Tesla Inc.’s Risk, Uncertainty and Managing Incentives

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Table of Contents

Risk and Uncertainty Management
Adverse Selection and Moral Hazard Problems
Principal-Agent Problem
Organization Structure
Conclusion
References

Tesla Inc. is a large automotive and energy enterprise launched in 2003 and located in Palo Alto, CA (Tesla, 2019). The company specializes in the production of electric vehicles (EVs) and may be regarded as a pioneer in this niche. Tesla is perceived as an innovator in the industry as it was among the first to utilize cutting-edge technologies, automation, and digitalization for car assembly (Tesla, 2019, para. 2). The firm also innovated in the very choice of its business model. Unlike other automotive companies that distribute their products via dealers, it started to sell vehicles directly to consumers (Righi, 2015).

However, the company is currently under the threat of significant financial loss. Collins (2019) indicates that its “profit per car dropped dramatically in the December quarter [2018]” (para. 3). It is valid to say that the main reason for such reduced profitability is the firm’s approach to the management of its operational and strategic risks. This issue will be discussed in the present paper along with Tesla’s organizational structure, adverse selection, principal-agent, and moral hazard problems and their effects on profitability.

Risk and Uncertainty Management

Tesla’s current operations are more costly than profitable and this puts the sustainability of business at risk. The focus on the production of luxury sports cars seems to contribute to such an outcome. As noted by Elon Musk, Tesla’s CEO, the enterprise’s founders were aware from the very beginning that their first product was going to be expensive in any possible form (Zucchi, 2019). Since the manufacturing of high-quality EVs is a technology-intensive process, the choice of such a pricing strategy may be viewed as logical.

At the same time, the company fails to deliver vehicles to customers on time (Collins, 2019). Moreover, the price of the final product that they will need to pay in the end may be higher than it was initially stated by Tesla (Collins, 2019). Such a situation increases customers’ perceived financial and service quality risks associated with Tesla’s brand that, in turn, can negatively affect their loyalty and trust in the company (Marakanon & Panjakajornsak, 2017). It is valid to conclude that with the reduced attractiveness of the brand, the company’s ability to generate profits will drop even more.

Nevertheless, it seems that Musk’s strategic decision to invest in SolarCity, an enterprise specializing in large-scale solar panel manufacturing, could be viewed as an attempt to increase the company’s profit margins. As noted by Furr (2019), when taking into account Tesla’s overall mission of accelerating the world’s transition to renewable energy use, by building large battery factories and promoting their output, the company may eventually make solar energy more affordable. In this way, production costs and the final prices for Tesla EVs can decrease as well, strengthening the demand for products.

Nevertheless, SolarCity itself has been losing money, which puts the attainment of this long-term goal at risk (Collins, 2019). It means that Tesla’s strategic decisions are based on “bad math” (Collins, 2019, para. 14). Besides, the statement about the company’s profit-loss was followed by a layoff notice for about 7% of subordinates (Collins, 2019). All these points at Tesla’s failure to foresee and prevent various risks and makes one question Tesla’s tactics in the realization of its vision and mission.

To improve its performance, it may be recommended for Tesla to apply a more holistic approach to risk management. The integration of an Enterprise Risk Management (ERM) system can be beneficial in this regard since it aims to evaluate operational and non-operational, direct and indirect, internal and external risks that may affect the performance of various organizational units (Yang, Ishtiaq, & Anwar, 2018). The assessment of highly diverse risks is then used to create integral strategic responses to risks and promote reasonable, evidence-based risk-taking behaviors (Yang, Ishtiaq, & Anwar, 2018).

Comprehensive risk analysis as part of ERM provides enterprises with a chance to improve competitive advantages yet, as noted by Yang, Ishtiaq, and Anwar, (2018), to maximize the favorable outcomes, top executives should be financially literate. Thus, by increasing the level of its financial competence (for instance, through collaboration with credible analysts) and by using ERM, Tesla’s management will become able to improve the company’s current position through better risk forecasting and response.

Adverse Selection and Moral Hazard Problems

An issue that could be regarded as either an adverse selection problem or a moral hazard problem is an increase in the starting price for Tesla’s Model 3. The price promised by the company was USD 27,500, which “assumed a full $7,500 tax credit removed from a $35,000 base price” (Collins, 2019, para. 7). However, customers who expected to buy their EVs for this sum can no longer do so because automakers are eligible for this tax deduction only before they sell 200,000 items (Reklaitis, 2019).

As such, Tesla’s management could be aware that by the time it will commence manufacturing the USD 27,500 Model 3, the company would already hit that number of cumulative EV sales. Therefore, there could be informational asymmetry before the deal since buyers were not aware of Tesla’s sales statistics before placing an order and making advance payment. At the same time, Tesla could undertake some changes in its initial sales strategy and realize the problem with tax deduction only after the deal. In this case, the issue can be defined as a moral hazard.

According to Hui, Saeedi, and Sundaresan (2019), both forms of information asymmetry are associated with risks of low service/product quality and deterioration of firms’ reputations. The latter is regarded as “a strategic intangible asset, using which tangible profits and an increased added value could be generated” (Zaby & Pohl, 2019, p. 2). Thus, Tesla needs to undertake effective measures aimed to deal with moral hazards and adverse selection as they may negatively affect its turnover, operating expenses, and various stakeholders’ perceptions of the company.

As stated by Bergh et al. (2019), to achieve this, companies can employ various initiatives that make the internal information flows more accessible to consumers and implementing solutions targeted at the protection of stakeholders’ interests. By reducing information asymmetries, strategies aimed to improve information transparency and accountability result in greater buyer satisfaction and improved seller performance (Hui, Saeedi, & Sundaresan, 2019). Adoption of a corporate social responsibility (CSR) strategy may be viewed as a comprehensive way to minimize the negative effects of moral hazard and adverse selection on the company’s reputation and transactions.

At the present moment, Tesla does not use good tools that would ensure the firm’s transparency and accountability. According to McMahon (2018), the company does not report on its programs and initiatives aimed to address various socially important issues and does not disclose almost any information regarding its internal processes. Due to this, Tesla may be unable to prevent the incidence of moral hazards and adverse selection.

At the same time, CSR implies that a company puts the interests and preferences of consumers and other relevant stakeholders above the commercial ones and strives to satisfy them through ethical conduct (Zaby & Pohl, 2019). Overall, CSR allows targeting a great variety of reputation-related issues and promote a favorable brand image. What is more important, by emphasizing the importance of accountability and transparency, it may be regarded as one of the best instruments for combating information asymmetries.

Principal-Agent Problem

The principal-agent problem occurs at Tesla primarily because Elon Musk plays the role of both a CEO and a major shareholder of the organization. For instance, in 2016, he offered Tesla’s board members to purchase SolarCity where he also was and remains the chairman and where his cousin, Lyndon Rive, is a CEO (Wieczner, 2016). It means that the overall profitability of Tesla is important for Musk as one of its largest shareholders. However, there is still a big risk that he may be biased in his strategic decisions and can put personal financial interests above those of other shareholders.

Changes in the corporate governance strategy may be viewed as the best way to resolve the principal-agent conflict at Tesla. For better control of the situation, the board must be comprised primarily of independent directors (Gay & Denning, 2014). They can be more capable of evaluating strategies objectively proposed by CEOs and, thus, protect the interests of the company as a whole (Gay & Denning, 2014).

Besides, it is essential to adopt policies and initiatives that would ensure the behavioral transparency of top managers and encourage them to act in a way that increases the value of the organization (Chappelow, 2019). One of the possible ways to do that is through the alignment of CEO compensation with specific profitability goals. At the present moment, there is no evidence that Tesla adheres to any of the abovementioned corporate governance recommendations.

Organization Structure

Tesla Inc. consists of multiple organizational departments, including energy, sales, engineering, production, and so forth (Dudovskiy, 2018). Each of them is managed by a few vice presidents who are directly accountable to Elon Musk (Dudovskiy, 2018). The company’s structure was more hierarchical just a few years ago but, nowadays, the CEO aims to flatten it to facilitate inter-division communication and enhance flexibility (Dudovskiy, 2018).

The shift from a traditional bureaucratic structure may be viewed as a step towards greater profitability. Besides removing information flow barriers, such a structure is characterized by greater employee productivity, creativity, and autonomy, as well as reduced budget costs due to the elimination of middle management positions (Rishipal, 2014). Moreover, flat organizations are normally more focused on customers than on tasks (Rishipal, 2014).

Therefore, by pursuing further flattening of Tesla’s structure, Musk will be able to increase both customer satisfaction and employee satisfaction. The latter can be achieved since workers will be provided with more independence in terms of task completion (Rishipal, 2014). Considering that motivated and satisfied employees tend to be more productive, there is a great potential to improve profitability in this way.

Conclusion

The analysis revealed that Tesla Inc. currently faces many problems in terms of risk management. The fact that the company does not make money, experiences delays in production, and fails to deliver on the promise about product prices indicates that it has no effective risk management strategy. Besides, it lacks transparency and efficient agent controls, which increases the chance that information asymmetry may affect its transactions and reputation negatively. To improve profitability, it is recommended for the enterprise to adopt ERM, as well as effective CSR and corporate governance strategies. These solutions will help Tesla to manage the identified threats and uncertainties better.

References

Bergh, D. D., Ketchen, D. J., Orlandi, I., Pursey P. M. A. R. Heugens, & Boyd, B. K. (2018). Information Asymmetry in management research: Past accomplishments and future opportunities. Journal of Management, 45(1), 122-158.

Chappelow, J. (2019). Principal-agent problem. Investopedia. Web.

Collins, J. (2019). Tesla’s profit warning is further evidence that Elon Musk’s math does not add up. Forbes. Web.

Dudovskiy, J. (2018). Tesla organizational structure: divisional and flexible. Research Methodology. Web.

Furr, N. (2019). Tesla’s business strategy is not chaotic – it’s brilliant. The Conversation. Web.

Gay, S., & Denning, C. (2014). Corporate governance principal-agent problem: the equity cost of independent directors. SSRN Electronic Journal. Web.

Hui, X., Saeedi, M., & Sundaresan, N. (2018). Adverse selection or moral hazard, an empirical study. The Journal of Industrial Economics, 66(3), 610-649.

Marakanon, L., & Panjakajornsak, V. (2017). Perceived quality, perceived risk and customer trust affecting customer loyalty of environmentally friendly electronics products. Kasetsart Journal of Social Sciences, 38, 24-30.

McMahon, J. (2018). How Tesla scored a zero on climate management. Forbes. Web.

Reklaitis, V. (2019). Tax-credit expansion sought by Tesla, other EV players is among tax breaks getting lawmakers’ attention as year ends. Market Watch. Web.

Righi, B. (2015). Tesla brings driverless technology—and cybersecurity concerns—to the masses. Risk Management Monitor. Web.

Rishipal, Dr. (2014). Analytical comparison of flat and vertical organizational structures. European Journal of Business and Management, 6(36), 56-65.

Tesla. (2019). About Tesla. Web.

Wieczner, J. (2016). Why Tesla and SolarCity have an Elon Musk problem. Fortune. Web.

Yang, S., Ishtiaq, M., & Anwar, M. (2018). Enterprise risk management practices and firm performance, the mediating role of competitive advantage and the moderating role of financial literacy. Journal of Risk and Financial Management, 11(35), 1-17.

Zaby, S., & Pohl, M. (2019). The management of reputational risks in banks: Findings from Germany and Switzerland. SAGE Open, 9(3), 21-15.

Zucchi, K. (2019). What makes Tesla’s business model different?Investopedia. Web.

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