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  • Tesla's move to open its patents is not about altruism but about hardcore strategic thinking.
  • Tesla hopes to remove obstacles to EV industry growth by helping develop homogeneous solutions.
  • More importantly, Tesla can use this as a Trojan horse to become a toll collector on all EV revenues in the future.

Tesla's (NASDAQ:TSLA) enigmatic leader Elon Musk said yesterday in a blog post that All Our Patent Are Belong To You (sic). This announcement has led to much debate in the Tesla investor and fan circle about Tesla's motives. The general thinking is that somehow this move is altruistic for the benefit of the EV industry or that this has something to do with parallels like Mac OS X, Wikipedia, and crowdfunding. We disagree.

This is simply a strategic move to rapidly expand and monetize the EV market. This move is hard-core strategy and really has nothing to do with altruism.

Firstly, investors should be aware that there is nothing groundbreaking about Tesla's patents. Most, if not all, of the intellectual property (IP) is likely implementation IP and not fundamental IP. There is no risk to Tesla that some company can take these patents and emulate Tesla in any way in the near future. By the time the competition develops solutions using these patents, Tesla would have moved far ahead. As Elon Musk himself noted:

"Technology leadership is not defined by patents, which history has repeatedly shown to be small protection indeed against a determined competitor..."

In other words, there is nothing that Tesla does that other automotive companies cannot do. Tesla patents will not stop other companies from solving problems. It is just that other companies will solve the same problems differently. If left unchecked, every company will implement EV solutions in its own way and cause for a highly fragmented EV market. Fragmentation is a problem for this nascent industry as it will retard growth and increase costs to customers and all the players in the supply chain. To have an orderly and rapid growth in the EV market, standardization is essential. Standardization improves plug and play compatibility, enables a wider range of solutions, and reduces costs. Standardization also improves the chances that Tesla can better utilize its factories (such as the upcoming Gigafactory).

The EV market is in the early stages now and the need for standardization may not be a great impediment today for the market players. However, the market will soon reach a stage when there will be an acute need for standardization. Once the problems become obvious and industry players realize the need for standards, each major vendor will attempt to force its own solution on the market (ex: VHS/Betamax; PC/Mac, Bluray/HD-DVD) and companies with vested interests will attempt to thwart any one player from dominating by initiating a drawn out standards processes - a group situation where theoretically no player has an edge.

Tesla, recognizing the challenges and the risks that lie ahead, has now initiated a plan that it hopes will make Tesla specs the de facto standards. This is an end run to preempt competitors and preempt standards bodies - instead of letting competition and committees set the stage, Tesla is trying get de facto standards developed Tesla's way.

Suppose Tesla does not take this path, how is the EV industry likely to develop?

Tesla is supply constrained and will remain that way for the foreseeable future. Its growth will be rapid but its share of the overall auto market will be small. To the extent the EV market takes off, competitors will have plenty of time to catch-up and create their own solutions. There is no way that Tesla can finance its growth in a timely way to effectively stop fragmentation of the EV market. And in a market without standards, a diversity of solutions from competing players means that EV market will likely grow slowly. Essentially, Tesla will be stuck in a capacity constrained situation in a fragmented slow growing market. A small player in a small pond. How attractive is this option?

On the other hand, opening up the IP creates goodwill for Tesla in a competitive market. Many companies will take the Tesla IP as is and develop products that adhere to the standards created by Tesla. This does not mean that all the companies will follow this path. There is no guarantee that companies using these patents will not have their own proprietary implementations. However, over time, if a critical mass of companies initially adopt Tesla solutions, the inertia of the system will move the industry in the direction of Tesla.

Opening up the IP also enables other companies to rapidly develop much needed EV solutions at a low cost and without the threat of litigation. This dynamic fuels the rapid development and improvement of the EV infrastructure that Tesla and other EV manufacturers need.

This is the phase of the market in which the hidden part of Tesla's strategy kicks in. Tesla's hope is that by this stage of the market evolution, the patents Tesla released would have created considerable amount of standardization and homogeneity across the industry. Tesla can then release a new improved set of standards protected by rev 2 patents that are not open sourced but are license oriented. Assuming Tesla creates sufficient additional value, which we have no doubt they will, many manufacturers will adopt these revised standards quickly even if they have to pay royalties to Tesla. It will only be a question of time before other companies will feel the competitive heat and adopt the newer Tesla standards.

By this point in time, the industry would have become dependent on Tesla's open patents and it will become harder for any other company to implement a competing set of standards. So, instead of being a bit player in fragmented EV market, Tesla can become the key ingredient in every EV in the market. In this sense, this strategy is somewhat similar to that of ARM (NASDAQ:ARMH).

When Elon coyly says, "We think the market is plenty big enough for everyone. If we can do things that don't hurt us and help the U.S. industry, we should do that", he is understating Tesla's long-term goals. This is not just a move that is about "don't hurt us". It is a move that can hugely profit Tesla in the long term. The release of this initial batch of patents is first step in Tesla becoming a long-term toll collector on the EV market.

In summary, Tesla's opening up of the patents is about becoming a big player in a big pond instead of a small player in a small pond. This is all about creating homogeneity and establishing de-facto standards that Tesla can benefit from - both in terms of accelerating the adoption of its vehicles and in terms of future IP royalties.

The current problem with Tesla is its insane valuation. While the company may grow sufficiently in time to justify its valuation. We have little faith that company will provide a decent return to the stockholders buying at the current level. However, this move to open the patents does help sow the seeds in accelerating the adoption of its technology and start moving the company in the right direction in terms of shareholder returns. We believe Tesla bulls will send the stock further into stratosphere once they understand the significance of this IP strategy.

Our Sentiment: Trading Buy

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Tesla Opens Up Its Patents: What Altruism? This Is A Strategic Move