How Elon Musk and Tesla use finance to make their cars more attractive

South African born entrepreneur Elon Musk is renowned for his visionary innovation and ability to transform industries. For the few that don’t know he’s founded and profitably exited from Zip2 and PayPal. He’s currently founder/CEO of both SpaceX (the first private company to re-supply the International Space Station), and Tesla Motors (which makes world-leading electric automobiles). The bottom line is that he’s a large global thinker who tackles problems that are truly massive and also inspirational, and he’s happy to tackle more than one at a time.

What makes Musk standout is that he tackles industries where private capital historically hasn’t stood a chance. Think of SpaceX: even today, some 40+ years after the USA put a man on the moon there are only a few countries who have the ability to reliably deliver rockets into space. Space exploration is incredibly capital intensive and incredibly risky – a single tiny point of failure can literally destroy the rocket, its cargo, its crew and all the capital invested, which until now has been government money only. Yet Musk has proved that a privately owned and funded company cannot only build rocket-ships, but can also win a major contract from NASA to repeatedly supply the International Space.

Tesla Motors is another example: starting a new company to produce an electric car (with all the associated R&D costs of new technologies), then setting up a production line to reliably manufacture them in mass is requires deep pockets. Yet he’s done it again and at the same time as setting up SpaceX! It’s widely known that he’s used government grants/loans and other incentives along the way, but the fact remains that he’s tackled a highly competitive and capital-intensive industry as a brand-new entrant and so far he looks to be successfully on his way. For Musk to have succeeded in these industries he’s not only had to have a clear understanding of the technological advantages in his re-usable rocket components (SpaceX) or Battery technologies (Tesla) but he’s also used finance as a strategic tool; I’d argue that his true ability has been to successfully raise the capital to fund the technologies (a trait which Richard Branson also shares – both are exceptional story tellers).

Musks’ ability to use finance as a tool to extend his competitive advantage goes further than that, as shown by their recent announcement of the financing scheme they provide with the Tesla Model S. Here are the core ideas:

  • US Bank and Wells Fargo have agreed to provide 10% down financing for purchase of a Model S (on approved credit). These are big-name trusted banks putting their weight behind a new technology.
  • The 10% down payment is covered or more than covered by US Federal and state tax credits ranging from $7,500 to $15,000. New Jersey, Washington and DC also have no sales tax for electric vehicles. (These advantages are not available when leasing, so it’s NB that the contract is clearly a sale).
  • When considering the savings from using electricity instead of gasoline, depreciation benefits and other factors, then Tesla claims that the true net out of pocket cost to own a mid-range Model S drops to less than $500 per month. In other words, he makes a strong case that its not a very expensive purchase, actually.
  • After 36 months, you have the right, but not the obligation to sell your Model S to Tesla for the same residual value percentage as the iconic Mercedes S Class, one of the finest premium sedans in the world, made by Daimler (also a Tesla partner and investor). Here Musk does 2 clever things – he anchors the new Tesla brand to the well-established premium brand of Mercedes, and he justifies a similar pricing range by linking the resale value directly to the S Class.
  • Not only is Tesla guaranteeing that resale value, but Tesla CEO Elon Musk is personally standing behind that guarantee to give customers absolute peace of mind about the value of the asset they are purchasing.

In other words, you own the car, but you have the option to sell it back to Tesla. You’re basically getting the benefits of both leasing and owning a car. In the world of finance, this is called a put option. The holder of a put has “the right, but not the obligation” to sell back an asset at a certain price. Of course, options aren’t free – Investors buy options for a premium, which in Tesla will be priced into the upfront cost of the car.

Any risk that you don’t like the product shifts towards Tesla and ultimately Musk. In effect, Musk is gambling that you’ll like the car so much that you’ll keep it, but he’s also set up a financing scheme that gets the benefits of a lease while retaining the tax credits from the sale, and he’s pulled of a great marketing ‘anchor’ by linking the resale value of the car to a great, established brand.

How can you structure your offering to customers to best take financial incentives into place?