesla stays a successful, even a growing niche player, and Musk gets to live his dream of seeing more people drive electric cars.

In this scenario Tesla might even be able to raise prices are people would be buying the vehicles for status as well as functionality reasons.

It's only a matter of time

That scenario is certainly a best case for Tesla but up until Musk announced he was giving away access to the company's patents, proprietary data had been an important part of its strategy.

In the "Investors Overview" section of its website, Tesla lays out how it plans to capitalize on how the big companies are unlikely to move quickly into electric vehicles because of their "legacy investment" in internal combustion technology. The company also specifically cited that it uses "proprietary technology, world-class design and state-of-the-art manufacturing processes to create a new generation of highway capable electric vehicles."

Now, that proprietary technology is no more. The company is laying open its research to anyone who wants to see it. That may not matter in the short term as the bigger players may not care about the tiny pure electric market to bother eliminating Tesla. If, however, Musk succeeds and his company creates a bigger market, it likely will become a victim of its own success and one or more of the big boys will become a competitor.

In opening up Tesla's patents Musk has done the right thing for mankind. Tesla is not likely to reach the kind of audience that will make a difference whereas any major automaker or even a tech giant like Google might. That's a noble move that may help put us all in electric cars one day. They just may not be Tesla electric cars.

To read my colleague Jake Mann's take on why this was a smart business move for Tesla, click here

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A major technological shift is happening in the automotive industry. Most people are skeptical about its impact. Warren Buffett isn't one of them. He recently called it a "real threat" to one of his favorite businesses. An executive at Ford called the technology "fantastic." The beauty for investors is that there is an easy way to invest in this megatrend. Click here to access our exclusive report on this stock.

Daniel Kline has no position in any stocks mentioned. The Motley Fool recommends Tesla Motors. The Motley Fool owns shares of Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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