3 Reasons Why Tesla Motors Inc.'s Sales in China Will Accelerate When It Starts Manufacturing In-Country

Here's a look at how Tesla plans to establish local manufacturing of its electric vehicles in the world's largest auto market in three to four years.

Apr 23, 2014 at 1:03PM

Tesla Motors (NASDAQ:TSLA) CEO Elon Musk, who's in China to kick off the initial deliveries of the company's Model S sedan in the country, said on Monday: "At some point in the next three or four years we'll be establishing local manufacturing in China."

Model S Socal

Model S. Source: Tesla Motors

This "local manufacturing" will likely be in the form of a joint venture with a Chinese company, which is required of Tesla in order to avoid China's steep 25% import tariff.  

Here are three reasons why Tesla's sales in China should considerably accelerate when the company sets up a manufacturing shop in the country.

No. 1: elimination of the import tariff
Producing its cars for the Chinese market within the country, as part of a joint venture with a Chinese partner, would allow Tesla to avoid China's 25% import tariff on its vehicles. Naturally, this scenario would result in increased sales, especially of the more affordable "Gen III" vehicle, slated to launch in about three years, as mainstream buyers are typically more price sensitive than affluent buyers of high-end products.

No. 2: qualification for China's EV subsidies
Tesla's Model S doesn't currently qualify for China's EV subsidy program because it isn't manufactured in the country. Once Tesla starts producing its vehicles for the Chinese market within the country's borders, its vehicles will be eligible for these subsidies. China's EV subsidies were as much as 60,000 yuan (about $9,900) in 2013, and are only being cut 5% in 2014 and 10% in 2015, rather than the previously planned 10% and 20%. This is due to the outcry among the populace and other nations for China to curb its horrendous air-pollution problem. Subsidies should help increase sales of both the Model S and Model X crossover, to some degree, though should prove to be a much bigger factor with the third-generation vehicle for the reason noted in the previous section.  

No. 3: decreased transportation costs
Lastly, manufacturing vehicles closer to where they're being sold would naturally cut down on transportation costs -- and these costs are considerable when we're talking about heavy products such as cars being shipped across the ocean. It's likely Tesla would pass most to all of the transportation cost savings onto consumers, and the lower vehicle sticker prices would result in more vehicles being sold.

The three reasons above should accelerate what I believe will already be better than expected sales in the world's largest auto market. My primary reasons for believing that Tesla will do very well in the Chinese auto market are:

  • The exceptionally strong preference among affluent and so-called "aspirational" Chinese consumers for high-status, foreign, brand-name consumer products.
  • Beijing's draconian license plate policy, which strongly favors EV buyers.
  • The goodwill Tesla earned when it priced the Model S on par with the U.S. base price. (The total cost of the Model S in China is about $121,000, or approximately $40,000 more than its cost in the U.S., solely due to taxes, customs duties, and transportation costs.)

As to this last factor, automakers have traditionally charged Chinese buyers considerably more than they have U.S. and European buyers.

The Foolish bottom line
Tesla's plans to establish a manufacturing presence in China in three or four years should result in Tesla selling considerably more vehicles in the country, because the cost of a Tesla vehicle will drop significantly due to the factors discussed.

This scenario is a huge positive development for investors, given that China is the world's largest auto market. Further, China is projected to take the No. 2 premium auto market spot from the U.S. by 2016, and to tie Europe for the No. 1 spot by 2020. 

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Beth McKenna has no position in any stocks mentioned. The Motley Fool recommends Tesla Motors. The Motley Fool owns shares of Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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