Driving innovation: lessons in integration from Tesla’s Elon Musk

What Tesla has taught managers about the importance of vertical integration

PUBLISHED : Friday, 02 December, 2016, 2:54pm
UPDATED : Friday, 02 December, 2016, 9:55pm

Elon Musk has stunned the car industry again. The famously ambitious CEO tweeted last Friday that Tesla will roll out self-driving capabilities in mid-December, right before Christmas.

Model S, Tesla’s most popular sedan, and Model X, the family SUV, will receive incremental updates to their autopilot features.

Owners will soon start enjoying features ranging from “exit ramp autonomy” on highways and automatic lane-changing, to auto-steering which helps cars navigate complex roads, and smart summon – where the car comes to pick you up. These changes don’t require a visit to a service centre; the new software will be quietly downloaded overnight.

The idea of an autonomous vehicle isn’t new. It wasn’t even started by Tesla or Google. Aircraft got autopilot a decade after the world’s first flight by the Wright brothers. For years, autonomous harvesters have been active in corn fields and driverless excavators have been going down mine shafts.

Elon Musk saw depending on foreign suppliers as a weakness, not cost savings

As early as 1939, at the New York World Fair, General Motors invited visitors to its “Highways & Horizons” pavilion that showcased a futurama ride of a then imagined world of the 1960s. Automatic highways were in full rage. Trench-like lanes helped keep cars apart in their own “tracks”. Drivers would relax until the designated exits. The system promised safety, speed, and access. More cars could share the road, while intelligent intersections minimised congestion.

What followed in the next seven decades was disappointing. The grand vision was there, but GM, Ford and Chrysler, along with their Japanese counterparts, fumbled. Even Google, Apple and Microsoft were far behind. So what’s special about Tesla? If it is down to a CEO’s audacity, couldn’t Steve Jobs, Bill Gates, or Sergey Brin have done something similar?

Outsource and lose

By the turn of the 20th century, Corporate America was characterised by behemoth organisations. Household names such as Standard Oil, DuPont, IBM, Ford, and General Electrics were all vertically integrated. They regularly bought out upstream suppliers and acquired downstream distributors. Their activities were broad, touching all stages of production – from R&D to manufacturing and assembly to marketing and branding.

But by the 1980s, the system had been dismantled. Private equity was in full swing. Big, lacklustre and publicly listed companies were taken over, often unwillingly, by activist investors who then streamlined the companies into leaner descendants with a narrower focus.

Incumbent management was often swept away. New CEOs were incentivised by high compensation. Companies were reborn agile and regained market leadership, and in so doing, unlocked shareholder value.

No less powerful was the emergence of another idea: global outsourcing. In the pursuit of higher return on investment, CEOs were dreaming about eliminating capital expenditure. Taking advantage of cheap labour in Asia, companies exited manufacturing en-masse in America.

In 1999, the then world’s largest computer company, HP, outsourced its laptop division to several suppliers in Taiwan including hardware assembly, software installation, product testing, final packaging, and shipment to consumers. The only physical relationship HP had left with its computers was the company logo. Carmakers fared little better.

Gone were the days when Henry Ford still ran his rubber plantation, timberland, coal and iron ore mines to feed raw materials to his Michigan factory. Today, almost no one makes their components. Automakers rely on a worldwide array of foreign suppliers. Their domestic manufacturing plants only perform final assembly.

Designerless design

Traditional car makers still invest in innovation. Big car companies routinely spend up to $1 billion and employ hundreds of people to design a new vehicle. But they do so across a great span of geographic regions while making sure thousands of moving parts perform to perfection. When knowledge becomes so scattered, compliance is key to successful innovation, however incremental it is.

“If Daimler wants to change the way a gauge looks, it has to contact a supplier half a world away and then wait for a series of approvals,” observed Ali Javidan, former head of vehicle prototyping and R&D at Tesla. “It would take them a year to change the way the ‘P’ on the instrument panel looks.”

But Tesla has long realised breakthrough innovation demands the integration of multiple disciplines. Elon Musk saw depending on foreign suppliers as a weakness, not cost savings. At the Palo Alto headquarters, visitors would notice the dramatic use of vertical integration. But Tesla integrates only where the current supply chain underperforms, most noticeably for batteries.

Tesla started developing its own battery chemistry with partners like Panasonic long ago. It is also building its Gigafactory which will allow it to produce batteries at a scale that exceeds the current capacity of today’s global supply chain, and drive down production cost to an unprecedented level.

Finally, a driverless car?

Tesla’s integration spans into software as well. After a three-year flirt with Mobileye, a Jerusalem-based maker of camera sensors and software, Tesla abruptly terminated the partnership to do software itself. Amnon Shashua, Mobileye’s chairman and CTO accused Tesla of “pushing the envelope” with the design of its Autopilot. “No matter how you spin it, Autopilot is not designed for that. It is a driver assistance system and not a driverless system,” Shashua explained in an interview.

But that’s exactly what Tesla set out to do. Musk wanted an uncompromised autonomous vehicle and Mobileye was moving too slowly for Tesla.

And just like that, the company has fused together electronics, software, and metal and batteries that traditional automakers are now struggling to match. Before Christmas, lucky Tesla owners will finally experience first-hand the strategic vision that General Motors had back in 1939.

For corporate executives, Tesla taught us important lessons about innovation. To stay on top of competition, we must ask ourselves:

To what extent is our innovation trajectory dictated by our current suppliers in the global supply chain, rather than what customers really want?

To what extent are we integrating new capabilities critical to future success?

As a thought experiment, imagine Elon Musk were to enter your industry, what would he do differently from the others?

Howard Yu is professor of strategy and innovation at IMD Business School in Switzerland (@howardhyu)