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Page 2 9B15M074 TESLA - COMPANY BACKGROUND Tesla was an automaker headquartered in Palo Alto, California. The company designed, manufactured and sold fully-electric vehicles (EVs) as well as EV powertrain components. " Tesla was formed in 2003 and went public in 2010. Musk joined the company in 2004. He set the company's mission, which was "to accelerate the advent of sustainable transport by bringing compelling mass market electric cars to market as soon as possible." While the concept of fully-electric vehicles was not new, automakers had struggled to balance design with performance. Furthermore, the batteries used for these vehicles were not optimal, and a single battery charge only offered a short driving distance."However, by partnering with Panasonic, a major Japanese electronics corporation, Tesla was able to develop a lithium-ion rechargeable battery for EVs, which solved the driving- distance-per-battery-charge issue." In doing so, Tesla succeeded in developing technology that other major automakers, such as General Motors, had been pessimistic about."* Tesla also formed partnerships with other automakers and component manufacturers, such as Daimler and Toyota. This enabled Tesla to overcome design and performance issues and to develop fully electric and optimally designed vehicles. By December 2012, Tesla had established a presence in the United States and Europe. Furthermore, it had also opened up stores and galleries in Japan and Australia. Corporate Strategy Consistent with its vision to eventually create a mass market for cost-effective, fully-electric vehicles, Tesla set out with a strategy to "go down the market." This involved starting by developing and marketing high- end products for affluent customers, and as the company, its products and its customers became more mature, the company would use the profits and experience generated to refine the technology. " This strategy was similar to that employed by companies in fast-moving technology industries such as Apple, but was quite unique in the automotive industry, where major companies like General Motors and Ford tended to start at the lower end of the market. 17 Vehicles and Complementary Products In 2008, Tesla introduced its first vehicle, the Tesla Roadster, to the North American market. Priced at about $ 109,000 and aimed at the richest individuals, it was a two-seat convertible and the first high-performance electric sports car. It had the ability to accelerate from zero to 97 kilometres per hour in 3.7 seconds, with a maximum speed of about 193 kilometres per hour, and a range of 394 kilometres on a single charge of the battery." Tesla stopped production at the end of 201 1 because its contract with Lotus Cars had expired, and Lotus had provided the case component for the Roadster." Tesla sold its remaining Roadsters throughout 2012 in Europe and Asia. By December 31, 2012, it had sold a total of 2,450 Roadsters in a four year period. Tesla's second vehicle, the Model S sedan, was released in North America in June 2012. The Model S offered customers a lower cost of ownership compared to other sedans that were available at the time." The Model S was a fully-electric, four-door vehicle, with a range of 426 kilometres for each charge of its battery. It also boasted an acceleration capability of zero to 97 kilometres per hour in 4.4 seconds."It was offered with several battery pack options (40, 60 and 85 kilowatt-hours). Depending on the option chosen, Tesla priced the Model S between $52,400 and $72,400.24 By December 2012, Tesla had sold 2,650 Model S cars, mainly in the United States. It had also announced plans to sell the vehicle in the European and Asian markets from 2013 onwards.Page 3 9B15M074 The Model S was different from the Roadster in that it had an adaptable platform architecture and its own electric powertrain. This common base would be used for newer Tesla models, and would help shorten both the cost of, and time needed for, developing future models. This would help to fulfil Tesla's vision to accelerate the creation of a mass market for cost-effective EVs. Tesla unveiled a prototype of a third vehicle, the Model X, in February 2012, with an intention to produce it after 2014. Tesla had intended to set a price for the Model X that would be appropriate to a comparable version of the Model S." The Model X was designed to be a hybrid and to feature both the roominess of a minivan, and the style of a sports utility vehicle, while still offering high-performance features such as a dual-motor all-wheel- drive system. In the long term, Tesla had outlined plans to release a car priced between $30,000 and $40,000. TESLA IN THE UNITED STATES Tesla opened its first retail stores in Los Angeles and Menlo Park, California, in the summer of 2008.26 By December 2012, it operated a network of more than 30 stores, sales and service centres, and galleries around the world. Locations included Seattle, New York City, Osaka, Sydney and Toronto. Showrooms Tesla's ability to adapt and innovate in uncertain times came under examination in 2008. Such uncertainty was characterized by a decline in automotive industry sales due to the credit crisis and a general lack of acceptance of the "electric car" concept by U.S. consumers. The appeal of electric cars suffered from a steep drop in fuel prices in the United States at the end of 2008."Tesla needed to be creative in order to develop a successful strategy to sell its vehicles to consumers. While a traditional dealership-based franchise model had been implemented by all other car manufacturers in the United States, Musk believed that such a model would not meet Tesla's needs. He felt that this model had two major disadvantages for the sale of EVs. First, dealers would encounter a fundamental conflict between the sale of gasoline-dependant cars and EVs. They would not be able to explain the benefits of an EV without undermining the advantages of their traditional business. Second, Musk believed that when consumers visited a local dealership, the majority of potential buyers had already come to a tentative decision about which vehicle they would purchase. This could potentially reduce the dealer's opportunity to educate those consumers on the benefits of Tesla's EV. Tesla decided to pursue an alternative strategy to sell its vehicles by making them available through their own dealerships." Tesla's strategy allowed the company to offer a compelling customer experience while operating efficiently. The company was also able to capture sales and service revenues that other automobile manufacturers would not be able to attain through the use of the traditional model. Tesla also believed that it would be have better control over the sales process if it sold its own vehicles. Factors such as the costs of inventory, management of warranty services and the pricing of the products could be better maintained. All of this would serve to strengthen the Tesla brand, and obtain rapid customer feedback. 30 However there was one problem: U.S. law-makers in some states had prevented the direct sale of vehicles to customers by their manufacturers. This created a barrier for Tesla to overcome in its pursuit of company- owned dealerships." In 48 of the 50 states, Tesla was required the sell and service its automobiles through a middleman franchise - a dealer. Once dealers had invested in inventory and facilities, automotivePage 4 981581074 companies could pressure dealers to accept shipments of cars. If the dealer did not comply they; could face the possibility of the manufacturer nding another local dealer to use instead In such a situation, the dealer would lose the money that had been invested' In the dealership To prevent such situations from occurring, the states had begun to enact laws to provide dealers with exclusive rights in local markets Tesla overcame this obstacle with a revolutionary solution. -- -- - 1- - On July 8, 2010, Tesla announced the appointment of George Blankenship as the Vice-pres1dent of desrgn and store development for Tesla. 33 Blankenship, the former vice-president of real estatia' for Apple was best known for his work on Apple' 5 brand- building retail strategy one of the most successful retail growth strategies in history?4 Blankenship, through the use of his knowledge acquired at Apple: was able to devise an innovative strategy to adaptto the laws that prohibited the sale of vehicles by a marinfacturer. His strategy would also maximize the number of consumers that would be exposed to and educated about the product. Blankenship recommended that Tesla position its new stores, which. they called \"showrooms,' in retail venues that had high footname and visibility. Places such as malls and shopping districts, where people were regularly in a relatively open and buying mood were considered the ideal places for the \"showrooms. \" He believed this would satisfy the company's need to educate consumers because Tesla would be able to interact with potential consumers before they had decided on which new vehicle they wanted to purchase 35 Also, implementing these showrooms in high foot-trafc areas ensured maximum exposure for the company 5 brand More importantly, Blankenship s showrooms enabled Tesla to sell its own vehicles in the United States without violating the dealership laws Each showroom was used to display the vehicles and to educate consumers on the benets of EVs and Tesla' it other products. If the consumer did decide to purchase at Tesla vehicle a company employee would direct the consumer to the company 3 website, where they would complete their order. By having the customer purchase the vehicle online, Tesla would not infringe on state laws and would be allowed to sell'its' own vehicles. Charging Statlons - Consumers had questionpd the vehicles potential to serve as a primary form of transportation This was due to limitations on long-distance travel associated with EV's and their power sources. Without an improvement in the vehicle 5 range, the product would be considered impractical This would prevent Tesla 'om producing vehicles on a mass scale Similarly, questions were being asked about the practicality of a vehicle that required a long time to charge its battery. Tesla products had two feasible charging options. The wall charger and the universal mass; connector The wall charger would be installed in the consumer's home, and could retire] a Model S at a Sill-kilometre range per hour (approximately four hours). The universal mobile connector was designijd to allow consumers to travel longer distances. It could charge the vehicle at a 52-kilometre range per hour (slitihours for a full charge). 3' With the high-end Model S able to travel only a 426kilometre range between charges. the time required to refuel would cause the vehicle to be considered impractical for everyday use. tn response to this challenge, Tesla developed a solution that satised both the chargingmeeds of its vehicle ritnd the'd'j'equirement for the vehicle to be able to travel longer distances. These challenges were ameliorated '-with the introduction of Tesla' \"supercharger stations.\" A charging station allowed a consumer to recharge "vehicle at a much higher speed then previously possible Tesla vehicles could now replenish half of the" battery power in as little as 20 minutes. 7 The signicant improvement in charging time eliminated a portion 9' consumer concerns related to using at Tesla vehicle as a primary mode of transportation Page 5 9B15M074 The supercharger stations also addressed long-distance travel concerns. As of December 2012, Tesla had implemented supercharger stations in two separate corridors in the United States that allowed for efficient long-distance travel. The first corridor used six charging stations to connect San Francisco, Lake Tahoe, Los Angeles and Las Vegas. The second corridor connected the District of Columbia, New York City and Boston." Tesla announced further expansions in 2013 for its supercharger stations which included a network that featured a "supercharger highway" that would connect Los Angeles to New York. Battery Swap Tesla's implementation of Supercharger stations placated many critics that questioned the Model S's potential to serve as a primary vehicle. However, a few detractors remained. Some believed that without an option for instant charges, Tesla products would be too time consuming for many customers. If the cars could not refuel instantly like their gasoline-using counterparts, the issue would continue to be seen as a weakness. To address this issue, Tesla designed a system that would allow consumers to "swap" batteries in their vehicles, allowing for immediate refuelling. The swap option was implemented in 2013. TESLA IN SINGAPORE In the 2000s, Singapore was one of the wealthiest economies in the world. The real gross domestic product per capita was fourth and fifth in the world, in 2009 and 2010, respectively, exceeding US$60,000 (purchasing power parity)." Singapore's population amounted to around five million people, while the number of cars used in Singapore exceeded half a million (see Exhibit 1)." Alongside a high tax policy for conventional fuel-using cars, the Singaporean government pursued a policy of maintaining a green and clean city that included limiting air pollution. Singapore was technologically advanced and offered local expertise in electronics, power and precision engineering. These factors, together with its small size, compact urban environment and robust power grid, as well as an information and communications technology infrastructure, made Singapore an ideal location for testing EVs. Singapore generated around 80 per cent of its power from natural gas. It was estimated that a 30 per cent penetration of EVs in private car ownership would provide the benefit of a 7 per cent reduction in carbon emissions in the country. Moreover, the size of Singapore meant short average driving distances (55 kilometres per day). This put passenger vehicle distance requirements within the range of a fully charged EV (90 to 160 kilometres)." Another benefit of moving over to EVs was the potential reduction in the Singaporean preoccupation with cars as status symbols. This was hoped to be an added benefit if EVs could be seen only as functional vehicles with the single purpose of getting from point A to point B. The move over to EVs would potentially shift consumer focus from the fastest, most powerful cars to the most environmentally friendly ones.$4 In May 2009, the Singaporean government announced its decision to establish a two-year test-bed program for EVs." The program was dubbed the Transport Technology Innovation and Development Scheme (TIDES). The program prompted the government to look for commercial partnerships with foreign companies. There were two different types of investments within the program. First, companies were needed that were able to provide EVs. Second, companies were needed that could help develop a charging-station infrastructure in the city. Singapore had already offered a 40 per cent discount for EVs on the Additional Registration Fee (ARF), but TIDES was a great opportunity for electric car manufacturers to build their presence in Singapore." When TIDES was announced, the Renault-Nissan Alliance was already appointed as a partner, but applications from other players were still being accepted.Page 6 9B15M074 Tesla's Response and Subsequent Outcome Tesla opened its first store and service centre in Singapore in 2010. In order to take advantage of the opportunities offered by the Singaporean government, Tesla applied for participation in the program. Tesla felt that it met the government's criteria." Although it had already taken advantage of a 40 per cent rebate for the ARF, the company endeavoured to obtain additional tax breaks through TIDES; this would allow it to decrease the initial price of the cars offered in Singapore by 50 per cent. Meanwhile, a new player had joined the program: Mitsubishi i-MiEV. The i-MiEV had an open market value (i.e. dealership price) of about SG$85,000, which would increase to about SG$190,000 after payment of full ARF, Certificate of Entitlement" and road taxes." Under TIDES, each i-MiEV was priced at only SG$90,000, with exemption from the above duties and taxes for a maximum period of 10 years. Tesla's price for the Roadster was much higher - SG$500,000 (more than SG$400,000 without any tax exemptions). By becoming part of TIDES, the price for the Roadster would come down to SG$250,000. Despite all of the favourable conditions, Tesla did not receive the aforementioned tax breaks. Only four companies managed to obtain the grant from the Singaporean government (Daimler, Mitsubishi, Nissan and Renault)." It was reported that Tesla did not meet the technical requirements for EVs. Consequently, Tesla did not sell a single car in Singapore." The company had garnered about a dozen orders, most on the condition that the tax break be granted." A few people were willing to buy the car without the tax break, because they perceived Tesla as the car manufacturer of the future, but the numbers were too small to justify Tesla's presence in Singapore. Tesla Motors" Asia-Pacific director Kevin Yu told The Straits Times: "Unfortunately, Singapore has not turned out to be the market we hoped it would be." He followed: "Given the Roadster's limited production run and the enthusiastic support from both customers and governments for the vehicle in other markets, Tesla has decided to focus our limited resources elsewhere."$5 Failing to Meet World Demand By the end of 2012, Tesla's automotive sales revenue had increased to $385.7 million from $148.6 million due to a dramatic increase in demand. 3 2,650 units of the Model S were delivered in 2012, but the total number of reservations was 15,000. Those vehicles that were delivered were all in North America - none were delivered in Europe or Asia. In addition, the supply of the Tesla Model S significantly lagged the demand. Tesla could not provide vehicles in any of the countries where it operated in 2012. Tesla explained that the delays were due to "difficulties in training new employees to use new equipment, and in part to delays from suppliers."$7 CONSIDERING CHINA The electric and hybrid automotive industry in China consisted of well-known car manufacturers such as Mercedes-Benz, Hyundai and Toyota, as well as other Asian brands, like Chery and BYD. Customers with high incomes, who wanted to have high social recognition, preferred well-known manufacturers, while customers with lower incomes, who were also concerned about environmental issues, tended to choose the Asian brands. The market was already competitive and Tesla had no reputation amongst such players. China had been suffering from severe air pollution, and the Chinese government had taken a variety of approaches to reduce emissions. One of those approaches was to encourage EV purchases. At the end of 2012, the Chinese government planned to provide tax credits for those who purchased EVs and also implied that potential subsidies would be issued to some EV manufacturers in the future.Page 7 9B15M074 If Tesla could apply for said subsidies it would be able to offer more competitive prices for its vehicles. However, nothing concrete had been confirmed. In addition, Tesla did not have much information on the demand conditions in the Chinese market. It was thought that Tesla would need to invest in measures to educate local customers on its business vision, design and manufacturing. Another important issue was the electric charging infrastructure. In China, most people lived in apartments with limited parking space, which they often shared with others. Chinese customers were going to experience difficulty charging EVs which would result in less incentive to purchase one. A similar issue existed for supercharger stations: there were not enough of them, despite high population density in some regions. DECISION POINT Given the outcome in Singapore, as well as the mixed performance in the United States and Europe, was the time right for Tesla to enter China? If Musk took Tesla into China, what could he learn from the experiences Tesla had had elsewhere in order to make China a success? How could he deal with some of the unknowns that confronted the company in China? What should the company's entry strategy consist of? EXHIBIT 1: NUMBER OF CARS IN SINGAPORE 2006 2007 2008 2009 2010 Total vehicles 799,373 851,336 894,682 925,518 945,829 Cars* 465,482 505,987 540,455 566,608 584,399