Why Tesla Beats GM, Ford, Nissan

The last 12 months Tesla Motors stock has been on a tear.  From $25 it has more than quadrupled to over $100.  And most analysts still recommend owning the stock, even though the company has never made a net profit. 

There is no doubt that each of the major car companies has more money, engineers, other resources and industry experience than Tesla.  Yet, Tesla has been able to capture the attention of more buyers.  Through May of 2013 the Tesla Model S has outsold every other electric car – even though at $70,000 it is over twice the price of competitors! 

During the Bush administration the Department of Energy awarded loans via the Advanced Technology Vehicle Manufacturing Program to Ford ($5.9B), Nissan ($1.4B), Fiskar ($529M) and Tesla ($465M.)  And even though the most recent Republican Presidential candidate, Mitt Romney, called Tesla a "loser," it is the only auto company to have repaid its loan. And did so some 9 years early!  Even paying a $26M early payment penalty!

How could a start-up company do so well competing against companies with much greater resources?

Firstly, never underestimate the ability of a large, entrenched competitor to ignore a profitable new opportunity.  Especially when that opportunity is outside its "core." 

A year ago when auto companies were giving huge discounts to sell cars in a weak market I pointed out that Tesla had a significant backlog and was changing the industry.  Long-time, outspoken industry executive Bob Lutz – who personally shepharded the Chevy Volt electric into the market – was so incensed that he wrote his own blog saying that it was nonsense to consider Tesla an industry changer.  He predicted Tesla would make little difference, and eventually fail.

For the big car companies electric cars, at 32,700 units January thru May, represent less than 2% of the market.  To them these cars are simply not seen as important.  So what if the Tesla Model S (8.8k units) outsold the Nissan Leaf (7.6k units) and Chevy Volt (7.1k units)?  These bigger companies are focusing on their core petroleum powered car business.  Electric cars are an unimportant "niche" that doesn't even make any money for the leading company with cars that are very expensive!

This is the kind of thinking that drove Kodak.  Early digital cameras had lots of limitations.  They were expensive.  They didn't have the resolution of film.  Very few people wanted them.  And the early manufacturers didn't make any money.  For Kodak it was obvious that the company needed to remain focused on its core film and camera business, as digital cameras just weren't important. 

Of course we know how that story ended.  With Kodak filing bankruptcy in 2012.  Because what initially looked like a limited market, with problematic products, eventually shifted.  The products became better, and other technologies came along making digital cameras a better fit for user needs. 

Tesla, smartly, has not  tried to make a gasoline car into an electric car – like, say, the Ford Focus Electric.  Instead Tesla set out to make the best car possible.  And the company used electricity as the power source.  By starting early, and putting its resources into the best possible solution, in 2013 Consumer Reports gave the Model S 99 out of 100 points.  That made it not just the highest rated electric car, but the highest rated car EVER REVIEWED!

As the big car companies point out limits to electric vehicles, Tesla keeps making them better and addresses market limitations.  Worries about how far an owner can drive on a charge creates "range anxiety."  To cope with this Tesla not only works on battery technology, but has launched a program to build charging stations across the USA and Canada.  Initially focused on the Los-Angeles to San Franciso and Boston to Washington corridors, Tesla is opening supercharger stations so owners are never less than 200 miles from a 30 minute fast charge.  And for those who can't wait Tesla is creating a 90 second battery swap program to put drivers back on the road quickly.

This is how the classic "Innovator's Dilemma" develops.  The existing competitors focus on their core business, even though big sales produce ever declining profits.  An upstart takes on a small segment, which the big companies don't care about.  The big companies say the upstart products are pretty much irrelevant, and the sales are immaterial.  The big companies choose to keep focusing on defending and extending their "core" even as competition drives down results and customer satisfaction wanes.

Meanwhile, the upstart keeps plugging away at solving problems.  Each month, quarter and year the new entrant learns how to make its products better.  It learns from the initial customers – who were easy for big companies to deride as oddballs – and identifies early limits to market growth.  It then invests in product improvements, and market enhancements, which enlarge the market. 

Eventually these improvements lead to a market shift.  Customers move from one solution to the other.  Not gradually, but instead quite quickly.  In what's called a "punctuated equilibrium" demand for one solution tapers off quickly, killing many competitors, while the new market suppliers flourish.  The "old guard" companies are simply too late, lack product knowledge and market savvy, and cannot catch up.

  • The integrated steel companies were killed by upstart mini-mill manufacturers like Nucor Steel.  
  • Healthier snacks and baked goods killed the market for Hostess Twinkies and Wonder Bread. 
  • Minolta and Canon digital cameras destroyed sales of Kodak film – even though Kodak created the technology and licensed it to them. 
  • Cell phones are destroying demand for land line phones. 
  • Digital movie downloads from Netflix killed the DVD business and Blockbuster Video. 
  • CraigsList plus Google stole the ad revenue from newspapers and magazines.
  • Amazon killed bookstore profits, and Borders, and now has its sites set on WalMart. 
  • IBM mainframes and DEC mini-computers were made obsolete by PCs from companies like Dell. 
  • And now Android and iOS mobile devices are killing the market for PCs.

There is no doubt that GM, Ford, Nissan, et. al., with their vast resources and well educated leadership, could do what Tesla is doing.  Probably better.  All they need is to set up white space companies (like GM did once with Saturn to compete with small Japanese cars) that have resources and free reign to be disruptive and aggressively grow the emerging new marketplace.  But they won't, because they are busy focusing on their core business, trying to defend & extend it as long as possible.  Even though returns are highly problematic.

Tesla is a very, very good car. That's why it has a long backlog. And it is innovating the market for charging stations. Tesla leadership, with Elon Musk thought to be the next Steve Jobs by some, is demonstrating it can listen to customers and create solutions that meet their needs, wants and wishes.  By focusing on developing the new marketplace Tesla has taken the lead in the new marketplace.  And smart investors can see that long-term the odds are better to buy into the lead horse before the market shifts, rather than ride the old horse until it drops.

 

 

Hostess’ Twinkie Defense Is a Failure

Hostess Brands filed for liquidation this week.  Management blamed its workforce for the failure.  That is straightforward scapegoating.

In 1978 Dan White killed San Francisco's mayor George Moscone and city supervisor Harvey Milk.  The press labeled his defense the "Twinkie Defense" because he claimed eating sugary junk food – like Twinkies – caused diminished capacity.  Amazingly the jury bought it, and convicted him of manslaughter instead of murder saying he really wasn't responsible for his own actions.  An outraged city rioted.

Nobody is rioting, but management's claim that unions caused Hostess failure is just as outrageous. 

Founded in 1930 as Interstate Bakeries Co. (IBC) the company did fine for years. But changing consumer tastes, including nutrition desires, changed how much Wonder Bread, Twinkies, HoHos and Honey Buns people would buy — and most especially affected the price – which was wholly unable to keep up with inflation. This trend was clear in the early 1980s, as prices were stagnant and margins kept declining due to higher costs for grain and petroleum to fuel the country's largest truck fleet delivering daily baked goods to grocers.

IBC kept focusing on operating improvements and better fleet optimization to control rising costs, but the company was unwilling to do anything about the product line.  To keep funding lower margins the company added debt, piling on $450M by 2004 when forced to file bankruptcy due to its inability to pay bills.  For 5 years financial engineers from consultancies and investment banks worked to find a way out of bankruptcy, and settled on adding even MORE debt, so that – perversely – in 2009 the renamed Hostess had $670M of debt – at least 2/3 the total asset value!

Since then, still trying to sell the same products, margins continued declining.  Hostess lost a combined $250M over the last 3 years. 

The obvious problem is leadership kept trying to sell the same products, using roughly the same business model, long, long, long after the products had become irrelevant.  "Demand was never an issue" a company spokesman said.  Yes, people bought Twinkies but NOT at a price which would cover costs (including debt service) and return a profit. 

In a last, desperate effort to keep the outdated model alive management decided the answer was another bankruptcy filing, and to take draconian cuts to wages and benefits.  This is tanatamount to management saying to those who sell wheat they expect to buy flour at 2/3 the market price – or to petroleum companies they expect to buy gasoline for $2.25/gallon.  Labor, like other suppliers, has a "market rate."  That management was unable to run a company which could pay the market rate for its labor is not the fault of the union.

By constantly trying to defend and extend its old business, leadership at Hostess killed the company.  But not realizing changing trends in foods made their products irrelevant – if not obsolete – and not changing Hostess leaders allowed margins to disintegrate.  Rather than developing new products which would be more marketable, priced for higher margin and provide growth that covered all costs Hostess leadership kept trying to financial engineer a solution to make their horse and buggy competitive with automobiles. 

And when they failed, management decided to scapegoat someone else.  Maybe eating too many Twinkies made the do it.  It's a Wonder the Ding Dongs running the company kept this Honey Bun alive by convincing HoHos to loan it money!  Blaming the unions is simply an inability of management to take responsibility for a complete failure to understand the marketplace, trends and the absolute requirement for new products.

We see this Twinkie Defense of businesses everywhere.  Sears has 23 consecutive quarters of declining same-store sales – but leadership blames everyone but themselves for not recognizing the shifting retail market and adjusting effectively. McDonald's returns to declining sales – a situation they were in 9 years ago – as the long-term trend to healthier eating in more stylish locations progresses; but the blame is not on management for missing the trend while constantly working to defend and extend the old business with actions like taking a slice of cheese off the 99cent burger.  Tribune completey misses the shift to on-line news as it tries to defend & extend its print business, but leadership, before and afater Mr. Zell invested, refuses to say they simply missed the trend and let competitors make Tribune obsolete and unable to cover costs. 

Businesses can adapt to trends.  It is possible to stop the never-ending chase for lower costs and better efficiency and instead invest in new products that meet emerging needs at higher margins.  Like the famous turnarounds at IBM and Apple, it is possible for leadership to change the company. 

But for too many leadership teams, it's a lot easier to blame it on the Twinkies.  Unfortunately, when that happens everyone loses.

 

Innovation Matters; or Why You Care More About Apple than Kraft

Apple is launching the iPhone 5, and the market cap is hitting record highs.  No wonder, what with pre-orders on the Apple site selling out in an hour, and over 2 million units being presold in the first 24 hours after announcement. 

We care a lot about Apple, largely because the company has made us all so productive.  Instead of chained to PCs with their weight and processor-centric architecture (not to mention problems crashing and corrupting files) while simultaneously carrying limited function cell phones, we all now feel easily interconnected 24×7 from lightweight, always-on smart devices.  We feel more productive as we access our work colleagues, work tools, social media or favorite internet sites with ease.  We are entertained by music, videos and games at our leisure.  And we enjoy the benefits of rapid problem solving – everything from navigation to time management and enterprise demands – with easy to use apps utilizing cloud-based data.

In short, what was a tired, nearly bankrupt Macintosh company has become the leading marketer of innovation that makes our lives remarkably better.  So we care – a lot – about the products Apple offers, how it sells them and how much they cost.  We want to know how we can apply them to solve even more problems for ourselves, colleagues, customers and suppliers.

Amidst all this hoopla, as you figure out how fast you can buy an iPhone 5 and what to do with your older phone, you very likely forgot that Kraft will be splitting itself into 2 parts in about 2 weeks (October 1).  And, most likely, you don't really care. 

And you can't imagine why I would even compare Kraft with Apple.

Kraft was once an innovation leader.  Velveeta, a much maligned product today, gave Americans a fast, easy solution to cheese sauces that were difficult to make.  Instant Mac & Cheese was a meal-in-a-box for people on the run, and at a low budget.  Cheeze Whiz offered a ready-to-eat spread for canape's.  Individually wrapped American cheese slices solved the problem of sticky product for homemakers putting together lunch sandwiches for school children.  Miracle Whip added spice to boring sandwiches.  Philadelphia brand cream cheese was a tasty, less fattening alternative to butter while also a great product for sauces. 

But, the world changed and these innovations have grown a lot less interesting.  Frozen food replaced homemade sauces and boxed solutions.  Simultaneously, cooking skills improved.  Better options for appetizers emerged than stuffed celery or something on a cracker.  School lunches changed, and sandwich alternatives flourished.  Across Kraft's product lines, demand changed as new technologies were developed that better fit customers' needs leading to revenue stagnation, margin erosion and an increasing irrelevancy of Kraft in the marketplace – despite its enormous size.

Apple turned itself around by focusing on innovation, becoming the most valuable American publicly traded company.  Kraft eschewed innovation for cost cutting, doing more of the same trying to defend its "core," leaving investors with virtually no returns.  Meanwhile thousands of Kraft employees have lost their jobs, even though revenues per employee at Kraft are 1/6th those at Apple.   And supplier margins are a never-ending cycle of forced reductions as Kraft tries to capture their margin for itself.

AAPL v KFT 9-2012
Chart Source:  Yahoo Finance 18 September, 2012

Apple's value went up because it's revenues went up.  In 2007 Apple had #24B in revenues, while Kraft was 150% bigger at $37B.  Ending 2011 Apple's revenues, all from organic growth, were up 4x (400%) at $108B.  But Kraft's 2011 revenues were only $54B, including roughly $10B of purchased revenues from its Cadbury acquisition, meaning comparative Kraft revenues were $44B; a growth of (ho-hum) 3.5%/year. 

Lacking innovation Kraft could not grow the topline, and simply could not grow its value.  And paying a premium price for someone else's revenues has led to…. splitting the company in 2 in only 2 years, mystifying everyone as to what sort of strategy the company ever had to grow!

But Kraft's new CEO is not deterred.  In an Ad Age interview he promised to ramp up advertising while slashing more jobs to cut costs.  As if somehow advertising Velveeta, Miracle Whip, Philadelphia and Mac & Cheese will reverse 30 years of market trends toward different products which better serve customer needs!

Apple spends nearly nothing on advertising.  But it does spend on innovation.  Innovation adds value.  Advertising aging products that solve no new needs does not.

Unfortunately for employees, suppliers and shareholders we can expect Kraft to end up just like Hostess Brands, owner of Wonder Bread and Twinkies, which recently filed bankruptcy due to 40 years of sticking to its core business as the market shifted.  Industry leaders know this, as they announced this week they are using Kraft's split to remove the company from the Dow Jones Industrial Average

Companies that innovate change markets and reap the rewards.  By delivering on trends they excite customers who flock to their solutions. Companies that focus on defending and extending their past, especially in times of market shifts, end up failing. Failure may not happen overnight, but it is inevitable.