Transportation

Special Report – Tesla forsakes $7.7 billion to build semi trucks instead of delivery trucks, but saves planet Earth


Main Findings (TLDR)

Elon Musk for once under promised. Our estimates show Tesla Semi drivers could recoup the higher cost of an electric truck 7 months ahead of Musk’s promise of 2 years. They would also go on to save over $229,000 in operating costs over a million miles compared to diesel trucks, $29,000 more than what Musk announced.

Tesla is however forsaking $7.7 billion dollars in cumulative revenue over 10 years by choosing to build semi trucks instead of a delivery trucks. Missing a great opportunity. Sales of semis and demand for heavy freight are expected to follow relatively flat GDP growth. On the other hand, sales of delivery trucks are expected to increase faster due to growing demand for last-mile e-commerce deliveries.

So why build a semi? To save the planet. Semi trucks travel far more miles than delivery trucks. They in turn use more fuel and emit more pollution. A fleet of Tesla Semis would save more than four times the amount of carbon emissions than a fleet of Tesla delivery trucks. We estimate that a fleet of Tesla Semis could go on to save 11,173 millions lbs of CO2 from the atmosphere by 2025. Enough to single-handedly meet 30% of target carbon reductions asked from trucks by the Paris Climate Change Accord.

The biggest challenge facing Tesla is mass manufacturing. Its anti-Toyota manufacturing philosophy of relying on robots rather than humans is proving ineffective. Tesla lags industry peers in both quality and cost. Not to mention its slow production line is failing to meet demand. Trucking companies will not be as patient as consumers waiting for their vehicles. No truck means no revenue. Business customers will be prone to cancel orders and buy from more reliable competitors.

We also expect driving electric trucks to significantly lower operating costs for freight companies, but fail to boost profit margins. Trucking is highly segmented and hyper-competitive. Lower operating costs will likely lead to a price war. The real winners will be freight customers, electric truck manufacturers, and of course the environment.


Elon Musk wakes up the sleepy world of trucking

The age old problem of moving stuff from point A to B has grown enormous. Truck transportation is now a $700B+ market in the United States. Almost 4% of GDP. Trucks haul over 10 billion tons of goods every year, 60% of total U.S. freight. More than trains, boat and planes combined.

A sea of companies share this opportunity. Schneider National, one of the few publicly traded freight companies, describes the U.S. trucking industry as highly fragmented. There are over 550,000 trucking companies: 90% of them own less than 10 trucks, some 50 carriers have revenues exceeding $100M per year, and only 10 carriers have revenues of more than $1B.

Everything considered, it’s relatively easy to buy a truck and start delivering. Truck shipping is effectively a commodity.

Two major events shaped the trucking industry we know today: 1) president Eisenhower kicking off construction of the Interstate Highway System in 1956, paving the roads on which trucks drive; and 2) deregulation in 1980 resulting in many more trucking companies and drivers.

Not much has changed since then.

Until November 16th 2017. The day Elon Musk announced Tesla was building a semi-trailer truck: A class-8 tractor truck with a range of 300 or 500 miles, capable of recharging in 30 minutes. Promising much lower operating costs than diesel trucks. This was the sound of music to truckers with razor thin margins.

In this investigation, we:

Long-haul trucking is short on profits

Let’s first take an in-depth look at the business of long-haul trucking Tesla aims to disrupt.

We’re defining long-haul trucking as any delivery trips over 500 miles, requiring at least one overnight stay away from home. Research by the American Transportation Research Institute estimates 52.3% of all freight routes require overnight stays, while a further 6.2% of long-haul routes are served by team drivers (one sleeps while the other drives). Such trips represent 31% of freight by value and 11% by weight.

2.75 million tractor-trailer combination trucks handle this work. Together they travel over 170 billion highway miles a year, using 28.9 billion gallons of diesel. They covered 56% more miles and use twice the amount of fuel compared to the 8.46 million class 3 to 7 single unit trucks (cargo box and engine are on the same frame).

Intense competition leads to low profit margins

The result of a highly fragmented trucking market is intense price competition, thus thin profit margins. Even for the big guys. YRC Freight, one of the largest publicly traded trucking company, had an income of $41.4 million dollars on revenue of $3.07 billion dollars in 2017. That’s a margin of 1.35%. YRC’s profits are on the low-end of industry average, but not many competitors are swimming in cash:

Table: 2017 sample operating margins of publicly traded trucking companies

Transforce LTL & TL Knight-Swift (Excl. Logistics) YRC Freight XPO Transportation Fedex Freight
5.5% 9.9% 1.35% 5.5% 6.2%

The most significant operating expense aside from driver wages is fuel. Research estimates the median percentage of operating costs spent on fuel at 24%. That ranges from as high as 30% for smaller fleets and 16% for the largest fleets. That’s partially because larger fleets can afford longer payback periods when investing in fuel saving technologies such as aerodynamic modifications: 24 months as median for fleets of 500+ trucks versus 12 months as median for fleets of 1 to 20 trucks. Trucks in larger fleets tend to therefore achieve better mileage.

Small margins, increased regulation, and retiring owners of family-operated truck companies are also pushing the industry to consolidate. This helps truckers gain cost advantage through high volume and lower overhead.

Tesla takes advantage of forced resting time for drivers

The other variable limiting profitability is the driver.

Humans drive trucks and humans need rest. Regulations around active driving time for truckers are strict. Drivers are allowed to work for a total of 14 hours per day, during which they can drive for 11 hours. They must also take a 30-minute break after driving for 8 hours straight.

Mr. Musk is betting big on those 30 minutes. They would allow drivers to recharge their electric trucks up to 80% capacity using a megacharger without feeling like they’re wasting time. A diesel truck fills up in 15 minutes by comparison.

The law is on Mr. Musk’s side. Safety is no joke and Federal Motor Carrier Safety Administration is pushing ahead with mandatory electronic logging of driving time for all commercial trucks.

Growth in long-haul shipping is chugging along, but lags GDP

The value of truck transported goods is projected to grow at an average of 1.6% annually until 2045, while weight of goods trails behind at 1.15%. That’s because more and more goods shipped are high-value low-weight. Think iPhones and Chinos pants rather than dirt, wood and fuel.

Growth in tractor-trailer truckload transportation has effectively lagged behind GDP growth since 2000. A rapid increase in our services economy explains one side of the story. Another reason lies with the miniaturization of freight goods. Not only do transported goods weigh less than before, they’re also smaller, need less space, and are cheaper to ship.

The number of tractor-trailer trucks on the road grew 5.4% annually between 2013 and 2015, following a decline in wake of the recession from 2010 to 2013. There are currently more than 2.75 million semi trucks on the roads.

This recent increase in capacity is forcing freight companies to compete aggressively by slashing prices. Supply is outpacing demand. Excluding revenue growth from mergers and acquisitions, many freight transportation companies have seen revenue decline in the past two years:

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How have class-8 semi truck sales fared?

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Sales bottomed in 2009 and started to recover afterward. Growth averaged 18.79% between 2010 and 2015, largely due to a sales boost of 59.9% in 2011 to make up for slack in capacity. The number of new trucks sold peaked in 2015 with close to 250,000 new trucks hitting the road. This large increase in capacity is what created a supply/demand imbalance, putting pressure on shipping prices. 2016 then saw a 22.6% decline in truck sales as freight companies tightened capacity. The largest drop since the recession.

Truck manufacturers remain nevertheless optimistic. With the economy on fire, increasing in consumer spending, and strong commercial and residential construction, Paccar, the manufacturer of Kenworth and Peterbilt semi trucks, expects record freight tonnage and high fleet capacity utilization in 2018. Navistar, manufacturer of International trucks, is seeing a 151% increase in orders for its class 8 trucks.

Another indicator of stronger truck sales is the fact fleets will be replacing a large number of equipment in the coming years. Large fleets replace their equipment after 3 to 4 years. For example, the average truck in Knight Swift’s fleet is only 1.9 years old. Newer trucks are simply cheaper to maintain.

With most fleets having a large number of 2016 trucks, we can expect 2019 and 2020 to see a high number of new trucks sold to replace them. Just when Tesla’s Semi plans to hit the market.

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Freight companies rely on two elements to sustain growth: 1) Drivers; and 2) Trucks.

Drivers are hard to come by. Turnover in long-haul trucking is sky high at 95%+. Knight-Swift notes in its annual report that this tends to be a bigger problem when the economy is good and jobs are plentiful. Truckers can easily find jobs locally so they can go home for dinner. A low unemployment rate of 4.1% therefore doesn’t help. As result, companies pay long-haul drivers 30% more in wages than local drivers.

The ability to buy new trucks can also present a challenge for freight operators. Knight-Swift specifically lists “decreased availability of new revenue generating equipment, and the failure of manufactures to meet their sale obligationsas a risk. If production is delayed, freight companies will have to use older trucks that cost more to operate. Eating into margins.

Diesel Trucks: Old faithful of freight shipping

Diesel tractor trucks are the backbone of long-haul trucking.

Why diesel rather than gasoline? Diesel fuel contains 14% more energy. This allows for better fuel efficiency and more power.

Diesel engines also generate more torque (rotational force) at low engine RPM. They can therefore accelerate with heavy loads faster than gasoline powered vehicles. For example, a diesel Ford F150 pickup truck achieves peak torque of 440 lb-ft at 1,750RPM, versus peak torque of 375 lb-ft at 3,000RPM in a gasoline version.

Let’s now take a close look at the operating cost of a diesel truck:

Truck price & depreciation

Based on the market value of the popular Freightliner Cascadia:

  • A new truck costs $150,000
  • A 2-year-old truck with 200K miles costs $80,000
  • A 5-year-old truck with 480K miles costs $40,000

This means the value of a semi truck depreciates at $0.35/mile in the first two years of operation, and $0.14/mile from year 3 to 5. Large fleet operators such as Knight-Swift tend to replace their trucks after 3-5 years to optimize maintenance costs.

Fuel Fuel efficiency of class 8 diesel trucks, which hasn’t changed in the past decade, depends primarily on…

  1. Payload: NHTSA found that a Kenworth T-700 tractor-trailer achieved 6 miles per gallon (MPG) fully loaded and 7MPG half-loaded.
  2. Speed: Aerodynamic drag force quadruples when speed doubles. This means power required from the engine increases at double the rate of speed. Cummins, a diesel engine manufacturer, estimates that each 1MPH above 55MPH reduces fuel efficiency by 0.1MPG. No wonder most trucking companies cap their trucks’ top speed at around 60mph.

The American Trucking Research Institute reports that median fuel efficiency varies between 6.3MPG to 6.8MPG depending on a company’s fleet size. For our investigation, let’s assume tractor-trailers operate at 6.55MPG (average of median values found by ATRI).

With diesel price projected at $2.86/gal in 2019, We can thus estimate fuel cost at $0.437/mile ($2.85/gal ÷ 6.55miles/gal) when Tesla’s Semi hits the road.

Maintenance Let’s get a real-life sense of how much maintenance costs by looking at Knight-Swift, one of the top large fleet operators by operating margin. Here’s their 2016 stats:

  • Amount spent on operations and maintenance: $76.25 million
  • Number of company owned tractor trucks: 4,286
  • Average maintenance cost: $17,790 per truck

(How we got this number: $76.25 million / 4,286 trucks)

  • Average miles driven per truck: 85,805

(How we got this number: Knight-Swift reported $129.7M on fuel. This translates into 56.15 million gallons of diesel when it cost $2.31/gal in 2016. Their trucks therefore drove around 368 million miles assuming a fuel efficiency of 6.55MPG. Each of their 4,286 trucks in turn averaged 85,805 miles.)

  • Average maintenance cost per mile: $0.207/mile

(How we got this number: $17,790 / 85,805 miles)

The average truck in Knight-Swift’s fleet was 1.9 years old, so our maintenance cost per mile can be considered typical of any large operators who replace trucks after 3-5 years.

It’s important to note that over half of the recommended maintenance tasks for class 8 trucks are unrelated to the diesel engine. That means an electric truck would also need them. We’ll come back to this point as we review maintenance cost of the Tesla truck.

Payload A typical class 8 truck tractor weighs 17,000 lbs. Other sources report 35,000 lbs including fuel, a sleeper section and the trailer. This allows for 45,000 lbs+ for payload, considering a maximum gross vehicle weight of 80,000 lbs to protect roads and bridges. Most shipments don’t weigh this much. The average shipment weight of YRC Freight is only around 1,200 lbs.

5,500 lbs of the truck’s weight can be attributed to the diesel powertrain and fuel:

Infrastructure Diesel trucks have access to an extensive refueling infrastructure in the U.S. There are 156,000 fuel stations and more than 55% of them sell diesel. That’s 85,800 diesel stations serving 11.2 million trucks. One for every 130.5 trucks.

A problem however exists with the parking infrastructure. Current demand for truck parking spaces exceeds supply. There are only 308,920 truck parking spaces available across the U.S. for over 2.7M registered tractor-trailers. As result, 75% of truckers report difficulty finding safe and legal parking during rest periods required by Federal Hours of Service regulations. This increases to 90% at night when drivers wait for their drop off destinations to open and accept deliveries, and sleep. Pilot Flying J even advertises the ability to reserve a parking spot as a competitive advantage over other service stations.

Environment Transportation is the largest source of carbon emissions. Commercial trucks account for 23% of emissions from transportation, while passenger cars dominate with over 69%. That’s because there’s a lot more passenger cars than trucks, and gasoline releases more CO2 than diesel.

Burning one gallon of diesel emits 22.38 lbs of CO2. That’s 3.36 lbs CO2 / mile at a fuel efficiency of 6.55MPG for tractor-trailers.

The figure above however doesn’t account for the emissions generated producing diesel fuel. An investigation by the state of California reports the Well-to-Wheel (from extracting crude oil to burning diesel) emission of diesel to be 92g CO2 per MJ of fuel (0.203 lbs CO2 per MJ). This translates to 29.6 lbs CO2/gal as diesel has an energy density of 146MJ/gal.

The total environmental cost of using diesel is therefore 4.52 lbs CO2/mile. This of course varies per region depending on how diesel is produced and transported. Higher in areas that use less renewable energy to power refineries, and that have to ship fuel across longer distances.

Burning diesel also emits NOx pollutants. They’re responsible for acid rain, ozone destruction and many health issues. The good news is that the amount of NOx produced by diesel trucks has been steadily decreasing over the past decade. Largely because the EPA required the use of ultra-low sulfur diesel fuel in 2006. Yet trucks still produced more than 2.3 million tons of NOx in 2016. This is projected to decrease to 975,000 tons in 2030.

While many people express concern for the environment, few are willing to make meaningful personal sacrifices. Mainly because we don’t feel the economic cost of our emissions. But what if it were cheaper to be green?

Tesla’s Semi goes far on the cheap, if there’s a megacharger along the way

“What do people want? They want reliability. They want the lowest cost. And they want driver comfort… So we reimagined the truck.”Elon Musk

Mr. Musk is right. Trucking companies care about revenue and costs more than anything. Environment is not a priority, so he didn’t even mention it. Mr. Musk instead promised to reduce operating cost by 17% or $0.25/mile to appeal to customers. He pledged a 2-year payback period, and $200,000+ in fuel savings over a million miles.

Let’s put those numbers to the test.

Truck price & depreciation Tesla lists its semi truck at:

  • $150,000 for 300 miles range
  • $180,000 for 500 miles range

The 500 miles range model is 20% more expensive than a comparable sleeper diesel truck costing $150,000.

What about resale value? A used Tesla truck’s value will be strongly tied to its battery performance. A low-range battery limits the types of deliveries it can make. How long can we expect Tesla’s battery to last?

Tesla’s vehicles (Model S, X, 3) use batteries composed of lithium, nickel, cobalt, aluminum oxide (NCA) and have a lifetime of 1,000 to 1,500 cycles. This means batteries will only have a capacity of 80% afterward (defined as end-of-life). The bigger truck’s range would then decrease to 400 miles.

For consumers that only drive about 15,000 miles a year, these batteries can easily outlast the vehicle itself. A Model S with a range of 300 miles only goes through 50 to 60 full cycles a year. Hence Tesla’s generous 8-year infinite mile warranty.

Trucks are however on the road a lot more. Knight-Swift’s trucks average 85,805 miles a year. This translates into 190 cycles a year, based on 2 cycles a day: One overnight cycle that allows 500 miles range and one megacharger cycle that allows 400 miles range. The truck’s battery would therefore hit end-of-life in 675,000 miles or 8 years.

Interestingly, hitting end-of-life won’t affect the Tesla truck’s daily maximum range. Daily range is limited by the trucker, who can only drive 660 miles a day due to regulations: 400 miles at 60mph in 6.67 hours + 260 miles in 4.33 hours = total of 660 miles in 11 hours. At end-of-life or 80% capacity, a 500-mile range Tesla can still do a max of 720 miles a day on 2 charges (400 miles after overnight charge + 320 miles after megarcharger). More than the 660 miles a driver is allowed to drive.

The functional value of Tesla’s batteries are therefore the same as new even when end-of-life is reached.

The perceived value will however change. What a 500 mile range of a new truck has over a 400 mile range is extra freedom in choosing a recharge location. If a route’s closest megacharger station is 401 miles from starting point, the truck is useless. A truck’s value is therefore tied to the availability of megachargers along its route.

Let’s assume for calculation purposes that the battery’s value decreases at double the rate to its capacity. One-fold for losing capacity and another for losing freedom on where to refuel. So a battery retains 60% of its value when capacity hits 80% at end-of-life.

The price of lithium batteries is predicted to decrease at an annual rate of 5% as batteries become more abundant and cheap to manufacture.

Assuming the rest of the truck depreciates at the same rate as its battery, the Tesla truck is expected to depreciate at a rate of $0.16/mile. Less than half that of new diesel trucks. An $180,000 Tesla semi will still be worth $71,600 after 675,000 miles or 8 years. The same price as a much newer 2 to 3-year-old diesel truck.

The fact Tesla cars retain better resale value than competitors has been proven in the consumer market. A Model S loses 28% of its value after 50,000 miles versus 40% for German luxury car makers.

Large fleets that replace trucks after 3-5 years could therefore recoup much more money.

Fuel One major reason electric vehicles are more fuel efficient is because 70% to 90% of the energy from electricity is directly used to move the car. Only ~35% of the energy stored in diesel fuel is used to move the car by comparison. The rest is lost as heat.

At 6.55MPG, a diesel truck requires about 6.32kWh of energy from 0.152gal of fuel to move one mile (at 60mph). Tesla’s semi is expected to only use 2kWh of electricity do the same. A 70% saving in energy.

Mr. Musk further guarantees a charging rate of 7 cents per kWh at future megacharger stations. This means truckers will only pay $0.14/mile for fuel. Compared with $0.437/mile for diesel trucks.

That’s if Tesla manages to stay in business. The average commercial rate for electricity in the U.S. is around 10.3 cents per kWh. But electricity price also varies by the peak rate at which electricity is drawn from the grid, so Tesla’s megacharger stations are likely to pay a premium. It’s estimated Tesla’s true cost to be around 40 cents per kWh.

The market rate for energy required by the Tesla truck is therefore $0.80/mile with a megacharger, and $0.26/mile with normal charging. Using a megacharger without subsidies is twice as expensive as diesel at $0.437/mile. Diesel fuel would have to cost $5.25/gal to match the megacharger’s market cost.

Guaranteed cheap electricity is thus a critical part of Tesla truck’s appeal.

What may help Tesla lower charging costs includes batteries installed at charging sites that can draw energy from the grid at normal rates, and discharge into trucks without peaking the grid. Such technology is already in use by a fleet of UPS delivery trucks in London. Add some solar panels and it’s possible Tesla’s electricity will only cost around 10 cents per kWh. Normal market rate.

All this would however necessitate a large capital investment.

Maintenance While Mr. Musk likes to mention that electric cars don’t need oil changes, the fact is that they still need many of the same maintenance items as diesel trucks.

Teslas are also more expensive to repair. So much so AAA raised insurance premiums for Tesla drivers. Consumer Reports currently gives Tesla an “Average” mark for reliability. Drivers have complained of assembly issues and driving problems that degrade the experience of a luxury car. As result, Tesla also incurs higher warranty costs than peers. These problems are less because of vehicle design than of poor manufacturing.

Let’s look at how existing Tesla vehicles fare relative to peers to estimate maintenance cost of their truck. We compared below the cost to maintain and repair a Model S ($74,500+) against that of a similarly luxurious Audi A7 ($69,700+) and the uber reliable Toyota Camry ($23,495+).

Annual Maintenance Cost

Tesla Model S Audi A7 Toyota Camry
1 year old $2,666 $3,359 $1,568
5 years old $3,800 $4,200 $2,260

A Tesla is slightly less expensive to maintain than an Audi, but 40% more expensive than a Camry. Taking the average maintenance and repair cost of Audi and Toyota, we can expect a Tesla to be 8.5% more expensive to maintain than the average vehicle.

Assuming a similar ratio for semi trucks, we can expect the Tesla semi to cost around $0.225/mile to maintain and repair compared to $0.207/mile for average diesel trucks.

Payload The heavy weight of Tesla’s batteries will limit payload.

Tesla’s semi truck needs a battery pack of 1,000kWh to achieve 500 miles at 2kWh/mile. This translates into a weight of 6,667Kg or 14,700 lbs as lithium batteries are expected to have an energy density of 150W/Kg in 2020. Some are more optimistic about Tesla’s engineering capabilities and estimate the semi’s batteries will only weigh 11,000 lbs. That’s still double the weight of a diesel powertrain (5,500 lbs).

This means 5,500 lbs less haulable load than a Diesel truck.

Does it matter? A 48’ trailer has an interior volume of 3,566CuFt. A Tesla truck will only be able to carry a max load 39,500 lbs in this space while a diesel truck carries a max load of 45,000 lbs. It will therefore matter if payloads include goods with a density of 11.08 lbs/CuFt or more. A Diesel truck could carry 900 more gallons of gasoline (45 lbs/CuFt), 300 more MacBooks (18.5 lbs/CuFt) or one more Model S sedan (4,700 lbs).

This could affect Tesla truck’s ability to compete for shipments of high density freight worth more than 5 trillion dollars: i.e. electronics, motorized vehicles, gasoline, fuel oils, etc. These commodities account for more than 25% of all goods shipped.

The Tesla semi’s payload capacity however won’t be a problem when carrying low density goods such as furniture, appliances or ping pong balls. Or if it carries less than a full payload.

Refuel Network The Tesla truck’s maximum daily travel distance is mainly restricted by the driver, not its battery.

A trucker can drive 8 hours straight before needing to take a mandatory 30 minutes break. That’s 480 miles at 60mph. Less than Tesla’s 500 mile range. The driver can go for another 3 hours to complete his 11-hour daily driving limit. Adding 180 miles to the trip. This totals 660 miles a day.

Range only becomes an issue if the battery doesn’t allow the truck to cover 660 miles in a day with one megacharger cycle. Or when x + 80%*x < 660 miles, where x represents the truck’s range. That’s 367 miles solving for x. That’s also when battery capacity drops below 73.6%. Way past the end-of-life expected for the battery at 675,000 miles or ~8 years of driving we previously calculated.

367 miles is also the minimum distance a Tesla semi has to travel before megacharging to achieve the optimal daily travel distance of 660 miles. So an operator needs to make sure a megacharger is located 367 miles to 480 miles from the starting point.

This may limit the truck’s adoption rate.

Tesla’s megacharger construction plans are unclear. Looking at North American supercharger stations as proxy, their numbers grew 100% annually from 2014 and on. From 50 in 2014 to 361 stations in 2017. Even if megacharger stations grow at this rate, it’ll still be a tiny number compared to the existing 156,000+ diesel stations. This will affect the number of routes electric trucks can cover.

It appears the first megachargers will be found at regional distribution centers of Tesla partners (likely close to metropolitan regions). Beyond Tesla partners, only trucks operating routes that pass by these stations will be able to complete their journey.

Tesla trucks also need to find a place to charge up overnight. That’s another problem considering the lack of parking spaces even for diesel trucks. Needing an electrical outlet won’t help.

Cold weather will also limit the routes Tesla trucks can operate on. According to recent research, lithium-ion batteries have reduced capacity in freezing temperatures due to bad charge transfer, low electrolyte conductivity, and reduced solid-state diffusivity [1]. That’s bad news as half of America experiences freezing winters between December and February. It’s been found that for the capacity of a Li-ion cell at -20℃ is only 60% of its room-temperature value [2]. To combat this issue, electric vehicles actively manage the batteries’ temperature using heaters.

Two different sources (Teslarati, Consumer Reports) report a reduced range of ~180 miles in real-life winter conditions for Tesla’s 265 mile range Model S P85. That’s a 30% drop in range. Enough to limit the daily driving range of the truck.

One solution may be to maintain a mixed fleet of electric and diesel trucks. Sending the electric trucks south and diesel trucks north in winter months. And the opposite in summer months. Diesel trucks have no issues in winter as long as winter fuel with additives to lower solidification temperature is used.

Environment A Tesla truck indirectly emits greenhouse gases if fossil fuels are used to generate the electricity it uses. An investigation by Wired however reports that electric cars still come ahead after considering grid emissions, rare earth manufacturing, and battery recycling.

The department of energy estimates emissions from electricity production at 1,085 lbs CO2/MWh. For a Tesla truck consuming 2kWh/mile, this translates to 2.17 lbs CO2/mile. Less than half of diesel trucks at 4.52 lbs CO2/mile.

Grid emissions have also been steadily dropping since 1970, when they produced 1,540 lbs CO2/MWh. Much more electricity was generated from coal plants then, which emit 2,200 lbs CO2/MWh. A larger proportion of natural gas plants emitting 946 lbs CO2/MWh and renewable energy plants (e.g. solar and wind) are expected to bring down grid emissions down to 750 lbs CO2/MWh by 2040.

One growing environmental problem facing electric cars is the fact lithium batteries are seldom recycled. It is currently five times more expensive to acquire Li-ion through recycling than it is to mine new lithium material. For recycling programs to become economically viable, we need [3]:

  • A much greater number of Li-ion batteries in use
  • More expensive Li-ion marketplace (it’s actually trending cheaper)
  • Easier methods to separate different elements used in Li-ion batteries (i.e. standardized chemical compounds, and standardized designs)

Tesla vs. Diesel: Elon Musk surprisingly under promised

So does Mr. Musk’s promises in savings live up to the test? Our calculations prove so. Even more astounding, Mr. Musk was under promising.

A diesel truck costs a total of $0.644/mile for fuel and maintenance, compared with $0.365/mile for Tesla. This amounts to operational savings of more than ~40% or ~$0.279/mile. Beating Mr. Musk’s estimate of 17% or $0.25/mile in savings.

When does a Tesla semi breakeven with diesel truck? After 120,000 miles or 1 year and 5 months if one drives 85,805 miles per year. 7 months ahead of Mr. Musk’s promised break-even time of 2 years. This accounts for the $30,000 higher sticker price of the Tesla Semi and operational savings of $0.279/mile.

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An operator who decides to resell their Tesla truck after 5 years or 430,000 miles can also expect to recoup $100,000. $50,000 more than a diesel equivalent. They’d have already saved more than $80,000 in fuel and maintenance by that time.

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One could also decide to drive until Tesla’s batteries hit end-of-life at 675,000 miles. Total operational savings will then hit $146,000. Potentially more if Tesla manages to keep maintenance costs steady while that of diesel trucks grow with age. Savings will finally amount to $229,000 should one decide to test Mr. Musk’s 1 million mile guarantee. 14.5% more than Mr. Musk’s estimates of $200,000.

It’s our belief all long-haul operators should take a serious look at Tesla’s semi truck. Especially if you:

  • Carry low density payloads, which represent 75% of goods shipped
  • Have access to a megacharger 367 miles to 480 miles from origin to maximize daily travel
  • Plan to keep the truck for more than 1 year and 5 months or 120,000 miles to break-even
  • Allow the truck to charge overnight (6.2% of routes are covered by team drivers that don’t rest and instead drive through the night)
  • Operate in states where winter temperatures average above freezing point (26 out of 50 states, where 59% of semi truck drivers operate)

With the right megacharger infrastructure, Tesla could be a fierce competitor in at least 41.5% of the U.S. semi truck market. (We use the percent of semi truck drivers in states with above freezing temperature as proxy for the share of trucks that operate there: 59%. We then account for the fact 75% of shipments are of low density payloads Tesla trucks can carry without disadvantages, and that a further 93.8% of routes are operated by drivers that can allow the truck to charge overnight and rest at the same time.)

Hydrogen Fuel Cell: As quick to fuel up and as dirty as diesel

Another technology trying to displace diesel’s monopoly in long-haul trucking is hydrogen fuel cell. The Nikola One semi being a contender. Its main advantages compared to electric trucks lie in the fact refueling time and driving range match those of diesel trucks. 15 minutes to refuel for a 1,200 miles range. The mental switching costs are thus lower than that of electric trucks.

The main problem hydrogen faces is the high cost of infrastructure. A hydrogen refuel station is estimated to cost one to two million dollars to build versus $300,000 for an electric charging station. That’s why hydrogen infrastructure is sparse, even after 50 years of development.

Nikola is planning to produce hydrogen right at its refuel stations to lower costs. Eliminating the need to transport H2. Nikola is also promising free fuel to drive up demand. That has attracted over 8,000 pre-orders.

Environmentally, hydrogen fuel cell technology emits almost the same amount of CO2 as diesel trucks.

The problem is that hydrogen requires a lot of energy to produce. Electrolysis, the process of producing hydrogen by breaking up water molecules into H and O, is 80% efficient at best. To produce 1Kg of H2 with an energy density of ~40kWh/Kg requires 50kWh of electricity. Hydrogen further loses energy when it is transformed into electricity via fuel cells to move a vehicle; The Nikola One can only transfer 70% of the energy from hydrogen into kinetic motion. Total energy efficiency of a hydrogen fuel cell vehicle is therefore only around 50% to 60%. That compares with 80%+ for electric drives:

  • Hydrogen Fuel Cell Drive System: Electricity source -> hydrogen -> fuel cells -> electricity -> motors [50-60% efficient]
  • Pure Electric Drive System: Electricity source -> battery -> motors [80%+ efficient]

The Nikola One has reported consumption of about 4.6Kg H2/100km. Since we need 50kWh of electricity to produce 1Kg of H2, energy consumption corresponds to 3.71kWh/mile. We already know that electricity production in the U.S. generates 1.085 lbs CO2/kWh. The Nikola One thus produces roughly 4.025 lbs CO2/mile.

That’s double the emissions of Tesla’s semi at 2.17 lbs CO2/mile, and not much less than diesel emissions of 4.52 lbs CO2/mile. Below is a chart showing how many trees are needed to offset the carbon emissions produced annually by each vehicle type. One tree can process 48 lbs CO2 per year for reference.

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It’s clear the environment will not benefit from fuel cell vehicles. They merely push the problem of carbon emissions onto electricity producers. Even fuel cell experts are lobbying against the use of hydrogen in transportation. That includes Mr. Musk who calls fuel cell cars “incredibly dumb.

Hydrogen fuel cell is largely a hedge automakers are making in case customers fail to adopt electric vehicles. Manufacturers and freight companies are scared to make an all-in commitment. There’s too much uncertainty in the air.

There’s more money in short-haul trucking

One question Tesla hasn’t answered is why they didn’t build a delivery truck instead of a semi. Delivery trucks represent a much bigger opportunity.

For a start, there’s 8.46 million single unit delivery trucks versus 2.75 million semis on the road. They deliver goods from distribution centers to brick and mortar shops and to end-users. Completing the last-mile. Despite being three times as numerous, they only traveled 109,597 million miles in 2015 compared to 169,830 million miles for semi trucks. These class 3 to 7 single unit trucks carry the bulk of local and regional shipments traveling less than 249 miles; representing 67% of total truck freight.

The rapid growth of e-commerce is also boosting demand for short-haul shipping. Online sales grew 16% in 2017. As result, courier and package shipments are growing much faster than the 1.6% expected growth for overall truck freight. UPS’s domestic packages segment experienced annual volume growth of more than 9% in the past two years, with trucking playing a vital role. Research indicates the development of next-day and 2nd-day courier services, often used by e-commerce stores such as Amazon, has made trucks critical to operations. They reduce airport congestion and allow greater schedule flexibility [4].

This unprecedented growth is even attracting long-haul freight operators into the courier business. XPO entered the U.S. home delivery business in 2013 and is actively seeking to grow their market share; specializing in last mile transportation for appliances, large electronics and heavy goods. Schneider National is following a similar growth strategy with their recent acquisitions of Watkins & Shepard and Lodeso. Both companies that handled last-mile deliveries of oversized items.

Is the demand for class 3-7 single unit trucks growing just as quickly?

Class 3 to 5 trucks, carrying out the bulk of urban deliveries, experienced average sales growth of 11.2% per year since 2010. From 204,000 vehicles sold in 2010 to 382,000 vehicles in 2016. Class 6 and 7 trucks, capable of delivering oversized items such as furniture, grew at a similar pace of 10.6% a year. From 67,000 vehicles sold in 2010 to 122,000 vehicles in 2016. Unlike semi trucks, sales have yet to peak.

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Navistar International, one of the top single unit truck manufacturers, experienced a 16% increase in unit sales in Q1 of 2018 versus the same period last year. They also had a 43% boost in orders and 40% increase in backlog. Ford’s F-Series trucks (mainly class 2 to 7 vehicles) saw a 2.2% increase in sales in January 2018 versus the same period last year. Utilimaster, one of only two manufacturers of walk-in vans used by UPS and FedEx (the other being Morgan Olson), saw their order backlog increase by 198.9% in 2017 with the award of a $214 million UPS contract.

There’s a clear opportunity for electric trucks to disrupt the single unit delivery truck market.

Electric vehicles are highly efficient in the stop and go traffic delivery trucks find themselves in. A Dodge Ram Promaster diesel van achieves 13mpg in the city versus 18mpg on the highway. 28% less efficient in city driving. A Tesla Model X achieves 81mpg-e in city and 92mpg-e on the highway. Only 12% less efficient in city driving by comparison.

Let’s therefore imagine Tesla designed a class 5 electric delivery truck. One that any operator driving class 3 to 5 trucks could use to haul their loads. How would it compare against diesel delivery trucks?

Diesel Class 5 Delivery Truck Tesla Class 5 Delivery Truck
Price A delivery van can cost anywhere between $50,000 to $85,000 depending on specs. For our analysis, let’s assume we’re buying a brand new class 5 Freightliner MT55 walk-in van priced at $85,000. Assuming Tesla’s lower operating cost can justify a 20% premium just like the semi truck, a class 5 delivery electric truck could therefore be priced at $105,000.
Fuel The top-of-the-line, composite body, Utilimaster Reach reports 15MPG at the pump and claims to be 35% more fuel efficient than standard trucks. We can thus deduce that a standard delivery truck averages around 11MPG.

This translates into $0.26/mile at 2019 diesel prices of $2.86/gal.

Let’s look at an existing electric delivery truck for clues on energy consumption: The Workhorse E-Gen class 5 electric truck averages 1kWh/mile. We can expect a Tesla delivery truck to achieve a similar consumption rate.

This translates into $0.07/mile for fuel if Tesla sells electricity at 7 cents per kWh.

Environment A diesel delivery truck emits 2.7 lbs CO2/mile when accounting for 11mpg and 29.6 lbs CO2/gal well-to-wheel emissions for diesel. The electric truck is expected to emit 1.085 lbs CO2/mile when accounting for energy consumption of 1kWh/mile and 1.085 lbs CO2/kWh grid emissions. Less than half that of diesel.

What does this mean to a carrier like UPS? UPS operates a fleet of 101,863+ small package delivery vehicles worldwide. They travel anywhere from 60 miles to 100+ miles a day depending on whether they’re delivering downtown or in suburbia.

Let’s assume they average 60 miles a day. At $0.26/mile for 313 days a year (working 6 days a week), cost of fuel amounts to $497 million. That’s compared to $134 million if they were to run an entire fleet of electric trucks sipping energy at $0.07/mile. Savings of over $363 million or 75%.

It’s no surprise UPS is actively investing in electric trucks, but they remain an experiment. UPS operates 8,500+ alternative fuel vehicles, representing only 8% of their fleet. 84% of new vehicles purchased are still standard diesel trucks. As result, UPS still spent $2.69B on fuel in 2017 (for planes and trucks). A lack of charging infrastructure may very well be the biggest obstacle to the electric revolution.

Tesla forsakes $49.5 billion, but saves planet Earth

Is Tesla missing an opportunity by not selling an electric delivery truck? Let’s compare the potential revenue of selling a semi vs. selling a class 5 delivery truck.

First, we must estimate the market share Tesla can realistically gain.

Elon Musk has set the bar at 100,000 semis to be sold annually by 2022. That’d result in a market share of over 50% two years after launch as 200,000 semis are sold each year. And wishful thinking at best.

Mr. Musk set a similarly outlandish goal for his Model 3 sedan in his Q1 2016 investor call. He envisioned 100,000+ Model 3s produced before end of 2017. He updated that figure to 20,000 in July of 2017. The reality? 1,550 Model 3s delivered in 2017. 1.5% of his original target.

Mr. Musk clearly suffers from chronic planning fallacy. He’s over-optimistic about Tesla’s ability to hit goals. Overlooking obstacles and uncertainties on the way. For example, manufacturing problems could push back the semi’s production schedule. Or freight companies could be slow to adopt electric trucks due to uncertainties around infrastructure. Perhaps planning fallacy helps to push ahead big dreams.

For more realistic growth estimates, let’s look at the story of Hyundai Translead. The top semi truck trailer manufacturer in 2017 with 19% market share. One would never have guessed that they only started selling trailers to U.S. freight companies in 1994. They took advantage of lower wages south of the border by establishing a plant in Mexico: $1.30/hour in Mexico vs. $12.60/hour in the U.S. That allowed them to offer lower prices and added value. They claimed 3.1% of the market share in the first year. Hyundai Translead’s market share then grew on average 8.2% a year for the next 23 years. Nothing short of amazing.

Many similarities exist between Tesla’s Semi project and Hyundai Translead’s early days. Both started with no market share in the trucking business. Promising lower operating costs and added value.

There is one important difference though: Hyundai was already a manufacturing powerhouse when they entered the U.S. trailer market in 1994. They manufactured over a million cars that year. Tesla produced less than 30,000 cars last year.

It’s safe to say that replicating Hyundai Translead’s growth would be a best-case scenario for Tesla. Let’s thus use Hyundai’s market share growth as proxy to Tesla’s future growth.

We now need to forecast how the overall market for trucks will grow. Two measures we found to predict truck sales include the industrial production index (IPI) and advanced retail sales (ARS). Assuming a linear relationship, we found annual sales of class 8 trucks to correlate meaningfully with the IPI, with a correlation coefficient of 0.654. We then found a strong relationship between annual sales of class 3 to 5 trucks and ARS, with a correlation coefficient of 0.94.

These relationships allow us to perform linear regression to forecast future truck sales.

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We can estimate future IPI and ARS figures based on historical growth rates from 2001 to 2017: 0.794% and 3.279% per year on average respectively. This in turn allows us to create trendlines to forecast future market size for truck sales.

The number of semi and delivery trucks Tesla could sell can finally be estimated based on Hyundai Translead’s market share over time: 3.1% of the market in 2020, their launch year, and all the way to 19% of the market 23 years on.

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Potential annual revenue can also be estimated by assuming Tesla sells its semi truck and delivery truck at $180,000 and $105,000 per unit.

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It becomes clear Tesla would make much more money selling delivery trucks. By 2030, Tesla could generate annual revenue of $5.2B by selling a class 5 truck compared to $3.65B by selling the semi. 42% more. The cumulative revenue forfeited by selling a semi instead amounts to $7.7B+ over these first ten years. During which Tesla could make $17.3B selling delivery trucks versus $9.85B selling semi trucks. The loss in cumulative revenue grows to $49.5B by the 20 year mark in 2040. The delivery truck market is simply larger and growing faster than the semi market.

The loss in cumulative revenue of selling semi trucks instead of delivery trucks amounts to $49.5B after 20 years.

Mind these are rosy forecasts that assume retail sales will keep growing at historical rates. And that no disruptive technology comes in to replace trucks altogether.

Even more appalling is the amount of profits Tesla’s giving up by not selling delivery trucks. Let’s compare the cost differences of producing both vehicle types:

Tesla Semi Tesla Delivery Truck
Electricity

Tesla will be selling electricty at $0.07/kWh to commercial truck customers.

As previously explored, megachargers are expected to cost of $0.40/kWh due to peak rates, and overnight normal charging will cost $0.103/kWh (average electricity rate).

Let’s assume each truck uses a normal charger 55% of the time (overnight charge to give it a 500 miles range) and megacharger 45% of the time (quick charge to give it a 400 miles range in the day). This means an average long-haul truck traveling 85,805 miles a year at 2kWh/mile will take 94,386 kWh from normal charging stations and 77,225 kWh from megachargers. Costing Tesla $40,612 per truck per year.

Electricity is likely to cost $28,599 per truck per year, even after accounting for income of 7 cents / kWh.

Let’s assume a Tesla delivery truck is designed to travel 200 miles. Double the average distance of UPS suburban trips. At 1kWh/mile, the vehicle only needs a 200kWh battery. Similar to those used in its passenger vehicles.

Most delivery trucks won’t travel more than 200 miles per day, so won’t need megachargers. They’ll simply recharge overnight at normal rates. This means a delivery truck traveling an average of 13,116 miles a year will cost Tesla $1,350.95 to charge ( $0.103/kWh).

Electricity will only cost $433 per truck per year, after accounting for income of 7 cents / kWh.

Battery

In 2020, lithium batteries are expected to cost ~$180/kWh

The Semi’s 1 MWh battery will cost $180,000, the price at which Tesla’s selling the vehicle. A 200kWh battery will cost $36,000. Much less than the vehicle’s sticker price.
Profit per Truck in First Year Tesla stands to lose at least $28,599 per semi truck sold in 2020, accounting for electricity and battery costs. Each delivery truck will still have $65,867 in margin after electricity and battery costs. Likely enough to build the rest of the truck and turn a positive profit in 2020.

If Tesla manages to replicate Hyundai Translead’s success and gain 3.1% market share in the first year, it would sell 7,271 semis or 14,055 delivery trucks in 2020. Under the semi truck scenario, it would lose more than $200 million. Under the delivery truck scenario, it could very well turn a profit.

Tesla could also save millions in capital expenditure: Delivery trucks don’t need megacharger stations. Most of them can charge overnight in operators’ parking lots.

So why is Tesla building a tractor truck instead of a delivery truck? Certainly not to deliver above average returns to investors. Maybe to save the planet? Let’s compare the environmental effects of electric semis versus that of delivery trucks.

Tesla could have 57,418 semi trucks on the road by 2025 based on our growth model. Or they could have 118,979 delivery trucks. This is assuming every truck produced from 2020 and on stays on the road. The fleet of semis would travel a total of 4,754 million miles that year versus 1,560 million miles for the fleet of delivery trucks.

A fleet of Tesla semis could therefore save 11,173 million lbs of CO2 from the atmosphere versus 2,536 million lbs of CO2 for a fleet of delivery truck. More than four times the amount of CO2. Semi trucks in the U.S. simply travel far more miles, use much more fuel, and in turn emit a lot more pollution than delivery trucks. Even though there are less of them.

(Reminder: Each Tesla semi emits 2.17 lbs CO2/mile versus 4.52 lbs CO2/mile for diesel semis; compared with 1.085 lbs CO2/mile for electric delivery trucks and 2.71 lbs CO2/mile for diesel delivery trucks.)

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A fleet of Tesla semi trucks could as result significantly help the U.S. meet the Paris Climate Change Accord. That agreement calls for a 26% reduction in carbon emissions in 2025 from 2005 levels. The U.S. emitted 7,313M metric tons of CO2 in 2005. The goal is thus to emit 5,412M metric tons of CO2 in 2025. Americans generated 6,587 metric tons of CO2 in 2015, so we still need to cut 1,175M metric tons or 2,590B lbs of CO2 per year. About 1.45% of that amount or 37.54B lbs CO2 comes from trucking. A fleet of 57,418 Tesla Semi trucks could single-handedly cut that by 30%.

A fleet of Tesla Semi trucks could single-handedly hit 30% of carbon reductions called for trucks by the Paris Climate Change Accord.

Mr. Musk and Tesla are effectively building a semi truck to save the planet. Money comes second.

That leaves the delivery truck market for others to profit. Daimler is already experimenting with their Vision One and eCanter trucks for regional and local deliveries. Workhorse is working with UPS and others to build electric walk-in vans for courier service. We also find startups such as Chanje and Boulder Electric fighting for a piece of the pie. A pie that’s big enough for many players to thrive. Maybe even robots.

Big dreams, little experience

Tesla’s Semi truck program faces many obstacles as they:

Let’s explore these issues in detail.

Is anyone working on the truck?

It’s unclear how truly committed Tesla is to the truck project.

Tesla’s VP of Trucks, Jerome Guillen, is the only Tesla executive on LinkedIn to have any experience building class 8 trucks. He helped with new product development at Freightliner from 2002 to 2007. The rest of Tesla’s executive team have only helped build passenger vehicles:

VP Engineering: Michael Schwekutsch Helped engineer drivetrain components at auto suppliers BorgWarner and GKN before joining Tesla. No truck building experience
VP Engineering: Doug Field Started his career as a development engineer at Ford. Most recently VP of hardware engineering at Apple.
VP Production: Peter Hochholdinger A lifer at Audi. He filled many production engineering and leadership roles from 1994 and on. He was Audi’s director of production for the A4, A5 and Q5 vehicles before joining Tesla.
Dir. Manufacturing: Stephan Graminger Another lifer at Audi before joining Tesla. Likely poached by his former boss Peter Hochholdinger. He worked on different production processes and projects at Audi from 2003 to 2017.
Dir. Manufacturing: Yannick Roux Served as project manager for Fiat Group and Renault-Nissan before joining Tesla.
Dir. Manufacturing: Jan Just Helped engineer specialty roofs such as convertibles and glass tops at Magna CarTopSystems before joining Tesla.
Dir. Engineering: Charles Mwangi Previously a manufacturing engineer at Nissan Motors before joining Tesla.
Dir. Manufacturing: Shen Jackson Worked on the engineering of glass materials and solar cells before joining Tesla. No car building experience before Tesla
Dir. Manufacturing: J. Eric Purcell Worked at Kia and Nissan before joining Tesla. He helped lead Nissan’s body assembly of light commercial vehicles from 2005 to 2008. Experience engineering light commercial vehicles (light trucks and vans).

Tesla also doesn’t appear to have a dedicated team working on the truck. Searching for “truck” or “semi” on their career page leads to no results. Engineers working on the Model 3, such as Aaron Johnson or Rafath Rahman, also list the semi truck design as part of their list of responsibilities. It appears Tesla is relying on existing talent for the truck project. That spreads their engineering team really thin. They’re also unlikely to prioritize work on the truck when grappling with model 3 production and quality problems.

Tesla may be underestimating the differences in producing semi trucks and luxury cars. Only one of the top 6 tractor truck manufacturers also makes passenger cars: Freightliner’s parent company Daimler makes Mercedes. Even then, Freightliner stands as an independent entity.

Mr. Musk has also promised a new roadster to be launched alongside the semi truck, and is even considering designing a new light truck. All distractions that could hinder the semi truck launch date and production.

Beyond limited expertise and dedication to building the semi truck, Tesla also runs the risk of losing critical talent. A string of top leaders have already left Tesla this year, including:

  • President of sales & services Jon McNeil
  • Chief Accounting Officer Eric Branderiz
  • VP Finance Susan Repo

Many other leaders have also left the organization in 2016 and 2017:

  • CFO Jason Wheeler
  • Autopilot Lead Chris Lattner
  • Battery Lead Kurt Kelty
  • VP Business Development Diamuid O’Connell
  • VP Manufacturing Josh Ensign
  • VP Production Greg Reichow

Greg Reichow may be the most missed alumni. Before joining Tesla, Greg had the unique experience of jumpstarting and ramping up manufacturing at SunPower from 2003 to 2011. Designing and building factories that produced solar panels from the ground up. It’s possible Tesla’s Model 3 production ramp up could have been spared some pain should Greg still be around. That leads to our next risk: production.

Production Ramp Up: Tesla bets against Toyota and loses

Tesla will likely face problems mass producing semi trucks. Just as it’s struggling to do with the Model 3.

Truck operators will not be as patient as consumers. The inability to acquire new revenue generating equipment (trucks and trailers) is cited by operators as a clear risk in their financial reports. It’s very likely they’d cancel orders and buy diesel trucks instead when faced with delays. No truck = no shipments = loss of business. Operators are thus much more likely to choose to make less money than making no money at all. Mr. Musk needs to prove it can consistently meet production targets in the B2B realm.

Tesla’s production philosophy may however hinder progress. Its approach to manufacturing is the complete opposite of Toyota’s lean manufacturing system. A system that tops both quality and quantity.

Toyota developed its “just in time” production system to tackle three problems [5]:

  1. The manufacturing of vehicles involves thousands of parts. Each part has undergone its own unique production process and can cause problems to overall vehicle production
  2. Car production involves many different models with numerous variations (options) and large fluctuations in demand for each variation
  3. Vehicles are completely remodelled every few years

Tesla faces the same problems, but deals with them very differently. Let’s compare the two schools of thought.

Toyota Manufacturing Tesla Manufacturing
What’s the goal? To produce better quality goods having higher added value and an an even lower production cost than competitors. To lower production costs by thinking about the factory as a product.
How do they achieve their goal? Toyota attains low cost production through elimination of waste. Anything other than essential amount of equipment, materials, parts, and workers are considered waste.

One priority is to minimize dead time spent resetting and configuring machines necessary for short production runs of different car models. So it seldomly uses sophisticated machines. Allowing workers to quickly tweak and improve processes. Toyota can in turn quickly change production schedule based on the latest sales trends.

One key characteristic of the process is Toyota’s emphasis on putting humans at center of manufacturing. Not robots. As Wil James, president of manufacturing in Kentucky, shared: “Machines are good for repetitive things… but they can’t improve their own efficiency or the quality of their work.

Toyota is effectively relying on continuous improvement to lower costs. Betting that building things right the first time, and constantly getting better at it, is cheaper than an automated production line that cranks out poor quality products they need to fix later.

Tesla wants to attain low cost production through automation. As discussed in their 2017 Q3 report, Tesla is focused “on highly automated manufacturing processes that we expect will ultimately result in higher volumes at significantly lower costs.

Mr. Musk explains: “You really can’t have people in the production line itself. Otherwise you’ll automatically drop to people speed… There’s still a lot of people at the factory, but what they’re doing is maintaining the machines, upgrading them, dealing with anomalies. But in the production process itself there essentially would be no people.”

Mr. Musk’s words have been backed by heavy investments in manufacturing equipment. Assets listed under “Property, plant and equipment” grew from $3.4B in 2015 to $10B in 2017 as the Model 3 production line came online.

Mr. Musk is effectively relying on machines to achieve economies of scale and lower production cost. Betting that robots can crank things out faster than humans. This requires a production line that never stops. As result, Tesla’s manufacturing process tends to be inflexible and unresponsive to changes in the market. There’s little opportunity to improve.

Because Tesla’s automated production line can’t quickly adapt to changes in demand for its cars, pre-orders are a necessity. Not a nice-to-have.

Who’s in command? It is not the conveyor that operates men. It’s men that operate the conveyor.

Any production line can be stopped by workers at any given moment to prevent making too many parts, control for defects, make improvements, or prevent accidents. Allowing for continuous improvement.

Nothing must break the continuity of production.

One line worker recalls a moment when a robot broke down and the supervisor came screaming: “That’s $18,000, $20,000, $30,000, $50,000 because you guys can’t get this done.” Another employee shared that safety is not a top priority.

Tesla’s reliance on automation to lower costs means it cannot afford to stop the machines. Even when improvements need to be made. A robot offline is a robot losing money.

Since we humans tend to hate losing money, as described by prospect theory, Tesla is likely to forgo small improvements to their production line they perceive as money losers, and only stop machines for major works. Such as the recent days long production pause in February and again in April. It’s clear they have difficulty tweaking on the go.

How do parts flow? The need to minimize waste led to the creation of Toyota’s just-in-time system: All processes produce the necessary parts at the necessary time and have on hand only the minimum stock necessary to hold processes together.

This means all production lines need accurate knowledge of timing and quantity needed for their products. Information on priority of orders is gathered from the final assembly line and shared with foremen on subassemblies. These front-line leaders then decide on job dispatching and overtime.

Control is effectively decentralized.

Keeping an automated production line running tends to promote surplus manufacturing of parts to lower risk of downtime. Tesla’s recent acquisition of a large warehouse indicates its production indeed has buffer stocks to help smooth our imbalances between various flows of parts into main assembly.

This tends to be expensive not just in terms of storage costs, but also because parts may become obsolete should designs change.

Poor management adds fuel to the fire. One employee complained that the company is disorganized from the top down, with priorities changing daily. Another shared that nobody knows what needs to be done on a daily basis, leading to much more confusion and frustration.

These signs point to information bottlenecks and centralized command.

Mindset on quality? Quality before quantity.

Setting up a new production line is a matter of building it up slowly, making piecemeal improvements in the process over years.

Toyota believes testing for quality is far more expensive than building it right the first time.

Build quickly. Fix it later.

Employee comments show that Tesla believes trial production runs are pointless. They jump right into production. Coupled with sky high goals, this leads to all hands on deck situations to meet targets.

This is consistent with Silicon Valley’s move fast break things mentality and agile software development philosophies. The difference in manufacturing however is that one can’t patch problems later with a software update. Customers must take time away from their lives and visit the shop. Not to mention increased warranty cost for Tesla.

Data Sources: See references [5] and [6]

Toyota’s human-centered system is best suited to produce different products that change over time. It makes full use of humans’ ability to improve. To spot problems, identify their root cause, and creatively imagine better solutions.

By contrast, Tesla’s robot-centered system is best suited to produce one product that meets the needs of many. Manufacturing researcher Andrew Sayer explains [6]:

Where advanced automation, such as flexible manufacturing systems, is introduced, its effects on productivity are greatest where it is applied to a production system that has already been rationally organised; otherwise it is likely to perpetuate the inefficiencies of the old technology and working practices, as has been found with many major new technologies, including computer-integrated manufacturing and office automation.

In other words, Toyota’s system thrives in a changing world. Tesla’s system thrives when nothing changes.

So far, Toyota’s winning the cost game. Toyota’s cost of products sold represented 80.8% of revenue in 2017. Compared with 83.4% for Tesla.

Production costs will stay high as long as Tesla continues to develop new models or to improve designs of existing cars. It’s simply expensive to take robots offline for tuning. This heightens the risk of Tesla running out of cash.

Tesla’s “build it first, fix it later” mentality also leads to high servicing costs. Service cost as percent of total cost of revenues grew from 7.2% in 2014 to 12.9% in 2017. For every $1 customers paid to get service, Tesla had to pay $1.23 to get the job done last year. A sign of high rates of in-warranty repairs.

Mr. Musk’s cash problems will likely to persist as long as he puts quantity over quality.

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Interestingly, Tesla and Toyota were partners. They worked on an electric version of the Rav4 together. This ended in 2016, supposedly because of a culture clash. It wouldn’t be surprising to find they broke up because of opposing manufacturing philosophies.

The irony is that Mr. Musk instinctively believes in continuous improvement. He shared in an interview how “I always see what’s wrong… When I see a car or a rocket or spacecraft, I only see what’s wrong… It’s not a recipe for happiness.” He really should really think twice about investing more in automation. It won’t allow him to quickly fix and improve designs. Likely leading to further displeasure.

More recently, Elon Musk appears to be awakening to the fact too many robots can slow down production. He tweeted in April 2018: “Yes, excessive automation at Tesla was a mistake… Humans are underrated.” That’s a good start. Tesla however has a long road ahead in convincing its human workers it has their best interest at heart. That it’ll create a safer work environment. That it won’t again try to replace them with robots. Necessary for workers to trust their employer, and in turn, lead continuous improvement initiatives.

Tesla looks up to the Ford Model T for inspiration, a 90-year-old car that competed with horses

Unlike other car manufacturers, Tesla tends to both design and manufacture its parts in-house. When battery problems surfaced with a supplier, Mr. Musk cut the supplier and directed his engineers onto the issue, bringing manufacturing in-house. The same happened when problems arose with the Model X’s second row seat supplier.

This means Tesla only has one supplier for many of its parts: itself. It greatly increases the risk of production delays should any of these parts face manufacturing or design problems. Most manufacturers hedge that risk by using multiple suppliers for the same part. Some even use suppliers in different geographic regions to hedge political and natural disaster risks [7].

The tendency to build parts in-house may stem from Mr. Musk’s success in reducing cost of rockets at SpaceX through vertically integrated manufacturing. Over 80% of parts used in Falcon rockets are made in-house. There is however a fundamental difference in rocket production and car production: Delays experienced in launching a rocket are expected and unlikely to affect revenue, whereas delays in car production directly leads to revenue loss. Threatening liquidity.

Tesla’s production model is reminiscent of Ford’s just-in-case system used to make the Model T. Model T production also focused on lowering cost by using more machines and by making parts in-house at the Highland Park plant. The result was the first car every American could afford. Ford’s Model T only cost $370 in 1921 ($5,060 in 2017 dollars). Less than twice the cost of the cheapest GM vehicle: A Chevrolet costing $795 ($10,900 in 2017 dollars).

Low cost was partially achieved by producing only one car model at Ford: The Model T. Ford believed that the Model T was all the car a person would, or could, ever need. He was wrong. The Model T fell out of fashion as GM both reduced cost of its vehicles and introduced different models suiting the needs of different customers. Production of Model Ts ended after 18 years in 1927.

Tesla is already producing three vehicle models by contrast. Each with dozens of options. Its robots therefore need to be much smarter and flexible than Ford’s, having to adapt to many different specs. Adding a truck to the production line will only complicate things. The semi is also likely to have many options – Freightliner’s Cascadia comes in 5 different configurations to meet the needs of different jobs. Unless Tesla’s robots are super easy to tweak, they’re bound to continue experiencing much downtime.

Both Tesla’s Semi and Model 3 also face a greater challenge than the Model T. They’re competing with existing truck and car manufacturers with far more experience mass producing vehicles. The Model T didn’t even have a competitor capable of mass production in the early days. Heightened competition could lower demand for Tesla vehicles. Especially if competitors have trucks in stock while Tesla struggles to produce them. It’s thus critical Tesla learns to consistently mass produce with the Model 3.

Peter Hochholdinger, Tesla’s VP of Production, may not be of much help. The Volkswagen Group was already a manufacturing powerhouse producing over 3 million cars when he joined them at Audi in 1994. Mr. Hochholdinger’s current challenge thus lies in boosting production without the support of an experienced manufacturing organization. Something he depended on from the very start of his career. During his time at Audi, production increased from 617,000 in 1998 to 1.9 million cars in 2016. An average growth of 6.6% per year. Tesla’s total car production would grow from 103,184 vehicles in 2017 to around 172,000 vehicles in 2025 at that rate, missing all production targets.

There’s enough raw materials to make a lot of batteries

Three main ingredients in Tesla’s batteries include Lithium Hydroxide (LiOH), Nickel (Ni) and Graphite.

Existing reserves of Lithium can sustain current production rates for the next 372 years. Large producers in Chile and Australia have already begun increasing production in anticipation of rising demand from electric cars. This rise in supply is even expected to surpass demand for EVs, so prices won’t likely rise. Interestingly, Lithium is not traded as a commodity. Producers sell many different grades of the material for different purposes. The price battery manufacturers pay for Lithium will therefore vary.

Existing reserves of Nickel can sustain current production rates for the next 40 years. More reserves can also be developed on land and at sea. It’s thus unlikely we run out of Nickel.

Price of Nickel is expected to increase. 85% of Nickel produced currently goes toward stainless steel production. Electric batteries consume only about 3% of production. However, that figure grew 44% in 2016. It will accelerate further as electric cars become more mainstream. Price of Nickel is forecast to rise 5% a year according to the world bank.

Lastly, reserves of graphite (one of two forms of carbon, the other being diamonds) can sustain current production rates for over 225 years. It is also not a rare element. Much of the mining for graphite occurs in China, where, ironically, it’s causing an environmental disaster.

Tesla only needs 56 megacharger stations

There are about 156,000 fueling stations across the United States and 55% of them sell Diesel. That’s 85,800 diesel stations serving about 11.2 million trucks on the road. Each station services 130.5 trucks and covers an average land area of 44,000 square miles.

How many stations will Tesla need from the get-go?

We estimated that 7,270 Tesla semis will be produced in 2020 to gain a market share of 3.1%. That’s 56 charging stations to build at a ratio of 130.5 trucks per station. Quite feasible considering Tesla added almost 150 supercharger stations in 2017 in North America alone. They could cover an area of 2.46 million square miles at 44,000 square miles per station. More than double the combined area of Northeast and Midwest U.S., which together generates over 40% of the nation’s GDP.

It will however be a challenge to identify where to exactly position the megachargers. Tesla needs to identify popular freight routes and appeal to as many freight operators as possible. Each truck route will need a megacharger:

  • At base
  • After a maximum of 300 miles of travel (the smaller electric semi only has a range of 300 miles)
  • At destination

This is where certainty effect may hinder adoption. We humans tend to pay a premium for certainty. Freight companies may therefore be ok operating at a lower margin with diesel truck that can for certain refuel anywhere, rather than risk running out of electricity for a slightly higher margin. Freight companies may prefer to make less money for sure than maybe make more money.

It’s therefore no surprise Tesla Semi customers are partnering up to build the initial charging infrastructure, guaranteeing megachargers on their routes.

Investors beware: Elon Musk is pursuing happiness, not above average returns, and certainly not a $2.6B pay package

Mr. Musk’s ability to disrupt industries is second to none. Paypal revolutionized payments. SpaceX is lowering the cost of launching satellites by 10x. He’s also advancing artificial intelligence at Neuralink and digging cheap tunnels at Boring.

Mr. Musk is clearly a man of many goals. Bloomberg dedicated a complete website to track his ventures. Yet he is also very focused and dedicated to each one of these goals. SpaceX was founded in 2002 and Tesla in 2003. Mr. Musk has been consistently leading those efforts for more than 15 years.

What fuels Mr. Musk’s strong animal spirit?

Mr. Musk is not chasing more money. He called SpaceX and Tesla the “dumbest things” from a business standpoint. This is supported by the fact he’s building a semi truck instead of a delivery truck (saving 4x the amount of carbon emissions but sacrificing billions of dollars in potential revenue).

Instead, Mr. Musk is driven by a vision for the future. Doing his bit to advance humanity. Commenting on Asimov’s Foundation series, Mr. Musk shared: “The lesson I drew from that is you should try to take the set of actions that are likely to prolong civilization, minimize the probability of a dark age and reduce the length of a dark age if there is one.

Mr. Musk’s companies are in effect for-profit social ventures. Working to help us survive longer. And if he can make a dollar while at it, why not?

Investors need to take note. One dollar invested in Tesla may not yield above average returns. It’s not a priority. Investing in Tesla is supporting a vision of the future where tailpipe emissions don’t exist.

Why is Mr. Musk so focused on his visions? He shared in an interview with Rolling Stone a feeling of discomfort in solitude, saying: “I will never be happy without having someone. Going to sleep alone kills me.” He also shared how he was virtually raised by books as a child, not parents. And that he doesn’t respect his father. It appears things are not all rosy in Mr. Musk’s personal life. Perhaps tackling extremely difficult engineering projects is the only thing bringing him joy. That alone should keep him working at Tesla for a really long time. There was no need for a $2.6 billion dollars compensation plan.

Diesel trucks can use psychology to fight back

Humans prefer avoiding losses to acquiring equivalent gains. Given a choice, we’d rather not lose $5 than make $5. This is called loss aversion and was reported by nobel winning psychologists Amos Tversky and Daniel Kahneman.

Loss aversion also explains that in order to choose to acquire additional gains, we must perceive the value of gains to be more than twice that of the value of losses. Not losing $5 becomes less appealing of a choice if potential gains stand at $10 or more.

To facilitate adoption of Tesla’s semi truck, the perceived switching costs must therefore be compensated by larger gains. At least twice the amount according to Kahneman et al. How does Tesla fare?

Switching costs of going electric from diesel include:

  • $30,000 more in initial equipment cost: diesel sleeper semi truck costs $150,000 to Tesla’s at $180,000
  • 15 minutes additional fill-up time on megachargers during the day: This is the equivalent of $32, when truckers average revenue per mile of $2.13 at 60mph. This cost is expected to be felt every 900 miles as we expect drivers to charge normally overnight for a 500 miles range and use megachargers once in the day for an additional 400 miles range.

Gains of switching to an electric truck mainly stem from savings on fuel and maintenance. As per previous calculations, a diesel truck is expected to cost $0.644/mile for fuel and maintenance, while a Tesla truck is expected to cost $0.365/mile. Savings of $0.279/mile.

So when will gains sum up to double the amount of losses? After about 290,000 miles or 3.4 years if a driver averages 85,805 miles per year. Considering most fleets keep their trucks for roughly 4 years, loss aversion may play to Tesla’s advantage.

Chart

That’s of course assuming prices of diesel trucks don’t decrease. It’s very likely manufacturers of diesel trucks will give upfront discounts to compete with electric trucks’ lower operating cost.

A $10,000 reduction in price, which raises Tesla’s price premium to $40k, would push the mental break-even point at which gains equal double the losses to ~390,000 miles or 5-year. Fleet operators replacing trucks every four years could become more reluctant to go electric. Especially considering they’re likely okay paying a premium for certainty on refueling their diesel trucks anywhere.

What if Tesla succeeds with the Semi?

Everyone else will get migraines. Freight companies will see new price wars, while diesel related industries face existential threats.

Operating a fleet of Tesla semis won’t boost profit margins

Tesla may help truckers lower fuel costs, but not increase profit margins. Trucking is a highly competitive and segmented industry as we explored in the beginning of this investigation. Lower operating costs will likely bring about a price war that pushes profits down. Making low operating cost electric trucks necessities. Freight companies who can’t compete on new low prices will go out of business. Freight customers will be the ultimate winners as truck shipping becomes cheaper. And the environment of course.

The fact shipping is perceived as a commodity is the main strategic problem facing freight transportation. Different shipping companies offer relatively undifferentiated service. All are simply taking stuff from point A to B. Customers don’t lose anything by shopping around for better prices, and are unlikely to pay a premium.

Freight operators need to offer unique value to customers to gain a competitive edge and charge premium prices. They could also offer added value to their customers’ customers. UPS Access Points that make it convenient for shoppers to pickup and return retail purchases is a good example. Freight companies need to consider playing more active roles in helping customers increase sales, manage logistics (some large freight companies already do), or become an extension of their service teams. Customers should feel pain at the thought of using a different shipping company.

Marketing also has a major role to play. Companies turning commodity products into premium brands and premium profits is not uncommon. Intel’s “Intel Inside” campaign and Corning’s “Gorilla Glass” serve as examples.

It’s no longer a matter of if electric trucks will hit the road, but a matter of when they’ll take over the road.

Time to hedge against diesel

Tesla and the electric truck revolution won’t happen overnight. It will however spook investor confidence in a number of industries as they face the prospect of slower or declining growth. That includes:


References

[1] Yan Ji, Chao Yang Wang, Heating strategies for Li-ion batteries operated from subzero temperatures, Electrochimica Acta, Volume 107, 2013, Pages 664-674, ISSN 0013-4686

[2] Bugga R, Smart M, Whitacre J, West W. Lithium Ion batteries for space applications. In: 2007 IEEE aerosp conf; 2007. p. 1–7.

[3] Linda Gaines, The future of automotive lithium-ion battery recycling: Charting a sustainable course, Sustainable Materials and Technologies, Volumes 1–2, 2014, Pages 2-7, ISSN 2214-9937,

[4] John T. Bowen, A spatial analysis of FedEx and UPS: hubs, spokes, and network structure, Journal of Transport Geography, Volume 24, 2012, Pages 419-431, ISSN 0966-6923,

[5] Sugimori, Y., Kusunoki, K., Cho, F., Uchikawa, S. Toyota production system and kanban system materialization of just-in-time and respect-for-human system (1977) International Journal of Production Research, 15 (6), pp. 553-564.

[6] Sayer, A. New developments in manufacturing: The just-in-time system (1986) Capital & Class, 10 (3), pp. 43-72.

[7] Tang, C.S. Perspectives in supply chain risk management (2006) International Journal of Production Economics, 103 (2), pp. 451-488.

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