Tesla’s recent price cuts are such an obvious red flag that it’s hard to believe anyone might actually think that these price cuts are a positive sign for Tesla. I wanted to add a little to what I wrote yesterday regarding what these price cuts mean.
Early in my career I was the chief analyst at Herman Miller’s SQA division for one of our new product lines. I had a pricing disagreement with the division VP whom I thought was grossly underpricing an already money-losing product. It was my first exposure to pricing a new product at future volume prices. With future volume being 10-20 times what it was at the time, the product was able to grow into positive gross margin territory by getting volume material price discounts and more efficient labor and overhead costs.
So I’m very familiar with the concept of “growing into margins”. But only financial fools would believe that what Tesla is doing is anything similar. Tesla cutting prices on the Model S is almost exactly the opposite of growing into margins on a new product. Tesla is cutting prices on a mature product that is on the downswing. The Model S is basically obsolete at this point and sales have been cratering over the last 18 months.
So I’m very familiar with the concept of “growing into margins”. But only financial fools would believe that what Tesla is doing is anything similar. Tesla cutting prices on the Model S is almost exactly the opposite of growing into margins on a new product. Tesla is cutting prices on a mature product that is on the downswing. The Model S is basically obsolete at this point and sales have been cratering over the last 18 months.
Now it is possible for some companies to cut prices on mature products after they’ve become fully depreciated and still enjoy positive gross margins. Apple does this with their older iPhone models. But this only happens if the item was profitable BEFORE they cut prices. If it wasn’t profitable before depreciation goes to $0, than you need to leave prices alone so that the product is finally profitable.
For Tesla, who has never turned an annual profit in it’s lifetime, the Model S has always been at best a break even product. In reality, it has probably always been a money loser. If demand for the Model S was healthy, and depreciation had just gone to $0, Tesla would have never cut prices. They would’ve taken the opportunity to finally boost their corporate gross profit by selling the Model S at a much higher gross margin.
For Tesla, who has never turned an annual profit in it’s lifetime, the Model S has always been at best a break even product. In reality, it has probably always been a money loser. If demand for the Model S was healthy, and depreciation had just gone to $0, Tesla would have never cut prices. They would’ve taken the opportunity to finally boost their corporate gross profit by selling the Model S at a much higher gross margin.
The Model S isn’t the only Tesla sliding in Europe
The fact that Tesla just cut prices on a mature product like the Model S that is shrinking in sales tells you that there is a serious demand problem for their older products. This is not some master stroke of genius by Tesla to spread goodwill to the masses by allowing more people to buy EVs. This is desperation to avoid plant overhead from burning cash.
Why do companies willingly cut prices when they know that it’s going to reduce gross margins? Because they are trying to prevent an even larger loss caused by idle manufacturing plants. First, if Tesla has invested $10 billion in manufacturing equipment, that doesn’t show up in the income statement the year that they purchased it. It is spread over all their manufactured cars for the next few years. The more cars they sell, the less the depreciation charge per car. So Tesla has an incentive to lower prices to minimize their losses. Second, those plants are huge black holes that suck money if they aren’t kept busy. Either Tesla cuts prices or they need to consolidate manufacturing.
When you look at Tesla’s situation, there are no scenarios where price cuts means anything positive.
Why do companies willingly cut prices when they know that it’s going to reduce gross margins? Because they are trying to prevent an even larger loss caused by idle manufacturing plants. First, if Tesla has invested $10 billion in manufacturing equipment, that doesn’t show up in the income statement the year that they purchased it. It is spread over all their manufactured cars for the next few years. The more cars they sell, the less the depreciation charge per car. So Tesla has an incentive to lower prices to minimize their losses. Second, those plants are huge black holes that suck money if they aren’t kept busy. Either Tesla cuts prices or they need to consolidate manufacturing.
When you look at Tesla’s situation, there are no scenarios where price cuts means anything positive.
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