Tesla's Innovations Are Transforming The Auto Industry, According to Forbes

The company name evokes very different yet equally strong responses from critics and fans. Critics argue Tesla loses money on each car sold. Indeed, with losses of $290 million in 2014 and $888 million in 2015, it’s unclear when the company will eventually hit profitability. Critics also point to the fact that co-founder and visionary CEO Elon Musk often oversells what the company can do in the short run. The company has missed stated goals and new vehicle launch deadlines. Moreover, the company has sometimes struggled with its innovations, like getting the Model X doors to work just right. On the other hand, proponents ignore the short term losses and point out that Tesla produces highly desirable electric vehicles—cars that go faster, go further (than other electric vehicles) and are safer than internal combustion engine (ICE) vehicles. They point out the astonishing fact that Tesla reeled in nearly 400,000 reservations for its Model 3 in a single week – pre-orders that will rack up over $16 billion of vehicle sales. A single tweet from Musk teasing a product announcement sent Tesla shares surging yesterday. Investors continue to back Tesla with a lofty market cap of over $30 billion, which translates into a significant innovation premium.

It’s this innovation premium that helped Tesla race to the top of our Forbes Most Innovative companies list in 2015 – and stay there. It maintains its #1 position for the 2016 ranking. Tesla’s next challenge is whether or not it can become profitable and deliver on its huge market value. And will Tesla ultimately be the catalyst behind transforming the auto industry from ICE vehicles to electric vehicles? Our analysis signals it can and likely will.

Tesla deserves its high market cap only if it can reach profitability – preferably in the next four years. Musk has long stated that the path to success was to start at the high end of the market with cars like the Model S and X and then move down market, producing more affordable cars like the Model 3. But if Tesla can’t make money on expensive vehicles as some analysts suggest, the obvious question is: can they make money selling cars at half the price?

The answer? Absolutely. Our analysis (with professor David Kryscynski of Brigham Young University) of Tesla’s improvement in cost per vehicle shows Tesla is making money on the Model S and will likely make solid profits on the Model 3. Let us explain. One of the tools of any strategist is a scale (or experience) curve. A scale curve calculates how rapidly the cost per unit (in this case, vehicle) decreases with every doubling of unit volume.[1] This analysis is useful for projecting how Tesla’s costs per unit will change going forward based upon its history.