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Tesla (TSLA) bulls must be feeling pretty pleased with themselves right now after riding TSLA's mammoth 500% run up over the last 12 months. At a $20 + billion cap, the market is now assuming that Tesla will grow to reach the size of car makers such as Audi, Mercedes and BMW, all within the space of a decade.

(click to enlarge)

From Yahoo finance

Tesla's strategy for achieving mass adoption has been well publicized: start with high end vehicles and steadily work down to mass produced models aimed at the mainstream. The Roadster, Tesla's first vehicle, was priced at $110,000 and built up an enthusiastic following.

In 2008, Tesla announced a family of midrange models, called the model S, meant to bridge the gap between the Roadster and Gen 3, Tesla's $35,000 mainstream model car. Its pricing was to be $60,000 (for the mid range 60kw battery option).

In actuality the model S 60 has risen in price by $10,000 to $70,000, while the average selling price for a Model S is now $90,000 including options. What should be more worrying for Tesla in the long term is that buyers have chosen the most expensive model, the 265 mile range S 85 over the cheaper, 206 mile range, S 60, while Tesla has discontinued the 160 mile range model, the S 40, entirely.

Why is that a concern? Normally when a car manufacturer has a family of models, it expects the cheapest models to sell in the highest volume. The BMW 3 series outsells the 5 series, which in turn outsells the 7 series. This pyramid of sales is healthy and normal and reflects the fact that there are far fewer rich people buying cars than poorer ones. So Tesla's inverted pyramid must mean that at least one of the following statements is true:

· Buyers have a very strong preference for electric vehicles whose range matches that of ICE vehicles.

· The demand for electric vehicles is restricted to those buyers who want high performance luxury vehicles - the Model S 85 has 0-60 acceleration in 4.2 seconds compared to only 6.5 seconds for the Model S 60.

If the second of these is true, then Tesla will be destined to only ever be a niche luxury car maker, like Aston Martin. Sell TSLA.

What about if the first statement is true?

Well, at this point, bulls will inevitably bring up Tesla's supercharging network. Won't this make range anxiety problems disappear? Won't Tesla then be able to offer a model with a smaller, less costly battery with say 150 - 200 miles range, which will be acceptable to potential buyers?

Range anxiety will be replaced by detour frustration.

Certainly, Tesla's forthcoming network of stations will allow its Model S cars to be within reach of a station in most cases; however, what actually matters to a potential car owner is whether or not they will need to make a significant detour to reach a supercharging station during their journey.

Here is a map of Tesla's supercharging station build out plans for North America to 2015:

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From Tesla Motors.

Tesla claims the average distance between its stations is 80 miles in high density areas. In contrast, the average distance between the 120,000 gasoline stations in the whole of the United States - i.e. not just high density areas - is only 6 miles. This means that on many journeys, Tesla drivers would be forced to undertake absurdly massive detours of up to 80 miles to reach their destination. That number will be even higher in less populous areas.

It's hard to know what potential Tesla car buyers might consider a reasonable detour distance. However to bring the detour distance down to a more reasonable figure will require Tesla to build even more superchargers: halving the distance between supercharging stations means quadrupling the number of supercharging stations. If 20 miles is the maximum distance electric car owners will put up with, then Tesla will need to build 16 X 200 = 3200 supercharging stations throughout North America alone. At $500,000 a station that's a considerable extra capital expense.

Even if battery costs drop, other car makers are better placed to benefit

Now this article hasn't touched on whether battery costs can in fact come down enough for Tesla to actually build a vehicle with 150 miles range for $35,000. Let's assume for the sake of argument that battery costs can do so.

Clearly, the additional upfront cost of buying an electric vehicle can't be so high that it deters people from buying them. Let's also assume that the upfront cost of an electric vehicle must be no more than half the total vehicle lifetime gas savings of an ICE vehicle to interest someone in buying it. To somewhat simplify, that means the battery cost plus electric motor cannot be more than a few thousand dollars more than the cost of a IC engine and associated components.

The average price of a new car in the U.S is $30,000. That number, however, is for cars produced in very large volumes, in the hundreds of thousands per year. This is a crucial point, since a large portion of a car's cost is not the cost of individual components like engines or batteries, but rather the amortized cost of R&D, the cost of the production line and marketing spending, spread over many vehicles.

Tesla can't possibly start off selling its Gen 3 vehicle in such quantities, but other manufacturers could do so easily. They will have the cost advantage to price any Tesla cars out of the market.

Ironically, Elon Musk could still achieve his goal of an all electric future, while Tesla shareholders are passed in the slow lane.

Conclusion

Tesla's valuation is premised on it becoming a mass volume manufacturer at a dizzyingly fast pace, yet logic and the early evidence from its buyers, suggests that Tesla will remain a niche luxury car maker only.

Source: Sell Tesla Now, Its Strategy Is Already Failing