Tesla is likely to become a dominant energy, auto and battery manufacturer. Morgan Stanley analyst Adam Jonas said of Tesla “we may be witnessing an interplay of technology, industrial strategy, and capital not unlike Cornelius Vanderbilt and the railroads, or Thomas Edison and electrical distribution.” There are three reasons to believe this:

All transportation will go electric due to falling battery costs (Except rockets). Most power generation will be solar, which will increase demand for batteries and reduce power costs. There is a high likelihood that Tesla will dominate competitors because they are 4 to 5 years ahead and the winner take all dynamics of economies of scale and network effects.

All transportation will go electric

Elon Musk often says all transportation will go electric with the ironic exceptions of rockets. The first principal idea behind that assertion is that battery cost are falling at an exponential and accelerating rate. Low range and high costs are the two primary factors that have traditionally held back EV adoption. These factors are both improving exponentially and will continue to do so for a generation. Consider how cell phone batteries have improved in size and cost since the 1980s and that there is another generation of similar improvements in the pipeline. In contrast, internal combustion engines are a mature technology and costs are not improving at exponential rates.

Driven by changes in chemistry, batteries typically improve 7 to 8 percent per year in energy density. Currently Tesla battery cells are about 250 Watt hours per kilogram. The maximum theoretical value is about 850 Watt hours per kilogram and will likely be approached over the next 20 years. Gasoline has high energy density partially because we don’t consider the oxygen that it uses for combustion, but another possible advancement is air batteries that could theoretically achieve 12kWh/kg, which is close to gasoline which has 13kWh/kg. We are not near the theoretical limits, therefor, similar to Moore’s law, battery energy density has a high probability of continuing to increase over the next 20 years. As such Tesla’s goal is to increase battery pack capacity by 5% per year. As energy density increases it correlates with longer range because the car weighs less.

From 2010 to 2014, battery costs were dropping at 16% per year, up from 14% in the 2000s. Battery costs are correlated with energy density and economies of scale. Increased energy density improves battery cost because it require less material for the same amount of power. Lower battery prices are primarily driven by economies of scale. Economies of scale are, in turn, driven by energy density because as energy density increases new applications become possible and more compelling. Since the 1990s, the economies of scale have largely been driven by demand for consumer electronics such as cell phone and laptop batteries. With increased energy density and lower costs, electric vehicles (EVs) and energy storage applications are likely to increase demand by several orders of magnitude.

Battery costs are confidential, but Goldman Sachs estimates Tesla’s battery pack costs to be $200 per kWh and Tesla’s target is $100 per kWh by 2020. If Goldman is correct battery prices are dropping faster than 16%. JB Straubel, Tesla’s CTO also confirmed that the rates of cost decreases for batteries is accelerating. The goal of the GigaFactory is to drive down battery costs by over 30% by 2017 and 50% by 2020, by decreasing logistics, and creating custom machinery for battery production. EVs are competitive in luxury class now, but will be universally cheaper than ICE around $100 per kWh. As the rate of cost reduction is accelerating, there could be a large advantage to Tesla, or anyone that can sell and invest at larger economies of scale.

As energy density increases and costs decrease, Tesla will have the option of increasing range, lowering prices, or increasing gross margins. Tesla has set a minimum threshold for range, about 200 miles. Tesla prices their vehicles based on competitive pressures. The Model S is priced to compete with Mercedes S class. The Model 3 is priced to compete with the BMW 3 series. Absent new competitive pressures, Tesla has the option of increasing gross margins or lowering prices to spur demand as costs decrease.

In most other ways EVs are comparable or better than than ICE vehicles. Teslas are safer, accelerate faster (0–60 in 2.5 seconds), handle better (due to low center of gravity from battery skateboard design) and are fives times more energy efficient. Because they have less moving parts, they require ten times less maintenance than ICE vehicles and they will last longer (Tesla Model S has an 8 year, unlimited mileage warranty on the drivetrain). EVs also have more room, are quieter, and produce zero emissions.

Thomas Edison said “We will make electricity so cheap that only the rich will burn candles.” Today you could say we will make EVs so cheap only the rich will burn gasoline. There may always be a niche market for ICE car enthusiasts just as some people still ride horses. But Because of falling costs and increasing range, I estimate that 80% of vehicles sold will be electric by 2030 or sooner. This is the fundamental long term investment thesis for EVs.

We will make EVs so cheap only the rich will burn gasoline.

Most power generation will be solar

Solar power is also dropping in price at exponential rates and it has a synergistic effect on EVs for 2 reasons.

1) Solar power creates demand for batteries and accelerates lower battery costs.

2) Solar power costs are dropping exponentially and lower electrical power costs means lower “fuel” costs for EVs.

Solar power panels costs are also dropping exponentially due to economies of scale and innovation. Solar panels have low marginal costs of operation. Stanford professor, Tony Seba, estimates all power generation will be solar by 2030 . According to Bloomberg the price of solar has fallen 99.3% since the 1970s. Many areas with high electricity costs, like Hawaii ($.32/kWh), have already reached grid parity. Solar panels create demand for batteries because solar power is generated during the day and batteries can store excess energy during the day and discharge at night when the sun is not out.

Energy storage is a growing market. Tesla Powerpack, an industrial scale battery pack, is an increasingly competitive option for supplying power at peak load and storing energy when spot prices are low or negative. Negative spot prices are becoming increasingly common with renewable energy. Long term, as the cost of batteries fall, battery storage will replace other energy storage and peaking power plants. Tesla is also selling the Powerwall as residential backup for emergencies, load shifting, and to complement solar systems. Energy storage installations grew 243% in 2015 to 221 MW, and is predicted to grow to 1.7 GW by 2020. Tesla is planning to install 167MW of energy storage in 2016 just in Hawaii. The long term market (10–15 years) is likely in the terawatt hours. Elon Musk estimates the market for energy storage to be the same size as the market for EVs.

Long term, supply and demand suggests the falling cost of power will increase demand from developing markets and new applications. Long term the cost of solar power and battery combination is likely to drop below cost of transmission. Presumably the sales will transition to selling mostly to consumers to complement rooftop solar and power companies will primarily power large industry and dense cities. As the cost of power falls, there will be new energy hungry applications that are more practical, like the hyperloop, rail guns, electric planes, or water desalination that will drive demand beyond current levels.

Additionally, as solar reduces the cost of power exponentially, it makes the charging for EVs cheaper. The price of oil is volatile and not dropping exponentially.

Competitive Advantages

There are three reason Tesla will dominate it’s auto competitors.

1) Legacy car manufacturers face conflicts of interest in selling EVs.

2) New entrants face high capital costs that serve as a barrier to entry.

3) Tesla currently is the market leader in BEVs and is years ahead. They are making large capital investments that are fueling economies of scale, and network effects that will limit competitors ability to catch up.

Currently, no legacy ICE auto company is all in on EVs. No competitor has super chargers (or destination charging), a direct sales models, a Gigafactory, or energy storage products all of which are critical to selling EVs in high volumes. They are mostly making token efforts for regulatory purposes and producing unappealing “compliance cars.” Many car companies, such as Toyota, Hyundai, Honda, and Daimler are foolishly pursuing fuel cells despite it’s high fuel costs, inefficiencies, and lack of distribution network.

The legacy car manufacturers face numerous conflicts of interest in selling EVs. Typically dealership’s derive 45% of profit from the service center, but EVs require 10 times less service. The dealerships owners have little incentive to sell cars that require less service. Car salesmen work on commission and have little incentive to spend extra time educating consumers about EVs. The dealership model is likely not viable for EV sales. Elon Musk said of dealerships “It didn’t work for Fisker, didn’t work for Coda. In the last 90 years, when did it work?” If legacy car manufacturers attempt to bypass dealerships it is likely to result in lawsuits and put their sales channel at risk.

A scalable sales process is one of Tesla’s biggest, long term challenges. Their answer to dealerships are a fixed price, internet ordering process, and over 250 stores and galleries in high profile retail areas. The stores are often compared to Apple stores. Another analogy is Sleep Number stores because they both reduce overhead by not stocking large inventory items, like mattresses and cars, in valuable commercial retail space. Tesla is also experimenting with different customer referral programs and hiring a “growth team” whose goal will be to make their products go viral. Tesla has managed to generate strong demand with legal limitations on their galleries and no advertising. In Q3 2016, Sales, General and Admin is 14.6% of revenue versus about 10% for other auto makers. However, the large number of pre-orders for Model 3 indicates that their current sales infrastructure can support much large sales numbers.

Culturally, legacy car manufacturers face a conflict of interest because one of the few components they haven’t outsourced over the last few decades is the engine. They have a lot of in house mechanical engineering expertise that is heavily invested in internal combustion engines. Whereas Tesla’s culture is embedded with Silicon Valley DNA. Teslas have over the air software updates, a feature typical of computer companies, and one that could slow existing car sales if customers got free automatic updates. Tesla has other technical strengths such as autonomous driving features, like Autopilot and summon. The Model 3 is planned to be autonomous. Tesla is also planning to apply high tech automation to the manufacturing process. Elon Musk stated in the 2016 Q1 conference call their goal is to become the best manufacturer in the world and they see more opportunity for technological advancement in the manufacturing process than they do in automobiles. He has also suggested in the Q3 2016 conference call, they plan to fully automate their productions such that cars are not touched by a human by Summer of 2018.

The most serious conflict that legacy auto makers face is, why build a compelling, comparably priced EV that competes with your existing ICE vehicle, when it could be difficult to meet demand because of battery supply constraints. Currently, Model S has a large backlog. For an incumbent auto company a more compelling, or cheaper EV model could threaten sales of a current version, create long wait times, like Tesla’s own backlog, and cause a decline in revenue. In 2015 falling gas prices reduced the sales of the Nissan Leaf by 43% over 2014 sales, but Tesla’s sales grew. Tesla’s strategy is not to create the best electric cars, they are creating the best cars in their class.

Legacy auto manufactures face other conflicts of interest, like planned obsolescence , that Tesla does not face. Incumbent companies often have a difficult time transitioning through disruptive innovations, like IBM and the PC, Kodak and the digital camera, newspapers, encyclopedias, or cable companies and the internet, record stores and digital downloads. This is not a recent tech trend and transportation is not immune. The same conflict existed for maker of sail boats and steam boats. It existed for horse buggy makers and auto manufacturers.

With regards to new EV companies competing with Tesla, they will be limited in number because they require billions in capital, and will face long odds of success due to fierce competition from an increasingly entrenched Tesla ecosystem. Apple is widely known to be planning to compete. Apple has strengths with regard to capital, industrial and software design, battery supply, and retail, but they lack a new blockbuster product since Steve Jobs passing (Apple watch?) and they have always been limited by their resistance to enter low end, mass markets. Another competitive threat Tesla faces is from companies like Uber and Google, because ride sharing and autonomous driving threaten to disrupt the car ownership model.

There are several Chinese competitors, such as BYD, and Kandi. BYD is the currently the most formidable. They currently have $100B+ market cap and Warren Buffet is an investor. They make EVs (e6), electric buses, plug in hybrids, energy storage products, solar panels, lighting and they are a large battery manufacturer. They are planning to build more capacity similar in scale to the GigaFactory. There are also a several Chinese funded startups. Future Mobility, (backed by FoxConn and Tencent) plans to build an electric car it will sell for less than $15,000. FoxConn is a large battery manufacturer and supplier to Apple. Faraday Future is backed by Jia Yueting and they plan to build a $335 million battery factory in Nevada. Others include Karma, Atieva, NextEV, LeEco, and CH Auto. (Here is my breakdown of all EV competitors)

Tesla is the market leader in EVs. I will not consider Tesla to have a mass market competitive threat till one emerges with a decent looking car with 200 mile range, that competes on cost with ICE vehicles in the same class, and a realistic strategy for the entire ecosystem. They will need a strategy for a cost competitive, high volume battery supply, a viable sales model, and high speed charging for long distance travel. As an example, the Chevy Bolt fails this test because it has the design of an economy car, but it’s priced to compete with mid-size sedans. It also fails because there is not a viable strategy for long distance travel.

Demand for EV and energy storage has the potential to dwarf current battery demand. The original plan was when the GigaFactory is complete it will produce 35 giga Watt Hours per year of batteries, enough for 500,000 cars per year. That will double the 2013 worldwide capacity for battery production. Considering there were 82 million cars sold in 2015, the EV market could increase battery demand 164 times. The energy storage market is likely the the same size as the EV market. According to the IEA, in 2012 global electric energy consumption was 20,900 TWh, even a small percentage stored in batteries would be many orders of magnitude increase.

The economies of scale of battery production are pushing costs down at an accelerating rate. Cell phone and laptop manufacturers have a cost competitive, high volume battery supply from a host of competitors. One might assume EV manufacturers and energy storage manufacturers will also have this luxury. However, Tesla is outselling competitors in it’s class with increasing gross margins. If Tesla continues to outsell in these new high volume markets and raise more capital, they can continue to invest aggressively in battery production, and the accelerating cost advantages of economies of scale could accrue disproportionately to Tesla. It has the potential to give Tesla massive leverage with battery cell suppliers, such as Panasonic and Samsung. It could give Tesla substantial cost and supply advantages over other EV, and energy storage competitors.

In addition to economies of scale, there are many network effects at play, like charging, and maintenance networks. But consider the implications of the network effects related to autonomous driving. Tesla is collecting 1 million miles of data per day from their fleet for autonomous driving. “Big data” is a critical component in the race to perfect autonomous driving. To date, legacy auto manufacturers are not collecting data, and tech companies interested in autonomous driving like Google and Uber don’t have a convenient means of collecting data. Autonomous vehicles are likely to dramatically reduce the costs for ride sharing companies, like Uber and Lyft, by eliminating the driver side of their network. Tesla has indicated they plan to compete in the ride sharing business.

Future Growth

Tesla is currently experiencing rapid revenue growth. In 2015, Tesla sold over 50,000 new vehicles (up from 31,655 in 2014 and 22,442 in 2013). In 2016, they are projecting to sell 80–90 thousand vehicles. They plan to launch the Model 3 in late 2017, for which they currently have over 300,000 paid reservations. They plan to produce 500,000 vehicles in 2018 and 1 million in 2020. At the 2016 shareholders meeting Elon Musk indicated the GigaFactory can produce 3 times as many batteries as originally estimated. That puts the estimated capacity at 150 GigaWatt hours of packs, enough for 1 million cars per year and an equal amount for energy storage products. Tesla plans to create a wide range of new vehicles including a crossover SUV comparable to Model 3 (the Model Y), a next generation roadster. Model S and X currently has margins of about 27.7% and are projected to go to 30%.

In 2015 there were 82.9 million vehicles sold. In 2020, Tesla has project to be selling 1 million cars per year. They will have only scratched the surface of what is possible. It’s difficult to grasp the magnitude of the opportunity Tesla may have with the combination of falling EV battery costs and challenges for competing EV manufacturers.

Here is my most optimistic prediction. In 2020, Tesla will sell 1 million vehicles (around $40B in revenue), battery costs will at or less than $100 per kWH, gross margins will be around 38% on luxury models. Tesla stock will more than double to over $500 per share. I estimate this 2020 prediction has a 66% chance of happening with a possible delay of 1 year (Goldman Sachs gives a similar prediction an 11.7% chance). I predict in 2025 they will be a top tier car manufacturer selling over 5 cars per year with luxury class margins of 42%. By 2030, most vehicles sold will be electric, 50% or more of vehicles sold will use Tesla drive trains and super chargers. The total number of cars sold by 2030 may have stabilized or dropped due to ride sharing and autonomous driving.

Model S Gross Margin projections. 16% reduction in battery cell cost and 1 time 30% GigaFactory reduction

The mission at Tesla is to accelerate the adoption of electric vehicles, not to be a monopoly. Tesla is keeping the door open to become a supplier of batteries, drivetrains and SuperCharger access to other auto manufacturers. However, they had a deal to supply Toyota and Mercedes, but it has been discontinued because Tesla can’t meet demand for Model S. If you look out to 2030, there may be 50 Gigafactories. The question is who will fund them? If Tesla has a technological lead and strong demand why wouldn’t they be able to raise money from the public markets rather than partnering with auto manufacturers whose business model will be threatened. Tesla bought their Freemont factory at a deep discount for $42 million dollars in the wake of the 2008 financial crisis. The threats of disruption from EVs, ride sharing and autonomous driving will likely lower demand for ICE vehicles and could force manufacturers out of business. There may be more good deals on auto factories in the 2020s.

Because of the economies of scale being critical to costs we are in a land grab situation, similar to Rockefeller and the creation of the oil industry. But investors don’t seem to realize what’s happening. Barclays recently called Tesla a “cash-hungry start up unicorn.” The disconnect is largely because of people’s inability to grasp exponential growth. Or as Elon Musk puts it, people think by analogy rather than first principles. The key is to focus on the numbers and rates of change rather than using your intuition or “common sense” about how fast things can change. Curiously, as Elon Musk pointed out, the same people who are wrong about how fast technology will change are the same people that think it was obvious in hindsight.

Another challenge Tesla and investors face is a slew of misinformed, negative press fueled by entrenched business interests, political pundits, and short sellers. Also because Tesla does no advertising media outlets have little motivation to present them in a positive light. The other auto companies don’t have too many conflicts of interest to build environmentally friendly vehicles and they want to turn public opinion to their side to make their lobbying efforts easier to undermine emission mandates, and zev credits. This trend is likely to get worse as changes accelerate. Although, it’s a challenge, it’s also an opportunity for free publicity and to buy Tesla stock at lower prices.

Macro-economic conditions, government intervention, and oil prices are factors in determining Tesla’s growth rate, but they are not determining factors in long term success. The long term success is a matter of execution.

Check out Tesla news feed.