How Will The Model 3 Price Cuts Impact Tesla?

Tesla (NASDAQ: TSLA) has cut the price of its Model 3 sedan twice this year. After slashing prices of all its vehicles by $2,000 following the reduction of the federal tax credit for its cars in January, the company dropped Model 3 prices by another $1,100 earlier this month after ending its customer referral program. In this note, we take a look at the potential impact of the price cuts on Tesla.

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Why The Price Cuts Are Necessary 

At the start of 2019, the federal tax credit for Tesla buyers fell to $3,750 from $7,500, as the company crossed the sales threshold of 200k cars set by the government. The total price cut of $3,100 over the past few weeks largely helps to offset this, and now the least expensive version of the Model 3 sells for $42,900 for a car offering mid-range battery capacity (264 miles) along with the premium interior package. However, it will become important for the company to move further down the price curve in early July, as the tax credit again drops by half, effectively making Teslas more expensive by $1,875. The credit will go away entirely in January 2020. With Tesla being the first automaker to lose access to the full credit, and competition in the broader EV market heating up, the company will have to launch the standard version of the Model 3 ($35,000) to mitigate the impact. However, it appears that Tesla will have some work to do on this front. Towards the end of last year, Tesla indicated that it would cost about $38,000 to make the standard range Model 3, implying that it would still need to make meaningful cost cuts to make the vehicle profitably.

How Is Tesla Enabling These Price Cuts?

Tesla has been taking multiple steps to cut costs. Firstly, the scale-up of Model 3 production could help the company improve economies of scale and reduce costs. Tesla is likely to be producing over 5,500 Model 3 vehicles per week currently according to the Bloomberg Model 3 tracker, up from less than 2,500 units a week in mid-2018, and the metric is expected to approach 10k vehicles by the end of this year. Moreover, the production process for the Model 3 uses a significant amount of automation, which helps it drive down costs. For example, in Q4 Tesla has said that the number of labor hours per Model 3 declined by roughly 20% compared to Q3 and by about 65% in the second half of 2018. The company also decided to cut 7% of its full-time workforce in January to save costs. Tesla also has an advantage in terms of battery costs, with the company aiming for battery cell costs of less than $100/kWh last year, which is well below the broader industry. Separately, Tesla also ended its customer referral program – which offered new buyers six months of free supercharging, while offering existing owners other perks – and this could also help the company cut costs.

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