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Tesla Motors Is Already Enjoying Reverse Cannibalization From Model 3

By Evan Niu, CFA - May 5, 2016 at 9:00AM

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Model 3 is actually boosting demand for Model S, and not the other way around.

Some people are buying a Model S while they wait for a Model 3. Image source: Tesla.

As a famous smartphone maker once said, it's better to cannibalize yourself than to let another company do it.

However, when it comes to Tesla Motors (TSLA -2.36%), the company is actually benefiting from a sort of reverse cannibalization. With the company's $35,000 Model 3 in the pipeline for 2017, the traditional thinking would be that the affordable product could threaten to cannibalize the expensive product. If you're in the market for a compelling electric car that satisfies base transportation requirements, specifically in terms of range, wouldn't most people go with the more affordable one?

Sort of.

Halo effect
What Tesla is subsequently seeing is that all the excitement and interest around Model 3 is actually boosting demand for the Model S and Model X. Many customers reserved a Model 3 purely on the strength of Tesla's brand and reputation. The vast majority of Model 3 reservation holders (93%) had never had any prior experience with the company or its vehicles.

Tesla is also gently encouraging Model S and X sales since it is giving Model 3 production priority to current vehicle owners. The company is doing this as a special thanks to all the customers that have helped it get to where it is today. It might sound extreme, but a faster route to taking delivery of a Model 3 is to buy a Model S or X now, in order to get priority status.

Wanna go for a ride?
Many people are averse to test driving a car that they have no intention of buying, in part because they expect a hard sales pitch after the test drive. Plus, they don't want to feel as if they're wasting a salesperson's time. This expectation has been drilled into our heads thanks to the antiquated dealer model, and the related high-pressure sales environment that we've all come to know and love. This is especially true for high-end luxury cars.

In contrast, Tesla employees are more than happy to grant most people test drives. Since they're primarily compensated on education rather than sales, they're often happy enough just showing off the car to spread the word. Sure, they'd prefer if you bought a car, since they will get a small commission, but their compensation is not predicated on sales volumes.

Most people are not aware of this, and as such have never test driven a Tesla vehicle. Customers that have placed a Model 3 reservation feel more entitled to a Model S test drive just to experience a Tesla vehicle. But once those people test drive the Model S, they don't want to wait the 18 months (or more) to buy a Model 3. A lot of these customers would rather just buy the Model S right now. Those that are willing and able to afford it are doing just that.

However, this situation may change once both vehicles are readily available. But considering the massive backlog for Model 3, that'll be a while.

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