Recently, there has been a great deal of discussion as to whether Tesla Motors is a disruptive company. In this study I show that Tesla's Model S may indeed be considered a disruptive innovation which in turn leads us to conclude also that Tesla Motors is a disruptive company.
To tackle this issue, we first need to define innovation and then conceptualize the term disruptive. Following the Organization for Economic Co-operation and Development (oecd), innovation can be defined as "the introduction of technologically new or improved products". Likewise, according to Webster's Dictionary, the term disruptive may be thought of as "to cause (something) to be unable to continue in the normal way: to interrupt the normal progress or activity of (something)." Now if we put these two ideas together, we obtain the following working definition of disruptive innovation: The introduction into the market of technologically new or improved products that causes the interruption of the normal progress or activity of incumbent companies.
Except for one thing, this definition resembles that of Clayton Christensen in his book entitled The Innovator's dilemma published in 1997. What's different in this author's approach is that he believes that the disturbance may end up in a breakdown of current firms. As he suggests, there is a clear distinction between technologies developed by top corporations in a given industry to sustain "the industry's rate of improvement in product performance" and technologies that disrupt or redefine performance trajectories and consistently result "in the failure of the industry's leading firms." In a recent contribution, a Forbes author puts it quite clearly: "Disruptors are innovators, but not all innovators are disruptors." Hence "a disruption displaces an existing market, industry, or technology and produces something new and more efficient and worthwhile. It is at once destructive and creative."
This way of viewing innovation constitutes an important advance over the simpler differentiation between incremental and radical innovations - introduced in the late 1970s by a number of writers and popularized by Giovanni Dosi, Christopher Freeman and Carlota Perez since the early 1980s - which Christensen uses only to describe the degree of difficulty or complexity of sustaining innovations.
Somewhat curiously, at the end of his book published 17 years ago, Christensen illustrates "how managers can succeed when faced with disruptive technology change" through a case study of electric vehicles. In it, he identifies two symptoms of disruptive innovation, namely that: (I) electric car technology was progressing faster than the rate of enhancement required in the market; and (ii) mainstream automakers naturally doubted that there was a market for this type of automobiles.
To support his two-fold contention, in the first case he shows evidence of significant improvements in technology trajectories of electric vehicles in terms of top speed, range capabilities and time needed to go from 0 to 60 miles per hour over the period 1970-1997. But, of course there are limits as to what Christensen calls "performance oversupply" which in a way is a measure of functionality. That is why, after some point, he suggests shifting away from functionality toward other attributes such as reliability and convenience to challenge product competition and customer choice. This opens the door for simpler, less expensive and more convenient technologies, which may lead, for instance, to quick battery recharging; feature, function and styling changes made quickly and at a low cost; and a lower sticker price point, albeit their cost in use may be higher.
Similarly, in the second case, he criticizes the idea that "without a major technological breakthrough in battery technology, there will never be a substantial market for electric vehicles" because, he says, that could be right for sustaining technologies with established market value networks but doesn't make any sense in relation to disruptive technologies. Why? Well, because electric vehicles cannot initially be used in mainstream applications since they don't meet their basic performance requirements and creating a market "in which the weaknesses of the electric vehicle become its strengths" should be the result of a trial-and-error strategy rather than a predetermined one. He then makes the most striking remark in the book:
"Historically, disruptive technologies involve no new technologies; rather, they consist of components built around proven technologies and put together in a novel product architecture that offers the customer a set of attributes never before available."
It's my impression that Christensen was most likely referring here to breakthrough technologies, a pair of terms that over the course of the years would be changed to "breakthrough innovations." In effect, in a 2012 interview, Clayton Christensen elaborates a bit more on the concept as follows: "A disruptive innovation is not a breakthrough innovation that makes good products a lot better, but it … transforms a product that historically was so expensive and complicated that only a few people with a lot of money and a lot of skill had access to it, … [and] makes it so much more affordable and accessible that a much larger population have access to it."
Lastly, Christensen justifies the creation of "new distribution channels for electric vehicles" because he finds "mainstream dealers of gasoline-powered automobiles" uninterested in selling this type of disruptive consumer goods.
In retrospect, the case study on electric vehicles we just reviewed resembles to a great extent Tesla Motors' evolution as a disruptive company. Let's see how this happens to be the case.
First, since the introduction of the Roadster in 2008, Tesla showed a clear indication that, just as envisaged by Christensen in his first symptom of disruptive innovation, electric car technology was progressing faster than the rate of enhancement required in the market. In fact, as reflected in Tesla's web page, the Roadster and Model S performance numbers are quite impressive: Top Speed: 125mph versus 70mph in 1997; Range Capability: 245-265 miles versus 90 miles per charge in 1997; and Time Required to Go from 0 to 60mph: 3.7-5.4 seconds versus 15 seconds in 1997.
Second, perhaps in part because Tesla didn't manage to sell as many Roadsters (only 2,450 in total over the period 2008-2012, according to its 2012 Annual Report), mainstream car makers had at first no real reasons to think that there was a market for these vehicles which provides additional support to the second symptom of disruptive innovation suggested by Christensen.
Third, Tesla's supercharging, which has become a key companion of the Model S in recent times is indeed an example of a simpler, less expensive and more convenient technology; so is use of carbon fiber (in the Roadster) and aluminum (in the Model S), for the body structure of both types of cars, as put forward by Christensen.
Fifth, the Li-ion battery of the Model S appears as an exemplification of a disruptive technology to the extent that it relies on a proven technology of 18650-type cells used extensively in laptops and other electronics devices, organizes them in modules and packages that altogether configure the basis for a new product never offered before.
And sixth, dealers have been deliberately excluded from Tesla's sales scheme precisely because, according to Musk, they don't seem to have incentives to sell electric cars for at least two reasons. One, that "it is much harder to sell a new technology car from a new company when people are so used to the old", and two, "that they make most of their profit from service, but electric cars require much less service than gasoline cars." This has put Tesla Motors at a virtual state of war with them to the extreme that in some states of the U.S. the revolutionary start-up is not allowed to directly sell its cars, albeit there are some recent signs that this is beginning to change.
Christensen's views have given rise to a number of criticisms. In what follows, I concentrate on just two of them. They both take up the subject matter of this analysis, albeit from different angles and with distinct perspectives. In a nutshell, the first critique suggests that Christensen's approach shows an "over-optimism regarding new entrants' abilities to disrupt established industries" (Bergek, Berggren, Magnusson, and Hobday, 2013), whereas the second one argues that it "is insufficient to clarify the chances of success for nascent technologies" (Hardman, Steinberger-Wilckens, Dan van der Horst).
In Bergek et al's contribution, published last year in Research Policy, a leading scientific journal, it's explained why electric vehicles (EVs), a disruptive innovation, failed to displace significantly internal combustion engine (ICE) cars since their introduction in 2010 and why Toyota's hybrid vehicles, a sustaining innovation, managed to find their way throughout the years since the late 90s despite their intrinsic complexity with respect to both gasoline vehicles and EVs.
According to them, EVs failed to make their way in the car industry mainly because they weren't able to: "satisfy established performance demands in main markets," in terms of range and flexibility; (ii) offer "a complex set of non-substitutable criteria, including driving experience, styling, fuel efficiency, convenience, functionality, reliability, safety as well as price"; and (III) insure "access to charging stations at convenient locations" and promote "new driving patterns among users."
By contrast, hybrids were successful because at least one incumbent (Toyota) was able "to combine the virtues of combustion engines and electric drives," through "innovation… in new components such as batteries, power electronics and electronic control systems as well as in the power-train's overall architecture." In addition, the incumbent strategy was aimed at optimizing all "system level restrictions, such as comfort, safety, serviceability, reliability and cost", together. This integrated effort was carried out both in-house or in close partnerships, "in a process where 'the Prius teams' had to test how each component integrated into the constantly changing system." Its scheme involved accumulation of knowledge of new component technologies both in terms of properties and manufacture which allowed the giant motor company to become a mass producer of electric motors and engage in close collaboration with Panasonic, its supplier of batteries, with which formed a joint venture with a controlling interest.
This study is inscribed into a new approach to disruptive innovation developed by the above mentioned authors called 'creative accumulation' which departs from the idea that "industry incumbents are burdened with 'core rigidities' and the legacy of old technology," while highlighting "the importance of accelerating the development of established technologies, acquiring new technologies and integrating these technologies and attributes with existing ones" as a way to neutralize the attacks of new entrants.
As insightful as it might seem, this analysis appears to be outdated, shortsighted and misleading. Even though it was available online in April 2013, it doesn't really consider the role of Tesla's Model S in the recent EV rush. Contrary to what the authors suggest, as we have seen earlier on, the Model S does indeed satisfy all three conditions mentioned by them (i.e. range and flexibility; features, styling and price; and charging) as key to the success of EV commercialization. In addition, the 2011 numbers they use as evidence for the failure of EVs to make a difference in the market don't pick up a clear positive trend for the following years. In effect, to state their case, they compare less than 18,000 plug-in cars with 12.8 million ICE cars sold in 2011 in the U.S. (which amount to an overall plug-in take rate of 0.14%) and refer to quite inaccurate forecasts for 2012: Note that, according to hybridcars.com, the overall plug-in take rates for 2012 and 2013 were 0.37% and 0.62%, respectively. Lastly, in a rather awkward attempt to diminish the importance of plug-in cars in relation to conventional hybrids, they contrast sales of the Chevrolet Volt (16,348 cars) with those of the Toyota Prius (183,340 cars) in the first nine months of 2012 when the correct thing to do there would have been to compare, for instance, sales of all plug-ins (53,172 cars in 2012) with those of all conventional hybrids, including Prius and Insight (20,726 cars in 2001) during their corresponding third year of market penetration.
Hardman et al's article, published also last year in the International Journal of Hydrogen Energy, start their analysis with a review of seven successful cases of disruptive innovations.
They then suggest also seven common characteristics of successful technologies, namely: (1) The threat of the new technology is not recognized by incumbents; (2) disruptive technologies are initially more costly than the incumbent technologies; (3) the quality of the disruptive technology initially is often worse than the quality of the technologies they seek to replace; (4) the technologies have some form of 'added value' to the consumer; (5) the disruptive technologies will fill niches markets first, here they spread to other niches, the meso level and eventually reach the macro level of the market; (6) the incumbent technology is never wiped out all together; it in turn becomes the technology for niche market applications; and (7) socio-technical systems are ever evolving.
According to the authors, the seven observations were found to be true for Tesla, with special consideration to characteristics (2)-(5).
Next the article takes up the case of electric cars to describe two different trajectories followed by either incumbents or new companies in recent years: electric cars for mass markets (Nissan Leaf, Peugeot iOn, Mitsubishi i-MiEV, Renault Twizy and Zoe, Smart Electric) and electric cars for niche markets (Tesla Roadster).
In this context, the authors suggest three criteria, based on the seven common characteristics identified above, for a technology or innovation to be considered as disruptive: First, it should be disruptive to market leaders, which implies that its manufacturers should be different than those producing the incumbent technology. Second, it should be disruptive to end users, which means that it should provide greater equivalence of service over incumbent technologies often leading to change the way technologies are used. And third, it should require different infrastructure than the incumbent technology and/or effect negatively existing infrastructure."
These criteria can be used to: a) evaluate if a technology was a successful disruptive technology upon market entry; b) assess whether a technology in the market penetration stage is a disruptive technology to the current market; and c) predict whether a new or innovative technology has the potential to become a disruptive technology.
To my astonishment, they then advance a rather ad hoc proposition: "For a technology to be a disruptive technology, it must meet at least two of these three criteria." This means, however, that a technology that satisfies all three criteria is more disruptive than another that meets only two and that a technology that only meets one criterion can't be called disruptive.
Lastly, they conclude that Tesla is disruptive on all three accounts whereas fuel cell vehicles are only disruptive to end users and infrastructure.
No doubt Hardman et al's approach does add to the literature on disruptive innovation and disruptive companies but is also a bit outdated and somewhat biased against electric cars and in favor of fuel cell vehicles. For one thing, since it was published in October 2013, it didn't pick up Musk's news about the planned launch date of Model E which together with the announced Li-ion battery giga-plant as well as the expansion to Europe and possibly China put Tesla in a rather different situation than that portrayed by the authors. For another, the authors' arbitrary way to determine that fuel cell vehicles are disruptive because they meet two of the three criteria leaves indeed much to be desired.
In sum, Christensen's scheme seems to be much more powerful than many critics believe. His case study on electric vehicles published in 1997 is a clear visualization of the kinds of things that needed to be done for EVs to become a disruptive technology. After reviewing his work I have come to believe that Elon Musk must have read it to put together his original plan to disrupt the automotive industry.
But of course Tesla has no complete dominion over a future that appears full of hurdles, particularly after knowing that Panasonic is not completely convinced of Tesla's Li-ion battery giga-plant. This brings me to a pair of issues I would like to discuss before closing my argument. The first pertains to Tesla's value chain, something neither Christensen nor his critics have said anything about. In fact, it seems like all these approaches assume all companies are totally vertically integrated. The fact of the matter is though that nowadays Tesla heavily depends on its only supplier of Li-ion cells and that Panasonic does in turn have to rely on its current suppliers of lithium and other inputs.
In a previous article I have discussed the possible resource constraint that Tesla may confront in about three years from now. As for the second tier of its value chain, it seems like so far neither Tesla nor Panasonic has confronted any difficulties to meet production targets and have mutually benefited from the introduction of the Model S into the market. As we can see in Figure 1, a year-and-a-half ago, Panasonic was just about to collapse. Beginning October 2012, it began to rebound. Similarly, in Figure 2 Tesla Motors stock was essentially flat until October 2012 and started to increase substantially through October 2013. Following the three Model S fires, it went down somewhat towards November-December 2013 to start to climb again thereafter.
Evolution of Panasonic shares
(August 2012-February 2014)
Evolution of Tesla shares
(August 2012-February 2014)
What happened? It now seems reasonable to think that Tesla Motors in general and the Model S in particular had much to do with Panasonic's reversing situation. In fact, as shown in Figure 3, Model S sales climbed from 71 in August 2012 to 2,100 in April 2013; they then went down to 1,100 in September 2013 but increased again thereafter to attain the current level of 1,400 cars.
Model S Sales
(August 2012-February 2014)
These findings confirm that Tesla acted as a lead agent in the Model S value chain exerting a leading and coordinating position over Panasonic within the chain while setting parameters in the entire chain.
The question remains as to why Panasonic may be reluctant to participate in Tesla's giga-plant project, which takes us directly to the second issue I am now in a position to take up. This concerns some strategic intricacies in which another relevant player may be involved. I refer here to Toyota.
As mentioned above, Panasonic and Toyota have kept over the years a long standing partnership in which Toyota has a controlling interest. Is Toyota influencing Panasonic not to make a transcendental step with Tesla? It's hard to tell at this point, but it may be in its interest to do so. After all, the last thing Toyota has announced is that it's committed to fuel cell vehicles, a rival technology for EVs.
Nevertheless, what Toyota doesn't seem to realize is that, according to Hardman et al, there's still a long way to go for this technology to become a clear competitor to Tesla. Perhaps the time has come for Toyota to begin thinking that EVs do have indeed a huge potential market. In the mean time, as shown in Figure 4, Tesla appears to have over the last twelve months consistently outdone Toyota in the stock market.
Tesla Versus Toyota in the Stock Market
(March 2013 - March 2014)
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.