Tesla's Market Dominance Challenged

As we look towards an era defined by autonomous driving, it is clear that the core demand of the automotive industry—to facilitate travel from Point A to Point B—remains unchangedNo matter how groundbreaking Tesla's innovations may seem, they are still deeply rooted in the essence of the automotive sectorThe company has yet to fully escape this characteristic, and an ecosystem entirely centered around autonomous driving is still on the horizon, requiring the emergence of new, powerful products.

Recently, Tesla's third-quarter report for 2023 caught the attention of investors and analysts alike, offering a rather sobering glimpse into the company's performance:

Total revenues reached $23.35 billion, marking a 9% year-on-year increase but a 6% decrease from the previous quarterGross profit stood at $4.18 billion, down 22% year-on-year and 3.6% quarter-on-quarter, with a gross margin of 17.9%, slightly lower than 18.2% in the last quarterNotably, total automotive revenue was $19.625 billion, reflecting a 5% year-on-year gain but a downward shift of 7.8% compared to last quarterThe company recorded a net profit attributable to shareholders of $1.85 billion, down 30% quarter-on-quarter and 43.7% year-on-yearIncreased investment in R&D, especially in Cybertruck and AI development, contributed to a research expense ratio of 5.0%, rising by 1.2 percentage points, while the operating profit margin fell to 7.9%, continuing its decline for the fourth consecutive quarter.

These figures paint a complex picture for Tesla, suggesting that despite being a pioneer in the electric vehicle market, the company is undergoing a period of adjustment—returning to a state of equilibrium while waiting for truly groundbreaking advancements or the dawn of the self-driving age.

Throughout business history, it is often observed that significant shifts in industries are characterized by several key factors: a transformative change in the supply chain and human lifestyles, a redefinition of the industry, a fresh consumer experience; or the era's economic benefits presenting traditional sectors with unprecedented demand

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Innovations that build upon prior achievements tend to have a first-mover advantage, while disruptive innovations often benefit from a late arriver's advantagesThere is a necessary duration of sustained momentum (typically spanning 5 to 10 years) with an adequate market size; and it must also possess commercial viability, generating returns that surpass average levels.

Tesla undeniably embodies these characteristics, having initiated a revolution by reinterpreting vehicles through software—transforming cars from mere mechanical products into sophisticated electronic devices, thus beginning the electronic automotive eraThe future value of automobiles lies not in engines or chassis, but in batteries, chips, systems, and dataThis innovative leap positioned Tesla as a self-propelling, integral player in information technology, thriving on Silicon Valley's rich ecosystem of semiconductors and the internet industryMany of Tesla's talents hail from illustrious companies like Apple, AMD, and Microsoft, contributing critically to the brand's identityWith this early mover's edge, Tesla became the only automotive company capable of positioning advanced driving features as a primary selling point.

The cornerstone of modern automotive competition increasingly hinges on softwareThrough OTA (over-the-air) updates, the functionalities of Tesla vehicles have evolved rapidly, outpacing the iterative processes found in traditional fuel vehiclesTesla can address braking issues remotely since the required adjustments exist in the software rather than in the physical brake systemThey have elevated user experiences in terms of safety, enjoyment, and intelligence, while keeping costs downTesla's vehicles exude a futuristic aura, combining semiconductors, aerospace technology, and information systems, emerging as a chic, eco-friendly vehicle that brings enhanced safety and driving pleasure through autonomous capabilities

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Customers engage with their cars and with Tesla itself through apps that facilitate continuous updates and maintenance, significantly reducing upkeep costs.

One of the most significant advantages of electric vehicles compared to traditional gasoline counterparts is their impressive accelerationFor instance, even the base model of the Tesla Model 3 achieves a remarkable 0-60 mph acceleration in just 5.6 seconds, while the top-of-the-line version does it in an astonishing 3.4 secondsSuch performance is virtually unattainable in competing gasoline vehicles within a similar price rangeThe arrival of the Model 3 has spurred the widespread adoption of electric vehicles in the mid-range market, further expanding the sector's reach.

Autonomous driving represents a radically new technology, one that has the potential to profoundly reshape the worldTesla’s approach to achieving self-driving capabilities involves outfitting as many of their vehicles with sensors as possible, effectively collecting vast amounts of data from these sensorsBuilt atop a robust software platform, Tesla can relay this accumulated driving data back to their vehicles via software updatesThis creates a self-reinforcing cycle, generating a 'winner-takes-all' network effect: the more data they garner (currently at the scale of billions of data points monthly), the better their autonomous driving capabilities become, thus leading to increased purchases of Tesla vehicles, which in turn generates yet more data.

In light of these factors, Tesla's stock has experienced tremendous growth since its IPO, soaring by over 410 times, particularly following the launch of the Model 3, which saw its maximum increase exceed thirty-fold.

However, despite these notable achievements, it's evident that Tesla still retains manufacturing characteristics.

The year 2023 brought a wave of renewed pessimism regarding the American economy, compounded by the AI boom inspired by innovations like ChatGPT and Nvidia

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During this period, Tesla charging stations reached a de facto universal standard in the United StatesThese developments led to a surge in Tesla’s stock, approaching the $300 mark per shareYet, the latest quarterly results served as a sobering reminder of market realities.

Tesla advocates for vertical integration and capital-intensive processes, creating novel manufacturing practices such as integrated die-castingHowever, their late entry into battery production has stunted the growth of the in-house 4680 battery output, a primary factor in the slower reduction of overall vehicle production costsAlthough prior strategies leveraged first-mover advantages and technological supremacy to fundamentally transform manufacturing processes and sales methodologies for electric vehicles, there is still a need for a competitive moat to uphold those advantagesCurrently, the third-quarter report displayed a further drop in automotive gross margins, now down to 15.7%, with market analysts estimating margins around 18%.

Consequently, as significant breakthroughs in autonomous driving technology remain elusive, Tesla’s attributes still gravitate heavily towards traditional manufacturingIts valuation has entered a precarious phase, with the projected price-to-earnings (PE) ratio climbing as high as 70. Clearly, after moving beyond the high-growth benefits of the industry, the buzz surrounding AI and self-driving propositions currently lacks the strength to support such valuationsA more grounded evaluation will hinge upon assessing Tesla's continuing sales growth, as that will form the underpinning of its valuation.

A parallel can be drawn with Apple; during the era when the focus lay primarily on hardware, the PE ratio fluctuated chiefly due to product performance, remaining between the 10-20 rangeIt wasn’t until Apple integrated its hardware and software capabilities that it achieved substantial valuation uplift, with PEs stabilizing between 20-40.

Tesla set forth an ambitious goal in 2021, aiming for a compound annual growth of 50% in overall vehicle sales

By early 2023, as the market transitioned from a supply-driven to a demand-driven model, the company clarified that this growth was computed from a year in a specific low period—2020, the year the Shanghai plant commenced operations and the Model 3/Y began extensive production.

Now that this production ramp-up has been realized, new capacity hasn't achieved a corresponding accelerationThe manufacturing complexity surrounding the Cybertruck has increased, and recent calls left the previous 50% growth forecasts unconfirmedCommon sense indicates that the productivity gains and manufacturing innovation benefits seen previously are reaching diminishing returns, presenting considerable challenges aheadTesla's focus on efficient production has seen a shift; it has lowered steady-state capacity goals for its two new factories, abandoning aspirational targets like 10,000 units per weekIn 2024, the launch of the Cybertruck remains precarious, with the company having to manage expectations during recent discussionsThe decision to temporarily halt production under the guise of trade-in programs also subtly hints at a strategic alignment toward balancing supply and demandGiven that growth foundations for the next year will heavily depend on the new factories, it’s probable that the projected sales target for 2024 of 2.3 million units may face reductions, with any truly substantial contributions from new platforms likely postponed until 2025.

A clear observation reveals that Tesla’s automotive business trajectory has worsened this year, contrasting sharply with an optimistic narrative fueled by other business linesThe fundamental automotive operations, however, are poised for instability in the coming yearMarket realities often paint a linear growth narrative, and Tesla may face pressing recalibration in its valuation reflecting this.

As the stakes escalate with intense competitiveness in the automotive sector—a traditionally cutthroat marketplace—Tesla has enjoyed a decade-long first-mover advantage

Yet, the tide of competition keeps surging, with traditional German automotive giants gradually formulating their strategiesUnlike the smartphone industry, where shifts arose from social demands, the automotive domain, particularly before autonomous driving becomes widespread, still fundamentally revolves around practical transport from A to BTherefore, regardless of Tesla's flashiness, it remains tethered to its manufacturing roots, and the ecosystem that could rival Apple's software structure is yet to materialize.

Reports from market research firm Cox Automotive note that in the third quarter of this year, US electric vehicle sales surpassed 300,000 units for the first time, even as Tesla's market share dipped to an all-time lowExperian's data indicates that while Tesla retains over half the market share, it has consistently trended downwards over the past three years, dropping notably from 79.4% in 2020.

In China, competition is at its fiercest, as Tesla seems to shed the luster of its past gloryThe two flagship models currently offered by Tesla clearly fail to cater to the diverse mobility requirements of a populace of 1.4 billionTo reignite significant growth, the company must focus on the next generation of platforms and introduce more affordable models to facilitate broader adoption.

A critical aspect of Tesla's potential second growth avenue lies in autonomous drivingAccording to research from Dolphin, Chinese consumers still prioritize energy efficiency in electric vehicles over advanced driving featuresRecent data from the third quarter of 2022 indicates a 14.3% adoption rate for Full Self-Driving (FSD) in North America, a stark contrast with a mere 0.4% in the Asia-Pacific regionAdditionally, the intricacies of FSD implementation in China raise significant obstacles, involving acquiring credentials for data collection, local processing and storage, and establishing supercomputing centers.

Although Tesla's overarching vision remains intact, the company now confronts the brutal realities of the automotive industry: intense competition, substantial investments, and unpredictable returns

To navigate this landscape, it must take decisive actions to enhance profitability and reduce operational costsFurthermore, as competitive pressures mount, Tesla may need to refine its pricing strategies while scouting for new market opportunitiesContinued investments in research and development are paramount for the company to maintain its leadership position in the electric vehicle arena.