To meet the $35K price, Tesla has decided to close some of its display showrooms (and service centers). Surely all operational plans entail some amount of risk and uncertainty, but Tesla’s decision seems to be borne out of necessity rather than strategy. I am not the one making this statement. Indeed, it is right there in Musk’s announcement.
[…] As a result of the above, we unfortunately have no choice but to reduce full-time employee headcount by approximately 7% (we grew by 30% last year, which is more than we can support) and retain only the most critical temps and contractors. Tesla will need to make these cuts while increasing the Model 3 production rate and making many manufacturing engineering improvements in the coming months.
For a long time on this blog, I have been arguing that Tesla has been slowly emerging and getting stronger: the slowness is because fundamental operations related issues take time to solve.
As with every Tesla move, the recent decision has its fans defending and its critics up in arms. Critics hammer on the lack of reliability of their products, and fans argue on how dealerships are unnecessary in making the car buying decision. There is some truth to both.
But, the truth is somewhere in the spectrum of opinions. Let us break this down.
Dealership Selling is an Old Business Model
Everyone who has bought a car knows that very few customers love dealerships. Car buyers have increasingly disliked the entire process of buying cars: visiting dealerships, uncomfortable negotiations, and an unshakable feeling being on the short end of the information asymmetry.
It was Tesla that first successfully rethought the automotive supply chain like a retail supply chain. This business model of distribution is Tesla’s remarkable and unorthodox strength. By going directly to the customer through factory-owned stores, Tesla did not over commit like other carmakers to excess inventory and complex contracts at dealerships. For sure, this road has definitely not been easy.
With push back from dealerships, New Jersey had originally banned Tesla from selling cars directly to customers. Later in 2015, NJ then passed a law signed by then Gov. Christie allowing Tesla to operate the direct-to-consumer model. Here’s what New Jersey Coalition of Automobile Retailers said then:
The factory-store model advocated by Tesla, on the other hand: Creates a vertical monopoly and eliminates competition. Limits consumer access to qualified, independent warranty and safety recall service offered by independently owned and operated neighborhood new car dealerships. Generates jobs, tax revenue and economic benefits in Silicon Valley and on Wall Street, but not here in New Jersey.
Even today, several states such as Michigan & New Mexico ban Tesla from directly selling cars to customers (or servicing cars). There is some wiggle room in a few states. For instance, Texas law makes it illegal to buy a car directly from a Tesla showroom, but all Texas orders can be made online or over the phone. Some states, such as New York and Pennsylvania, allow direct sales but limit the number of physical stores. (In Pennsylvania, the limit is five stores).
I am squarely on the side that argues direct selling to customers, within some limits, must be allowed.
In any case, the way Tesla expanded shows that a firm does not need the traditional dealership structure. But, those who quibble that dealerships are not critical, also confound the point with the need for physical Tesla showrooms.
- Customers increasingly don’t need to “test drive” at a dealership to buy a Tesla. There are many ways to test drive a Tesla. In fact, according to a WSJ report, in the past two years, only 66% of Tesla buyers took test drives before their purchase, compared with 82% for the industry. While this number is still high, online orders are trending. Additionally, there are apps like Turo, where you can rent a Tesla, before deciding to buy.
- Buying Tesla online has been made very easy by the Tesla website. As long as you are willing to wait, you can even “customize” your choices directly. Combined with the new 7-day return policy etc., we will be seeing more customers make large orders online. (This direct ordering model for big-ticket items is growing by the day. See companies such as Carvana that sell used cars without dealership networks).
Given the above, why does Tesla need showrooms?
OmniChannel is the Way Forward: Showrooming is Critical for Tesla
Tesla needs showrooms not to sell cars, but to keep its customers close.
Showrooming is critical for high service differentiation. Recently, I wrote that Tesla cars ought to be thought of as product-service bundles, with service components being an important feature for retaining, luxury high-end customers. Let’s consider some high-end products
Apple: Opening Apple stores is the biggest product idea that Apple launched, perhaps after their iPhone. The vast geographic penetration of Apple stores has seriously re-invented chic retail, expanded its customer base, and helped introduce Apple financing (more on this later), all without moving their price points. Apple stores have become a point of contact for loyal Apple customers.
Online Retail Firms: Firms that need to differentiate themselves from the competition have opened showrooms: Warby Parker, Everlane, Rent the Runway, MM Lafleur, and many other brands. Similar to Tesla, all these firms engage in a Direct-to-Consumer business model.
Tesla needs showrooms because they are experiential, not just because they are “sales points”.1 The showrooms provide high-end service for core loyal customers when they need it regardless of how infrequently they may need it. Cars are bought less often and owned much longer than clothes, spectacles, and other household goods. It is hence natural that car owners will see more service issues than other customers — issues that cannot be solved without a reasonable customer engagement channel.
Most importantly, Tesla serves wealthy customers who expect high-quality service provision. Every mishap will become a pain point for high-end customers if there is no operational resolution and transparency. There is no effective way to provide this high-quality service than to have showrooms that welcome customers and hear their feedback and complaints.
Over the next few years, I expect Tesla to be back again and building more service centers and showrooms.
35K is a Specious Goal, which attracts Tesla’s Worst Customers.
Finally, these cutbacks are to meet the $35K price for Tesla 3. I understand that this price is a long-standing personal commitment and aspirational goal set by Musk himself. The investors on the street have definitely been egging Tesla on to achieve this price point.
However, 35K is not a very sacrosanct number. It was made years ago when the market was vastly different. Most importantly, all the price-cuts to attract the least profitable class of customers that Tesla will now have.
Here is the crux of my argument:
Tesla is in effect scaling back its top-level service from highest-end customers, to meet an arbitrary price point, that is desired by less valuable, highly price-sensitive, and probably less-loyal new customers.
This can only be a short-term action.
Let’s not forget that these customers are not exactly the masses. Customers in the market to buy a $35K for the lowest end Tesla are not economically poor. These buyers are quite likely in the upper-middle class, and can easily afford to buy other cheaper electric cars, and are probably buying Tesla as a second car. They would also expect the same high-end service offered by $40K+ SUVs of other luxury automakers. They have mostly held out on buying Tesla, balancing their anticipated fuel savings and their sensitivity to the earlier, higher price point. (In fact, US car loan data suggests that Tesla purchases are upmarket. The average car loan is about 30K and about 20 percent of borrowers are taking out loans of $50,000 or more).
My colleague and coauthor Pete Fader, who has done broad research in analyzing customer value, argues in his excellent book on Customer Centricity,2 that firms need to focus on their most valuable customers, not on broadening the base of all customers.
I feel that Tesla has, for the first time, engaged in a non-customer-centric idea casting a wide net. Regardless of the resolution of this temporary action, I expect Tesla to get back to showrooming trucks and the Roadster.
Notes:
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- “[…] a company can effectively deliver customer experiences that lead to early purchases through an offline channel, for example by providing outstanding service in a store or an inventory-only showroom…” See How to Win in an Omnichannel World by David R. Bell, Santiago Gallino, and Antonio Moreno. MIT Sloan Management Review.
- Customer Centricity. Focus on the Right Customers for strategic advantage by Peter Fader. Also see the excellent companion to this book by Pete Fader and Sarah Toms, Customer Centricity Playbook.