It happened again. After lowering the sticker price for several of the company's electric vehicles (EVs) -- including the highly affordable Model 3 -- back in January, earlier this week Tesla (TSLA -1.92%) pared back the prices of its more expensive EVs like the Model S and Model X. Depending on the vehicle in question, they're now between $5,000 and $10,000 less than they were just a few days ago.
The market is rattled, of course. After all, the move could be a sign that demand for electric vehicles is softening, or that competition is making a dent in Tesla's market share.
However, there's a critical detail mostly not being considered here: Tesla can afford to lower the sticker price of its electric vehicles. Its average production cost has been coming down for years now, and should continue to do so in a rather dramatic fashion.
Production costs are going down, profitability is going up
It's not data Tesla readily presents in its quarterly reports; you have to do some of your own number-crunching with the data that's been disclosed. As deliveries have grown since 2018, so has the amount of profit earned per car the company manufactures -- a gross profit of nearly $16,000 per vehicle as of last year.
Data sources: Tesla, Thomson Reuters. Chart by author. Profitability data is per vehicle.
That's because the production cost per vehicle (the cost of goods sold divided by total deliveries) has been steadily falling since 2018 -- from more than $70,000 then to a little over $40,000 now -- remaining well below the average selling price the whole time.
Data sources: Tesla, Thomson Reuters. Chart by author. Sales and production cost data are per vehicle.
What the graphics don't show is the relative cost and profitability of each model. The Model 3 certainly costs less to produce than the Model X. But, the Model 3's retail price also starts in the ballpark of $45,000, whereas the Model Y still typically sports a six-figure sticker price. Per-car profitability and the individual EV's profit margin rates probably aren't identical.
Think bigger picture, though. At an average sales price of around $62,000, there's still room left for profits even after the recent round of $5,000 and $10,000 price cuts for the company's most expensive vehicles.
And, there's likely going to be even more room for lower prices in the foreseeable future.
Exponential production capacity growth in the cards
Tesla intends to continue scaling up its production capacity, which should have the effect of continuing to lower its per-vehicle production cost. At last week's investor day event, in fact, Musk suggested the eventual production cost of its average electric vehicle could be halved.
Take the message with a grain of salt. Musk has something of a penchant for whipping up enthusiasm before the company is fully ready to make good on his not-quite-promises.
On the other hand, bear in mind that Musk usually (eventually) delivers... figuratively and literally. The company that delivered a market-leading 1.3 million electric vehicles last year wasn't actually making any cars as of 2011, other than a few hundred all-electric Roadsters that have little practical value for most drivers. Musk certainly hasn't disappointed for very long when he has fallen short of his stated plans.
And, perhaps more important, Tesla is now regularly profitable.
This may not remain the case in the immediate foreseeable future. CFO Zach Kirkhorn commented at the investor conference that Tesla may need to invest as much as $175 billion in its production capacity to reach the company's output goal of 20 million vehicles per year by 2030.
The math ultimately makes sense though. Assuming an average sticker price of $50,000, that sort of production would generate on the order of $1 trillion in annual revenue. With that sort of scale, it would be surprising if Tesla's per-car production costs weren't cut in half.
Tesla remains the name to beat
Yes, Tesla is a buy, not despite this most recent round of EV price cuts but because of them.
To be fair, Musk probably is getting a bit ahead of himself. The sensible thing to do is establish your newer, lower-cost production facilities first and then lower prices of the vehicles you're manufacturing. That's just not Musk's style though. In some ways he's once again "burning the boats," forcing himself and his engineers to make good on a goal. Whether or not they like it, he's bringing shareholders along for the ride.
The thing is, it's a tactic that's historically worked for the company, and paid off for investors.
The challenge for shareholders is simply sticking with what will probably remain a volatile stock while the market figures out when and how Tesla will do what it says it's going to do.
It's arguably worth the wait, however. The United States Energy Information Administration estimates the number of electric vehicles traveling the world's roads will swell from just a few million now to more than 670 million by 2050. There's no other manufacturer positioning better than Tesla to plug into this rapid expansion of the EV market.
