Tesla's vertical integration strategy and the resulting effects on the company

Tesla Inc. (Tesla from now on) is one of the leading and most successful electric vehicle (EV)

manufacturers worldwide. The company was founded in 2003 as a Silicon Valley startup and

after its reestablishment by Elon Musk in 2010 Tesla experienced rapid growth (Cooke,

2020). Thanks to its innovative and vertically integrated approach Tesla quickly became a

competitor to established car manufacturers and finally, in June 2020 surpassed General

Motors, Ford, and BMW to become world's most valuable car manufacturer on the stock

market (Naor et al.,2021). By 2022 Tesla produced over 1.36 million EVs and was able to

record a revenue of nearly 81.5 billion US Dollars (Tesla investor relations, n.d.).

In this essay I will analyze the degree of Tesla’s production strategy and how it differs from

the established approach of car manufactures. Finally, I will examine the effects of Tesla’s

vertical integration on the business.

After Tesla was founded in 2003, it quickly became clear that the company did not have the

knowledge to design and develop its own car. Therefore, the company's management decided

to negotiate a contract with the automotive manufacturer Lotus that allowed Tesla to replace

the combustion engine of one of the models with an electric motor to utilize the design and

mechanical structure developed by Lotus. (Chen et al., 2019)

In its early years as a startup Tesla had only limited capabilities and financial resources so it

relied on an outsourcing strategy. In 2008 Elon Musk, one of the co-founders, became CEO

of the company and fundamentally changed its strategy: He began hiring experienced

automotive engineers and started buying production facilities to pursue a strategy

characterized by vertical integration, controlling every part of the supply chain from battery

manufacturing to charging infrastructure (Chen et al., 2019).

manufactures tend to outsource as much of the production as possible and are highly

dependent on their suppliers. In many cases car manufactures only manufacture the engine

and undertake the final assembly and outsource over 90% of their component production

(Ahmad & Khan, 2019). Tesla however has integrated over 95% of its production and

produces most of its batteries, software, and components in-house. For the few components

that Tesla cannot manufacture in-house, they have usually only one supplier in order to

maintain maximum control over the end product. Tesla’s vertical integration goes even so far

that they own their own charging infrastructure that is only accessible for Tesla owners and

has a significantly higher power input than conventional charging plants (Perkins &

Murmann, 2018). Furthermore, Tesla is currently investigating the opportunity to enter the

mining business to mine the lithium and other natural resources they need to manufacture

batteries (Naor et al.,2021).

Something that really distinguishes Tesla from other EV manufacturers is that they produce

their own batteries: currently Tesla is the only well-known EV manufacturer that produces its

own batteries. In 2010 Tesla opened a factory in Nevada in which the company produces,

together with Panasonic, the batteries they need for their cars (Ahmad & Khan, 2019). The

dynamics of their partnership are very similar to the ones of a vertically integrated company:

A Tesla employee interviewed by Chen et al. (2019; p. 49) states that “Panasonic was almost

a vertical integration because Tesla decided on everything and took the associated risk.” The

factory covers all steps of the battery manufacturing: from the raw material to the final

battery packs that are shipped to alle Tesla factories to be installed into the cars (Ahmad &

Khan, 2019). The factory has a very advantageous location close to many other Tesla

factories to keep transportation costs low and close to many natural lithium occurrences

which, as stated above, Tesla is planning to mine themselves (Naor et al.,2021).

that provides that all cars are assembled, and all components are manufactured in so called

Gigafactories. All the single components are shipped to a factory where they are assembled,

and the car is finalized. The factories are extremely modern and highly automated: more than

160 robots are used during the production process (Cooke, 2020). All the factories are

distributed in a way that transportation costs are minimized. (Naor et al.,2021)

Tesla’s high degree of vertical integration has a remarkable impact on the business: The

company has a much higher control over the end product and its quality as well as the user

experience which offers Tesla a notable competitive advantage (Ahmad & Khan, 2019).

Furthermore, the high degree of vertical integration makes the company independent from

other companies, suppliers or business partners which makes it much easier for the company

to implement innovation and differentiate itself from its competitors: for instance, if a

company wants to differentiate itself from other companies and implement new and

innovative ideas it needs to be vertically integrated because suppliers profit from an economy

of scale and need to take huge investments to manufacture the specific components that

match with the companies new concepts (Chen et al., 2019).

In-house production in the giga-factories makes the company less susceptible to fluctuations

in the supply chain, as it has fewer suppliers, and the company also benefits from economies

of scale. (Ahmad & Khan, 2019). Apart from that the factories are designed to maximize

simplicity and effectiveness (Naor et al.,2021).

In conclusion one can say that Tesla has evolved from a startup that relied mainly on

outsourcing to a highly vertically integrated company. Although the trend in the automotive

industry is against vertical integration and vertical integration is always involving risks such as

higher costs and a possible unprofitable outcome, Tesla has succeeded in integrating all parts
of the supply chain, from battery production to charging infrastructure, into its company.

Ultimately, Tesla's efforts at vertical integration paid off: the company was able to reap major

benefits from its integration strategy which created a remarkable competitive advantage for

tesla in the EV market.

References:

Ahmad, S., & Khan, M. (2019). Tesla: Disruptor or Sustaining Innovator. Journal of Case

Research, 10(1).

Chen, Y., Chowdhury, S. D., & Donada, C. (2019). Mirroring hypothesis and integrality:

Evidence from Tesla Motors. Journal of Engineering and Technology Management, 54, 41-

55.

Cooke, P. (2020). Gigafactory logistics in space and time: Tesla’s fourth gigafactory and its

rivals. Sustainability, 12(5), 2044.

Naor, M., Coman, A., & Wiznizer, A. (2021). Vertically integrated supply chain of batteries,

electric vehicles, and charging infrastructure: A review of three milestone projects from

theory of constraints perspective. Sustainability, 13(7), 3632.

dynamics in the global automobile sector?. Management and Organization Review, 14(3),

471-480.

Tesla investor relations. Tesla Investor Relations. (n.d.).

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