In an email that arrived over the weekend, Tesla announced pricing and details for their connectivity subscriptions. Tesla owners will be able to choose between a Free “Standard Connectivity” option and a $10 / month “Premium Connectivity” plan.

First, let’s dig into what these plans are. Then, let’s talk about what they mean for Tesla.

Everything you need for free. Everything you want for $10.

The standard connectivity option allows your Tesla to connect to the internet over an LTE network absolutely free. You’ll be able to control or check on your car remotely from your phone, and your car’s computer will always be able to get online. However, Tesla will put some restrictions on the software to try and limit the amount of data usage they have to foot the bill for. Access to cellular data anywhere without having to pay a monthly fee is a great feature, and very customer friendly.

Navigation and traffic-based routing will always be supported regardless of your connectivity plan, but the free option won’t show you live traffic or satellite maps on the car’s touch screen as those features require more data usage.

In addition, in-car video streaming from Netflix and Hulu, “Caraoke”, Spotify streaming, and the in-car internet browser will require a WiFi connection if you don’t have a paid connectivity plan. This means you should be able to use your phone’s hotspot or a nearby network to avoid the $10 a month fee for Premium Connectivity if you want to be frugal.

Customer Reactions

This is fantastic news for Standard Plus owners, who have never been able to access Satelite Maps or Live Traffic before. Now, any of those customers can upgrade their car for just $10. Reports are coming in that for the rest of the year, Standard Plus customers will get access to Premium Connectivity absolutely free. Big win for SR+.

There were some grumbles from people who bought premium cars after June 30, 2018 –– that was the cutoff date for unlimited lifetime premium connectivity. Anyone who bought before that date will never have to pay for Premium Connectivity for the life of their car. After that, most new Teslas include just 1 year of free Premium Connectivity with purchase, meaning you start paying after 12 months if you want to keep the premium connectivity features. Only Standard Plus Model 3 buyers don’t get the free year subscription with their car. Nobody will be charged until 2020 starts, regardless of when they got their car in 2018.

Overall, this is a very compelling subscription offering for Tesla customers. About 75% of people will just pay Tesla to subscribe and never worry about it. If you don’t want to pay $10 a month, just don’t subscribe. Your car will still work fine, and be able to connect to the internet.

If you have a Tesla, will you pay $10 a month for premium connectivity (RT conducting research)

— Tesla Tested (@TeslaTested) December 7, 2019

I have a bit of a personal bias here: I bought my car early enough that I have free premium connectivity for the life of the car. That should add a few hundred dollars to the value of my Model 3.

Details about your connectivity subscription can be viewed in your Tesla Account Vehicle Details, or in the Software tab in your car’s Vehicle Controls.

Selling Digital Services Instead of Cars

In the past, Tesla made money selling cars: Big hulking physical masses of metal and glass that take time to build, distribute and sell.

But today we’re increasingly seeing signs of a major transformation in Tesla’s business model: It now seems clear that in the future Tesla will generate most of its earnings from digital services, not sales of physical goods.

A Whole Different Animal

Many skeptics will roll their eyes at an assessment like this. For 15 years, Tesla has made money selling cars. It’s closest competitors appear to be… other auto OEMs. Sure, Tesla’s products involve a lot of cutting edge technology and advanced software… but doesn’t every car company use software in their products? How is Tesla any more a software company than Toyota? If it looks like a duck, walks like a duck, quacks like a duck… it must be a duck. And the last 15 years of financial statements make Tesla look like a duck that sells cars.

That’s starting to change very quickly. Tesla’s business has always been very different than legacy auto (since they sell and service all of their cars themselves) but that chasm is growing wider at an accelerating rate as Tesla shifts its focus towards digital services. The business looks like a duck, walks like a duck, quacks like a duck… until all of a sudden it’s a moose. A moose that sells digital subscription services.

What kind of digital services could possibly generate greater earnings than selling cars? Let’s take a look at my Tesla account again for a sneak peek into the future:

Here you can see five digital services Tesla has already started offering:

1. Autonomy Services

Autonomy seems very likely to be the primary driver of Tesla service revenue growth over the next decade. Today, Tesla only allows customers to purchase a “Full Self Driving” subscription as a one time unlimited-use item that is “attached” to the car. The package is currently priced at $7,000 and Tesla has and will continue to raise the price as more features are added and the software becomes more mature. The price of a vehicle-lifetime subscription is expected to reach $20,000 or more in the next 5 – 10 years, although that could change.

Whether you purchase the “Full Self Driving” package with your Tesla or not, you get the same car. The only difference is the software. Just think about what that means!

Tesla Sells Software & Services

Having a product line and pricing structure that is differentiated by software and digital services rather than hardware is a big deal. Not only does it dramatically simplify inventory and supply chain management (which lowers costs) but any car can be upgraded instantly over the internet if the customer decides they want to purchase the service later.

Legacy auto’s relationship with the customer is over when they finish making the car. For Tesla, that’s when the relationship begins. You can’t go back to the Ford dealership and upgrade your Mustang to a Mustang GT when you get a big bonus check –– but you can take that check and instantly activate your Full Self Driving subscription online.

Making $7,000 selling software and digital services is arguably much more exciting than the $39k earned on the rest of the car. Selling hardware is capital intensive, labor intensive, and has high variable costs. Making money selling software is a much more capital light endeavor, and requires much less human labor, and includes almost no variable costs.

Econ 101: Why Wall Street Takes Silicon Valley’s SaaS

When you order a new car from Tesla, they have to go buy a ton of metal, parts, and batteries. They have to hire workers to build the cars, test the cars, and ship the cars. Then deliver and service the cars. It’s a lot of work! 80% of the money you give Tesla for your car goes straight to other companies who sold Tesla what they needed to make that car. If you didn’t place your order, they wouldn’t have had to incur those costs.

On the other hand, once you’ve written a piece of software you can provide additional copies of that software to other people at almost no marginal cost. Tesla just has to pay a large fixed cost to build the software. Whether it gets downloaded and used by 1 million or 10 million people their fixed cost remains largely the same.

That means instead of keeping 20% of the revenue as profit like when they sell cars, Tesla gets to keep 80% or even 90% of the revenue they bring in selling digital services. Other car companies just don’t sell $7,000 digital services with fat gross margins. They make money selling hardware.

On Wall Street, every dollar isn’t created equal. Some kinds of revenue are valued more highly than others. And easy, stable, reliable digital service/subscription money is just much sexier than boring, risky, cyclical, old motor vehicle production money.

The Future of Autonomy Services

There will be that too, but economics will favor initial purchase

— Elon Musk (@elonmusk) April 13, 2019

Tesla CEO Elon Musk has already confirmed that Tesla will offer “Full Self Driving” as a subscription service in the future. While purchasing a vehicle-lifetime subscription will cost more upfront, it will ultimately be cheaper than paying for a monthly subscription for the life of the car. This is similar to how other SaaS providers give discounts for purchasing an annual subscription rather than the monthly option.

Many people order their Tesla with the “Full Self Driving” option because they think it’s worth it given what the package offers today. Many others would like to buy it but just can’t afford to spare that much cash upfront. In the future, those customers will have more options to give Tesla their money.

Rather than paying $7,000 for a vehicle-lifetime subscription, you might be able to pay $149 to gain access just for one month. That would be helpful with rental cars and road trips. Maybe there would even be an Autopilot day pass for $5.

The Tesla Network

We do know that any Tesla will be able to join the “Tesla Network” whether it has a full self-driving subscription or not. Once your car is online on the Tesla network, people you approve will be able to summon it and pay you for a ride. Tesla will take a 20% – 25% cut of the revenue for operating the service.

We can also deduce that in the future, you will be able to pay for Full Self Driving by the ride. Even if you didn’t subscribe to FSD, your car still has the technical capability to join Tesla’s Robotaxi network anytime. That means other people can summon it for a ride and pay you. The obvious corollary to that is that you can also summon your own car for an autonomous ride and only pay 20% of the retail price for that ride (since you keep your own cut).

Today, you have to pay for your FSD subscription in full. In the future, Tesla will expand autonomy services so you can pay by the month, pay by the day, or pay by the mile. Every time anyone uses an autonomous Tesla for any task, Tesla gets a cut for maintaining the software and network. Autopilot is never done and is always learning, so pricing it like a service makes a lot of sense. Assuming everything goes according to plan autonomy services revenue should eventually grow to eclipse revenue from new hardware sales.

Imagine a world where nobody cares how many vehicles Tesla delivered or produced last quarter. That’s what will happen when the vast majority of their profits come from the services they sell every day through their existing fleet.

The $40 / Month Tesla Subscription

We’re just one small logical leap away from our inevitable conclusion: The entire vehicle consumption experience becomes a digital service subscription.

We’ve already established you’ll be able to buy a car and purchase autonomy services by month, by day, or by mile. Well, let’s say you bought a car and now you find yourself paying for autonomous trips because it’s nice and you’re too lazy to drive. At that point, maybe you’ll want to just sell the car and purchase an autonomy subscription that gives you access to different cars. Maybe you’ll decide it makes more sense for you to just pay for Uber-type rides when you need them.

When cars can be shared, there’s no need to buy a whole car anymore. Rather than purchasing an expensive asset, many people will purchase digital service substitutes that accomplish the same purpose as buying a car today.

Today the minimum price to lease a Model 3 is around $400 / month. By the end of the next decade, I wouldn’t be surprised to see subscription offerings for as little as $40 a month.

I imagine it working something like this: You go online and configure a new Tesla to your liking. Put down a $100 deposit and you’ll instantly see a nearby car start driving towards you –– it’s yours now. You should be able to do this with new and used cars.

You only need your car to go to work and back, so you pick a low priced subscription that doesn’t offer daytime use. Every day your car takes you to work and then heads out to pick up lunch for you and a few dozen other people. It spends the day making deliveries, stops at your office to drop off your lunch, and then continues on fetching and delivering dinner.

When it’s done, it charges itself off and returns back to the office to pick you up. It stays in your garage overnight in case you need to use it for anything, but you could lower your monthly subscription price further by sending it out again after you get home. Maybe to pick up the kids and their friends from practice, and drop them all off at their homes? Funds from each of their parent’s subscriptions will help pay for the ride.

Is a $40 a month Tesla too crazy to believe? You can already lease a Model 3 for $400 a month. We need the price to come down by $360 a month, or about $12 a day. That’s a $1 per sandwich delivery fee for 12 people who work in the same office as you. Tesla is happy to offer the car for $40 a month because others using the car will help pay for the rest.

Selling a car is hard. Selling a subscription you can cancel anytime is easy. Expect Tesla’s revenue and vehicle production to explode as they transition from a hardware-based model to a digital subscription service-based model of car buying.

2. Insurance

Sorry, I got a little carried away with #1 there. It really is kind of a mind-fuck rabbit hole when you start thinking about it where Autopilot is going. Digital service #2 is Insurance.

“But insurance isn’t a digital service! It’s expensive and risky and there are costs involved! How could Tesla get into an industry they know nothing about?!? They’re going to go bankrupt!”

Okay, imaginary counter-argument moron –– you clearly haven’t been paying attention. Tesla isn’t handling any of the actual “insuring” for Tesla Insurance. Tesla is providing digital data services to insurers.

Rather than spending money on marketing and sales, an insurance company can simply partner with Tesla to handle customers who purchase Tesla-branded insurance directly online. The Tesla website makes it easy to add insurance to any new car purchase.

Tesla’s software helps insurers reach high-value customers without wasting money on talking Gecko ads. It’s called insurance, but look a little closer: It’s a digital data service.

The potential for what Tesla software can do for the insurance industry is exciting. Tesla Insurance already seamlessly copies vehicle information and customer information so you don’t have to enter it again, and there are opportunities for even more data sharing in the future when it can improve the customer experience. Tesla can also help insurance companies by using their autonomous stack and active safety features to continue to drive down accident rates and insurance claims.

Tesla insurance is more than just another digital service Tesla sells, and more than just a way to make the customer’s life easier. As Tesla charges forward into an autonomous world, a lot of the problems will be insurance-related rather than technical. Starting to design custom insurance services integrated deeply into the ordering process is delightfully forward-thinking.

3. Supercharging Services

Imagine if Toyota customers around the world tended to fill-up only at Toyota stations when taking road trips. Imagine that these Toyota stations filled up faster, were less expensive, and were easier to use than other gas stations. Toyota might even integrate the stations into its navigation system. Do you think these Toyota stations would have a positive or negative effect on Toyota’s valuation?

Thankfully we don’t have to imagine. We can just look at Tesla’s Supercharger Network: an electric vehicle charging network that works exactly as I described above. Because of vastly superior technology, ease of use, and seamless integration Tesla essentially has a monopoly on selling energy to its customers on road trips. This isn’t a profit center for the business, but its effect on Tesla’s competitive positioning is massively underappreciated. In an age of autonomous cars constantly needing to recharge, the Supercharger network could become a goldmine (if it can scale up fast enough).

Premium cars like Model S and Model X get free unlimited supercharging for the lifetime of the vehicle. More affordable models like Model 3 and Model Y pay for Supercharging based on the amount of electricity they use. In the future, you can imagine Tesla offering different Supercharging plans, essentially making Supercharging another digital subscription service.

Tesla doesn’t just sell you cars, they sell you energy services for that car too. They’re Ford and Standard Oil all rolled into one. They’ll sell you energy on the road at their Supercharger stations, or sell you a solar subscription you can use to generate electricity on your roof starting at just $50 a month.

It may not have a huge impact on the bottom line today, but it’s yet another example of how Tesla’s relationship with the customer begins where legacy auto’s relationship ends. When BMW sells you a car, you go buy fuel from Shell. When Tesla sells you a car, you buy fuel from Tesla –– and maybe grab Tesla panels to make your own fuel at home.

Tesla’s business model is profoundly different from BMW’s, and the primary reason for that is digital subscription services. Though the two automakers may seem like direct competitors on the surface, stark differences in how each company operates and where it makes its money inform financial models and valuations derived by vastly different principles.

4. Vehicle Servicing

If you haven’t raised your eyebrows so far, you should probably do it now. I know, I know. How is physically servicing vehicles a digital service?

At first glance, maintenance doesn’t seem like something that involves much software. But that’s only until you see the way that Tesla does it. When you need roadside assistance, service, or maintenance, you can schedule it completely from your mobile app. Often, mobile service can come to you so you don’t have to drive to the service center.

When your car’s computer notices something is wrong, it immediately contacts the nearest service center and places an order for the parts it needs. This helps minimize repair times.

Tesla has even used software to extend the range and enhance the performance of their vehicles. This software development work helps counteract battery degradation and other issues that might cause the vehicle to be replaced sooner than later. If you think about it, Tesla is doing software development work to honor their battery performance guarantee: by improving the efficiency, they will replace fewer batteries due to unacceptable performance. That’s good for the environment, good for your wallet, and good for the car.

In the United States, auto dealers only generated 50% of their revenue selling cars. The other 50% comes from servicing all the cars they previously sold. This is notable because auto manufacturers don’t typically service their cars –– the dealerships do. This is another service revenue stream Tesla can collect and legacy auto can’t, and it’s actually a lot more digital than you think when your car is mostly made of software.

I imagine future Tesla digital service plans for regular maintenance, paint touch-ups, and anything else an autonomous car needs to keep running. These would work much the same way as the other digital subscription services described above.

5. Premium Connectivity

Finally, we arrive back where we started: Connectivity. This revenue stream is going to be a drop in the bucket, but it’s a peek at where Tesla is going. It lets Tesla offer features that use more data, and that’s exciting too.

I can’t speak to margins on this today, but long term it seems clear that it will be priced so that Tesla’s data cost is less than the average revenue per user.

While it may seem like a small and insignificant change, this is going to be the #1 most popular paid digital subscription from Tesla. Customers will link their credit cards to their Tesla accounts (if they haven’t already) and make sure it stays working so they can watch movies in their car. Thousands of Tesla customers are now dipping their toes into the subscription pool. Once you’re in, the water feels just fine.

Tesla Prime?

A common sentiment I hear is that people don’t like keeping track of a bunch of different subscriptions. One way to handle this would be to create a unified billing system that condensed all Tesla services into one monthly payment. So rather than a $399 lease payment, you might have several subscriptions or packages for autonomy, insurance, and solar that add up to roughly $349 billed once a month. You would be able to add or remove services anytime to change your monthly payment or send the car away at the push of a button. At the end of the day, it’s more or less the same for the consumer as making a monthly car payment.

Another possibility is that Tesla could offer some kind of bundle discount for using all or a number of the various subscription services they offer. Think Amazon Prime, but for Tesla.

All the Things We Can’t Imagine

There will probably be a million other little services we can’t even think of yet. Think about something like “I’m feeling hungry”: a quick button you can push to instantly get routed to some food.

That could become a huge service in an autonomous era. Yelp alone is a $2.3 billion company. Imagine a future where the car’s touch screen becomes a hub for deciding where to go and what to eat. What would sponsors pay to drive traffic to their restaurants?

Why Tesla Remains Hilariously Undervalued

After a record-breaking Q3, Tesla soared past Daimler to become the third most valuable auto manufacturer on Earth. For many analysts and industry insiders, this just doesn’t make any sense.

How can tiny little Tesla, which makes just a fraction of the cars Daimler makes be worth more than the company that invented the car?

You can see this sentiment in a recent comment by Morgan Stanley analyst Adam Jonas, as he raised the bull case for Tesla to $500 a share:

To be clear, we are not bullish on Tesla longer term, especially as, over time, we believe Tesla could be perceived by the market more and more like a traditional auto OEM [original equipment manufacturer]; we are prepared for a potential surge in sentiment through 1H20 but question the sustainability.

Adam Jonas, Morgan Stanley

What worries Jonas (and likely at least a few other investors) is that the market might start to value Tesla more like a traditional car company in the future. Let’s be clear: This would mean a total collapse in the stock price. If you try and value Tesla like other car companies, it looks like Tesla is being given credit for becoming one of the largest global automakers before actually growing to that size.

But that’s a very shorted sighted and narrow way to look at things. Sure, it’s possible that Tesla’s services transformation could fail and they could end up making most of their money selling cars, just like they always have. But it seems like Tesla’s digital services are taking off. If they continue to grow, the market will value Tesla more like a SaaS company or an energy company than a legacy auto OEM.

When you take a look at the list of the Top 25 Global Auto OEMs, Tesla looks hilariously overvalued. How could Daimler sell 2.3 million cars and be worth less than Tesla when Tesla sold less than 250,000 cars that same year? Comparing the numbers to other automakers, it might seem like Tesla is far too high up this list.

The Wrong List

Here’s the problem with comparing Tesla’s valuation with the other companies on this list: These companies all sell cars, and that’s where their similarities to Tesla end. We’ve now examined in detail the digital subscription and energy services Tesla offers today. If we make a list of the top 25 biggest energy, technology, and consumer goods companies where does Tesla stand?

Guess what? It doesn’t even make the list.

Compared to other software and energy companies, Tesla is hilariously undervalued. VMWare, which is worth roughly the same as Tesla booked $9 billion of revenue in 2018. Tesla booked $21B.

Yeah, yeah, let’s not get into an argument about how Tesla is different than these other software businesses. All I’m trying to say is their business sure as hell isn’t the same as legacy auto OEMs. When you put Tesla on the right list, it quickly becomes clear just how large the company could grow.

Autonomous transport, electrification and “the car as software” are “Holy shit” large scale technological revolutions each on par with the creation of the personal computer, the world wide web, and the smartphone. I see no reason why Tesla can’t grow to be worth more than the winners of the last tech revolution: Apple, Microsoft, Google, and Amazon which are each about 10 – 20 times larger than Tesla by market capitalization. I certainly don’t see why Tesla’s technology couldn’t be valued at $100 billion or $200 billion someday –– just slightly more than Volkswagen or Toyota.

Notably, Tesla CEO Elon Musk’s compensation plan doesn’t fully vest until the company hits a valuation above $600 billion.

Did you get all this from that Premium Connectivity email?

Is that what we were originally talking about?

Sorry, my bad… I get lost sometimes thinking about the next generation transportation system Tesla is trying to build here.

Anyway, uh… tl;dr:

Tesla is increasingly offering digital services that will grow to make up the majority of their revenue. Much of this depends on their Autopilot autonomy stack and the rollout of Full Self Driving. If successfully executed, Tesla’s business model transformation should fundamentally alter the way the business is perceived and valued.

Right now Tesla is in this awkward middle stage. It’s smaller than most global auto manufacturers but valued more highly than many of them. It’s very cheap for a software or energy company, but people don’t see it as a tech or energy business yet.

One of two things will happen:

1. Wall Street will start to see Tesla more like a legacy auto OEM, and the share price will crash
2. Wall Street will start to see Tesla more like a tech company, and the share price will soar once it breaks free of the gravity of legacy auto valuations

The way this plays out all depends on whether Tesla is able to start generating its earnings from digital subscription services rather than selling expensive hardware.

I’ll leave you with one final shitty chart:

What I’ve done here is take Tesla’s past sales data and future projected sales and calculated the average amount of subscription revenue per user needed to generate $141 million –– the amount of GAAP net income Tesla recorded in Q3 2019. To turn that profit Tesla had to deliver 97,000 cars, which is more than it ever has in the history of the company. It was a lot of hard work.

In 2012 it would have cost $45,000 per customer to generate that same $141 million. That makes subscriptions to existing customers unviable as a way to generate earnings since the subscriptions would have to cost half as much as the car.

In 2020, the ARPU required will fall to $280. In the decade after that, the average subscription revenue needed to generate a Q3 2019 sized profit would fall under $15 per customer.

This means that if everyone gave $25 of Robotaxi rides a month, or signed up for Tesla insurance, or used a Supercharger, Tesla could generate $141 million in earnings without selling cars. Obviously I’m dramatically oversimplifying but the point is this: Rather than having to work their asses off to achieve record deliveries and turn a profit, in the future money will just roll in even if Tesla doesn’t sell any cars at all.

That’s why Tesla isn’t like any other car company on Earth.

The launch of premium connectivity highlights @Tesla’s transformation into a digital services business. @elonmusk

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One more thing…

Some morons will say: “Well if Tesla is a software and services business why do they make cars at all? Wouldn’t they make much more money just selling their software to every other car maker?”. To those who don’t understand the benefits of a beautiful vertically integrated design when trying to break major new ground, I’ll end with this quote from a software legend:

People who are really serious about software should make their own hardware.

Alan Kay