Tesla (TSLA 5.34%) rolled out a new version of its driver-assist software over the weekend. While some of the improvements seem to be quite significant based on commentary in YouTube videos posted by owners who received the update, the biggest news about the improved software isn't its features -- it's the software's price hike. The software, which Tesla calls "Full Self-Driving beta" software because the company believes it will eventually enable autonomous driving, will now cost $15,000 in North America beginning Sep. 5. This is $3,000 higher than the software's previous price tag.
Tesla's ability to add both significant value to its software with over-the-air updates and steadily raise the price of the software combine to be a major potential catalyst for the electric car company over the long haul.
Extreme pricing power
Anyone who has read a number of books on investing has likely come across the term "pricing power," or a company's ability to command a high price tag -- even better, a price tag that increases over time -- while still maintaining customer loyalty.
Tesla's driver-assist software is proving to have extreme pricing power. At launch, the software cost just $5,000. The next price increase in October of 2020 moved the price tag to $10,000. Then the price rose to $12,000 earlier this year, and now it will set new purchasers back $15,000 starting Sep. 5.
Now that's pricing power. Not only is the price high in the first place, but the company is able to repeatedly raise the price of its driver-assist software as it rolls out over-the-air updates, which don't even require customers to bring their vehicle to a service center. Even more, every time Tesla announces an upcoming price increase, many customers who haven't upgraded likely make the decision to pay up for the software before the price increase. So price increases, in a way, drive incremental adoption from Tesla's customers.
And here's the kicker: Tesla CEO Elon Musk has said he believes the software could eventually sport a price tag of more than $100,000 (for those who opt to pay for the software upfront instead of monthly), particularly as it gets closer to regulatory approval to enable autonomous driving. Of course, Musk has been known to be overly optimistic from time to time. Furthermore, there's no guarantee Tesla's existing vehicle fleet ever achieves full autonomy with the current built-in hardware. Nevertheless, this audacious view for the software presents an extremely rosy bull case for the software's potential impact on Tesla's business.
A free cash flow machine
While Tesla doesn't reveal exactly how many customers are requesting access to the beta program for its advanced driver-assist software, there's clearly enough interest for the company to keep raising the price.
This is likely why Musk is optimistic about the software's potential contribution to its business.
"[S]olving autonomy ... will really be an amplification of free cash flow to a degree that is -- you run the numbers, and it's like, wow, can it really be that crazy?" Musk said in the company's most recent annual shareholder meeting. "But it could be that crazy."
Any investor can easily run the numbers on the potential revenue to be derived from Autopilot using their own estimates. And since we're talking software, the potential revenue is likely going to be extremely high margin, with a large portion of it converting to free cash flow.
Solving autonomy is not going to be easy. But if Tesla can pull it off, analysts and investors may be drastically underestimating the electric car maker's cash flow potential.
