Toyota investment gives Tesla economy of scale to build affordable EVs

NASDAQ, long known as the marketplace for companies based in Silicon Valley, added TSLA to its index on June 29 when Tesla Motors sold 13.3 million shares at $17 per share, raising just over $226 million in the Palo Alto car company's initial public offering. Interest was so great that Tesla increased its planned offering by 2.1 million shares at the last minute. Investment banks notwithstanding, much of the hype surrounding this particular IPO was due to a single investor: Toyota Motor Company.

A month earlier, Akio Toyoda and Elon Musk, the respective CEOs of Toyota and Tesla, announced at a joint press conference that Toyota would be purchasing $50 million worth of Tesla stock. While the presence of such a knowledgeable investor undoubtedly boosted Tesla's credibility on Wall Street, what it meant to Toyota was anybody's guess. The potential benefits to Tesla, including a new factory and possible access to Toyota's vast technological resources, are myriad. By its own estimates, Toyota spends $1 million per hour researching and developing technology and safety systems. What would the largest car company on the planet possibly want with a bunch of tech geeks from Silicon Valley?

The picture became clearer on July 9, when, during an unrelated safety seminar in Japan, Akio Toyoda told a group of reporters that his company is already developing a prototype that will run on Tesla's powertrain technology, which is essentially an electric motor powered by thousands of lithium batteries. J.B. Straubel, Tesla's chief technology officer, followed up by saying that "since our announcement in May, Toyota and Tesla engineering teams have made a lot of progress in a short amount of time, and it is exciting to start seeing some initial results."

Those results will be unveiled later this year, according to Tesla communications chief Ricardo Reyes. "Toyota and Tesla have signed a joint vehicle-development agreement reaffirming in writing what was described at the joint press conference a few months ago," Reyes says. Specifically, the partnership will combine a high-volume Toyota (most likely a Corolla or a RAV4) with a battery-powered electric powertrain from Tesla. "The first driving prototype has already been built and is undergoing testing," Reyes says. "It will be unveiled to the public later this year. We'll be delivering the first two prototypes [to Japan] by the end of the month." This is meaningful because no car company—with the possible exception of Chrysler (remember the Dodge Tomahawk?)—builds prototypes just for the sake of building prototypes.

What's In it for Toyota?

Jeffrey Liker, a professor of industrial and operational engineering at the University of Michigan who has written several books about Toyota's production system, thinks Tesla could be a quick fix to the inherently slow process of product development in large car companies. In Toyota's long-held view, Liker says, purely electric vehicles are not likely to be viable anytime soon. "My initial reaction was that this was a great idea for Toyota," he says. Given their range limitations, EVs are aimed at a niche of commuters who typically own a second car. "It certainly makes sense for Toyota to get involved with a manufacturer they don't compete with directly," Liker says. "It allows them to participate in the EV market rather quickly."

There's also the distinct possibility that Toyota, like any good gambler, is simply playing the odds and hedging its bets. "They're basically working as venture capitalists," Lumumba Di-Aping, a Yale World Fellow who specializes in renewable energy and climate-change finance, says of Toyota's interest in Tesla. "Early seed capital can result in a multiple return on investment, they secure branding in difficult times, and they gain entry to an innovative market with a knowledge base they'll inevitably tap into." But most important, Di-Aping says, "Toyota realizes that Tesla is not what it appears to be." Relative to consumption, Di-Aping contends, the car market—whether on the tiny scale of Tesla or Titanic proportions of Toyota—"is merely a subset of a much larger market: energy."

While Toyota already has plenty of experience mass-producing complex cars, it doesn't have the strong connection to the U.S. government that Tesla already appears to enjoy. The Department of Energy pledged $465 million in loans to Tesla earlier this year. The IPO raked in another $226 million in liquidity. Aside from gaining positive publicity in a negative environment (the massive recalls and Consumer Reportsissue are still fresh wounds), Toyota is virtually guaranteed that it won't be losing its $50 million investment anytime soon.

Others point to Tesla's experience in EV technology as one of Toyota's possible motivations. "Toyota has made their mark in hybrid penetration, so creating a relationship with Tesla, a pure EV company, saves them a lot of time," says Rebecca Lindland, an analyst with IHS Automotive, a Lexington, Mass.–based research firm. While we may not know for some time if Toyota was attracted to Tesla for a specific technology, any patented software or battery system that would take Toyota more than 50 hours of concentrated effort to work around could be well worth a $50 million investment.

"When you add it all up, $50 million is a trivial investment," Liker says.

What's In it for Tesla?

The key to the Toyota/Tesla relationship is the NUMMI factory in Fremont, Calif., which is situated just across the Bay from Tesla's powertrain factory in Deer Park. NUMMI, which stands for New United Motor Manufacturing Incorporated, opened in 1984 as a joint venture between GM and Toyota. NUMMI closed earlier this year, making it the only plant closure in Toyota's 73-year history, a fact that did not sit well with leadership. It's where Toyota showed GM the secrets of building small cars at a profit, otherwise known as the Toyota production system, a topic on which Jeffrey Liker has written volumes. "Akio Toyoda was personally unhappy they couldn't find a partner to replace GM at NUMMI," Liker says.

Tesla already has the personnel in place to make the transition to the new factory seamless. According to Gilbert Passin, Tesla's vice president of manufacturing, who used to manage the NUMMI factory for Toyota, Tesla only purchased a portion of the NUMMI facility—the central manufacturing building—which encompasses approximately 5.5 million square feet. "It's a very big facility," Passin says, "and more than what we need initially, but we want to grow. It's an investment for the future." That future starts soon, with Tesla scheduled to move in to its new digs as early as September of this year. Prepping a vehicle assembly line will begin immediately.

A big benefit to the new Tesla factory is its ability to produce multiple vehicle lines. Toyota built the Corolla, Matrix/Vibe and Tacoma simultaneously at the old NUMMI facility. The first vehicle produced there will likely be the Model S sedan, but there will be more than enough room for the Roadster, along with a third model line that could possibly be shared with Toyota. With a sports car and family sedan already in the works, a small SUV would give Tesla the broadest model range.

Tesla has already established itself as a pioneer in the electric vehicle market, but Nissan is poised to challenge that dominance with its mass-market Leaf. The bulk of the transfer of knowledge will flow from Toyota to Tesla, Liker says. "They'll put a lot into the relationship in terms of knowledge and human resources. Based on past experience, [the factory] will be a kind of showcase," Liker says.

The Bottom Line

In light of Toyota's year thus far, any good news is good news. "In my opinion, the big news media have jumped on the opportunity to bash Toyota every opportunity they get," Liker says. It's harder to bash tiny Tesla, unless you want to attack its CEO for matters concerning his personal life (as some have). Profitability and relatively meager production figures aside, the company has at the very least succeeded in developing and delivering a highly entertaining electric car in the Roadster.

Like Nissan, Toyota is more than capable of building an electric car of its own, but it considers EVs to be a niche market.

As for Tesla's future, Liker is cautiously optimistic. "For a specialty low-volume company in California that charges a premium, Californians are one of their prime markets," he says. "Toyota executives often use the term ‘makes sense' when referring to business deals. If something makes sense, they move ahead. The other thing Toyota does is once they adopt partners, they try to help in any way they can. Once you're part of the family, you're in. They're committed."

If that commitment turns out to be solid, this partnership could be the deal that makes Tesla a viable car company. The next challenge for Tesla will be to produce its first car, the Model S, from the ground up. The current Roadster is a Lotus Elise with an electric powertrain, so the company didn't have to engineer and validate the myriad systems (chassis, crash safety, suspension, etc.) that make mass-produced cars so expensive and difficult to produce. Finally having a dedicated factory is an asset, but getting a factory up and running is no small feat, and as we saw with the Roadster, promised delivery dates are meaningless until customers receive their orders.

We'll have to wait and see how this plays out over the next two years; history is littered with failed car companies that were built on dreams. Of course, startups like Tucker didn't have the backing of the largest car company in the world.

_{Originally published July 14, 2010 on PopularMechanics.com.}