Production of the Model 3 was delayed when a subcontractor "dropped the ball" © PA Photos
Production of the Model 3 was delayed when a subcontractor "dropped the ball" © PA Photos

What's behind Tesla's supply chain woes?

12 December 2017

Have you heard, it’s in the stars, Elon Musk wants to launch flying taxis that orbit Mars! Well, did you ever, what a swell CEO he is.

If Cole Porter were alive, he might be tempted to celebrate Musk in such terms. Along with Jeff Bezos and Mark Zuckerberg, the Tesla CEO is a titan of the new economy – and probably the most high profile of them.

In recent weeks, Musk has publicly challenged Boeing to a race to Mars, admitted that Tesla is making its own AI chips for driverless cars, previewed a battery-powered truck and fuelled his rage against Los Angeles’ horrendous traffic congestion into a map of an underground transportation system. For most CEOs, that would be a big enough ‘to do’ list, but Musk is also, through his company Neuralink, exploring the opportunity to connect human brains to computers.

No business leader since Steve Jobs has captured the zeitgeist quite like Musk. His blunt, yet visionary pronouncements – such as his declaration that colonising Mars is the only way for us to avoid a “doomsday event” – have made him a cult hero. At one recent presentation of Tesla’s solar panels, a member of the audience shouted: “Save us, Elon.”

Yet Musk doesn’t seem such a swell CEO if you are a Tesla shareholder. Last month, he revealed that the company would not be manufacturing 5,000 Model 3 sedans a week until March 2018, three months later than he had previously forecast. “In the grand scheme of things,” he declared, “this is a relatively small shift.”

The company’s share price – down by 6.8% – told a different story. Jeffrey Osborne, an analyst at Cowen & CO, urged his clients to sell their stock. In a frank note to customers, he said: “Elon Musk needs to stop over-promising and under-delivering and the board should rein in a CEO who publicly shares aspirational goals that have rarely been hit.”

One of the factors that led Tesla into what its boss calls “production hell” was faulty procurement. The assembly line that packages battery cells at the company’s gigafactory near the town of Reno, Nevada, has struggled because, Musk says, a subcontractor “really dropped the ball”. Software had to be completely rewritten and mechanical and electrical elements in one part of the factory had to be redone. The fact he was on the factory floor at 2am one Sunday morning to help resolve robot calibration problems underlines how serious the issue was.

Musk blamed himself for picking the wrong system integration subcontractor. He says the company can claw back some of the money it paid the supplier but not enough to make up for lost revenue.

Investors were also confused by reports that the company was firing 400-700 workers, including some factory staff. This isn’t the kind of thing that high growth tech companies usually do – and led to speculation that management needed to trim expenses. The company is burning roughly $500,000 cash every hour  – and the delays mean that it will take much longer to generate revenue from the 400,000 customers who have paid $1,000 to pre-order the new sedan.

This isn’t the first issue Tesla has had with its supply chain. In May 2016, Musk announced an investigation into claims that German manufacturing company Eisenmann had hired 140 workers from eastern Europe, paying them as little as $5 an hour, to build a paint shop for the Model 3 in Fremont, California.

Tesla’s customers seem less concerned by the latest announcement than its shareholders. Yet even their patience may snap if production is further delayed. Musk realises this – which is why Tesla has acquired Perbix, one of its main suppliers of automated manufacturing machinery.

American journalist Travis Hoium says Musk needs to be bolder. Writing on Motley Fool, he argued: “Workers putting parts on cars by hand, raw materials laying around the factory floor, and a production line moving at a snail’s pace aren’t signs of an efficient operation. They’re signs that Tesla is figuring out operations on the fly.”

Hoium believes that Tesla is too reliant on its suppliers – particularly Panasonic, which rescued the solar panel manufacturing operation and is providing much of the technology and expertise needed to run the carmaker’s Nevada gigafactory.

Musk needs, Hoium argued, to find his own Tim Cook, credited with designing the intricate, yet efficient supply chain that turned Steve Jobs’ visionary ideas – the iPod, iPad and iPhone – into profitable reality.

Audi veteran Peter Hocholdinger, appointed vice-president of production last year, could grow into that role. Bob Lutz, who did the same job at General Motors, told Reuters: “Musk would do well to elevate himself to the role of soul of the company and hire one or two really solid auto professionals to run the business.” This will be a stretch for Musk, a self-described “nano-manager” who, at one point, moved his desk to the end of a production line in Fresno. 

The challenge for Tesla is quantity – and quality. In a report published in March, industry consultants J.D. Power claimed that creaks, scratches and poor alignment meant that the Model S and Model X vehicles were “not competitive in the luxury car market. Tesla denies this, citing high levels of customer satisfaction – 91% of owners say they would buy again – but it cannot afford the quality of its Tesla 3 sedans to disappoint. 

The bigger worry for Tesla is that if it fails to meet its new targets, it could lose its competitive edge, raising the risk that it runs out of funds and threatening its very survival. 

Analysts are skeptical, saying that Musk has a history of setting targets and then missing them. Yet one of his projects has been completed ahead of schedule – the world’s largest lithium-ion battery array was built in South Australia before the 100-day deadline he set. If the project had slipped, he had promised to build it for free, but Tesla will now be paid $50m by the state government.

If Tesla can bring that kind of efficiency to automotive manufacture, it could revolutionise the world. Making cars is an unforgiving business – each vehicle has 3,000 parts all of which need to be in the right place at the right time and procured for the right price at the right quality. 

Get all of this right and Tesla can expect to achieve a profit margin of 6%. Get it wrong and Musk’s Martian taxi service will never get into orbit.

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