Tesla (TSLA 1.50%) has been one of the most remarkable comeback stories in the last decade. It was on the brink of bankruptcy a few times, most recently in 2017-2019. However, as the electric vehicle trend picked up steam in the last few years, Tesla became a huge winner, reporting higher revenue and profitability.
Despite its solid performance, Tesla has an even greater goal for its electric vehicle business: To produce 20 million cars by 2030. And to achieve that target, the company is taking a massive gamble with price cuts.
Image source: Getty Images.
Price cuts could help Tesla achieve its 2030 ambitions
Tesla's 20 million cars target is not a small thing. To put it into perspective, the combined sales of the top two car producers in 2022, Toyota and Volkswagen, were less than 18 million cars in 2022. And with a sales target of just 1.8 million in 2023, Tesla has about seven years to grow its sales volume more than tenfold.
Tesla's gamble on price cuts aims to achieve mainly two things: to increase sales volume and reduce unit production cost. Here's how it works.
Tesla reduces its car price to improve affordability, which will help grow its sales volume. A higher sales volume will expand its economies of scale and operating leverage, leading to a lower unit production cost. Tesla will then use its cost advantage to reduce sales prices further, hopefully growing its sales volume even more. In short, Tesla is counting on this virtual cycle of ever-lower unit cost and higher sales volume to propel it to become the largest carmaker globally.
Is the strategy paying off so far?
Tesla's price cuts strategy is to suffer in the short run to gain a competitive advantage in the long run. In other words, this strategy will inevitably lead to lower revenue growth and contracting margins in the short run. For instance, gross profit fell 22% even though revenue increased 9% in the third quarter of 2023.
Still, investors need a longer-term horizon when evaluating the effectiveness of Tesla's price cuts. To this end, two indicators could help investors track Tesla's strategy progress: unit production cost and sales volume.
Let's start with the former. Tesla sold 343,830 cars in the third quarter of last year with a cost of revenue of $13.1 billion, giving it a unit production cost of around $38,100 per car. In the third quarter of 2023, it incurred a total cost of revenue of $15.7 billion from selling 435,059 vehicles, giving it a unit production cost of $36,087. In short, unit production cost fell by around 5%, a positive signal. Similarly, sales volume surged 27% year over year in the third quarter of 2023 from 343,830 to 435,059, which is also positive.
Still, investors should note that the latest quarterly sales figure failed to top the peak of 466,140 achieved in the second quarter of 2023. While inconclusive, this weaker quarter-over-quarter sales volume suggests a weakening consumer demand for cars amid a challenging external environment plagued by problems like high inflation, high interest rates, and geopolitical tensions. Investors should keep a close eye on this trend in the coming quarters. A further decline in consumer demand would be a huge red flag since it will disproportionately impact Tesla's profitability.
What it means for investors
Tesla's strategic move to become the lowest-cost producer and grow market share could hurt in the short term but has tremendous long-term strategic benefits long term. While it's still early days, there are signs that the strategy is correct, evident in the lower unit production cost and higher sales volume in the latest quarter.
Still, this is a long-term strategic move to build sustainable market share, so investors should best evaluate the company's progress on a longer-term basis (preferably on a multiyear basis).
