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Tesla's Model 3 Faces Long Odds in the "Mass Market"

By Adam Levine-Weinberg – Feb 17, 2016 at 11:20AM

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The long-awaited Model 3 may succeed -- but not as a mass-market vehicle.

Tesla Motors (TSLA 0.03%) has taken the auto world by storm with its highly sought-after luxury electric vehicles. Its Model S sedan became the top-selling large luxury vehicle in the U.S. last year, with more than a quarter of the market. The new Model X crossover seems likely to be equally popular.

Demand for Tesla's new Model X is rising quickly. Image source: Tesla Motors.

Tesla's next vehicle will be the significantly cheaper Model 3. Tesla will start taking reservations for the Model 3 in late March, and the company says it is on track to begin deliveries in late 2017. Many observers are skeptical of this timeline, given Tesla's penchant for delays, yet there are some reasons for optimism about an on-time launch in this case.

Tesla bulls think that the Model 3 will make Tesla a huge success in the mass market. However, mass-market success will probably require an even cheaper vehicle than the Model 3. True mass-market automakers like General Motors (GM -2.67%) may be better able to fill that need.

The Model 3 will be expensive
The Model 3 will have a base price of $35,000 in the U.S., according to Tesla. A federal tax credit will knock $7,500 off the price -- although you need to have a tax liability of at least that amount to get the full benefit. In some states, such as California, state tax credits get the price down to around $25,000.

At that price, Tesla's Model 3 could be a big threat to traditional automakers in the mass market. However, most buyers will have to pay dramatically more than this amount.

Most notably, the $7,500 federal tax credit will start to phase out soon after Tesla reaches 200,000 cumulative sales in the U.S. This will probably occur sometime in 2018, depending on how fast Model 3 production ramps up. Thus, by 2020, Tesla buyers will be paying more than $30,000 for a base version of the Model 3, even after any available tax incentives.

Furthermore, very few customers will actually get the base model. A typical Model S buyer spends tens of thousands of dollars on options. Just upgrading the Model S battery to improve range from 240 miles to 288 miles costs an eye-watering $13,000.

Most Model S buyers spend tens of thousands of dollars on option packages. Image source: Tesla Motors.

Given that the entry-level Model 3 could have as little as 200 miles of range, it will be even more tempting to get a larger battery. Other options packages could bring the Model 3's average transaction price to $60,000, according to auto analyst Adam Jonas.

This isn't the mass market anymore
Given Tesla's typically slow production ramp and its strategy of delivering heavily optioned vehicles first, the federal tax credit will likely be on its way out (or already gone) by the time Tesla is ready to deliver cheaper versions. This means that even buyers choosing modest option packages will be paying $40,000 or more.

This price point is nowhere near "mass market" levels. While the average transaction price for new vehicles in the U.S. is currently around $34,000, the average for a compact car is barely more than $20,000 and the average for a hybrid is only $25,000. The Model 3 will really be competing with compact luxury cars like the BMW 3 Series and Mercedes C-Class.

Tesla's Model 3 will compete with luxury cars like the BMW 3 series. Photo: The Motley Fool

Combined U.S. sales of those two models totaled more than 180,000 units in 2015. This segment is clearly much bigger than the large luxury car market where the Model S competes. Yet it's still a small fraction of the auto market. Moreover, Tesla may find it hard to win customers away from BMW and Mercedes with a car that "won't have quite as many bells and whistles" as the Model S.

GM gets serious about electric cars
Oddly enough, the historically stodgy General Motors may have a better shot of winning in the mass market for electric vehicles. First of all, it will have a head start. It is on track to begin selling the Chevy Bolt -- an all-electric hatchback with at least 200 miles of range -- before the end of 2016. Early reviews for the Bolt have been quite positive.

Second, it is likely to hit a lower price point. General Motors probably will have sold about 100,000 tax-credit-eligible Chevy Volts in the U.S. by the time the Bolt goes on sale later this year. As a result, the federal tax credit probably won't start to phase out until at least 2019.

Since GM should have the whole range of option packages available from day one (more or less), buyers will have plenty of time to get an entry-level Bolt and still qualify for the $7,500 federal tax credit. Even with the Bolt's slightly higher $37,500 starting price, the result will be a cheaper car.

The Chevy Bolt will likely hit a lower price point than Tesla's Model 3. Image source: General Motors.

Finally, I expect GM to be competitive on price. Discounts will likely be available (as is typical for mass-market cars), which is not true for Tesla vehicles. Furthermore, as costs come down, GM is likely to cut the starting price to grow the market. The original Chevy Volt plug-in hybrid had a sticker price of $41,000, whereas this year's model starts at just $33,170.

It's all about price
I have no doubt that Tesla's Model 3 will be a very nice car, and it will probably outsell the Model S and Model X due to its lower price point. However, the price won't be low enough to really penetrate the mass market in a meaningful way.

While the Model 3 will theoretically be available for less than $30,000 after tax credits, in practice GM is more likely to get a car below that key price point with the Chevy Bolt. In the mass market, where price is a key consideration, that may be GM's key to victory.

Adam Levine-Weinberg owns shares of General Motors. The Motley Fool owns shares of and recommends Tesla Motors. The Motley Fool recommends General Motors. 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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