Elon Musk's Basic Economics

Imagine the fundamental market change that would bring. Imagine the amount of demand there would be for that $2,000 car or $100 laptop or $70 iPhone. That’s what Elon Musk imagined 15 years ago when he sat on a pile of $165 million dollars. Elon Musk’s businesses are all centered around some the most basic principles of economics out there. When he starts a business, he’s not necessarily trying to do something new, he’s trying to do something right.

Musk made most of his early fortune through his involvement with PayPal. In 1999 he founded a company called X.com which was quickly bought by Confinity—the creators of PayPal—so when PayPal was bought by eBay in 2002, Musk’s 11.7% ownership of the company translated to $165 million dollars. Elon Musk has always been deeply passionate about space exploration and, as anyone knows, public interest in space has been falling since the Apollo era.

Therefore, Musk’s plan with his newfound fortune was to launch a rocket to mars carrying a small greenhouse that would grow plants on the surface of the red planet. Basically, he wanted to take all his money and put it into a big publicity stunt for space exploration. But he had a problem—it was too expensive. The cost of launches was absolutely immense and, even when Musk tried to buy decommissioned Russian ICBM’s, he couldn’t find a way to pull off the project, but he had discovered something.

The space launch industry was ripe for disruption. Here’s Joseph, the economics expert from Real Life Lore to explain why. “The rocket development and space-launch companies before Space X were essentially aggregators. They bought engines and guidance systems and all the other various components from other companies to cobble together one completed rocket. But all the different component suppliers also had their own component suppliers to make their product.

The suppliers of the suppliers not only had to cover their development and manufacturing costs, they had to sell their components at a markup in order to make a profit, and then the next component manufacturer had to do the same which means that by the time the component gets to the company assembling the rocket, it’s expensive. Not only that, but the assembly company also has to pay for employees that work to actually figure out how to make all of the different pieces work together. SpaceX however, works differently. It makes 85% of the components it uses itself, which allows it to make cheaper parts.

For example, if SpaceX had bought their radios externally they would be paying $50,000-100,000 dollars each, but since they develop them internally they only cost $5,000 each to build, a dramatic improvement in reducing cost.” Joseph from Real Life Lore has a brand new book which includes two fantastic chapters explaining simple economic concepts like this that I’ll link in the description, but let’s talk Tesla. Tesla’s economic strategy is fairly similar to SpaceX’s. Tesla themselves makes about 80% of the 5,300 parts in a Tesla car, but for the most part they don’t make these, the batteries, at

least yet.

Batteries are very difficult to make at a competitive price so very few companies do. The largest three manufacturers—Panasonic, BYD, and LG Chem—make a combined 63% of the world’s batteries. Tesla, therefore, has historically just bought batteries from Panasonic at a cost of about $200 per kWh. But that means that Tesla’s smallest battery pack, the 50 kWh version, costs $10,000 dollars just in components. When you’re trying to sell a $35,000 dollar car and make a profit, that’s a significant cost that can be reduced. Therefore, Tesla is attempting to reduce the cost of their batteries by 30% by building their own factory in a joint-venture with Panasonic.

Their long-term goal, however, is to drop the battery price below $100 dollars per kWh which would either double the range or halve the price of that 50 kWh battery pack. But the vertical integration of Tesla and SpaceX isn’t all useful. The companies basically have to learn and perfect each step in the manufacturing process and, if one step isn’t working, no cars get made. For example, the Tesla Model 3, the low-cost Tesla, is built using steel instead of aluminum like the Model S and X.

With this change, the manufacturer is having troubles properly welding the vehicle bodies together and so the entire production line is slowed down massively. But there's something else unique about SpaceX and Tesla’s production lines—they’re in the US. Now this probably seems counterintuitive—why would you put the production lines of two companies working to make the least expensive products on the market in one of the most expensive labor markets in the world? Almost every US company has relocated their production lines to cheaper labor markets in Asia and Africa but Musk has always had his in the US.

Believe it or not, this isn’t a PR move. It actually makes sense for the two companies. Tesla and SpaceX’s production processes are constantly being tweaked and optimized as the companies learn to make their products. While China might be able to build Tesla cars at the same price by using cheaper human labor, Tesla’s US factory is just miles away from its headquarters in Palo Alto meaning that the executive, development, and production staff are all heavily integrated and can make changes fast. SpaceX even takes this a step further. It’s offices and manufacturing lines are all under one roof.

The Tesla factory in particular is also heavily automatized and the US excels in production line automation with its abundance of highly skilled workers, but just how much is Musk dropping the price on his products? The United Launch Alliance, which historically has won most of the highly lucrative US government launch contracts, is believed to charge more than $400 million dollars all-in for a military satellite launch while SpaceX charges about $80 million dollars. So, SpaceX is already at a fifth of the price, but as mentioned, Elon Musk wants that to fall to a tenth. Here’s the key for that—the fuel used in the Falcon 9 rocket only costs about $200,000 dollars per launch—it’s practically a non-factor in the launch price.

The real cost is of the rockets themselves, so that’s why SpaceX is making them reusable. The first stage of the rocket is now being designed to land back on earth and be put back into service with dozens more launches. Once this system becomes reliable, it’s believed that the cost savings will drop the launch price to $40 million dollars—a full 10 times cheaper than United Launch Alliance’s military launch price. SpaceX’s long-term goal is to get the launch price down to about $10 million dollars per launch. While the company has already made a significant impact on the space industry, a launch price as low as this would fundamentally change what’s possible in space.

Real space tourism would become feasible, commercial satellites would become downright commonplace, and Space would become closer than it’s ever been. But SpaceX does have a bit of a problem—people aren’t really buying more rocket launches even though prices are down. It’s what’s known as a price inelastic market. That’s the opposite of Tesla and the electric vehicle market where lower prices lead to huge increases in sales. The problem with the space launch market is that it is not a consumer market—normal people don’t buy rocket launches. Governments buy rocket launches and they don’t care about price nearly as much as people since it’s not the decision makers’ money.

The US Air Force, for example, decides they need to launch a certain number of satellites each year for the national security reasons and they’ll pay whatever it takes. But Elon Musk’s life goal is to get humanity to Mars—that’s why SpaceX exists—and he needs money to do it. Lots of money. So, SpaceX is getting into the internet business. The company is actively developing a satellite constellation that would provide high-speed internet to anywhere on earth.

Thousands of small satellites would be put into low earth orbit and then anyone worldwide could hook into the network using an inexpensive ground receiver. If SpaceX got just 50 million users out of the 7 billion in its proposed service area, this business could bring in $30 billion dollars a year. Since SpaceX would be building and launching the satellites themselves, costs would be dramatically lower than the competition’s. The whole commercial aspect of SpaceX essentially exists to fund Musk’s future space exploration projects.

For that reason, SpaceX is not a public company like Tesla. Elon Musk does not want to make money with SpaceX, he wants to get to Mars. He does not want to be beholden to shareholders and profitability. Musk has therefore publicly said that SpaceX will not go public until the company achieves regular flights to and from mars and thanks to the entrepreneur’s understanding of basic economics, that might not be too far off. If you’re looking to start a company, you’ll need not only an understanding of basic economics but also a domain. Hover makes finding and purchasing your domain super simple.


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