One of the justifications for the approximately $15 billion market cap of Tesla Motors (NASDAQ:TSLA) is that while its initial Model S and upcoming Model X compete in a rarefied (and thus limited) niche of $70,000 to $100,000 vehicles, four or so years down the road the company will have a fully electric vehicle (the so-called "third-generation" car) that can compete in both performance and quality with BMW's popular 3-series, and that this car will be sold at a 15% or so gross margin. Here's why I think this can't happen...
Last quarter Tesla's automotive business (exclusive of the sale of tax credits) generated gross margins of approximately 5.2%. (Automotive sales were $555,203,000 of which tax credit sales were $68 million, leaving $487,203,000 in Model S [and parts for Toyota's (NYSE:TM) RAV] sales. As "cost of auto sales" was $461,818,000, this means the overall auto gross margin was 5.2%.)
Seeing as Tesla's revenue-per-car ranges from approximately $70,000 for the base model with the 60kWh battery to over $100,000 for a fully-loaded 85kWh "Performance" model, it seems probable that with a blended gross margin of just 5.2% the company is making very little money (let's say $1000) on an unoptioned version of its most basic $70,000 model. (The cost to the buyer is currently $7500 less than $70,000 due to a tax credit.)
Meanwhile, here in the U.S. the BMW 328i sedan starts at $36,850, which means that with customary dealer discounts it can be bought starting at around $35,000. Thus to compete with the 3-series, Tesla probably must sell its third generation car at a base price of no more than $40,000, which means it will have to be able to build it for $34,000 in order to enjoy a 15% gross margin. (Keep in mind that once Tesla sells its 200,000th electric car the $7500 buyer's tax credit will be phased out; thus a $40,000 car will really cost the buyer $40,000 and not $32,500.)
So the question is: if Tesla is currently probably making no more than $1000 at a $70,000 sales price on its most basic model and thus has a $69,000 build cost, how can it expect to build for just $34,000 a somewhat smaller model that maintains BMW-level performance and interior quality? Well, let's see what Tesla can do to reduce the cost...
First, the smaller car will almost undoubtedly contain a smaller battery, so let's say its capacity is 48kWh instead of 60 kWh. I've heard battery cost numbers all over the map, but let's say Tesla's current cost is $265/kWh so a "48" would currently cost Tesla $12,720 while the "60" costs it $15,900. This battery shrinkage would thus account for $3180 in savings vs. the current estimated $69,000 build cost of the Model S 60. Let's further say that this 48 kWh battery will cost 30% less in four years and thus save an additional $4608, so today-- based upon battery prices four years in the future-- Tesla could build a "Model S 48" at a cost of $69,000 - $3840 - $4608 = $60,552. Needless to say, this is still a great distance from the $34,000 target cost necessary to sell a car for $40,000 with 15% gross margins. So where else can Tesla save some money?
Additional savings will come from the fact that the new car will be lighter. As a Model S weighs around 4600 pounds, let's say that the new car will weigh 20% less, which is roughly the weight difference between BMW's 7-series and 3-series. This 20% weight difference would amount to 940 pounds, and let's further say that all of those savings will be in form of aluminum, as the new car will supposedly have a higher steel content (steel is cheaper) than does the Model S. As aluminum currently costs around .80/pound, this savings would amount to around $752, which would now leave the new car with a build cost of $60,552 - $752 = $59,800.
Perhaps Tesla could offer this new car with less standard equipment than comes on the basic Model S? Well perhaps, but I'm not sure what they'd remove, as on the base Model S features such as navigation, a better stereo, back-up sensors, bi-xenon headlights, etc. are already extra-cost options; thus there doesn't appear to be a lot more to make optional vs. the equivalent options on the 3-series.
Undoubtedly there will be some additional minor savings with the smaller car via such items as smaller brakes and tires, but this is unlikely to amount to more than a few hundred dollars per car, perhaps bringing the build cost down to around $59,500. Additionally, there will undoubtedly be better pricing available to Tesla from suppliers if it can significantly ramp up its production volumes as well as better utilization of the factory, but this gap of $25,500 per car in order to hit a target cost of $34,000 still seems completely insurmountable.
In fact, it's interesting that BMW's new i3 will sell for $40,000 and is nowhere close to competing with its own 3-series in terms of size or performance, and I wouldn't be surprised if BMW were selling this car at basically break-even. So if that's what BMW-- with its massive financial and engineering resources-- can sell for $40,000, I don't see any way that Tesla will be able to come close to building a significantly nicer car for $6000 less.
Disclosure: I am short TSLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.