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Tesla, Apple, and Offshore Manufacturing

Autoblog ran a story on the impending public unveiling of the Tesla Roadster -- tomorrow, in fact, is the date. So far, Tesla has said that their Roadster will have two seats, go from 0 to 60 miles per hour in about four seconds, go 250 miles on a charge, and cost about 1 cent per mile to operate. Readers commenting on the story, speculating wildly about Tesla's chances before knowing the details, found Tesla CEO Martin Eberhard joining in (which I regard as a good sign for the company).

One commenter in particular was disappointed by the rumors that Tesla would not build and own its manufacturing capability:

America is totally relying on being a service economy but to this day I still see all great or greatly emerging economies to be doing it through manufacturing but no one cares to preserve this in America. Sure it looks like services have done well for America and they have but it isn't why America is as great (economically) as it is, at one point the U.S. manufactured over 85% of the world's products... Don't get me wrong, it I don't want get rid of the service companies I want America to have both service and manufacturing.

All you Silicon Valley guys seem to understand the concept of not putting all your eggs in one basket but when it comes to jobs putting them all into services seems to be just fine (i.e. in your purchases you don't look for American made is my guess and now with getting into a traditionally manufacturing based thing such as automobiles where it is made doesn't have to be America). Tesla isn't really a manufacturing company it is a service company. Tesla is really selling design (and for now, management). Contracting to buy parts from Asia and everywhere else and to contract to a factory to assemble the vehicle (especially *if* the factory is outside of the states then Tesla probably won't own the factory just contracting out) means the only thing Tesla is doing to add value is the design work (and for now, management).

Tesla isn't a service business any more than, say, Apple is a service business. Why doesn't Apple manufacture its own iPods? Because Apple has learned (like so many other firms have in their respective industries) that it is far more profitable to design, market, and sell iPods than it is to actually assemble them. Why is this? Because it's harder to design, market, and sell consumer electronics devices than it is to assemble them.

Think about it this way: how many firms could realistically compete to manufacture iPods for Apple? I'd guess at least dozens -- some in China, some in Taiwan, the rest in a few other Asian tigers. But how many firms have proven they can compete against Apple and win in the digital media player business? In the US, at least, the number is effectively zero, given that Apple's market share is north of 70 percent.

Or think of it this way: can you name the firms that assemble iPods? I'm betting you can't. But you can name Apple.

Or think of it this way: how much does an iPod assembler make on each unit? Well, given that they have to compete with dozens of other companies that can do the same thing just as well, I'd be surprised (though this is a guess) if they make more than $20/device, even on the highest-end iPods. How much, on the other hand, does Apple make on each iPod? iSuppli estimates gross margins of 50 percent on iPod nanos -- $101 on a nano, with $8 of the cost going to assembly. You can do the math, but it seems reasonable to say it's 10 times more profitable to be the designer-marketer-seller than it is to be the assembler, at least when you're the best at what you do.

Again, Apple isn't a service company. A more accurate way of thinking about them would be as an intellectual property company: they design proprietary hardware, design the user interface for the hardware, create (portions of) the software that drives the user interface, and create the software for the hardware to connect to computers (iTunes) as well as the software to provide back-end services to the hardware (iTunes Music Store). How relevant is the fact that they don't actually assemble their proprietary hardware? It's only relevant to the extent that to do so would actually lower their overall profit margins (given how much less profitable assembly is than design), therefore making their company less valuable. Who would want that? Not any rational Apple shareholder. In any case, since Apple controls the entire product creation cycle, including directing external suppliers and assemblers, though technically they're an intellectual property company, it's easier for us to think and say that Apple makes iPods.

When it comes to tying this back to Tesla, everything is speculative at this point. But assuming they've adopted a standard Silicon Valley design-market-sell model, subcontracting out assembly -- which seems to be the case given the comments made so far -- then I'd say they're doing exactly the right thing, because this model tends to reduce end-prices to consumers and increase profit margins for vendors. And it won't change the fact that Tesla makes cars.

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Comments

I really like how you compare the profits on Apple. The Wall Street Journal did that once on a Barbie doll being manufactured in China and then sold in the U.S. for $30. The Chinese factory was, I believe, getting about 30 cents per doll.

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