BMW Vs. Tesla: A Real Live Innovator’s Dilemma

Editor’s note: Peter Yared is the Founder & CTO of Sapho and was formerly the CTO/CIO of CBS Interactive.

Jill Lepore genereated quite a fracas in Silicon Valley with her New Yorker article that questions disruptive innovation and posits that large incumbent companies often survive and subsume disruptive technology with small incremental gains. Fortunately, we have a live Petri dish: BMW’s new electric i3 is an ongoing case study of a legacy manufacturer facing an innovator’s dilemma in the face of Tesla, a very aggressive new competitor with next-generation technology.

Elon Musk has defined the standard for a future mass-produced electric car – it must cost around $40,000, have a range of 200 miles, and be comparable to a BMW 3 series. In order to achieve that audacious goal, Tesla is embarking on a plan to build a “Gigafactory” capable of producing batteries at an efficient and lower cost that would make such a dream car feasible. Investors are betting that Tesla will be able to dominate the electric car market when it achieves scale, continuing a growth rate that values Tesla at $28 billion even though it only produces 35,000 vehicles a year. It is interesting that Musk directly compared the Tesla’s upcoming mass market Model 3 directly to the BMW 3 series, given that BMW is now delivering its new i3 to the US market in accessible volumes.

There are lots of great lessons for entrepreneurs to learn from watching the BMW versus Tesla battle since cars are so tangible and manufacturer sales tactics are so transparent.

Brand

Even though it has a “3” in its name, the i3 is decidedly not a 3 series BMW. It is two feet shorter, and should instead be in the BMW 1 series product family. The i3’s electric range of 80-100 miles makes it more similar to electric cars like the Nissan Leaf and the Chevrolet Volt and nowhere close to a technological wonder like the Tesla Model S.

Despite its limitations, the i3 is clearly resonating, with rave reviews and a price that is spiking over the last month on TrueCar, indicating high initial demand in the United States. BMW has (mis)used the power of the 3 series brand to its benefit, and can now add features like longer length and range incrementally as battery technology improves.

Lesson: Legacy companies can mislabel their products to leverage their brand, especially if an upstart compares itself directly to a particular model.

Technology

BMW invested tremendous resources in its electric car platform to develop an all-electric vehicle platform, and it is willing to integrate legacy technology in order to deliver immediate value to its customers. Conversely, Mercedes chose a partnership route and is buying the drivetrain and battery technology for its upcoming electric car from Tesla. Both BMW and Mercedes are well ahead of Tesla in advanced vehicle technology like self-parking and cruise control that can automatically follow highway lanes and maintain distance from other vehicles.

Rather than waiting for battery technology to evolve to make an all-electric car with a 200-mile range at a mid-range price point, BMW is selling an optional “range extender” consisting of a two cylinder motorcycle engine that maintains the batteries at a 5 percent power level and extends the car’s range an additional 80 miles. Since the range extender powers the batteries rather than a gas engine, the i3 is not a hybrid, but the range extender can be continually refilled so that the car is never stuck without power. It’s a total hack, but is well thought out and competitive. BMW’s engineers must have been giggling when they came up with this one.

With the i3, BMW has delivered a “good enough” luxury electric car for the urban driver and average commuter, who can also optionally use the car for longer trips without having to plan for supercharger stations.

Lesson: Legacy companies are often willing to hodgepodge new technology with their older technology to stave off new competitors.

Volume 

Tesla shipped its first car in 2006 and is expecting sell 35,000 Model S sedans in 2014, or roughly 17,500 units in the second half of 2014. BMW started selling i3’s in 2014 and sold 6,000 i3’s in the first half of the year, primarily in the European market, which now has 3 to 6 months waits for the car. Now that demand is spiking, BMW increased production to 20,000 units annually and is now producing 100 units a day, a run rate of over 30,000 units annually. The fact that a legacy manufacturer is on the verge of outselling Tesla in its own luxury electric segment in the first year of shipping is fascinating given Tesla’s superior product and years of market lead.

Lesson: Once legacy companies have hodgepodged technology, they can produce it at scale.

Sales

While Tesla is right in attempting to disrupt the antiquated dealership business model, BMW will be able to leverage its extensive dealer network to deliver to consumers worldwide, and consumers can use web services like TrueCar and Beepi to bypass the hassle of negotiating with dealers on the price of a new car and trade-in amount. BMW also has access to a deep well of financial incentives to drive consumers to buy cars. Auto manufacturers and their dealers are fighting Tesla with regulatory measures to slow the company down and limit market penetration.

Lesson: Innovators should not underestimate the power of a legacy company’s large, lumbering sales channel.

Market Entry

Tesla had to enter the market at the high-end in order to deliver batteries capable of long ranges at a margin that would deliver profits to fickle investors, years before it could deliver a mass market mid-range vehicle. BMW’s breadth enables it to enter at the mid-market and then move up into the ultra high-end next year in the U.S. with its i8 supercar. To BMW, the distinctive, urban-friendly i3 is essentially a rolling advertisement for BMW’s innovative and green future, so the company could even sell them at a loss and come out ahead.

Tesla’s high-end first approach could turn into a liability as the Tesla S is quite large and therefore not well suited for urban environments – it is wider than and almost as long as a 7 series BMW. Large, luxury four door sedans are typically purchased by upper middle class men over the age of 35 which, as a member of the demographic, I unfortunately have to admit we’re not exactly the most hip crowd. BMW examined the market thoroughly and is targeting hip, young, urban professionals with the i3’s forward design, a smaller urban-friendly size, and the brand’s proven appeal with a younger demographic.

Lesson: Legacy companies are often in numerous segments of a market and leverage their scale to beat an upstart’s roadmap.

Who Exactly Is Getting Disrupted?

The big question is what industry exactly are electric cars are disrupting? At first it seemed like the legacy auto manufacturers would not be able to step up to an electric car challenge. They have widely adopted hybrid electric cars, are now delivering somewhat competitive electric cars, and are continually experimenting with hydrogen fuel cells. From a broader view, it is possible that ExxonMobil and Chevron will be more disrupted by electric vehicles rather than BMW and Chevrolet.

Elon Musk is an entrepreneurial hero who is concurrently disrupting the passenger vehicle, space transportation and electric utility industries. Some of the legacy companies in those industries were bound to wake up at some point and respond aggressively. Fortunately, Musk can rest assured that the United Launch Alliance will not be as agile against SpaceX as BMW has been against Tesla!

Disclosure: The author is number 6,250 on the Tesla Model X waitlist.