Elon Musk, CEO of Tesla (TSLA), made a big admission on the afternoon of April 13th. Apparently channeling the Friday the 13th horror spirit, Musk announced via tweet that the electric car manufacturer had over-automated its production process:
“Excessive automation at Tesla was a mistake. To be precise, my mistake. Humans are underrated.”
The tweet was a follow-on from an interview with CBS that aired Friday morning in which Musk talked about gutting much of the overly complex Model 3 assembly line:
“We had this crazy, complex network of conveyor belts….And it was not working, so we got rid of that whole thing.”
This admission represents a major reversal of virtually everything Musk and his team at Tesla have been saying about the Model 3 production process. And it signals a death knell for the Tesla bull case that ought to send prudent investors running for the hills – or taking up a short position.
Let’s talk about the various consequences of Musk’s admission:
“Productizing” the Factory Proves a Daunting Task
Gallons of digital ink has already been spilled on the subject of the beleaguered ramp-up of Tesla’s first mass-market vehicle, so there is little point in recapitulating all the problems that have occurred – and continue to dog the process. All that need be said to provide context for this article is that the ramp has still failed to hit its end-of-March production rate target of 2500 Model 3s per week, and that Musk claims to still be sleeping on the factory floor in order to deal with the continued issues.
Musk’s latest admission matters because it demonstrates very clearly what numerous auto experts (and many savvy analysts here on Seeking Alpha) have been saying for years: The sort of automation Tesla has been boasting about contradicts decades of industry best practices. Musk has made a habit of mocking the legacy automakers as dinosaurs that do not really know what they are doing. He promised to upend the conventional methods of production and to revolutionize the auto manufacturing process:
“The competitive strength of Tesla long-term is not going to be the car, it’s going to be the factory. We’re going to productize the factory.”
That last quote was made during the latest earnings call, on February 7th, 2018. That is barely more than two months ago. Going from “automation and productization will give Tesla an indelible competitive advantage” to “We’ve made a big mistake” in the course of a couple months is a pretty huge reversal.
But the promise of “productizing” the factory was far from the most ambitious claim Musk has rolled out about the boons of total automation. In 2017, he stated that production would eventually move faster than the human eye could hope to follow:
"We should be caring about air friction because [robots] are so fast. You should need a strobe light to see it.”
Musk repeated that same claim during the February earnings call. Apparently, he expects the public – and his investors – to believe that this revelation is very recent indeed. But anyone who has been following the ongoing saga of Model 3 production hell will already know that the problems have been there from the beginning.
Deliberately Misleading? Incompetent? Both?
If industry experts and investment analysts looking in could see the problem of over-automation, then the man who claims to have taken up residence on the factory floor should be aware of them too. That leaves three options:
- Musk was deliberately misleading investors and the public
- Musk lacks the basic competence necessary to understand when a process is breaking down.
- Musk was both misleading and lacking in necessary core competencies.
We go with Option 3. For years, Musk has used obfuscation and misdirection (leavened with an ample helping of “visionary” goals and out-of-this-world promises) as a key business tactic. So it is hardly surprising that he has been pulling the same stunt with regard to factory automation.
But the evidence has also been gradually building to suggest that Musk lacks many of the core competencies critical to the effective management of an auto manufacturing operation. That was rendered painfully apparent during the February earnings call during an exchange between Musk, Jeffrey Straubel (also of Tesla), and Brian Johnson of Barclays. Johnson asked Musk to explain the differences between how Tesla was managing its factory versus how other established automakers, such as Toyota (TM), which has developed the Toyota Production System into the envy of the industry. This is what came by way of reply:
The most fundamental difference is thinking about the factory really as a product, as a quite vertically integrated product.
It's treating it as more of an engineering and a technical problem as well.
Right, which is the Toyota Production System.
Yeah. We don't think so.
I think that generally it's more of an optimized operational problem, being extremely lean and really managing the flows of materials and the supply chain. They're great at it, but this is I think a different approach, looking at it really from a deep technical lens in terms of automation, robotics, process.
The exchange with Barclays’ Johnson is quite shocking, highlighting as it does Musk’s apparent ignorance of, or obliviousness toward, the Toyota Production System. Evidently, his distaste for the old guard automakers is so great that he cares nothing for methods that have been tested and refined over decades of actual production. It also stands as further evidence that the supposed great competitive advantage Tesla has to offer – and that would supposedly deliver industry-defying profit margins – came through automation. That advantage has been, with a single tweet, consigned to the dustbin of broken promises and unrealized forecasts.
Time to Face the Consequences
Musk’s simple tweet has opened new floodgates of problems for Tesla. Many of them were already familiar with those bearish on the company’s outlook, but now they will likely permeate the broader market and public consciousness more fully.
Here is what matters:
1. There will be no margin boost from automation
With the promise of massive margin expansion via efficient and comparatively inexpensive automation burnt up on the social media pyre, investors would be right to expect Tesla’s projections about the Model 3’s profitability to come down. Realizing that the Model 3 production is going to be more akin to traditional auto manufacturing after all, the hopes of profitability any time soon should go out the window. Musk’s statement of a couple days ago that “Tesla will be profitable & cash flow+ in Q3 & Q4” ought to seem perplexing even to his devoted fans.
2. Human costs will keep rising
To surpass a weekly production rate of 2000 by the end of Q1 required moving workers from the Model S and Model X lines to support the Model 3 line staff. Tesla has made the case that these measures were temporary. Musk’s statement on over-automation throws that prior claim into serious doubt. Tesla looks destined to continue its escalating and unsustainable labor costs. In a touch of irony that Tesla has already been called out for inefficiency and having too many employees already. The notion that more manpower will fix its problems is actually rather laughable.
3. By backtracking on automation, Musk risks destroying his greatest asset: his reputation
Musk has built his empire on the basis of visionary leadership. His backers in the investment community, the media, and general public flock to his message of a bright future, a future in which Tesla will play a pivotal role. But now he has admitted that he was wrong, that perhaps the automakers he condemned as incompetent and inefficient actually knew what they were doing after all. That makes Musk look foolish and tarnishes his reputation as modern capitalism’s disruptor-in-chief. Tesla’s share price is buoyed by belief in a future that Musk has sold with immense skill. If his image is tarnished – or even smudged – it will have serious ramifications for Tesla’s share price.
Bringing it all in, what should investors take away from this latest development? First and foremost, they should see that the admission – while not particularly surprising to bearish types – will be rather shocking to those who have bought into the idea of cars being produced at nigh the speed of sound. Their expectations will have to be brought back down to earth. And Tesla’s share price is bound to follow in short order.
Things have been looking bad at Tesla for quite a while now, and the outlook keeps darkening. With the Model 3 gradually ramping, but still bogged down in production hell, Tesla has precious little room to maneuver.
With a single tweet, Elon Musk has sentenced Tesla to death. It may be a death by a thousand cuts, but the ending looks quite clear.
Disclosure: I am/we are short TSLA. 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.