Bizarrely, Tesla (NASDAQ:TSLA) CEO Elon Musk recently took time out of his 120-hour workweek for an interview with widely followed YouTube tech reviewer (and Tesla superfan) Marques Brownlee. During the interview, Brownlee asked about the possibility of a lower-cost Tesla eventually coming to market.
Musk responded that as Tesla gains scale, it may be able to deliver a high-quality car for just $25,000. He suggested that with a lot of hard work, it might be possible to offer a vehicle at that price point about three years from now.
If Tesla were actually able to profitably build a desirable electric car for as little as $25,000, it would be a game-changer for the company (and for the auto industry as a whole). At that price point, electric vehicles could quickly come to dominate the market. However, it could easily take a decade for Tesla to bring costs down enough to make this dream a reality -- and other automakers will likely get there first.
The elusive affordable car
Tesla has already experienced considerable success, but it is still firmly in the luxury car market. The cheapest Tesla that can be purchased today costs $49,000, and a few modest options push the price well beyond $50,000. That's beyond the means of most consumers.
A $25,000 Tesla would still cost a good deal more than the average compact car, but it would cost less than the typical U.S. vehicle purchase, even after adding on a reasonable number of options. This would clearly get Tesla a lot closer to fulfilling its mission, which is "to accelerate the world's transition to sustainable energy."
However, the idea that Tesla could profitably build a $25,000 vehicle within as little as three years seems wildly unrealistic. Indeed, investors should consider how long it has taken Tesla to deliver a car that can plausibly be described as "affordable."
In August 2006, Musk published his infamous "secret Tesla Motors master plan." In a blog post, he said that the company's strategy was to build its Tesla Roadster sports car, use the profit from that model to build a more affordable car that would cost about half as much as the Roadster's $89,000 price tag, and then follow that up with an even more affordable car.
Instead, Tesla's next two models after the Roadster -- the Model S and Model X -- have had average transaction prices higher than $89,000. Neither one was the "affordable" car that Musk had promised. The Model 3 fills that role, but it took more than a decade to arrive.
Economies of scale are a long way away
Furthermore, it's unclear how Musk expects to achieve the economies of scale needed to build a $25,000 electric car anytime soon. Earlier this month, I estimated that the $35,000 base version of the Model 3 would have a gross margin of around zero even at a production rate of 6,000 per month. A recent UBS study was even more pessimistic, estimating that Tesla would lose $5,900 per Model 3 at a $35,000 price point.
If Tesla can't make money on a $35,000 car yet, it would need far greater economies of scale to build a $25,000 car profitably. However, its current factory in Fremont has a theoretical capacity of 500,000 vehicles per year. Its second vehicle assembly plant (which will be located in Shanghai) is still in the planning stages and is at least four or five years away from reaching its full production capacity of 500,000 vehicles per year.
In other words, even with both of these factories fully operational, it's doubtful that Tesla would have the economies of scale necessary to sell a $25,000 electric car. But if the company has to open several additional factories to make a $25,000 car possible, then it's hard to see this low-cost Tesla arriving before the mid-late 2020s.
Others will probably get there first
Musk's recognition of the importance of economies of scale also raises questions about Tesla's long-term competitiveness in the "budget" electric vehicle market. Even after the opening of the Shanghai factory -- and perhaps a future European factory as well -- Tesla's annual output will still be a fraction of what the major global automakers produce.
Many of the world's top automakers have aggressive plans to bring electric vehicles to market over the next five years. Given that they already have massive economies of scale in virtually every aspect of production except for electric motors and batteries, these rivals should be able to develop attractive electric vehicles at a $25,000 price point long before Tesla.
Tesla may remain the most desirable electric car brand. But at lower price points, whichever automaker can deliver a product that checks all the boxes at the lowest cost is likely to win. That's not going to be Tesla at any point in the foreseeable future.