Will Tesla Motors’ Merger with SolarCity Shine? by Knowledge@Wharton
John Paul MacDuffie and Joshua S. Gans on the Tesla-Solar City Merger
Does Tesla, the maker of electric cars and battery storage, mesh well with SolarCity, which installs solar power systems? Elon Musk, who helped found the two companies and heads them as chairman, is convinced that their destinies are tied together as “the world’s only vertically integrated sustainable energy company.”
Musk first aired his thoughts on June 21, and Tesla announced the $2.6 billion merger on Monday to mixed reactions. Some saw synergies in the customer profiles of the two companies and cost savings. But skeptics felt Musk may not have the bandwidth to accommodate a merger while Tesla races to deliver its Model 3 car in 2017 and grapples with safety concerns over driverless technology after one if its cars was involved in a fatal accident.
Tesla said it expects to achieve cost synergies of $150 million in the first full year after closing; it expects the merger to close in the fourth quarter of this year. It said it also expects to save customers money “by lowering hardware costs, reducing installation costs, improving our manufacturing efficiency and reducing our customer acquisition costs,” while leveraging its 190-store retail network and international presence to extend the combined reach of the merged entity.
Big Bets, Compelling Visions
“Elon Musk is known for big bets, compelling visions and very much a long-term view, so this is clearly in that category,” said Wharton management professor John Paul MacDuffie. He is also director of Wharton’s Program on Vehicle and Mobility Innovation at the School’s Mack Institute for Innovation Management. He said it is too early to tell if the Tesla-SolarCity merger will be successful or not, adding that he did see pros and cons.
According to Joshua S. Gans, professor of strategic management at the University of Toronto’s Rotman School of Management, the merger move “is consistent with Musk’s world vision of what he is looking to do in the environmental technology space.” He said Musk took off in that direction with his Tesla electric car, but larger goals like combating climate change could be met only by addressing issues like distribution of solar energy.
“It’s not just about the car,” said Gans of Musk’s grand plan. “It’s about using the car to bring these sorts of energy sources into the house.” A key aspect of that goal is Tesla’s Gigafactory to make storage batteries that is under construction near Reno, Nevada, he noted.
MacDuffie and Gans discussed the business outlook for the merged entity on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)
Marriage of Brands
Gans described the merger as “a marriage of two good brands.” He also noted synergies between the two companies. He said that while Tesla has “a relentless focus on the customer,” SolarCity discovered that the people who bought its turnkey solar installations also bought Tesla cars.
“It’s not just about the car. It’s about using the car to bring these sorts of energy sources into the house.” –Joshua Gans
MacDuffie agreed with Gans on the overlapping customer profiles of the two companies. He noted that while Tesla has received deposits from customers for its forthcoming Tesla 3 car, SolarCity has relatively higher customer acquisition costs. In seven weeks after it opened pre-bookings for the $35,000 Model 3 car on March 31, Tesla said in a regulatory filing that it had received 373,000 reservations, with each customer making a down payment of $1,000. He recognized “an immediate advantage” if Tesla is able to convert those car buyers into SolarCity customers.
MacDuffie saw the possibility of the two companies merging their skill sets, too, as they ramp up their manufacturing plans. SolarCity plans to make its own solar panels, while Tesla plans to scale manufacturing of both its cars and batteries at its Gigafactory. “There is a way for Tesla to counter claims that the electricity that goes into electric vehicles is not clean,” he said. The merger allows Tesla customers to ensure that their vehicles use solar energy, he added.
Risks on the Horizon
“Unlike almost every other announcement from [Musk] in the last few years, this one made the market very nervous, and some of the investors and analysts who followed him closely have raised concerns about it,” said MacDuffie, adding that some of those initial concerns have faded in subsequent weeks. The stock crashed 12% to $193 over three trading sessions after the announcement, but had since recovered to about $227 by yesterday.
All the same, MacDuffie is skeptical. “There is a bit of concern is that not every move [Musk] makes will bring the same enthusiasm as his Tesla moves have made,” he said. “Does this begin to erode some of that almost automatic support?”
MacDuffie said the merger comes at a time when Tesla faces many challenges. According to him, “the biggest risk” is that the merger would be “a bit of a distraction for Elon Musk and his management team to try to pull this integration now.” He said the big challenge for Tesla is to bring the Model 3 to market as promised in 2017; people have paid deposits. Tesla also is dealing with safety concerns about driverless technology that have sprung up after a fatal accident in May involving one of its cars.
Another challenge for Tesla arises from its plan to scale production to become a successful mass-market car, said MacDuffie. He noted that Musk’s goal of reaching a combined production of 500,000 cars (Tesla models 3, S and X) by 2018 represents a 10-fold increase over the less than 50,000 cars it sold in 2015. That involves challenges not only in manufacturing, but also in mastering supply chains, distribution and after-market service, he added. “Managing an outsourced supply chain, while very common in the auto industry, would be new for Tesla and bring coordination complexities,” he had said in a recent Knowledge@Wharton article.
MacDuffie agreed that Musk is working towards the long-term vision that Gans alluded to. “But he can’t get to the long-term vision without successfully making it through these next few stages,” he said. “He may be able to get to a future with fewer cars, car-sharing with autonomous vehicles … but I’m not sure he can count on getting there unless he surmounts all of these challenges.” He also suggested that Musk’s “taste for vertical integration” may not be the best strategy. Tesla has responded at times to difficulties with component suppliers by deciding to make those parts in-house. Here, he said that while vertical integration has its advantages, many companies have moved away from that strategy.
Distraction or Not?
Gans disagreed with MacDuffie’s views on Tesla’s so-called distractions. He said Tesla is not attempting “to build a car company in the traditional model.” Musk’s master plan, which includes the plan to merge with SolarCity, “is all about changing the model of the car in society, in particular, moving away from car ownership towards … autonomous vehicles and Uber-like services,” he explained. “In that world, you need far fewer cars, because they get utilized more.”
“[I can see] shades of Henry Ford and the River Rouge.” –John Paul MacDuffie
In that scenario, Tesla wouldn’t have to worry about issues such as after-sales service and others that MacDuffie raised, said Gans. The merger move “is not a distraction” if Musk follows his “master plan,” he added. “But it is a distraction if you believe he’s going to build a new, replacement-car company.”
Twists and Turns
MacDuffie noted that while Musk meets his targets, he often misses deadlines, especially with the release of the Model S and Model X cars. He hinted that some people may want to cancel their pre-bookings for the Model 3 if it is delayed, and that the economics of the Gigafactory, too, would be hurt by delays.
MacDuffie noticed another possible dampener for residential owners of solar installations with many states going back on their promise to buy excess power generation from them. But he also spotted a marketing opening for Tesla: It could tell customers who are unable to sell their excess power to their state utilities that they could store their power longer with Tesla’s storage batteries.
MacDuffie also described Musk’s plan to include car manufacturing in the Gigafactory as intriguing. “[I can see] shades of Henry Ford and the River Rouge,” he said. (Henry Ford’s plan for Ford Motor was to achieve total self-sufficiency by owning and operating all the resources it needed to produce cars, according to a note by The Henry Ford museum. Central to that goal was Ford buying 2,000 acres of marshland along the River Rouge near Dearborn, Mich., in 1915 and The Rouge Plant it later built.)