Tag Archives: economics

Technology and Society

The Economics of Tesla Direct Sales


This is a guest contribution from Sharon of americasstartup.com.
America's Startup

America’s Startup

Check out her Tumblr at americasstartup.tumblr.com.


When I first heard that states were not allowing Tesla into the market because of their direct sales business model, my first reaction was – “whaaaaat?!” Now after some research and a re-visit of the
economics theories I learned in my UCLA days, my (now educated) reaction is –“whaaaaat?!”

To those who may not understand the situation, a quick introduction– In recent news, New Jersey banned Tesla from selling its cars directly to the consumer. One may think, that’s one state, no big deal. But it’s not just one state, it’s another state, and there’s the fear of a ripple effect with New York and Ohio possibly going in the same direction as New Jersey.

The history behind the legislation of no direct sales to the consumer within the automotive industry dates back to the mass production of cars aka back to Ford. At that time the economic model
concerning dealerships made sense from both the manufacturers’ and the consumer perspective.

It’s no secret that the automotive industry has some of the highest fixed costs in regards to manufacturing.

Tesla Direct Sales Economics with code(love) from University of Regina

Tesla Direct Sales Economics with code(love) from University of Regina

Historically – a manufacturer’s perspective

It’s no secret that the automotive industry has some of the highest fixed costs in regards to manufacturing. Due to this fact, manufacturing is usually isolated to distant areas in order to drive volume (maximize factory utilization) and maximize economies of scale. One problem is solved: the per-unit cost of each manufactured
car reaches its minimum – but new problems arise.

Firstly, there is a cash flow issue. The necessary investment needed to produce the cars (cash out) and the lead-time to which the cars are sold (cash in) easily results in illiquidity without a middleman digesting the inventory in the short term.

Secondly, if the element of time is included in the normal demand and supply curves it is understandable that the delay in sales to consumers (demand) does not match the rate to which the
cars are manufactured, resulting in large stocks of inventory, which requires storage, an additional cost to the manufacturer.

Today – The Internet’s effect on industry and Tesla direct sales

Of course certain elements to the automotive industry remain the same, i.e. capital-intensive investment. However, that being said, Tesla has a different business model that threatens to challenge and disrupt this, a Dell for the automotive industry.

At the time of what is now being called the “Great Recession”, I was working on Wall Street in a bulge bracket investment bank and I understood quite clearly the factors that led to this massive balance sheet correction and re-adjustment in asset pricing.  I am not arguing that the automotive industry caused the recession; however, I bring it up as a relevant point because of the massive amount of inventory that could not be sold on the dealership level when the economy crashed.

This was an operational disaster when demand shriveled to zero and the lead-time to halt the supply to the market resulted
in the need for government bail out. Fundamentally, the dealership business model is an economic inefficiency and was used at the time as a Band-Aid to facilitate mass production. But we are no longer living in the 1800s. With the easy access to information, the Internet has changed the landscape of B2C interactions.

We are no longer living in the 1800s. With the easy access to information, the Internet has changed the landscape of B2C interactions.

A “consumer’s” perspective according to the Middleman

The economic rationale for the middleman has always been the consumer’s protection from monopolistic pricing. To truly understand this point it’s important to understand the economics of a car dealership. There are two main revenue drivers within a franchised dealership, 1) the mark-up in price for service and parts and 2) mark-up in price for the car. Now consider the costs related to a dealership, there is the physical location, the labor, the overhead, the marketing and publicity, etc. All of which is paid by the mark-up.

Although slightly dated, Goldman Sachs put out a research report in 2000 regarding, savings in the “vehicle order-to-delivery cycle from build-to-order, direct manufacturer sales.” Based on an average vehicle price of $26,000, Goldman Sachs estimated a total cost savings in the order-to-delivery cycle of $2,225 or about 8.6%. Since 2000, GM has experienced great production efficiencies in its direct manufacturing sales in Brazil that also proves an interesting point in light of this topic. At the end of the day, the underlying economic principle is the consumer loses when there is a middleman.

Why would the dealership lobby their butts off to keep the status quo? I would argue  – survival. Let’s think another startup—Dell. Although Apple ultimately changed the nature of the
computing demands of the World, Dell’s just-in-time model was a huge disruptor to the market that ultimately led to lower prices for the consumer, customization, and contributed to the demise of its
middleman Circuit City and Best Buy.

Tesla Direct Sales with code(love)

Tesla Direct Sales with code(love)

Concluding Remarks

Two hundred years ago Tesla direct sales to the consumer would not be possible because of limitations to technology and information. But now we have the Internet.

Technology has been the single greatest contributing factor of GDP growth within the developed world. We have seen this transformation before. My older sister bought CDs at the music store when she was young,  but now she buys music online. Before computers were bought only at Circuit City and Best Buy, now computers are bought online.

In The Post, Buchwald was quoted as saying, “We shouldn’t change the rules midstream just as a company is starting out. Tesla’s goal is to sell cars, not upend the rest of the auto industry.” To this, I say maybe it is time to ” upend the rest of the auto industry.”

I support the American Dream. I support entrepreneurs. I support Tesla being able to make direct sales to consumers.

I support the American Dream. I support entrepreneurs. I support Tesla being able to make direct sales to consumers.

Founder | Producer of America’s Startup, LLC


Technology and Society

A Moral Opinion on Bitcoin

Why ultimately the ideals of the system may triumph over its’ practicalities

On this, the 100th anniversary of the Federal Reserve System’s founding, it is worth remarking upon the mysterious Satoshi Nakamoto and his bitcoin creations.

Are bitcoins prone to speculative excess, are they under-regulated, do they have some aspects of a Ponzi scheme? Do they represent the same tired attitude of having to burn societal value (in this case electricity, processing power, and fans) to gain private value? Is it possible Satoshi will come back and show us all his true face, while taking the system away with him?

Yes to all.

However, the ideals behind bitcoin represent the technologist’s perspective on how to cut the bloated financial sector to size. Bitcoin allows for individuals to use digital means to escape the real pressing needs of dealing with conventional banking systems (such as privacy, and avoiding the double-count of money). On that rationale alone, I can support Bitcoin in principle. Bitcoin may have had its’ Silk Road, but Wachovia had the Mexican drug cartels.

If only the penalties for those responsible were equivalent. Wachovia, after all, was fined a small percentage of its’ yearly profits and allowed to largely maintain “business as usual”. In contrast, Silk Road was shut down, and its’ owner was arrested. It is abundantly clear where government power fears to tread. Eric Holder, attorney general of the United States, put it best when he declared that some banks were becoming “too big to prosecute”.

Major banks have been caught in the last five years laundering drug money, laundering money for terrorists, forging foreclosure documents, manipulating markets, manipulating key interest rates, pushing shoddy products on clients, taking on unneeded risk due to Excel errors (London Whale), and generating a whole host of economic bubbles that put food and commodities away from the reach of those that need them most. The most infuriating aspect of this is that most of the time, they did this while they were under taxpayer protection and funding.

The Federal Reserve System, while nominally supposed to act as a check on the banks, has become dependent upon them to a point where it is abundantly clear that alternatives to the bloated financial sector must be considered. While bitcoin may be imperfect in terms of some of its’ practicalities, ultimately the ideal behind bitcoin stands out as a laudable cause that will triumph in some form, sooner or later, if we properly apply the lessons we should have learned in the last 100 years.

Technology and Society

The 21st Century Prisoner’s Dilemma

Decreasing labor in order to salvage profits, to the detriment of both

A prisoner’s dilemma is when two groups that would be better off cooperating in order to achieve a higher coordinated payout choose instead to sacrifice their better aggregate payouts because their individual incentives lead them to forgo cooperation.

Typically represented in a matrix form, one way to conceptualize it is to describe the following scenario: I and Stephen Colbert are both in prison for being fearless conservatives.  We are given the choice to either be silent or to cooperate with the statist authorities by informing on the other. If we are both silent, we would get two years each in prison, if we both informed we would get three years in prison, and if one of us cooperated and the other remained silent, the one cooperating would be free, while the other who was silent would get five years.

It is in both of our private interests to inform on the other, because then we face a choice between freedom if the other was silent, and three years if the other informed, rather than in the case of if we choose to be silent, in which case we face either two years in prison if the other was silent, and five years if the other informed.

In aggregate that means instead of having two years in prison if we both were silent, we will both inform on one another and get a negative aggregate outcome of having three years in prison each because it is in our private interest to arrive to this equilibrium, since both of us will seek the better payoff of informing on the other. We will harm each other as we seek to help ourselves.

The 21st century’s prisoner’s dilemma will be that every firm will not want to hire workers, but will want every other firm to hire workers in order to have a consumer base for itself. This is because the private payoff of having less labor (and saving on what for many businesses is the largest cost) is such a powerful private incentive. Despite what other businesses do in aggregate, it will almost always be better for the individual firm to shed workers.

Unfortunately, this will lead to a worse social equilibrium. Castes of the unemployed, political and economic volatility, and staggering inequality may become the norm. Ironically, this economic chaos will then lead to lower profits, as less consumers will be able to buy most products. If left unchecked, lower private costs will be overwhelmed by higher social costs.

The 1950s saw the rise of the Great Society, the establishment of the welfare state, and of mass infrastructure projects that set the foundation of the 20th century. We will have to do even better to build the 21st century, and ensure a balence between private and social incentives.

(Now please help break me and Stephen out of prison!)