The significant improvement in the operational efficiency that Tesla has achieved today is the result of years of research and development that enabled the company to become one of the world's most advanced and innovative car manufacturers.
Since 2016 the manufacturing engineering has been focused on the 'Machine that Makes the Machines', following Elon Musk's vision, who believes that the greatest potential is in the factory : "The competitive strength of Tesla long-term is not going to be the car; it's going to be the factory."
The team adopted a revolutionary approach to constructing a production facility, more similar to the one used for a product: instead of ordering standard machinery and plants available on the market; they started developing each piece of equipment involved in the manufacturing processes to achieve maximum efficiency. As Elon explained in the 2016 shareholder meeting, the potential room for improvement in the production facility is a factor of ten, greater than the one available on the vehicle side. Based on these assumptions, they started shifting design and engineering resources trying to improve motor technologies and power electronics to the factories, where the marginal benefits in terms of efficiency were much higher.
Giving a practical example, the giga press casting machine represents a game-changer in the auto industry and the heart of Tesla's manufacturing processes. The casting technologies were developed in 2019 by IDRA group, while Tesla provided a key element by creating a new aluminum alloy explicitly designed for the die casting process of the car. The advantages are basically:
simplification of processes as the Gigapress can make an entire vehicle frame in just 2 sections (from 171 as shown in the figure), resulting in a significant reduction in CAPEX on all the robots used in the body welding and assembly.
the production cycle time, as the aluminum alloy can go from molten metal to a chassis in less than ad 100 seconds, is a significant improvement if compared to all the steps in labor involved in fabricating and fastening more than 100 parts together
Let's look at the impact on financial performance. One of the most significant efficiency KPIs is the operating margin: it represents how efficiently a company can generate profit through its core operations. A comparison between competitors can provide a benchmark of the reference industry:
- Ferrari: 24.4%
- Tesla: 19.2% (from Q1 2022 earnings)
- Mercedes: 11.19 %
- BMW: 10%
- Toyota: 8.08%
- GM: 7.34%
- Ford:7.17%
- Volvo:7.1%
- VW: 6.38%
- Hyundai: 5.68%
- Honda: 5.01%
- Nissan: -1.92%
Source: YCharts, earnings reports
The stunning increase in the operating margin in the last two years gives an idea of how the improvement of production processes impacted the company's profitability. If we compare the result achieved by Tesla in Q1 2022 with the profitability of other carmakers, the only player who challenges Tesla is Ferrari, which clearly has a different target market.
The efficiency of the manufacturing process is not the only driver of Tesla's brilliant profitability. Others are:
- Strong pricing policy as demand still exceeds offer considering consumers' high interest in EV;
- vertical integration, as the company sells its products directly to the end customer instead of relying on the traditional dealership model used by other car manufacturers.
- Economies of scale.
The same conclusions emerge from the graph below, highlighting the dynamics of EBIT, which measures the profit generated from operations, making it synonymous with operating profit.
In order to demonstrate the benefits of efficiency on the operating margin, it is essential to highlight the fact that the driver of higher margins is the reduction in the cost of goods sold, excluding the price effect.
The boost effect on profitability driven by growth in efficiency, is evident looking to the dynamics of Average Selling Price and Gross Margin in the period 2017 – 2022Q1: relative GM keeps growing even though the ASP reduces by more than 50%.
To conclude the analysis, let's focus on the relationship between revenues and operating costs in the reference time frame: revenues increase by a multiple close to 7 while Operating Costs are less than doubled. OPEX impact on revenues was reduced by more than 3 times, reflecting the company's ability to increase revenues and keep under control business expenses not directly related to production volumes.