Tesla's Price Cuts are Unprecedented
I’ve been following the EV space semi-religiously… OK, very religiously, for over a decade. During that time, I’ve seen the public’s sentiment shift from having no idea that EVs were a thing, to having doubts that the technology would ever be a success, to an EV becoming the best-selling car in the world for the first half of 2023 – the Tesla Model Y.
During this time, many competitors have attempted to join in with varying degrees of success. You have legacy automakers like GM, Ford, VW, etc. entering the market by leaning on their decades of manufacturing expertise building gasoline-fueled cars. You also have newcomers like Lucid and Rivian using the same playbook as Tesla, deciding to start an EV company from scratch.
As more players have entered into the fray, EV adoption has soared exponentially, going from 1% of all new car sales globally in 2017, to 13% in 2022. That's 13x in five years. And the growth isn’t stopping, with many experts thinking EVs will cross the 50% threshold in new cars sold sometime between 2028 and 2030.
Many signs are pointing to this being the case, especially as Tesla continues on its path to sell 20 million cars annually by 2030, and Chinese car companies continuing their frantic pace of building EVs.
However, as competition heats up and more people consider an EV for their next purchase, Tesla is beginning to implement a strategy that has been in the works since the founding of the company.
Lately, much has been made about Tesla’s decisions to dramatically cut pricing on their vehicles. At the start of the year Tesla dropped prices across its entire line up by as much as 20%. These cuts have continued, most recently with large cuts to its S and X models, which are large luxury cars, by another 20%. This caused a lot of noise, many saying that this is proof that no one wants EVs, that it will cause Tesla to be unprofitable, and it’s a desperate attempt by the company to stay relevant.
We’ve now learned through the company’s quarterly earnings that yes – the company did take a hit on profitability from its price decreases, but it was nowhere near the amount some were calling for. Tesla has been able to stay quite profitable due to lowered production costs as we exited COVID supply chain shocks, increased scale from its newly built Austin and Berlin factories, and extremely high demand for its best-selling high-margin product, the Model Y.
Here’s the thing though – if we re-read Tesla’s mission statement, it’s clear that this was Tesla’s plan all along. Remember the word “accelerate” from earlier? This is how the company is choosing to accelerate the transition.
The usual car-maker playbook during times like these is to throttle production and focus on maximizing profit for every unit that’s sold. Because of higher interest rates, there’s going to be less demand for cars than usual, and ensuring that production marries demand is important for shareholders to feel like the company isn’t losing more money than it should. This means that automakers are willing to forego "units sold" in preference for more profits per car.
Sell less cars than usual, but make sure you are making a lot of money per car.
However, because of this short-sighted commitment to profitability, the door has been opened for a company to take market share in droves.
This is where Tesla comes in
Instead of catering to short-sighted profitability, the company has decided to maximize production by lowering pricing so that their factories are running at 100% percent WHILE THEY ARE GROWING. In other words, Tesla is pricing their products so that they sell MORE next year, instead of ensuring they make as much profit as possible this year.
This means that there will be more Teslas on the road relative to everyone else. And we are already seeing this, given that the Model Y is the best-selling car in the world (EV or gas). That’s proof that this strategy is working when it comes to flooding the market with your product.
Tesla is accelerating the adoption of sustainable energy products by maximizing the number of people that can afford it.
It is important to highlight though, that there is still a large gap in awareness of affordability. Many people have no idea that there are EVs that are affordable to the masses, especially Teslas. I find myself having many discussions with random folks where they had no idea they could purchase a Tesla (or any EV) for well under $50k, and well under $40k with the Federal EV tax credit. [And it's important to consider not just the purchase price, but the Total Cost of Ownership, which includes all fuel and out-of-warranty repairs over the entire length of ownership, and here, EVs win over gas-powered cars, hands down. - Don]
However, this is a problem Tesla could solve with some form of education and/or advertising. My gut tells me Tesla will choose to do this once they feel confident their production can keep up with the guaranteed increase in demand once this campaign is underway (if it’s needed).
However, and this is extremely important – the strategy that Tesla has chosen, to drop prices as quickly as possible, is necessary to fulfill its long-term revenue goals.
It may be counter-intuitive to think this, but in the case of Tesla, its long-term aspirations are for all their cars to be capable of driving themselves.
This reads like science fiction, but I assure you that it’s not.
Tesla feels the hardware equation for the car is already solved. The company has claimed the 8-camera system and the onboard computer in its cars are capable of making it significantly safer than a human, which will allow regulators to approve the car for Level 4 and Level 5 autonomy. This basically means that the car is responsible for the driving, and Tesla would be liable if anything were to go wrong. The responsibility is lifted from the human.
It is this data that will allow Tesla to fulfill this goal of offering Level 5 self-driving systems in its lineup.
The only missing piece here is software. Tesla needs to get the system to be good enough to achieve Level 5. And once it does, the company expects to rake in tens of billions of profits per year over the long term.
This is where the magic of price decreases come into play
Tesla’s mission may be to accelerate the world to sustainable energy by selling tons of super-affordable EVs, but in reality, their mission statement for the car business should be “to cover the Earth with data-gathering robots so that our AI-brain can teach itself how to drive in every corner of the world so that humans stop dying in car accidents”.
Let me explain a bit further.
But here’s the thing – without the video data, the car can’t learn how to drive itself.
For all of us who drive, we know we encounter a quasi-infinite amount of weird things on the road. Missing lane markings, vandalized traffic signs, broken traffic lights, erratic drivers, chairs and mattresses in the middle of a highway, you name it. Many of the world’s roads can be a chaotic nightmare.
For Tesla’s self-driving system to operate on all of the world’s roads, it needs footage of these things happening so that it can learn how to handle every situation. There are companies other than Tesla that are taking a different approach to solve this by overfitting their cars with a ton of sensors, as well as mapping the areas where they drive. Although successful in most situations, the smallest change to a given area can cause their systems to malfunction, and it is incredibly expensive to scale as it requires a large amount of upfront costs and human labor to execute.
Instead, Tesla's approach is to build a system so smart that any changes to road conditions will be easily handled by its 8-camera system and its onboard computer. The onboard computer would be able to do this because it has code from Tesla’s self-driving AI, which has analyzed a crazy amount of video data collected from every Tesla on the road. We're talk'n billions of miles of data!
And this is where Tesla’s price cuts are so incredibly important.
By maximizing affordability to the masses, Tesla is maximizing the chance of having a Tesla roaming the world’s roads capturing super-important data that is crucial in building a self-driving system that’s capable of handling any situation.
It is in Tesla’s best interest to flood the market with these data-collecting four-wheeled robots as quickly as possible so that it has an outsized advantage when they flip the switch on their self-driving software.
This is not well understood.
Now imagine living in a world where ride-hail transportation becomes incredibly inexpensive because A) it’s way less expensive to run an EV vs a gas car, and B) there’s no driver to pay. And because there’s no driver, the utility of the car multiplies since there’s no human that needs to rest and/or have a life.
Now take the profits that Tesla could generate from the above scenario and compare them vs increasing their short-term profits by a few thousand bucks per car by limiting their production and/or running campaigns to maximize profit per car.
Also, compare all of this to what every other automaker is doing.
Pretty different, right?
This is Tesla’s fundamental advantage as a company – it has built EVs that are loved by the masses, so much so that the best selling car in the world is its midsize SUV, and this happened with basically no advertising, just word-of-mouth... lots of mouths, and big mouths, like mine.
The question shouldn’t be “What happens to Tesla as they keep dropping prices?” The question should be “What happens when Tesla has enough data to flip the switch and turn on their self-driving cars?”