[U32] Tesla scores with an outstanding quarter
Vertical integration: a strategy other corporate boards are likely to reject is why Tesla is scaling "winner takes most"
Dear Reader,
Tesla released it Q1 2022 financial results on April 20, 2022. Highlights demonstrated significant progress for the company as it expands electric vehicle production with new sites in Europe (Gigafactory Berlin) and North America (Gigafactory Texas) in addition to existing sites in Asia (Gigafactory Shanghai) and North America (Tesla Fremont Factory).
Three highlights from Tesla’s Q1 2022 financial results are relevant related to Product | Strategy | Innovation.
Operating Leverage continues to expand
Giga Castings continue to reduce parts and welds
Automotive Gross Margin (TTM) continues to improve
And another important outcome shared in Tesla’s Q1 2022 financial results was a graph showing orders for Tesla the day after the Super Bowl relative to prior days all the way back to January 1, 2022. This is impressive, but even more so when Tesla didn’t even run a TV commercial during the Super Bowl. Legacy OEMs ran numerous ads promoting their EVs only to generate more demand for Tesla orders. Elon probably mocked an ad on Twitter with a link to Tesla’s website to purchase a real electric vehicle versus a prototype. Elon on Twitter is Tesla’s marketing and public relations department.
From personal experience, purchase orders at Tesla exceeding $5,000 in past quarters were required to be submitted to Elon for approval. This micromanaging is extreme, but creates a discipline at Tesla that is an outlier compared to other companies. I’m sure Elon delegates most of these approvals to an internal team, but when an employee submits a purchase order at Tesla, they don’t know what criteria are used to determine which purchase orders go directly to Elon for approval. You don’t want to go through Elon’s “first principles” gauntlet unless you can defend why your purchase order is critical to the mission of the company.
An Alpha deployment is rescoped to a smaller scale and at a significant discount to Tesla to fall under the $5,000 threshold to validate key assumptions with objective data. Success leads to larger scale for a Beta deployment and then a Charlie deployment. Employees want data to validate their business case assumptions for the projected return on investment to pass the gauntlet. Other OEM CEOs are in back-to-back meetings discussing slide decks prepared by MBAs. Elon hires talent for skills not degrees.
Vertical integration is key to many of Tesla’s advantages. Tesla created its own ERP system vs. sourcing enterprise solutions from SAP or Oracle that require building your company operations around their systems. Tesla developed their own processor to implement neural networks in an electric vehicle using edge computing with the required sensors. And Tesla is forming partnerships to source raw materials for lithium ion batteries like nickel to meet the projected demand when current supplies would not be able to meet that demand.
1. Operating Leverage continues to expand
In a prior post, I discussed Tesla’s operating leverage. This happens when fixed cost capital expenditures (Capex) are used with variable, but growing unit production and top line revenue to generate more profit.
And this isn’t just Capex into manufacturing process paths. Tesla has made significant investments into edge computing to equip every vehicle with proprietary full-self driving (FSD) processors it designed internally and sensors for real world AI. This enables 360 degree, wrap-around computer vision. This hardware and companion software enable a high-margin FSD add-on sale (currently $12,000) with the purchase of a new vehicle or a monthly $200 subscription whenever a Tesla owner wants to use this capability. FSD is currently limited to about 100,000 Tesla EV owners enrolled in the FSD beta program according to Elon.
But even more important, the FSD hardware and sensors enable Tesla to quantify an objective Safety Score. This was developed to qualify Tesla owners for enrollment into the FSD beta program. Initially, a perfect score of 100 out of 100 was required to enroll in the program beyond the first 1,000 or so invited participants. Then scores of 99 and 100 were permitted to enroll and so on. Tesla claims that by the end of 2022, anyone who purchased FSD should be able to enroll in the FSD beta program if they want to do so.
More recently, Tesla announced it was using the Tesla Safety Score to price Tesla Insurance dynamically based on leading indicators for risk of an accident. The 2022 target for Tesla Insurance is to make it available to up 80% of Tesla EV owners based on where they live. Thus, the high-margin FSD and Tesla Insurance programs are possible because of the investment Tesla made to equip their vehicles for future recurring service revenue.
2. Giga Castings continue to reduce parts and welds
Another example of vertical integration and operating leverage is Tesla’s installation of multi-ton, high-pressure, die-casting Giga Presses to injection mold large metal parts with proprietary aluminum alloys. Tesla started using Giga Presses to Giga Cast the rear underbody segment for the Model Y in its Fremont Factory. But Giga Texas is now Giga Casting both the front and rear underbody segments. This reduces parts from 171 pieces of metal to 2 large underbody Giga Castings and reduces the number of robots required to handle and weld more parts into the same final component by an estimated 600 robots. The quality and crash safety of the final components also improves.
3. Automotive Gross Margin continues to improve
Gross margin is determined by taking the gross profit (revenue generated - cost of goods sold) as a proportion of the revenue generated. Tesla has improved their automotive gross margin from 26.5% in Q1 2021 to 32.9% in Q1 2022 for an increase of 636 basis points or 24.2%. This was the result of Tesla increasing their average selling price across all EV models with demand far exceeding supply and managing cost of goods sold in spite of historic supply chain issues and raw material/component part price inflation. Many parts made abroad are being flown into the U.S. at much higher costs than standard transportation over sea in container ships to maintain automotive production schedules. For comparison, General Motors Q1 2022 gross margin was 8.3% down 100 basis points from 9.3% in Q1 2021.
Pricing power leads to higher gross margins to generate higher gross profits. But high gross margins also provide an opportunity to take market share with lower prices. This flexibility will allow Tesla to accelerate the transition to sustainable energy when lithium ion battery supplies are no longer constrained. Tesla unit vehicle production can ramp exponentially with more Giga Factories producing even more vehicles per day within the same continent as the sales order. Demand at scale with 20 million units eventually produced will require more price sensitivity in value segments. That is the primary reason Tesla is investing aggressively into scaled production and unit vehicle cost reduction.
Conclusion
Operating Leverage, Giga Castings and Gross Margin were 3 key highlights in the recent Tesla 2022 Q1 financial results in my opinion. Operating Leverage could also provide a clue for why Elon could justify an offer to acquire Twitter for about $44 billion in a tender offer using 3 X Holding entities. I mentioned X in my original post and why holding companies kill innovation. Obviously, Elon rejected this hypothesis, but he is using a holding companies for a much different objective than I discussed.
Once Elon realized real world AI was required to achieve full self-driving and he started investing into the required infrastructure to make that happen with computing systems, neural networks and one of the leading AI software teams in the world, he started imagining what else is possible with such infrastructure and AI talent. They need ongoing challenges to stay motivated to keep pushing the limits for Tesla’s real world AI infrastructure.
The Optimus humanoid robot repurposes computer vision developed for robo-taxis plus actuators to replace mundane tasks that human workers do not really want to do. But Twitter requires real world AI to interpret the intent of a tweet and identify disinformation. Elon has stated he wants to preserve free speech, but also wants to eliminate posts by algorithms and bots. Using open-source software and published rules used to enforce how Twitter monitors tweets, Elon intends to transform social media and the remittance of money across borders for basically free.
Jack Dorsey as the prior CEO of Twitter enabled a tweet to send Bitcoin to any other digital wallet anywhere in the world that is also on the Lightning Network. Let’s see if Elon is able to actually take Twitter private and what he does with it if he does assume control of its assets. Tesla doesn’t have a public relations department, but it does have one of the leading influencers on the Twitter platform. And with more say in how the Twitter platform operates, Elon could lead the way and optimize how to effectively communicate and build community around a brand.
Best,
Stephen
I’m long TSLA mentioned in this update. Nothing in this post is intended to serve as financial advice. Do your own research.