If you've never stood on the floor of a billion-dollar factory and watched as humans and robots work together to make the goods we use everyday, it would be tough to describe what a competitive manufacturing moat looks like. If you've never seen how much of an impact the coating on a roller, or the pressure from a paint gun, or a single line of code in a computer can have on a plant's operations, it might be difficult to understand how important experience in manufacturing can be.
And if you're trying to upend the automotive industry as we know it, it may be easy to hire some smart people and talk about new manufacturing concepts without truly appreciating the knowledge that thousands of engineers and technicians have gained over decades of making cars and trucks. Given recent travails, perhaps CEO Elon Musk is starting to see just how big a challenge he's taken on in Tesla Motors (NASDAQ:TSLA).
There have been a number of comments Musk has made recently that should concern investors. He's admitted that they made the Model X design too complicated, which resulted in a number of flaws reported by early buyers. This is on top of delays in launching both the Model S and Model X. With the Model 3 on the way, it's manufacturing that Tesla Motors needs to get right. Alas, Musk appears to be just starting to understand what he's taken on, saying at the Code Conference earlier this month:
We realized that the true problem, the true difficulty, and where the greatest potential is -- is building the machine that makes the machine. In other words, it's building the factory. I'm really thinking of the factory like a product.
At the same event, he would go on to say:
You might think that some of the most advanced car factories in the world are very good at making cars and they are maybe making a car every 25 seconds -- that sounds fast, but actually, if you say the length of the car plus some buffer space is approximately 5 meters so it's taking 25 seconds to move 5 meters.
This may seem strange to come from an auto executive who hasn't even proven that he can build a manufacturing plant that will create a vehicle with industry-standard quality at industry-standard speed. So, maybe he should catch up to what the rest of the industry can do before reinventing the factory?
Looking at the world through a different lens
I think it's important to cover the lens through which I peronally look at investing, Tesla Motors in particular, and why that view gives a different insight into Tesla Motors' current challenges. I'm a mechanical engineer by training and I spent seven years working at 3M, including two years in the company's largest manufacturing plant installing manufacturing equipment.
It's at 3M that I began to appreciate what it meant to create a world-class manufacturing facility and just how specialized the work was. Most of 3M's products are film, so there was a range of expertise within the company like roller design, material handling, tension control, and adhesive curing, just to name a few. These may sound like mundane tasks, but together they create the institutional knowledge that 3M is built on, and if you ever tried to run a mile long piece of paper through an oven at 3,000 feet per minute, you might want some people with experience guiding you. And we had an entire building dedicated to designing and building the equipment that made our products.
This institutional knowledge is the competitive moat in manufacturing and it's hard to create from scratch. It's expertise, it's culture, it's the mind-set of your designers that go into building a company that can manufacture products efficiently.
This same moat concept is replicated over and over again in manufacturing. From Intel's chips to General Electric's turbines to General Mills' cereal, a huge part of their competitive advantage is in designing the manufacturing facilities that make the products we use everyday. And auto manufacturing is equally specialized, making it very difficult for an upstart to generate the expertise needed to compete.
Manufacturing is hard
There's a reason that Ford's (NYSE:F) assembly line was so revolutionary in the early 1900s and why the Toyota (NYSE:TM) production system was a differentiator in the '70s, '80s and '90s. Manufacturing is hard and it takes an armyof people with staggeringly specific knowledge all working together in unison to make it work. A single mistake buried in the code of your equipment or a flaw in your stamping press can result in hours or even days of downtime. You can't just outsource a manufacturing plant that will make a car every 25 seconds, like you can in the tech world (see Foxconn).
And that's where I think Musk has underestimated his task ahead. His experience is in software where iterations and bug fixes can be made in an instant. Build the product, find problems, fix the problems, then rinse and repeat until it's right. When building a massive auto manufacturing plant, you have to find and fix problems before defective problems get into a customers' hands and I'm not sure Tesla Motors even knows what problems may arise as it ramps up production.
Yet, Musk has forged ahead with installing billions of dollars in equipment to build battery packs and electric vehicles without proving the expertise to do so at a world-class level. You can look at the flaws in the Model X and the fact that the Model S has been put on Consumer Reports' "Used Cars to Avoid Buying" list as an indication that flaws exist in manufacturing at Tesla Motors. The one thing Tesla Motors has to get right is the one thing it hasn't proven the ability to do.
Manufacturing will make or break Tesla Motors
The reason this is such a big deal for Tesla Motors is that it's what will make or break the company. If investors knew without a doubt that Musk would hit his manufacturing cost and timeline goals, we could project massive growth and even profits going forward. But Musk has consistently missed manufacturing targets and hasn't proven the ability to run a great manufacturing company. That gives competitors time to develop their own strategies and catch up. And they're coming fast.
General Motors (NYSE:GM) is launching the Chevy Bolt this year with over 200 miles of electric range and a price tag starting at $37,500 before tax incentives, at least a year before Tesla's Model 3 hits the road. The next-generation Nissan Leaf, expected next year, will have up to 150 miles of range. Even Ford's Focus Electric is expected to have over 100 miles of range per charge. And then there's VW, Mercedes, Porche, and others, all of which are working on EVs.
While these established automakers may not have a lot of experience building electric vehicles, they have a lot of experience building vehicles. And that's their competitive moat against Tesla Motors, who is still learning on the job.
Don't underestimate how big of a challenge Musk is taking on in building a company that's expecting to manufacture as many as 1 million vehicles per year by 2020. He's impressed everyone with high vision, design, and dedication to the electric vehicle movement. But if he can't become a world-class manufacturer in the next few years, it could break Tesla Motors. And that's a risk investors shouldn't underestimate.