Published on November 17th, 2020 |
by Johnna Crider
November 17th, 2020 by Johnna Crider
Dillon Loomis of the YouTube channel “Electrified” has shared a video on YouTube of Tasha Keeney from ARK Invest speaking about Wright’s Law, Tesla, and why many are still not understanding Tesla and its electric revolution. In the video, Tasha Keeney shared what she believed people are missing about Tesla’s stock. “So, for a long time, we’ve heard that there’s this demand problem with electric vehicles. To us, that’s a kind of a crazy idea, because if you look at this from a cost perspective, we’ve done the modeling using something called Wright’s Law. It’s a derivation of Moore’s Law.”
What Are Wright’s & Moore’s Laws?
Moore’s Law is the observation that the number of transistors in a dense integrated circuit doubles about every two years. It’s an observation and projection of a historical trend. In terms of investing, Moore’s Law states that the number of transistors on a microchip doubles about every two years while the cost of computers is halved. It tells us that we can expect the speed and capability of our computers to increase every couple of years and that we will pay less for them. Wright’s Law aims to provide a reliable framework for forecasting cost declines as a function of cumulative production more broadly. It states that for every cumulative doubling of units produced, costs will fall by a constant percentage.
“So, we think that battery costs are declining such that, by 2022, a mass-market EV will be cheaper than a gas-powered car,” Keeney explained in the video. Dillon took this moment to dive deeper into Wright’s Law and why it’s important for Tesla as the core driver behind the EV revolution. In 1936, Theodore Paul Wright, a U.S. aeronautical engineer and educator, determined that for every doubling of airplane production, the labor requirement was reduced by 10–15%. At its most basic level, the cost of each unit produced decreases as a function of the cumulative number of units produced.
For those who love math, Dillon explains the Wright’s Law formula: “Y equals AX raised to B where Y is the cumulative average time or cost per unit, X is the cumulative number of units produced, A is time or cost required to produce the first unit and B is the slope of the function.”
Moore’s Law, Dillon explained, focuses on cost as a function of time. Gordon Moore predicted that the number of transistors on a chip would double every two years. Moore’s Law also attempted to answer why technology cost declined over time, but it instead focused on the wrong variable, time, instead of focusing on the mechanism behind the actual cost declines — production volume.
“Moore embedded in his law an assumption that, over time, unit demand and thus production volumes would respond to continuous price declines. Instead of forecasting cost as a function of time, such a formula needs also to include production volume — the driving force behind cost declines,” Dillon said. Wright’s Law can be applied to pretty much any industry. Dillon examined a chart spanning a decade from ARK and noted that when using Wright’s Law, the accuracy of the chart was 40% higher than when using Moore’s Law.
Applying Wright’s Law To The Model 3 Production
“So, we think that battery costs are declining such that by 2022, a mass-market EV will be cheaper than a gas-powered car. Once that sticker price changes, you get a massive uptick in demand, so we don’t see demand being an issue at all for the company, and that cost equation will also help Tesla’s margins. So, right now, auto margins set out about 20% — a little bit less if you take out credits. We think that could go to up to 40% if you follow Wright’s Law, which is forecasted cost declines in the auto industry for over 100 years.” — Tasha Keeney, ARK Invest
Looking at Tesla’s recent quarterly data (Q3, 2020), Dillon pointed out that Tesla’s auto margins are now up to 27% and 23% without regulatory credits. “So, seemingly on their way to the 40% Tasha and ARK are eventually expecting,” Dillon added while posing a thought as to why he thinks this is happening. “If we start by looking at Tesla’s Model 3 cost decline curve, we see that for every cumulative doubling of its production, Model 3 costs have fallen by about 15% — and a very important note here, cumulative does mean the number of Model 3s manufactured since its launch.”
Some may think that the cost will eventually go down to zero, but in the chart Dillon looked at, the x-axis is not a function of time but of the total number of units produced in the history of the product. “Think about this,” Dillon Loomis of the YouTube channel “Electrified” has shared a video on YouTube of Tasha Keeney from ARK Invest speaking about Wright’s Law, Tesla, and why many are still not understanding Tesla and its electric revolution. Dillon explained, “A cumulative doubling of the number of units ever produced becomes exponentially more difficult and would eventually outpace the demand. Because of this, the line will terminate at a fixed point rather than $0.”
Applying Wright’s Law To EVs vs. ICEVs
Worldwide, automakers have only made around 4 million EVs over time, which is less than 1% of the 2.5 billion of the internal combustion engine (ICE) vehicles ever made. “Let’s say that ICE vehicles stabilize at 90 million vehicles per year,” Dillon theorized. “That would mean to cumulatively double the production would take 29 years. Compare that to about one year right now for the doubling of cumulative electric vehicles. Wright’s Law applies equally to both EVs and ICEVs, but the difference in time to achieve the cumulative doubling explains the difference in annual cost declines. The cost of the average ICE vehicle will go down by about 0.5% in the coming year while its EV counterpart costs will drop around 12%. This is how Tesla has been able to lower the cost while also increasing their auto margins, and this is all without autonomy.”
Tasha’s Thoughts On Autonomous Driving & The Markets In the Coming Years
Dillon’s video included Tasha’s thoughts on autonomous driving, which she pointed out is a massive opportunity that will expand the ride-hailing market, reduce accident rates by about 80% and even boost GDP:
“Only recently have we gotten any questions on autonomous driving and it’s something that Tesla’s been talking about for years, and this could totally change the business model. It’ll be a recurring revenue model like ride-hailing as opposed to a one-off sale. We think that’s a massive opportunity. We think this is going to expand the ride-hailing market and give a lot of people access to really cheap point-to-point travel that don’t have it today, particularly in markets like China. Of course, they’ll be much safer.
“We also think autonomous will reduce accident rates by about 80%. It gives back time to the consumer and what’s interesting sort of if you look at this on an economic perspective, that’s really unpaid labor that’s all of a sudden going to go into services. So we also think it’ll boost GDP. The U.S. will be the first market where this happens and I think within the next year you could see Waymo opening up its service to the general public.”
“Tesla … is coming a little bit from behind in terms of capability but could be a really large player because of their scale. That could be something more like in 2021. I think China will likely be the next market maybe a year or two after that, and then, in terms of the largest auto markets, Europe will probably be the most behind — maybe a year or two after that.” Dillon noted that the software as a service is already impacting margins, but the revenue and margin potential in this space will increase substantially from the levels they are at today.
Wright’s Law & Lithium-Ion Batteries
Pulling up another graph, Dillon shared an incredibly important point. “You could assume that lithium-ion battery cost declines have plateaued since 2005 after two decades of declining roughly 10% each year. However, the thing that’s overlooked is these 10% annual cost declines pushed the unit cost of lithium-ion batteries across a critical threshold which enabled the production of electric vehicles at scale.
“Using this, analysts could have forecasted that the time required for the cumulative doubling of production of lithium-ion batteries would drop in this scenario and that the decline in cost would then re-accelerate. Wright’s Law did correctly anticipate a re-acceleration in cost declines and the decline in prices due to the production ramp in the industry from the lithium batteries crossing that critical price threshold. It has also opened up new segments of the auto market to use lithium-ion batteries and, of course, a much bigger push toward utility-scale energy storage as well.”
Dillon noted that in order to land this plane, the cost declines that are expected from increased production volumes of lithium-ion batteries and EVs are the core driving factor for the electric revolution. “Not only will the ICE technology become inferior to electric, but Wright’s Law shows us that the cost declines from technology in the EV space should far outpace any small declines in the ICE space.” This is due to doubling the production of cumulative ICE vehicles is more challenging and time-consuming (roughly 30 years) compared to EVs, which only take around one year.
Tesla Is Sustaining Wright’s Law
“When you factor in the pace of innovation at Tesla at every level of the company, it becomes easy to see what’s going to happen when the cost declines hit parity with ICE cars,” Dillon pointed out. After Tesla’s Battery Day event, ARK analyzed whether Tesla’s innovations put the company on a new cost decline curve or whether ARK’s Wright’s Law analysis for lithium-ion batteries had predicted this cost of decline. ARK concluded that, given its battery breakthrough, Tesla is sustaining Wright’s Law, not only lowering costs by 56% on a $/kWh basis but also increasing range by 54% thanks to Tesla’s vertical integration, which ARK believes is unparalleled in the industry. ARK noted that Tesla may be parting company with its EV competition by focusing on dollars per range and vehicle performance.
You can watch Dillon’s full video here.
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