Tesla's New Car Costs 50% More, Which May Mean Its Disruption of Traditional Carmaking Has Failed

Without scale and a rebuilt supply chain, you can't change the world.

In the car business, where scale beats everything, one announcement from Elon Musk shows that Tesla's plan to use the Model 3 to break into the mass market and become a big automaker cannot happen, at least for now.

On Monday Beijing time, Musk announced on Twitter a new version of Tesla's electric sedan, the Model 3. This top-of-the-line model has motors on both the front and rear axles, goes from zero to 100 km/h in 3.5 seconds, has a range of 500 kilometers, and costs US$78,000.

Under Tesla's current pricing rules, that car would sell in China for around 750,000 yuan — already Model S 75D territory.

Adding one more configuration is nothing. What matters is that Tesla said at the same time that it is shelving production of the $35,000 base Model 3 and will build the more expensive dual-motor cars first. Musk put it bluntly on Twitter: "Building a $35,000 Model 3 right now would cause Tesla to lose money and die."

That day, the cheapest Model 3 anyone could order rose to $54,000, and that does not include the $5,000 Autopilot advanced driver-assistance software upgrade. The lower-spec cars have been pushed back with no date attached. Musk said the point to look for is roughly three to six months after Model 3 output reaches 5,000 a week (right now weekly output is under 2,500).

Now we know why, a few days earlier, when several analysts pressed Musk on the Model 3's average selling price and profit margin during Tesla's earnings call, he called the questions "boring" and refused to answer.

A 50% "Price Hike": The Model 3 Goes From Mass Market to Niche

To make money, a carmaker needs scale. Toyota and Volkswagen, the two most valuable companies in the industry, each build more than 10 million cars a year. Even BMW, a luxury brand by conventional reckoning, builds 2 million.

Tesla, a small company that builds 100,000 cars a year, was once worth more than $50 billion — more than Ford, and about a quarter of Toyota. That gap between what it produces and what it is worth is the future the Model 3 was supposed to deliver.

15

times

Every car Tesla builds holds up $500,000 in market value, 15 times BMW's figure

Measured by 2017 output and market value at the end of 2017, each car Tesla built held up nearly $500,000 in market value. Each car BMW built held up $33,000 — a 15-fold difference.

There is no obvious logic to this. Tesla has no all-powerful internet "ecosystem"; almost all of its revenue comes from selling cars, no different from BMW, which also sells luxury cars. What the market is paying for is the future the Model 3 brings once it is in mass production.

In today's market, the fiercest fight is over $40,000 mid-size luxury sedans. Take BMW, Mercedes-Benz, and Audi: their best sellers — the 3 Series, the C-Class, and the A4 — all sit in that $40,000 range.

In China in 2017, those three models sold more than 650,000 cars between them (taxes push the actual prices there above $40,000). Worldwide, the three sold a combined 1.23 million in 2016. That is far more than the 100,000 a year Tesla was selling with the Model S and Model X.

The Model 3, which opened for reservations in 2016 and started coming off the line in 2017, was aimed at the same price point. It started at $35,000, and within a week of the launch 400,000 people had put down a refundable $8,000 deposit.

The cheapest Model 3 came with a long list of limits: 350 kilometers of range, no self-driving, no wood trim or power seats, no fog lights, and black paint as the only choice. Add a few options and the price could pass $50,000. Even so, the average selling price counted so far is only $42,000, which means a good share of buyers ordered the base car.

Now the Model 3 no longer really offers a $35,000 version. The cheapest dual-motor car starts at $54,000, close to a BMW 5 Series or a Mercedes E-Class. Obviously the Model 3's size and positioning are nothing like the so-called "large luxury sedans" of the 5 Series class.

As for the top Model 3 Musk just announced, $78,000 puts it in the price band of luxury cars like the BMW 7 Series. But in 2017 the three benchmark cars at that level — the BMW 7 Series, the Audi A8, and the Mercedes S-Class — sold 52,000 units in China between them, about 8% of the B-segment market the BMW 3 Series sits in.

That split between luxury and mass-market volumes holds worldwide as well. So the market the high-spec Model 3 now aims at has shrunk by more than 90%.

The Model 3 is also weaker as a competitor in an expensive market. After the price change it faces the "full-size luxury sedan" class, where carmakers put their flagship products. Those cars carry a company's most advanced technology and also luxuries that go beyond function — real leather seats, natural-material trim. In size and in features, the Model 3 is now further from an S-Class or a 7 Series than ever.

An $80,000 Model 3 also starts competing with Tesla's own Model S: a Model S 75D with the self-driving option costs about $80,000 too, and next to the Model 3 it is bigger and does not come with an open-ended wait for delivery.

For the Model 3 and for Tesla, the Point Is to Take Market Share

Tesla bought its Fremont assembly plant in 2010, and its first real mass-produced car, the Model S, went on sale in June 2012.

Bradley Berman, writing for the Wheels auto column at The New York Times, said at the time that "changing the game" is a phrase carmakers love when they launch a model, but that nothing fundamental about the design or use of a car had changed since Henry Ford introduced the Model T a century earlier — "until I spent a week with the Model S."

The Model S, starting at 333 kilometers of range, was a breakthrough, and the breakthrough rested on Tesla going around the traditional auto supply chain.

Charging is far slower than filling a tank, so short range has always been a big obstacle to electric cars. Add weather and the power the heater draws, and electric cars before the Model S often managed less than 100 kilometers in real use — not enough even for daily driving inside a city. Because mainstream carmakers did not take electric cars seriously then, the industry's supply chain had no reason to solve the range problem.

For a century the core products of mainstream carmakers and parts suppliers were built around gasoline cars, and they do not suit electric ones. Today, apart from core pieces like the engine, chassis, and body, a gasoline or diesel car's parts — the transmission, the brake discs and pads — are mostly not made by the carmaker, which works with established suppliers instead.

By that measure the Model S did deserve the praise for changing the rules. Generic parts — door hinges, windshields, brakes, the aluminum body — were things the existing supply chain already handled well. But Tesla's most important technology, the batteries and the systems that manage them, it obtained itself or through joint ventures.

The batteries above all. Tesla's packs used 18650-format ternary lithium-ion cells (nickel-cobalt-manganese), a type long used in laptops, digital cameras, and other consumer electronics. Their energy density was 50% higher than the lithium-carbonate batteries then common in electric cars.

Later, as governments pushed electric cars for environmental reasons, the big traditional carmakers and their suppliers started to move. By 2016, GM's Chevrolet Bolt had finally matched the Model S on range.

Meanwhile Tesla was preparing the Model 3, writing its own battery specifications and expanding its factory. In Musk's words, the goal was to be "more Ford than Ford is today." The old Ford made everything itself, invented the assembly line, and turned the car from an expensive toy for the few into something the middle class could buy.

The Model 3 was likewise meant to cut production costs ahead of the rest of the industry and be the first to put a high-performance electric car within everyone's reach. Before 2015, Tesla's electric cars were far ahead of the field on performance; cars like the Nissan Leaf were cheaper but had a third to half less range.

By 2016-2018, traditional carmakers were bringing out products to compete with the Model S and Model X. But the Model 3 offered the same range and the same driving experience for less money than its rivals — and price decides directly how many potential buyers there are.

To build a $35,000 Model 3, Tesla put up a robot factory far more automated than anyone else's, trying to make the car at the lowest possible cost. In Musk's 2016 telling, Tesla's plant would look like an "alien dreadnought" next to other car factories, and once the factory reached version 3.0 there would not be a single worker on the line.

If everything went to plan, in a few years Tesla would become another company the size of BMW, holding the profitable mid-to-high-end electric car market.

Things have not gone that way. In a late-March analysis, Bernstein analysts said Tesla had struggled too long with a fully automated factory, spending heavily on industrial robots from Kuka — robots that were far worse than workers at some traditional carmaking steps, such as final assembly.

Tesla has put several billion dollars into building the Model 3, and the ramp-up is still slow. Since it formally announced the mass-production plan in the second half of 2017, the company has missed its targets again and again.

The original plan called for 5,000 Model 3s a week by early 2018; actual output was a tenth of that. By the end of the first quarter this year, output still had not reached the lowered target of 2,500 a week. It stood at 2,270.

Compared with the years when it built 30,000 to 50,000 Model S sedans a year, Tesla's production load and its command of the assembly line have improved a great deal.

But with this change, the Model 3 is no longer the mid-priced car it was at launch, and Tesla's push for scale is shelved once more. At a moment when the supply chain is still not mature enough to let carmakers easily build a mid-priced electric car, Tesla's do-it-yourself plan is not going smoothly either. For the string of Chinese companies copying it, none of this is a good sign.

For Tesla itself, missing production targets has also cost it Wall Street, which once hoped Tesla would be the next Ford or GM and is no longer willing to grant it a higher valuation. Since Tesla announced the Model 3 in the middle of last year, its share price has fallen 25%, erasing $10 billion in market value and returning to 2014 levels.

By the Financial Times's count, short sellers had sold about $12 billion of Tesla stock as of the end of April, making it one of the most heavily shorted stocks anywhere. Moody's, one of the world's three big rating agencies, cut Tesla's corporate family rating to junk in March, meaning Tesla could default on its debt and will pay higher interest on the bonds it issues.

Last week Goldman Sachs made a gloomy forecast: by 2020, Tesla will need to raise $10 billion through equity and debt refinancing simply to keep current operations running and to pay for new product development, higher output, and other projects.

Oil Prices Rise, and Electric Cars Enter a New Cycle

The Model 3's production trouble has arrived at a bad moment. European countries announced aggressive electric-car plans last year, and oil prices are climbing again. Both could push more buyers toward electric cars.

By now every mainstream car company in the world has announced a plan to switch to electric. Volkswagen was early, announcing an $80 billion electrification plan in mid-2017. Toyota was late: in early 2018, leaning on the China market, it stopped emphasizing the hybrid and fuel-cell technology it had long led on and said it would launch 20 electrified models in China. Against its more cautious 2020 electrification plan from 2017, Toyota has clearly changed its thinking.

By 2019 and 2020, new cars at the Model 3's price and with even longer range are coming — the Mercedes-Benz EQ, Volkswagen's I.D. line, and others. And a day earlier, Mobileye, Tesla's original driver-assistance supplier, bought by Intel for $15 billion, won a large order to supply an autonomous-driving system to an unnamed European carmaker, covering 8 million vehicles.

Cars are a scale business. For a traditional car company, developing a mainstream model always means mass production of at least a million units. These bigger companies have assembly lines tuned over decades, better sales networks, and brands the mass market knows far better. Tesla needs to take more of the market before they are fully ready, and to turn itself into a much bigger business.

Not all the recent news is bad for Tesla. China is going to lower its barriers further. On last quarter's earnings call Musk said details of a China factory would come this year, and in May Tesla registered a new wholly owned company, Tesla (Shanghai) Co., Ltd., in the part of the Shanghai Free Trade Zone set aside for carmakers. Tesla appears to want its China plant built as fast as possible.

A faster factory means faster growth in Model 3 output, and in theory a faster restart for the cheaper car that has the bigger market.

Tesla is the only new international carmaker to rise since the Korean companies, Hyundai among them, came up in the 1970s and 1980s. Whether it becomes a mainstream one depends on how fast it can move over the next two years.

Unless otherwise credited, the images in this article were taken by the author.

Cover image/Pixabay