25/4/18: Tesla: Lessons in Severe and Paired Risks and Uncertainties

Tesla, the darling of environmentally-sensible professors around the academia and financially ignorant herd-following investors around the U.S. urban-suburban enclaves of Tech Roundabouts, Silicon Valleys and Alleys, and Social Media Cul-de-Sacs, has been a master of cash raisings, cash burnings, and target settings. To see this, read this cold-blooded analysis of Tesla's financials: https://www.forbes.com/sites/jimcollins/2018/04/25/a-brief-history-of-tesla-19-billion-raised-and-9-billion-of-negative-cash-flow/2/#3364211daf3d.

Tesla, however, isn't that great at building quality cars in sustainable and risk-resilient ways. To see that, consider this:

1. Tesla can't procure new parts that would be consistent with quality controls norms used in traditional automotive industry: https://www.thecarconnection.com/news/1116291_tesla-turns-to-local-machine-shops-to-fix-parts-before-theyre-installed-on-new-cars.
2. Tesla's SCM systems are so bad, it is storing faulty components at its factory. As if lean SCM strategies have some how bypassed the 21st century Silicon Valley: http://www.thedrive.com/news/20114/defective-tesla-parts-are-stacked-outside-of-california-machine-shop-report-shows.
3. It's luxury vehicles line is littered with recalls relating to major faults: https://www.wired.com/story/tesla-model-s-steering-bolt-recall/. Which makes one pause and think: if Tesla can't secure quality design and execution at premium price points, what will you get for $45,000 Model 3?
4. Tesla burns through billions of cash year on year, and yet it cannot deliver on volume & quality mix for its 'make-or-break' Model 3: http://www.thetruthaboutcars.com/2018/04/hitting-ramp-tesla-built-nearly-21-percent-first-quarter-model-3s-last-week/.
5. Tesla's push toward automation is an experiment within an experiment, and, as such, it is a nesting of one tail risk uncertainty within another tail risk uncertainty. We don't have many examples of such, but here is one: https://arstechnica.com/cars/2018/04/experts-say-tesla-has-repeated-car-industry-mistakes-from-the-1980s/ and it did not end too well. The reason why? Because uncertainty is hard to deal with on its own. When two sources of uncertainty correlate positively in terms of their adverse impact, likelihood, velocity of evolution and proximity, you have a powerful conventional explosive wrapped around a tightly packed enriched uranium core. The end result can be fugly.
6. Build quality is poor: https://cleantechnica.com/2018/02/03/munro-compares-tesla-model-3-build-quality-kia-90s/.  So poor, Tesla is running "reworking" and "remanufacturing" poor quality cars facilities, including a set-aside factory next to its main production facilities, which takes in faulty vehicles rolled off the main production lines: https://www.bloomberg.com/view/articles/2018-03-22/elon-musk-is-a-modern-henry-ford-that-s-bad.
7. Meanwhile, and this is really a black eye for Tesla-promoting arm-chair tenured environmentalists, there is a pesky issue with Tesla's predatory workforce practices, ranging from allegations of discrimination https://www.sfgate.com/business/article/Tesla-Racial-Bias-Suit-Tests-the-Rights-of-12827883.php, to problems with unfair pay practices https://www.technologyreview.com/the-download/610186/tesla-says-it-has-a-plan-to-improve-working-conditions/, and unions busting: http://inthesetimes.com/working/entry/21065/tesla-workers-elon-musk-factory-fremont-united-auto-workers.  To be ahead of the curve here, consider Tesla an Uber-light governance minefield. The State of California, for one, is looking into some of that already: https://gizmodo.com/california-is-investigating-tesla-following-a-damning-r-1825368102.
8. Adding insult to the injury outlined in (7) above, Tesla seems to be institutionally unable to cope with change. In 2017, Musk attempted to address working conditions issues by providing new targets for fixing these: https://techcrunch.com/2017/02/24/elon-musk-addresses-working-condition-claims-in-tesla-staff-wide-email/. The attempt was largely an exercise in ignoring the problems, stating they don't exist, and then promising to fix them. A year later, problems are still there and no fixes have been delivered: https://www.buzzfeed.com/carolineodonovan/tesla-fremont-factory-injuries?utm_term=.qa8EzdgEw#.dto7Dnp7A. Then again, if Tesla can't deliver on core production targets, why would anyone expect it to act differently on non-core governance issues?

Here's the problem, summed up in a tight quote:

Now, personally, I admire Musk's entrepreneurial spirit and ability. But I do not own Tesla stock and do not intend to buy its cars. Because when on strips out all the hype surrounding this company, it's 'disruption' model borrows heavily from governance paradigms set up by another Silicon Valley 'disruption darling' - Uber, its financial model borrows heavily from the dot.com era pioneers, and its management model is more proximate to the 20th century Detroit than to the 21st century Germany.

If you hold Tesla stock, you need to decide whether all of the 8 points above can be addressed successfully, alongside the problems of production targets ramp up, new models launches and other core manufacturing bottlenecks, within an uncertain time frame that avoids triggering severe financial distress? If your answer is 'yes' I would love to hear from you how that can be possible for a company that never in its history delivered on a major target set on time. If your answer is 'no', you should consider timing your exit.

17/8/2014: Disruptive Innovation, Experimentation and Entrepreneurship

Last week I highlighted several studies relating to human capital and entrepreneurship. Here, continuing with the theme, couple more.

First, a paper by Acemoglu, Daron and Akcigit, Ufuk and Celik, Murat Alp, titled "Young, Restless and Creative: Openness to Disruption and Creative Innovations" (February 1, 2014, MIT Department of Economics Working Paper No. 14-07: http://ssrn.com/abstract=2392109). Per authors: the study argues that "openness to new, unconventional and disruptive ideas has a first-order impact on creative innovations" where such innovations are defined as those "that break new ground in terms of knowledge creation". The problem, of course, is not that this is something new - if anything, this is trivial - but that we (as society and managerial systems, firms, enterprise ownership structures etc) have a very hard time managing disruptive innovation to achieve 'openness' to the ideas and the generators of such ideas that deliver true disruption.

"After presenting a motivating model focusing on the choice between incremental and radical innovation, and on how managers of different ages and human capital are sorted across different types of firms, we provide cross-country, firm-level and patent-level evidence consistent with this pattern. Our measures of creative innovations proxy for innovation quality (average number of citations per patent) and creativity (fraction of superstar innovators, the likelihood of a very high number of citations, and generality of patents). Our main proxy for openness to disruption is manager age. This variable is based on the idea that only companies or societies open to such disruption will allow the young to rise up within the hierarchy. Using this proxy at the country, firm or patent level, we present robust evidence that openness to disruption is associated with more creative innovations."

All of the above is fine. All is neat and well-argued and empirically backed. But, now, try and tell your average HR manager that the firm they work for should hire someone who breaks consensus and bends rules of logic, thinking and creativity?.. Or try telling them that standard CV/interview/test metrics they employ make hiring disruptive talent actually impossible, let alone difficult… And try telling them that majority of people graduating with 'right' degrees and offering 'right' references and credentials are actually deeply conformist, rather than disruptively innovative…



The second paper of interest is by Kerr, William R. and Nanda, Ramana and Rhodes-Kropf, Matthew, titled "Entrepreneurship as Experimentation" (July 28, 2014, Journal of Economic Perspectives: http://ssrn.com/abstract=2473226) argues that "…entrepreneurship is about experimentation: the probabilities of success are low, extremely skewed and unknowable until an investment is made." The most interesting bit in the above is the unknowable nature of the probability of success ex ante actual investment. This really cuts across the entire notion of angel financing…

"At a macro level experimentation by new firms underlies the Schumpeterian notion of creative destruction. However, at a micro level investment and continuation decisions are not always made in a competitive Darwinian contest. Instead, a few investors make decisions that are impacted by incentive, agency and coordination problems, often before a new idea even has a chance to compete in a market."

Another interesting issue is that the authors "contend that costs and constraints on the ability to experiment alter the type of organizational form surrounding innovation and influence when innovation is more likely to occur. These factors not only govern how much experimentation is undertaken in the economy, but also the trajectory of experimentation, with potentially very deep economic consequences."

The reason why it is go interest from my point of view is nine years ago, I tried to formulate some of these exact fundamentals in relationship between ability to take risks, experiment, innovate and the macro-economic policy environments in the paper available here: http://www.tcd.ie/Economics/TEP/2005_papers/TEP2.pdf

25/10/2012: IFS Roundtable: November 1

I will be chairing an industry roundtable on disruptive innovation in international financial services on November 1, 2012. Details: