Tesla’s cars have dramatically more profitability potential than traditional automobiles

Why a car based on software dramatically changes the automotive industry and margins

Businesses have to carefully price products, but it can be quite arduous. Furthermore, the strategy for making it so each unit of the product is as profitable as possible highly depends on the industry they belong to. How much revenue a business generates relative to the cost it takes to produce the goods that they sell is called a company’s profit margin. Certain industries, like airlines, don’t have high per unit margins. Meaning that per unit (customer), they don’t make a lot of money relative to what they put in. They need to sell a lot of flights in order to become profitable; they make their money off volume. It takes a lot of money to pay pilots, refuel the planes, maintain them, as well as the other costs necessary to fly consumers from one location to another. In

Traditionally, the automobile industry has not been a high margin endeavor, especially per unit with lower end cars. The software industry, however, generally has significantly higher margins. In 2016, Ford, one of the industries more profitable companies, had a 9% profit margin. This is in contrast to Adobe, a technology company that sells editing and creativity software like Photoshop, Premiere (and more), that had a 19% profit margin that same year (and has a higher one now).

There’s an advantage to developing and selling software. Depending on the type of software a business sells, the means to distribute it is pretty seamless, especially in 2019. You can sell and deliver software digitally, as opposed to the olden days of exclusively having to use disks. One process that has remained consistent throughout the timeline of software development, even when floppy disks were primarily used, is the ease of copying software. Once the software is designed, and built, the processes for making 1 million copies for consumers isn’t as arduous as building 1 million cars. Cars require factories, production lines, and hardware that has to be shipped from various locations and sources. The materials to build cars are oftentimes sourced from overseas and vendors.

Software companies, on the other hand, generally have higher profit margins than hardware companies. This is because in software, the product is built once, and then copied digitally, which doesn’t use many resources. Pure software might have hosting, server and scalability costs, but this is frugal in comparison to what car manufacturers have to dish out. If the software is all self contained, meaning it doesn’t connect to anything outside of itself, or require hosting by the company, the businesses margins are even higher (e.g a single player video game).

Social media businesses build a platform for users online, scale it appropriately, and sell the digital screen real estate for advertising money. Materials don’t need to be shipped, and logistics aren’t as much of an issue for these Silicon Valley companies. Uber and service technology companies are different, however. They operate within the digital space, but rely on cars to operate with drivers, that aren’t in the digital space. This adds another layer of costs to the business that other pure software based businesses don’t have to rely on. Sticking to pure software makes it easier to become profitable.

This point about higher margins is why Tesla could spike in profitability if they are able to sell more software. The hardware and logistical operations have been tough on Elon, as he’s stated, he’s never mass produced cars before. It’s a given that automatic driving software is the end goal for Tesla, allowing people to ride in Tesla cars that drive themselves. But there are other profitability avenues for delivering a total driving experience that incorporates more software.

Making more driving fun, and a pleasure to do, is something people are potentially willing to pay for. Now that Tesla has a giant screen in the center they can utilize that medium to sell applications that enhance the car experience. Think of a mobile phone. Pretty simple right? It’s meant to call someone. Now think of a smartphone, and the introduction of the app store. Think of a car, it’s main job is to get you from point A to B. Now think of a digitally centered car (smart car was already taken). Did Personal Digital Assitants (PDA’s) already exist along with other side features? Sure. But there wasn’t a vast repository of applications to choose from. It wasn’t seamless. The main focal point was the calling aspect, now it’s become a tool with a plethora of ancillary functions. The main aspect of the car is driving. Are there cars currently with a digital screen and ancillary features? Sure. However, with more digital flexibility, the role of the automobile can extend much like the mobile phone did.

Analysts have speculated that Tesla would be a good acquisition for Apple. Apple reportedly tried to buy Tesla in 2013. Whether or not they had this intention in mind, creating a space like the current app store in Tesla cars could change their margins. Developers could want to create applications and sell them on Tesla’s platform. Applications could range from a plethora of entertainment options. Music, ambient sounds, series, movies, and interactive games that could engage users with their driving route. There could be applications that call out important landmarks as you pass them on the way to new locations. There is an endless amount of ideas that could be implemented with the capabilities the current Tesla models offer. If Tesla can keep selling cars, the main money maker could be the software with high profit margins.