Tesla: Lessons in Strategy and Governance

Tesla: Lessons in Strategy and Governance

An awful lot has been written about Elon Musk and Tesla in recent months from the now-notorious Q2 earnings call to the just-ended “going private” fiasco. Even more remains to be written about the daunting production and business challenges confronting Tesla and its mercurial CEO, Elon Musk, as the company seeks a way of rebuilding trust with investors.

Normally I wouldn’t want to ‘pile on’. But there is one element of strategy that I haven’t seen properly addressed anywhere yet, and another issue, on governance, that may not amount to an entirely new topic but is umbilically related to the strategic issue I am raising here.

On strategy, I think it’s high time that investors, pundits, customers, and industry observers all acknowledge that producing a luxury vehicle like the Model S in the low thousands of units is a completely different challenge to producing a popular car such as the Model 3 at a much lower unit price, in the tens and hundreds of thousands of units. The practical laws of business architecture have shown for decades that designing and producing automobiles (or other products) in high volumes, standardized for maximum simplicity is a completely different challenge from designing and producing autos (or other products) at low volumes, in different flavors and with differentiated service tailored for different types of customer.

This is not just to evoke the famous story of Henry Ford and his famous Model T car, the first mass-produced automobile that was for some time only available in black. Ford’s achievement was to convert a luxury – a personally owned and operated automobile – into a means of transport available to a much larger percentage of the population. The economics and physics of ‘volume operations’ are not only different, they are antagonistic to the economics and physics of ‘complex systems’. To cite an extreme example from the same industry, Volkswagen Beetles and Toyota Corollas sold in the millions are a totally different kettle of fish from Bentleys and McLarens that are tailor-made for a few hundred customers. Even within specific auto makers, decades ago GM realized that making, marketing, and supporting Cadillacs was a different ball-game than making and maintaining Chevys. So they set up a different division for design, marketing and assembly, and different dealer channel to sell and service these different types of vehicle.

Then in the eighties Toyota set up Lexus, its new luxury car division, as a completely separate business unit from the word go, realizing that it would need to be operated as a completely different business from its mass-market organization, not only to produce a different type of driving experience (while still leveraging some key elements such as standard Toyota chassis for Lexus ES and LS cars) but, more importantly, a completely different ownership experience – much of which I believe Tesla emulated and improved on using when it launched the Model S, essentially a software-enabled mobile device.

I use these examples to suggest that Musk’s ambition to take Tesla in just a few years from being an (unprofitable) up-market auto maker to being a (hopefully, profitable) mass-market manufacturer in essentially the same organization was always doomed to encounter serious problems, and most probably fail. To be clear, the current death struggle that we are witnessing on a monthly basis, as Tesla fights to reach reasonable production figures for the Model 3, is no surprise.

By all accounts Musk is a true industry-shaping visionary, with many of the same talents as a Steve Jobs, a Richard Branson, or a Jeff Bezos. What he pulled off with the Model S – voted Car of the Year by more than one respected automotive magazine – was quite extraordinary, making it the first beautifully designed and easily maintained electric sports sedan with a national and international recharging and service infrastructure that renders it virtually a daily-use vehicle for motorists in many urban areas.

Revolutionizing just one established and conservative industry – traditional ICE-powered automobiles – would be achievement enough. But, like Jobs before him, Musk is trying to revolutionize three industries at once, when you consider Solar City (solar power) and Space (commercial space exploration). While extremely admirable, this is also asking for trouble.

This brings me to the matter of governance. If Tesla’s highly-compensated board, paid five times or so more than board members of other major corporations, was fulfilling its basic obligations, Musk would never have been permitted to make the Solar City acquisition in what seemed to be such a sudden and expedient manner without a full assessment of its merits by the board, including Musk. Nor would he have been allowed to move markets with his fanciful tweet earlier this month about taking the company private for $72bn. with so-called “funding secured”. And, as importantly, the board would be expected to review the company’s – or rather, Musk’s – (over?)ambitious strategy of transitioning from luxury car production to mass-market car production without questioning the feasibility of such a move, or without validating the business design and organizational considerations that make this transition so disruptive and challenging. Given the sheer scale of ambition, and the considerable risks associated with each of his corporate undertakings, it is no surprise that Musk might be operating on fumes by now, and getting closer by the day to what in the old days we used to refer to as a nervous breakdown.

On one hand, you might wonder how the Tesla board can apparently stand silently by while Musk has made a succession of trust-destroying blunders one after another in the past several months. On the other hand, it may be even more relevant to ask what they could do to stop Musk doing whatever he wants? Not only is he a force of nature by dint of his personality, but he is in an extremely powerful position of control despite only owning 22% of Tesla shares. This is because of the existing “super-majority” provision mandating that, without the voting block he essentially commands, a minimum of 89.5% of outside shares must vote to approve key changes – “an incredibly high hurdle”, according to Ronald Orol, writing in The Street on April 23rd, 2018.

No matter what level of formal control your CEO exercises, nor what degree of autocratic behavior they display, there are limits to what over-reaches of authority a board can afford to accept – and I fear that the Tesla board has breached these limits on more than one occasion by omission, if not by commission. Every board has an obligation to deal with the Key Man issue; and no role is more crucial to the company’s success than that of the CEO, especially when they also have founder-level presence and authority. When you see clear signs of erratic behavior, you have to step in even if it’s only to conduct some form of friends-or-family intervention. I’m sure one or more board members have attempted on occasion to intervene in one or more ways; but just trying is not sufficient. And if the CEO refuses to cooperate, each board member has a choice. Resigning may feel like defeat, but if a company loses too many board members, the market will soon cotton on and make it harder for the CEO to get away with ignoring the board’s entreaties.

Overall, the Tesla board needs to conduct periodic and episodic reviews of strategy and operations, and it must take action when action is required. Why have board members not questioned Musk’s strategy for migrating from low-volume Model S production to high-volume Model 3 production? At the very least, you would expect them to help Musk minimize his exposure, and thus protect the company’s value, by not insisting in every earnings call that Tesla will achieve production milestones that require everything to go off flawlessly in the face of daunting technological and physical barriers.

From what I can tell Tesla badly needs a new board chairman to drive the board’s agenda. A board where the CEO is also the chairman is in essence an unmanaged entity, no matter what anyone tells you about the merits of having a lead director to whisper in the ear of the CEO/chairman. Tesla also most probably needs an empowered COO to direct the company’s day-to-day operations, and probably a CEO too – which would free Musk up to be CTO.

Without a strong set of corrections to the governance of the company along these lines, I believe Tesla’s future is, unfortunately, in serious jeopardy. The business world never has enough visionaries and leaders to emulate or learn from, and Musk has been one of the few truly inspiring figures in recent times. Let’s hope the flaws that he has been displaying in recent months – among them, some very understandable human ones – can be minimized, and that Musk as well as Tesla can return to prominence for all the right reasons rather than be remembered for too many of the wrong ones.

4 Comments

Mike Endacott

about 3 weeks ago

Tesla automobile only exists because of steep subsidy by California taxpayers. Some of whom support the anti carbon agenda of their progressive state leadership and can virtue signal to their friends by owning a Tesla. The Tesla 3 was initially promised at a price of $35,000, now it’s $50,000. Can this realistically be described as a mass market vehicle any more? Tesla is the most shorted stock in history for very sound reasons. A completely electrified motor vehicle universe in the US would require at least 30 new nuclear power stations to support. It is this type of omission in the thinking of progressive elites combined with condescension to dissenting opinion that will cause the inevitable collapse of Tesla to be greeted with much mirth when flakey environmentalism hits the inevitable wall of reality. Henry Ford delivered a usable product to the masses at a price they could afford. Tesla is an expensive boondoggle born of elitist fantasy. Rather than a weak board and a flakey CEO .. look to a poorly conceived business model as the cause of Tesla’s problems.

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Philip Lay

about 3 weeks ago

Mike, Thanks very much for your comments. As you saw in the article, I agree with you that the Model 3 has a problematic value proposition as a mass-market "popular" car. I guess I'm more supportive than you sound of what Tesla has accomplished in producing EVs that people actually want to drive, but I agree that there are implications that we have to take into account regarding how to produce electricity in the most cost-effective ways all things considered. Anyway, thanks again for your comment.

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Peter Van der fluit

about 3 weeks ago

Philip touches upon a hot item which is the combo CEO/Chairman role. Unfortunately this is still too often the situation in too many public listed companies including many in the US. GE is just another great example where even after Immelt stepping down from the top job, GE continued their "great tradition" by making appointing the new CEO John Flannery also Chairman. The GE board seems to keep ignoring to learn from mistakes from the past. I am sure every reader here can site their own examples. So what can be done about this? I offer one small example which originates from the country I currently live in. Almost 10 years ago the Dutch government commissioned the former Chairman of Unilever, Morris Tabaksblad to come with suggestions resulting in "Code Tabaksblad" which in no uncertain terms state that the combination of CEO and Chairman is a very bad business practice and should be avoided at all cost. This is not a law in Holland but a typical "polder" solution. It is kind of an unstated law, a best practice now adopted by public companies as a kind of "standard of business conduct" of good business governance. Perhaps others countries might follow this example?

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