Parts and servicing has been a significant part of the legacy automotive industry’s business model for a very long time. Now, however, Tesla the great disruptor is challenging that model: It plans to focus on reliability over servicing and it could have a profound impact on the global car industry.
At the end of Tesla’s Q1 earnings call this week, CEO Elon Musk elaborated on the incentive structure that exists in the traditional automotive industry and how Tesla’s business model, which is completely different, has been a key factor in the newcomer’s ability to not only survive, but thrive.
“I think it’s helpful to have the feedback loop with our service because that means we feel the pain of service and then we can address the design to make the car need less service,” said Musk
“And I think that gives us a the right incentive structure. The best service is no service. The car doesn’t break.”
Musk then went on to explain how the traditional automotive business model works.
“If you have say, a dealer network that is reliant upon service revenue, then you arguably have a misalignment of incentives where they’re making money on service, but actually the best thing for the consumer is the car doesn’t need servicing.”
Musk says the best short selling argument against Tesla for a long time is that it doesn’t have an existing fleet.
“In the auto industry, the reason incumbents succeed and newcomers fail, the biggest reason, is that the incumbents have a large fleet, and they’re able to sell new cars at close to zero margin, and then sell spare parts at a very high margin.”
“A sort of razors and blades type thing,” said Musk, alluding to how companies like Gillette sell shaving razors cheap but make most of their profits on expensive replacement blades which only fit its particular razor effectively locking in the customer for long-term revenue.
“And so the only way for a newcomer to succeed is to have a product that is so compelling that people are willing to pay a premium over the incumbent product.” said Musk. “And in the absence of electrification and autonomy. I don’t think a newcomer can succeed.”
No real incentive for reliability in traditional automotive industry
Musk’s point about a business model where new vehicles are sold with small profit margins while spare parts and servicing are sold at very high margins, is an interesting observation of how the global automotive business works.
In 2022 the world’s largest automaker Toyota only made around $1000 profit per vehicle sale. The parts and mandatory servicing of Toyota’s cars over their lifetime however would easily exceed ten times that amount.
Minimal maintenance = less $ vs comparable ICE vehicles pic.twitter.com/hAGV3jxABw
— Tesla (@Tesla) April 12, 2023
Perversely, this business model, which the majority of the world’s auto makers follow, doesn’t incentivise companies to produce highly reliable cars because a significant portion of profits are generated though servicing and spare parts.
Tesla’s business model incentivises reliability and longevity
Tesla’s business model, which includes lifetime revenue streams from supercharging and software subscriptions, tips the old model on its head.
Tesla’s vehicle lifetime revenue is now linked directly to reliability, meaning the more reliable the vehicle, the longer the lifetime, the more charging is done with the same vehicle and the more years worth of software subscription revenue is flowing back to the company.
This subtle difference in business model could have a profound impact on the world if other car companies are forced to replicate it in order to remain competitive.
It would mean the incentive structure around car manufacturing would trend towards higher and higher rates of reliability and quality rather than the “built-in redundancy” servicing model that has existed for decades.
Rather than continuously stripping costs out of vehicles to maximise profit margins at the expense of quality and reliability, engineers may now be incentivised to produce high quality, long lasting cars to maximise the vehicle lifespan and therefore software and charging revenue.
Daniel Bleakley is a clean technology researcher and advocate with a background in engineering and business. He has a strong interest in electric vehicles, renewable energy, manufacturing and public policy.