Tesla - Opening Up Its Patents Is A Great Business Strategy

| About: Tesla, Inc. (TSLA)
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Opening up patents reduces costs for automakers to build electric cars.

This will lead to significant expansion and economies of scale.

Tesla will have significantly reduced costs as the support ecosystem kicks in at scale.

In a landmark blog post, Elon Musk, Tesla's (NASDAQ:TSLA) CEO, announced that the company was opening up its patents. Musk's announcement is not altruistic - rather, it is all about market expansion and shrewd business strategy.

Musk alludes to this partly when he writes:

"our true competition is not the small trickle of non-Tesla electric cars being produced, but rather the enormous flood of gasoline cars pouring out of the world's factories every day"

The benefits to Tesla of opening up the market for electric cars are huge, and far outweigh any potential pitfalls. According to IHS, shipments of electric vehicles will grow 67% in 2014, leading to a worldwide installed base of 1.1 million electric vehicles by the end of the year. Compare this to yearly automobile production of nearly 100 million, and it is clear that electric vehicles are still barely a speck on the automotive landscape. In 2013, Tesla sold around 22,450 of its Model S sedans. In the US, 96000 electric plug-in vehicles were sold in 2013, barely 0.5% of the total market of 16.5 million vehicles.

These statistics prove that, after cutting out the hype, the electric car market is still very much in its infancy, and for good reason. The automotive industry is driven by economies of scale as well as service, and none of these exist in the electric car segment. There are three main reasons why electric cars haven't taken off:

1. Cost/style/convenience equation - Most electric cars, Tesla included, do not meet these three parameters at the same time for a sustainable number of customers. Tesla undoubtedly has style and (to some extent) convenience due to its relatively long range, but cost is a significant issue. The other alternatives, including the Chevy Volt and the Nissan Leaf, arguably suffer on the style and convenience dimensions.

2. Service and parts: Tesla has had to build up its own service network. This is a serious cost as well as a scale issue.

3. Charging stations: While Musk's idea of the Hyperloop is truly audacious, it is analogous to GM or Toyota building gas stations across the country - again, a matter of scale.

Musk is betting that by opening up his patents, he can truly kickstart innovation in the electric car segment by mainstream automakers and move the industry from a hobby to a business. If his bold move succeeds, the market for electric vehicles will grow exponentially far into the future. This will organically enable the industry to address all three issues listed above - there will be a range of vehicles at all price ranges (with Tesla arguably occupying the BMW/Lexus category), and the market will take care of the service and charging issues.

At the moment, innovation in the electric car segment has been built on the back of government subsidies and incentives. Through his move, Musk is hoping to enable the free market do what it does best - allocate resources where they earn the most reward. Tesla benefits big, as it grabs its rightful share of a much bigger market. Customers win, because they get wider, more affordable and more usable choices. Last but not least, our planet becomes a little cleaner.

I have been skeptical about Tesla's opportunity given the limited market in which it operates. With one fell swoop, Elon Musk has eradicated those concerns. I will be buying today.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in TSLA over 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.

Additional disclosure: I am short TSLA puts.