Tesla’s long-awaited Model 3, its first mass-market offering, has finally arrived. In June, Brent Goldfarb assessed the company’s prospects:

Silicon Valley investors love to talk about “disruption” — they are besotted with the storyline of small, scrappy, high-tech underdogs upending boring “legacy” corporations. And nowhere is this disruption fetish more evident than in the valuation of Tesla, maker of expensive, well-reviewed electric cars that bestow status on their owners.

Recently, Tesla’s valuation surpassed both Ford’s and General Motors’. BMW is among the other major carmakers in the rearview mirror. The logic of this is intriguing, given that Ford, for example, is coming off its second-best year in its 112-year history, earning $4.6 billion while selling more than 5.5 million cars worldwide. General Motors earned $9.4 billion selling 9.8 million vehicles.

Tesla, meanwhile, sold 76,000 cars while losing near $1 billion. Judged by the valuation, anyway, Tesla appears to be the first successful American entrant into the automobile industry since Chrysler in 1922.

Everyone likes to root for the underdog. David beat Goliath with his new slingshot technology and neutralized the advantages of a giant. The hapless, and slightly naughty, Bad News Bears win the championship. Disruption is fundamentally an underdog story, propelling entrepreneurs and infusing fear into incumbents. Much money has been made, and lost, on this storyline. And it’s a narrative that Tesla founder Elon Musk has cultivated well as he has jumped from one underdog-disruption scenario to the next, ditching various subplots as they become more and more implausible: Electric cars! Batteries! Solar! Self-driving cars! Recently he tweeted that Tesla is about to unveil a new semi and pickups. Truck companies beware!

By conventional measures, Tesla is a small concern, but investors are placing their bets that it is a disruptor, a concept that has near-magical qualities in some business circles. The term comes from the work of the Harvard Business School professor Clay Christensen’s Innovators’ Dilemma.

While the term is often used loosely to describe any exciting new company, disruption is actually defined fairly precisely in Christensen’s work (if with plenty of wiggle room). In theory, an existing firm can be disrupted if it complacently ignores the needs of its customers — or at least technological trends that threaten to make its market and technology positions obsolete.

A disruption theorist would explain Kodak’s downfall by arguing that Kodak ignored the threat posed by digital photography because it was too focused on the seemingly steady and solid profits produced by selling film. Likewise, Blockbuster ignored Netflix’s DVD-by-mail model and later streaming, leading to its bankruptcy.

Ignoring these innovations may have seemed sensible at first: Low-resolution digital photography did not appeal to Kodak’s customers, and Netflix started out by offering odd and old movies, i.e., not blockbusters. Why would Blockbuster bother to compete with that?

Slowly the quality of these offerings improved and neither Kodak nor Blockbuster were able to catch up. A textbook disruptive strategy targets the low end of the existing market. But sometimes disruption can come from above! Nokia as well as RIM (maker of the Blackberry) were unable to respond to the iPhone and Android one-two-punch. A disruption theory purist would insist that Kodak, Blockbuster, Nokia, or RIM might have navigated the technological transition — and thrived — if only they’d paid attention to the changing markets.

But a more plausible, if conventional, argument might be that transitions in those instances were not only improbable, but not even advisable. It would have been a herculean task to transform a chemical company specializing in the production of silver oxide film to a consumer electronics firm, fighting for attention in a low-margin industry.

Sometimes firms weather disruptive threats with little trouble. New biotechnologies that allow us to modify DNA led to a completely different drug discovery technology, eroding the drug discovery capabilities of large pharmaceuticals. However, the list of top pharma companies has barely changed in the past century. Their capabilities in shepherding drugs through the FDA process, as well as selling and marketing drugs — none of which biotech startups have easily replicated (Genentech notwithstanding).

The biotech startups still make money, but they typically end up licensing their technologies to, or are purchased outright by, big pharma. In 2000, online grocer Webvan set out to disrupt the bricks-and-mortar grocery business with a model that may have worked — if only 25 percent to 40 percent of groceries were purchased online. Sadly, that wasn’t the case then and still isn’t the case. As of 2016, about 5 percent of groceries were purchased online.

Nevertheless, the story soaked up $1 billion from public and private investors before failing. On-line ordering and delivery survivor Peapod eventually purchase by Giant, has taught us that online ordering complements bricks-and-mortar grocery stores, rather than substitutes for them. Most shoppers like to see, touch and feel their fruits and vegetables before purchasing them. Amazon deemed it wise to buy Whole Foods, as opposed to building an on-line fresh foods department independently.

Who and what is Tesla disrupting? Let’s explore some possibilities.

So is Tesla the next Honda, or the next Webvan? If one believes that Tesla is worth more than Ford or GM, one better have a decent theory of how Tesla is making current capabilities obsolete, why incumbents cannot replicate these capabilities, and whether Tesla will earn good margins in a post-Detroit world. In short, when betting on disruption, one has to identify how this disruption will occur — not just intone the magic word. I identify four bets that Tesla is plausibly making: the EV bet, the autonomous vehicle bet, a software-platform-in-a-car bet, or the clean-energy-and-battery-company bet. None of these bets appear particularly promising.

Getting this right matters. Investors stand to lose money if they bet on disruption, without thinking through the logic carefully. The disruption narrative drives the allocation of large sums of money — and directing these moneys based on ill-conceived stories is wasteful. The disruption storyline can cause corporate leaders to overreact — either by trying to catch a wave that they should ignore because it won’t affect them (as their chance of catching it is near hopeless), or because the new market is not worth winning at all.

The electric vehicle bet

My grandfather was a grocer in Duluth, Minnesota. He lived in a small apartment above the store and, in 1928, he purchased an “any color so long as you-like-black” Model T — the only car Ford produced between 1908 and 1927. My pragmatic grandfather’s purchase embodied a truth that has remained constant since the beginning of the industry: the sweet spot in the automobile market is practical cars for the middle class. One hundred years later, mid-size, practical cars such as sedans and smaller SUVs are still the largest market segments in the automobile market.

So far, Tesla has made its reputation selling exquisitely engineered electric vehicles in luxury market. Today the starting MSRP is $68,000, though most are sold for more.

For Tesla to disrupt via the EV bet — for it to sell enough electric vehicles to justify its optimistic valuation — it will have to sell a car in the sweet spot. Indeed, this is the point of the much-delayed Model 3, first deliveries of which are supposed to occur this year, for an expected average price of $42,000. The much-delayed part is not surprising. It is exceptionally difficult to mass produce cars — though, notably, it’s something that existing auto producers do exceptionally well.

But give the company the benefit of the doubt: Tesla may be able to learn. And indeed, 400,000 customers plopped down $1,000 deposits each for the Model 3! If they are the start of a trend, then this will give Tesla ample opportunity to learn to produce quickly and reliably. But keep in mind that electric vehicle sales have systematically underperformed projections for years. Last year, when the Model S fell short of projected sales, Tesla began discounting it by about 10 percent. Nevertheless, it still missed its sales targets by about the same number: 10 percent.

Just as important, for the disruption theory to play out, we’d expect incumbents to be ignoring the EV space, just as Kodak supposedly ignored digital photography at first. (They didn’t, but we’ll get to that in a minute.) If that were true, once the performance of EVs become sufficiently advanced, Tesla’s advantages would be solidified — and Ford and GM would become MBA case studies for what not to do in the face of a challenge. But as it happens, existing players are investing heavily in the space: Ford invested $5 billion in EV technology last year alone, it offers several EVs already, and the recent firing of Ford CEO Mark Fields suggests that its board is interested in moving even faster on this front.

GM is not asleep, either: Its Bolt is available with a 238-mile range. Nissan is expected to offer a similar product in the 2018 model year, and the plug-in hybrid Chevy Volt is selling very well. Toyota’s new $27,000 plug-in Prius will go 25 miles before its internal combustion motor kicks in. In fact, it is difficult to find a car company not selling an electric car or plug-in hybrid today.

But even if disruption is not occurring in the traditional sense, the incumbents may still be in trouble. While Kodak’s film business became obsolete, Kodak was not blind to the digital future. At several points in its history Kodak was a technological leader in digital photography. Kodak produced the world’s first digital camera in 1975. Yours truly still has floppy disks with digital images and software that were returned with developed Kodak film from 2002, and also owned an excellent Kodak digital camera in 2004 — when Kodak held a leading position in the digital camera industry. But it was difficult to compete in the low-margin consumer electronics industry (never mind that the low-end photography market is now completely occupied by smartphone manufacturers). Highly competitive markets are crappy to be in, disruption or no disruption.

Tesla has a similar problem. The target price for the Model 3 is an aggressive $35,000, the space occupied by a fully equipped Nissan Leaf, the Chevy Bolt and Volt, the Ford Focus EV, and the VW e-Golf. (Should I continue?) These cars may lack the cool of the Model 3, but EV buyers clearly have options. Moreover, these companies can lose money on EVs and finance this with sales of other cars; 100,000 cars is a rounding error for GM or Ford. Tesla’s strategy is to finance through pre-selling (admirable!) and raising lots of money through the sale of stocks and bonds.

If Tesla can profitably sell the Model 3 at $35,000, its margins will still be razor thin, as they are for other cars in this space. Consider that luxury car maker BMW’s margins are 8 percent. If Tesla’s margins are similar, they will need to sell not the 500,000 vehicles per year that Musk is currently predicting by 2020, but four times that. Even if there is demand for millions of EVs, developing that capability will take years, and Tesla needs to finance these years.

Pulling off this strategy would be an amazing feat, requiring not only building sales and distribution capabilities, but also demand, even as existing companies produce cheaper EVs with similar capabilities. Given these risks, the probability of failure must be high. If the current price is correctly weighting this likelihood of failure, investors must believe that Tesla will sell several million cars annually in a market niche that has consistently underperformed projections.

It is possible that I am underestimating Tesla’s potential margins. If they were 25 percent, then perhaps the company’s current valuation could be justified. But 25 percent margins would be astounding in a hyper-competitive part of the market occupied by cost-conscious consumers where existing manufacturers can produce excellent cars with remarkable efficiency. But I forget: Tesla’s disrupting! Maybe I am thinking too conventionally. It seems unlikely that Tesla can outmaneuver existing firms in the efficiency of mass production, but they may do better in software, or batteries. So let’s consider these bets next.

The software bet

Perhaps the Silicon Valley-based Tesla will disrupt because the company perceives an increased role for software in automobiles — and will dominate that new breed of automobile with an innovative software platform. In this view, the secret sauce might be Tesla’s ability to update their cars over the air, much as the operating system in phones are updated — and thereby enhance their cars over time. The ability to integrate software into the car throughout the design and build process could be a capability that existing automobile makers will struggle to replicate.

But one still has to think of something this design can accomplish that will get customers to purchase Teslas and not other cars. I was going to get a $15,000 Ford, but instead I spent another $10,000 so that I can update my car’s OS over the air! Now that’s disruption! Tesla only has to develop one software platform for all of its cars, as, say, Apple produces one operating system for all of its computers. And maybe such a platform strategy will allow sufficient economies of scale to reduce the average cost of producing each automobile.

In turn, it might be the case that legacy manufacturers can’t mimic this strategy because their ossified structures will not allow software engineers to integrate well into the design process and the legacy companies are unable to change these structures. In this world, the same software is deployed across similar cars — like the Models S, X and 3 — lowering development costs enough to increase margins.

It’s difficult to measure if incumbents are struggling on this front. The Tesla Model S has 62 microprocessors. Luxury cars such as Mercedes have close to 100, and even compact economy cars have around 30. By this measure, however imperfect, there appears to be little evidence that automobile manufacturers have not invested heavily and developed capabilities in the automobile software.

Additionally, a software-based upgrade may improve the attractiveness and reliability of the end product if the upgrades generated a constantly improving driving experience. Tesla is already deploying the self-driving capability to existing owners over the air — in other words, a significant upgrade in capabilities after the car is purchased. This enhanced experience may be attractive enough to create a price premium.

This is much different than selling a car with a large screen in the middle to control the stereo; rather, it is way to sell luxury. Perhaps this would help Tesla convince consumers ready to purchase a decked-out Nissan Leaf to fork out the difference and purchase a Tesla. But this software strategy seems far-fetched, given that Tesla’s marketing so far has been about range, safety and cool — not over-the-air updates.

The autonomous-vehicle bet

One aspect of the software strategy is so important that it deserves its own separate category. Perhaps Tesla will win the autonomous vehicle race. Alphabet (a.k.a. Google) is famously in this space, and Intel just bought the Israeli startup MobileEye for $15 billion. Uber raided Carnegie Mellon to begin to develop this capability, and every major manufacturer is investing in automation technologies. This is a very competitive space. But it’s undeniable that Tesla is at the forefront of self-driving technology that’s already on the roads. Tesla is able to learn as the technology is used — and this may be Tesla’s secret sauce: the difficult-to-get information that is necessary to perfect autonomous vehicles.

Driving is one of the most dangerous activities most people do on a regular basis. The technological problem of building software and sensors that replicate what a good driver does is difficult — and based on understanding rare events. (One Tesla driver, Joshua Brown, thought the technology was more advanced than it was and died when his auto-piloted Model S failed to recognize a semi-trailer and his car slid under it.)

Of all of the theories involving Tesla and disruption, this is the most intriguing — and convincing: Tesla is the first to roll out an autonomous driving technology. Its use allows Tesla to learn and improve, leading to a technological leadership position. Since the technology relies on machine learning, and machine learning only gets better with more data, Tesla is then able to develop a leadership position that becomes difficult to assail — analogous to Google’s in search. Tesla is then able to monetize this dominant market position.

The trouble, once again, is that at least 33 other companies are also developing autonomous vehicle technology, and also gathering a great deal of data. Any successful strategy would require a quick rollout that would prevent competitors from catching up. Mercedes’ new models already have advanced driver assistance capabilities similar to Tesla’s. Cadillac is expected to deploy within months. But perhaps the software platform is integral to this. Perhaps the software bet blends with the autonomous-vehicle bet! Tesla recently showed off this capability when it curtailed some of the autopilot features of Teslas with a software update.

Such deep software integration may be something other car companies are unable to replicate. That is, Teslas will have constantly improving autonomous capabilities, while competitors will not — or they will require a visit to the shop to upgrade. But still, to beat out competitors Tesla would have to sell millions of such high-tech cars, not hundreds of thousands. Tesla’s production capabilities on this scale are unproven, which in turn makes it doubtful that they will be able to deploy the technology across a wide range of vehicles quickly —and that would leave room for competitors to move down the learning curve quickly.

Many industry observers, yours truly included, believe autonomous vehicles have the potential to be far more disruptive than EVs, because they upend the logic of automobile ownership. Most cars sit idle at least 20 hours a day, which is incredible wasteful. But if you could simply summon a private, robot car at will, utilization would increase. This, in turn, has the potential to make mobility much cheaper — it’s public transportation on steroids! The software-plus-autonomous vehicle advantage might then allow Tesla to build out this mobility service. The vehicle-on-demand model requires the ability to find efficient routes and optimize routes across vehicles. Which car will come to pick you up? How will it get from point A to point B.

Unfortunately for Tesla, however, Google, Lyft, and Uber have these capabilities already. And GM has partnered with Lyft — it’s hardly standing by idly.

Still, might this be the disruptive path that Tesla is on? Again, there’s a complication: All signs suggest that one thing people will want from their future on-demand autonomous vehicles is affordability. Uber and Lyft have taught us quite well that the sweet spot in this space is price; Uber-X is much more popular than Uber Black. So, as foreseen by Henry Ford more than 100 years ago, the market will most likely support a mobility solution that is based on fairly utilitarian cars. This implies an industrywide shift in hardware to the production of a glorified, but low-margin golf cart — and adopting Uber’s business model. The production of low-end, and hence low margin, utility vehicles is unlikely to lead to the margins necessary to support Tesla’s valuation. (Though perhaps they can make this up in selling rides, like Uber? Hope springs eternal!)

Elon Musk, however, may not believe in the glorified-golf-cart future that I’ve sketched out here. (Note that he only began to peddle the autonomous-vehicle disruption story as the EV disruption story became less plausible.) Does that mean Tesla’s bet is that autonomous vehicles will not only be electric, but moreover super-cool Teslas — as opposed to lower-end EVs, or even plain old hybrids? That outcome seems unlikely.

Alternatively, Tesla may demonstrate success in their EV vertical and then license their OS with self-driving capabilities — a Windows-Intel-type strategy that implies Tesla software in every automobile on the market. Thus, Tesla would effectively be taxing every automobile on the market. It would let other people build the golf carts, just as Microsoft leaves the low-margin computer business to others. If Musk pulls this off, then Tesla’s valuation is surely justified — and then some!

The problem is that Tesla’s automotive operating system lead — if extant at all — is slight, and its competitors are working hard on this front. So any valuation should take into account the most likely outcome of this play: again, failure.

The energy bet

The final possibility is that Tesla is making a play as an energy company. Musk bailed out Solar City, a solar panel installation company, in October. The economics of solar are marginal, unless home owners can sell excess electricity they produce back to the utility, an activity called “net metering.” Solar City was in distress, in part because utility companies convinced state regulators and governments to eliminate or reduce net metering, undermining its business model.

Musk was the largest shareholder in both firms before the acquisition (Solar City was founded by his first cousins), and now he sees Tesla and Solar City’s missions as dovetailing. For example, he suggested that customers might purchase solar panels from a Tesla store, and energy gathered during the day might be stored in a Tesla home battery back or “Powerwall” — a product introduced in March 2016. You could then power your dishwasher, or charge your Tesla car from your Powerwall overnight.

The home battery packs are still too expensive to justify home storage of excess electricity production, so sales are meager. But Tesla is introducing a new solar shingle this fall, because the main barrier to solar installation apparently is an aesthetic distaste for solar panels on the roof. So this is cool, but mainstream adoption of solar roofs make sense when they are cost competitive, and oil remains cheap.

The batteries are produced in Tesla’s audacious $5 billion “Gigafactory.” Musk and some business analysts have suggested that Tesla might, through this factory, lock down the supply of raw materials for lithium-ion batteries and produce better batteries, at less cost than competitors. This, in turn, might lead to better margins for their EVs. For example, in February Tesla announced that the Gigafactory will lead to a 35 percent reduction in per-car costs for the entry level Model 3 battery, cutting it from $10,500 to $6,875.

This would double Tesla’s margins if nobody else were making improvements to their batteries. But that’s not the case — note Nissan’s ability to double the Leaf’s range within five years while maintaining the same price point. A few points better on margins, thanks to battery technology, is not enough to assure market dominance. It’s difficult to justify high valuations when you’ve build your advantage on a commodity — in this case, a battery.

Call me skeptical. But no matter — Tesla’s disrupting.

The disruption fetish

A Google search for “disruption theory” produces almost the same amount of hits as “competitive advantage.” Impressive for a theory that suffers from vagueness and has a poor record in explaining outcomes. My objection is not that incumbents never fail — that would be absurd. My point is that this rarely happens because managers are not paying attention to the competition.

Incumbents fail when their resources and capabilities become obsolete and they are unable to develop new capabilities themselves at a reasonable cost, or to buy these capabilities. That is, to believe in the disruptive potential of a company, it is necessary to also explain not only why the firm’s technology will be successful, but also why the incumbents cannot compete. Not superficially, but through careful consideration of these capabilities for both potential disruptors and incumbents.

Musk is admirable, ambitious and courageous — there is little doubt that he has created a threat to which big car manufacturers must respond. And Tesla may become a profitable business. But to get from that observation to its current valuation — bigger than Ford? — requires a boatload of faith.

In addition to considering the fetishization of disruption theory, we have to venture into psychology to explain the company’s valuation. Consider: Tesla is the only remaining pure-play electric vehicle company. If an investor believes EVs are the future, Tesla is the only way to go. Investing in Nissan because of the Leaf is just not as satisfying.

Moreover, if you own a Tesla, you probably love your car and you are definitely rich. That means Tesla owners are likely to invest — and what better to invest in than something familiar that you know and love? Tesla owners get to feel good not only for driving an electric vehicle, Tesla stock owners get a double dose of smug for believing in the save-the-planet-electric-vehicle social movement — all the while rooting for the underdog.

Tesla stock is a social movement that Musk works hard to cultivate with his reality distortion field. As he has cycled through disruption stories, the reality distortion has worked well — at least for those who’ve drunk the Kool-Aid. But in the end, Musk has chosen a space with incumbents with strong capabilities, who, far from ignoring technological challenges, are racing to meet them. He cannot disrupt competitive reality.

Correction: This article originally misstated the number of cars Tesla sold in 2016. It is roughly 76,000 (not 64,000). And it costs $1,000 (not $2,000) to reserve a Model 3.

Brent Goldfarb is associate professor of management and entrepreneurship at the University of Maryland's Robert H. Smith School of Business. He drives an e-Golf, and previously drove a Nissan Leaf. Twitter: @brentdg2

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