A lot of Tesla watchers and owners are perplexed at Tesla’s new habit of cutting prices in the last year. This is something that they’ve haven’t done much of prior to late 2022. So why start now? Is it all “part of the plan”?
No, price cuts are definitely not what Tesla wants to be doing. Regardless of what they’ve said in the past, a business never wants to cut prices. The main reason is that even if you secure a short term bump in sales, the pain that it causes you in future gross margin erosion greatly outweighs that benefit. The problem is that once customers get accustomed to certain price point, they resist paying the higher prices. They’ll then “wait you out” if you ever try to raise prices again. It’s a vicious cycle.
This is why Apple generally never cuts prices. And the iPhone is a great example of a product that is in equilibrium with its demand. There is no need for Apple to ever cut prices and Apple continues to gain higher and higher sales globally every quarter.
Now contrast that with Tesla. Their growth essentially stopped about a year ago. That’s when Tesla was forced to roll out significant price cuts across the board to keep their growth story alive.
But here’s the thing that most people don’t get. Tesla has to drop prices to absorb their fixed overhead costs. It’s not just about trying to keep growth alive. Even if Tesla suffers a small sales decline in 2023 despite the price cuts, they still perfect financial sense.
The reason the price cuts make sense is due to the the fixed costs for all their new factories. Whether Tesla produces cars or not, these factories are still going to burn huge amounts of cash every month. People forget that the cost of building those factories doesn’t show up on the income statement while it’s being built. And it’s not just the building, it’s every high priced piece of equipment inside that building. Plus any engineering work to install those machines or design the manufacturing process. All those costs are capitalized (parked on the balance sheet) when the factory is complete. They come back to the income statement in monthly installments.
Tesla has to spread those factory depreciation costs over a great number of cars to keep in the black. If they simply allow car sales to fall due to softening demand, it doesn’t take long before Tesla is reporting losses in their quarterly earnings releases. The high cost of auto manufacturing is one reason why it’s such a brutal business.
Is Tesla hurting their gross margins by cutting prices? Yes. But is this better than the alternative of letting fixed overhead costs simply decimate the income statement? Also yes.
This is why Apple generally never cuts prices. And the iPhone is a great example of a product that is in equilibrium with its demand. There is no need for Apple to ever cut prices and Apple continues to gain higher and higher sales globally every quarter.
Now contrast that with Tesla. Their growth essentially stopped about a year ago. That’s when Tesla was forced to roll out significant price cuts across the board to keep their growth story alive.
But here’s the thing that most people don’t get. Tesla has to drop prices to absorb their fixed overhead costs. It’s not just about trying to keep growth alive. Even if Tesla suffers a small sales decline in 2023 despite the price cuts, they still perfect financial sense.
The reason the price cuts make sense is due to the the fixed costs for all their new factories. Whether Tesla produces cars or not, these factories are still going to burn huge amounts of cash every month. People forget that the cost of building those factories doesn’t show up on the income statement while it’s being built. And it’s not just the building, it’s every high priced piece of equipment inside that building. Plus any engineering work to install those machines or design the manufacturing process. All those costs are capitalized (parked on the balance sheet) when the factory is complete. They come back to the income statement in monthly installments.
Tesla has to spread those factory depreciation costs over a great number of cars to keep in the black. If they simply allow car sales to fall due to softening demand, it doesn’t take long before Tesla is reporting losses in their quarterly earnings releases. The high cost of auto manufacturing is one reason why it’s such a brutal business.
Is Tesla hurting their gross margins by cutting prices? Yes. But is this better than the alternative of letting fixed overhead costs simply decimate the income statement? Also yes.
RSS Feed