Electric car icon and alternative energy manufacturer Tesla reported Q3 financial performance this week and delivered some somber news regarding the planned production ramp-up of the all-important, higher-volume Model 3 sedan.

From a quarterly financial performance perspective, total automotive revenues increased 10 percent from the year-earlier period fueled by a 4.5 percent increase in existing Model S and Model X production volumes. However, the company posted an operating loss of $619 million which rattled equity analysts and shareholders. Reports indicate that Tesla consumed some $1.4 billion in cash in Q3, likely fueled by the Model 3 ramp-up.  Tesla Model 3

Operational performance in Q3 included delivery of 26,150 vehicles, of which 14,065 were Model S, 11,865 were Model X, and 220 were Model 3. This was noted by Tesla as an all-time best quarter for Model S and X deliveries, representing a 17.7 percent increase over Q2 2017. Tesla now expects expect to deliver about 100,000 vehicles in 2017, which would be a 31 percent increase over 2016, which is rather significant given the prior history of operational challenges.

Most of the attention for the Q3 financial performance briefing focused on the current production ramp-up of the Model 3, which has not been stellar to-date. It would now appear from comments from Founder and CEO Elon Musk that the ramp-up milestone of a production rate of 5000 Model 3’s per week by the end of 2017 has been pushed to late in the first quarter of 2018.

The primary challenge was attributed to battery-pack assembly within the gigafactory located near Reno Nevada. Continuing reports, however, cite a series of challenges related to delays in delivery of automated assembly equipment, assembly line workers having to hand-assemble certain units, and new reports of assembly line worker agitation caused by recent firings and a reported labor union recruiting effort by the United Auto Workers.

In the latest letter to Tesla shareholders, Musk outlined further details related to the Model 3 ramp-up. In-part, statements included:

Model 3 has been designed for manufacturability, so the car itself is not difficult to build. That said, the Model 3 production process will be vastly more automated than the production process of Model S, Model X or almost any other car on the market today, and bringing this level of automation online is simply challenging in the early stages of the ramp. We continue to make progress resolving early bottlenecks related to these issues, and there remain no fundamental problems with our supply chain or any of our production processes.

Several manufacturing lines, such as drive unit, seat assembly, paint shop and stamping, have demonstrated a manufacturing ability in excess of 1,000 units per week during burst builds of short duration. Other lines, such as battery pack assembly, body shop welding and final vehicle assembly, have demonstrated burst builds of about 500 units per week and are ramping up quickly. Likewise, cell production at Gigafactory 1 continues to ramp, and current cell production makes it one of the largest battery cell manufacturing facilities in the world.”

The letter goes on to explain that within the four modules that make-up the Model 3 battery pack, the first two zones of a four-zone process were performed by manufacturing systems suppliers. These two zones had to be subsequently redesigned by Tesla engineers who are revisiting the robotic programming and automated assembly processes related to these modules.

While such detailed explanations seem plausible, they do beg the question that many of these challenges would have been expected in the original planning for Model 3 ramp-up as well as design-for-manufacturability specifications. There is also the age-old debate as to whether there was enough time and operational resources allocated in the overall ramp-up scheduling to meet each of the volume ramp milestones. In the specific case of the Model 3, there were obviously high expectations and high visibility from the company’s investors.

When an analyst on the conference call queered Musk on when the company would reach the milestone of 10,000 Model 3’s per week, after a marked hesitation, Musk indicated it was too early to determine that. He later added that the company is balancing a strategic choice between growth and capital spending. In other words, high volume manufacturing requires expensive infusion of capital, which is dependent on access to cash and borrowing, which comes from delivery of more automobiles. This has been a classic challenge for an innovative producer such as Tesla, that pushes through the barriers of technological innovation in product, but must deal with the realities of a high-volume auto manufacturer that must be able to maintain production scale.

This challenge is often the classic trade-off of high-tech companies such as Apple, invest in the product and the brand, and outsource the need for volume manufacturing to those that already have such capabilities. But, as Supply Chain Matters has often pointed out, the high-tech contract manufacturing model itself cannot sustain itself from a margin and profitability perspective without augmentation into upstream or downstream product value-add activities.

With the resetting of expectations relative to the Model 3 5000 per-week production milestone, Tesla has provided its operational teams the needed additional team to address ongoing automation challenges. As for the 10,000 per-week production milestone, we anticipate that other decisions will be forthcoming regarding the reset of stockholder expectations who increasingly grow impatient as to overall sustained profitability.

The Model 3 has great promise and potential for its market segment, but Tesla now, more than ever, needs to focus on renewed operational and supply chain execution.

 

Bob Ferrari

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