Tesla’s latest challenge is finding new customers for the Model 3
With the $35,000 Model 3 still not for sale, the company is turning to Europe and China
As Tesla transitions out of a year full of Model 3 “production hell” and “delivery hell,” a new question has emerged: how many more customers are there for the car?
This question was repeated a number of times during a call with industry analysts on January 30th where Tesla discussed its full financial results for 2018. Tesla still hasn’t started production of the $35,000 version of the Model 3 originally promised in 2016, and some on Wall Street are worried that the company has tapped out demand for the higher-priced versions of the car in the United States — especially as other automakers are warning of a rough 2019 as car sales cool worldwide.
It would be a stark turnaround in the story of Tesla, considering the company spent most of 2018 proving it could make enough cars to satisfy hundreds of thousands of preorders. “Tesla has now shifted from a production story to a demand story,” Wedbush analyst Daniel Ives wrote this week. There is clearly “heavy lifting ahead,” he said.
Tesla CEO Elon Musk dismissed the issue of demand a number of times on that call. “The demand for Model 3 is insanely high. The inhibitor is affordability,” he said. “It’s just, like, people literally don’t have the money to buy the car. It’s got nothing to do with desire. They just don’t have enough money in the bank account. If the car can be made more affordable, they will… the demand is extraordinary.”
So, according to Musk, the problem in the US is pricing. When that’s addressed, the demand will be there, just like it was when Tesla sold about 140,000 higher-priced Model 3s in 2018 during the first full year of production.
But it’s still not clear when that pricing will change. Musk admitted on the call that Tesla still hasn’t figured out how to make a Model 3 it can sell for a profit at that $35,000 price point. Until it does, the Model 3 still costs thousands — in some cases, tens of thousands — of dollars more than the originally advertised base price.
Tesla dropped the price of the current cheapest version of the Model 3 to $42,900 last week after lowering it by $2,000 in January. But the car still starts at about $6,000 more than the current average selling price in the US, which was $37,149 in January, according to Kelley Blue Book. Depending on certain options (like Autopilot or all-wheel drive), the Model 3 can cost as much as $70,000. In fact, a tricked-out Model 3 can become so expensive that Tesla recently removed the base versions of the Model S and Model X to avoid overlap, Musk said.
Unless there are further price cuts, the Model 3 is only going to get more expensive because Tesla’s cars are no longer eligible for the full $7,500 federal tax credit for electric vehicles. When the $35,000 Model 3 finally does arrive, which Tesla’s website says is still “4 to 6 months” away, there might only be a few months of overlap with any federal tax credit at all.
That’s because the automaker passed a crucial threshold last summer when it sold its 200,000th car in the US, which caused the federal tax credit to be cut in half to $3,750 on January 1st of this year. The credit drops again on July 1st to $1,875, and it will expire completely at the end of the year. State incentives can knock as much as $2,500 off the cost of the car, but $32,500 would be a long way off from the original dream of an under-$30,000 price tag after the federal tax credit. And that’s giving analysts pause.
“Despite management’s focus on expanding supply, we believe that pent up demand for the higher priced variants in the US has largely been exhausted,” Cowen’s Jeffrey Osborne wrote in a note this month.
“[G]rowth rates domestically appear to be rapidly decelerating,” he added. Reports of low sales figures in January and cuts to the company’s delivery team during recent layoffs have only added to that worry. This is why, in the short term, Tesla will “need to rely on these higher priced variants in Europe and China to offset” a dip in sales Stateside, according to Osborne.
(Tesla says it does not break out sales by country or region and would not comment on the reported January sales figures. It described the report about the cuts to the delivery team as “not accurate” in a statement, adding that call center employees at the location in question are still scheduling deliveries. Musk also said offering leases on the Model 3 — something it doesn’t currently do — would be another way to boost demand, but added he’s hesitant because it could make the company’s financials look worse.)
Both of those new markets for the Model 3 represent huge opportunities for Tesla in building on the car’s momentum. China is the largest EV market in the world, and Europe is on par with the US. Musk said on the call that he believes success in these new markets could someday lift Tesla sales “something on the order of” 700,000 to 800,000 Model 3s per year in a strong economy.” In a recession, he estimated, that could slip to about 500,000.
It’s not clear what the road to those kinds of global sales figures looks like, though. Tesla can’t yet make that many cars in a year, let alone that many Model 3s. The company only expects to sell between 360,000 and 400,000 cars worldwide in 2019, with around 100,000 being Model S and Model X, according to estimates the company released this month.
Tesla’s manufacturing capacity at its Fremont, California factory is also nearly tapped out. The company’s operation there was already “bursting at the seams” when the company started making Model 3s in a tent in the parking lot last summer. Tesla broke ground on a Gigafactory in China last month where it plans to make more Model 3s (specifically for that region), but production won’t start until the end of 2019 at the earliest.
Musk said on the January 30th call that the Shanghai factory is the “biggest variable for getting to 500k plus [Model 3s] a year.” Tesla’s best guess is it will be able to make 7,000 Model 3s per week by the end of the year, which means the company will spend most of 2019 making Model 3s at or near its current pace of production.
Meanwhile, Tesla hasn’t provided concrete information about the number of reservations it’s taken so far in China and Europe. In response to a question from Goldman Sachs earlier this month, Musk said there’s “absolutely” more demand beyond the reported 20,000 ordersalready placed in Europe and the “single digit thousands” in China.
He also said Tesla isn’t concerned about demand in Europe or China right now, and that the company is currently focused on hammering out the basic logistics of getting Model 3s to both places. But there are barriers in both markets. Tesla has had some trouble with early deliveries in Europe, and, in the case of China, Musk said Tesla is racing to deliver Model 3s before the trade war sparks any new tariffs. Pricing is already a challenge there for non-Chinese automakers, and likely will be until Tesla gets the Shanghai Gigafactory up and running. The company has already been tinkering with pricing and options there as a result.
Eventually, Tesla will have to care about demand for Model 3 sales in those markets because sustaining sales of the car is key to keeping the company out of the red. Tesla lost $1 billion across 2018, but it turned a profit in the final two quarters, thanks in part to the Model 3 reaching unprecedented levels of popularity for the company. In its first full year of production, Tesla delivered around 140,000 Model 3s, which is 40,000 more than the Model S and X combined and almost as many cars as it delivered in all of 2016 and2017. The Model 3 outsold a number of premium vehicles from the world’s biggest automakers, like the BMW X3 SUV or the Mercedes-Benz C-Class.
One key to that success was the pent-up demand for the Model 3 that came from taking hundreds of thousands of reservations for the car over the past few years. This meant sales were almost directly tied to how fast the company could make (and ship) the cars. As many as about 450,000 people had placed preorders for the car, so the more Tesla made, the more sales it could claim. (This is why there was so much focus on the Model 3’s production “ramp” throughout 2018.)
That changed heading into the second half of 2018. Tesla stopped taking reservations in the US. Instead, it allowed direct orders to come in in an effort to move more of the higher-priced versions of the Model 3 that the company has been making. This flipped the script: the company is now making a lot of the more expensive Model 3s, so it needs to keep finding buyers in the short term, which is why it’s turning to Europe and China.
If Tesla can get the $35,000 Model 3 into production, there is likely more demand waiting, as Musk said. But it’s unclear how many of those 450,000 reservation holders remain. Tesla said last October that “less than 20 percent” of reservations holders have asked for a refund, but it hasn’t provided an updated number.
Musk and outgoing Tesla chief financial officer Deepak Ahuja also curiously dismissed the reservations on that January 30th call, too. “Reservations are not relevant for us. We are really focused on orders,” Ahuja said, before backpedaling a bit. “Now, we do have a large reservations backlog still, which tells us that a lot of customers are still waiting for those cars. But I don’t think it’s appropriate to share the reservations number.”
There could be plenty of new customers for a $35,000 Model 3 once it arrives, even without the federal tax credit, but car sales are slowing around the world after years of growth. Automakers are warning investors that 2019 could be a bad year for their bottom line because of this, especially because China’s car market is seeing its first decline in decades. If Tesla is going to keep growing its business on the back of the Model 3, then the company will have to do the same thing it’s always done: prove its competitors wrong.