Tesla's Production Problems Are The Company's Achilles' Heel

Reuters article about extensive rework occurring at Tesla's Fremont, CA assembly plant hit home for me. I often wondered how it is possible for Tesla to burn so much cash while making only luxury cars--the Model S and Model X--and the Reuters story--quoting recently fired Tesla employees--opened a window on that process. The extensive re-work referenced in the article just should not be occurring now, especially since the Model S is entering its sixth year of production.

Some elements of the car buying public like to fall for the "it was made by hand" rhetoric for luxury models, but I can confirm that no automaker in the world aims for less automation, not more.  This is especially true as one goes up the curve in terms of volume, and that is the problem facing Tesla now.  The company has shown no evidence that it can produce luxury cars at a proper linespeed and now it is attempting to build a mass-market vehicle, the Model 3.

Exterior of the new Tesla Model 3, at the 2017 LA Auto Show in Los Angeles, California on November 29, 2017. / AFP PHOTO / Mark RALSTON (Photo credit should read MARK RALSTON/AFP/Getty Images)

Tesla's third quarter shareholder outlook contained the following passage:

We believe that we are well capitalized to accommodate the revised ramp of Model 3 production to 5,000 per week. Upon achieving this production level, we expect to generate significant cash flows from operating activities.

I still have very reliable sources in the supplier community from my days as a sell-side auto/auto parts analyst and those sources are telling me that Tesla is currently nowhere near that 5,000/week run-rate on Model 3 production.  It is the last day of November and the chances of Tesla achieving the linespeed necessary to reach a 5,000/week cadence on the Model 3 by year-end are near zero.

That's the existential problem with Tesla, and the reason its $50 billion valuation is incomprehensible to my friends at other automakers.  Tesla can't produce cars in the needed volume to hit its gross margin target of 25%, and the amount of re-work needed just to produce a salable Tesla ensures that target is illusory as Tesla enters the mass-market.

I've followed the auto industry for 25 years and have been fortunate enough to test drive cars and visit factories on all six inhabited continents. Through the maze of different languages and cultures, the process of making a car is actually very similar around the world. Simply put, automakers attempt to make as many cars as possible, and the highest correlation with margins is found in a basic metric: linespeed. Any time the line stops, profits are being wasted, but the heart of any modern auto production process, most notably the Toyota Production System, is a series of preemptive line stops when potential assembly problems are noted. This is done to prevent the most hated bugaboo of any plant manger: re-work. When cars come off the line and fail quality checks, re-work, or in the industry's euphemism "off-line assembly", is necessary to ensure the vehicle meets quality and safety standards. It is a most costly undertaking, and every automaker avoids it like the plague.

So yesterday's Reuters article about extensive rework occurring at Tesla's Fremont, CA assembly plant hit home for me. I often wondered how it is possible for Tesla to burn so much cash while making only luxury cars--the Model S and Model X--and the Reuters story--quoting recently fired Tesla employees--opened a window on that process. The extensive re-work referenced in the article just should not be occurring now, especially since the Model S is entering its sixth year of production.

Some elements of the car buying public like to fall for the "it was made by hand" rhetoric for luxury models, but I can confirm that no automaker in the world aims for less automation, not more. This is especially true as one goes up the curve in terms of volume, and that is the problem facing Tesla now. The company has shown no evidence that it can produce luxury cars at a proper linespeed and now it is attempting to build a mass-market vehicle, the Model 3.

Exterior of the new Tesla Model 3, at the 2017 LA Auto Show in Los Angeles, California on November 29, 2017. / AFP PHOTO / Mark RALSTON (Photo credit should read MARK RALSTON/AFP/Getty Images)

Tesla's third quarter shareholder outlook contained the following passage:

I still have very reliable sources in the supplier community from my days as a sell-side auto/auto parts analyst and those sources are telling me that Tesla is currently nowhere near that 5,000/week run-rate on Model 3 production. It is the last day of November and the chances of Tesla achieving the linespeed necessary to reach a 5,000/week cadence on the Model 3 by year-end are near zero.

That's the existential problem with Tesla, and the reason its $50 billion valuation is incomprehensible to my friends at other automakers. Tesla can't produce cars in the needed volume to hit its gross margin target of 25%, and the amount of re-work needed just to produce a salable Tesla ensures that target is illusory as Tesla enters the mass-market.

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