Coming soon - Get a detailed view of why an account is flagged as spam!
view details

This post has been de-listed

It is no longer included in search results and normal feeds (front page, hot posts, subreddit posts, etc). It remains visible only via the author's post history.

67
Tesla's pricing and production strategy
Post Flair (click to view more posts with a particular flair)
Post Body

This post is both memorializing my thoughts and an attempt to explain Tesla's current pricing strategy as I am reading a lot of criticisms on it which, I think, is related to a misunderstanding of how technology cost decline curves work.

Most of us have heard of Moore's Law which, in a nutshell, is the concept of dropping CPU prices over time. What many don't know is that Moore's Law is really just a subset of a broader observation called Wright's Law.

Wright's Law, in a nutshell, is the concept that as more of something is produced it gets cheaper to produce that something. Worded another way, for every doubling of the accumulated production of any good, the price of producing that good drops by some percentage. That percentage is different for different goods but the process has generally been observed for all goods.

Wright's Law is why the cost of new technologies tends to drop so rapidly in its early days. Think of LED televisions, cell phones, laptops, photovoltaic solar panels, etc. This isn't is a new concept, it has always been present, for example cars, refrigerators, microwave ovens, etc.

The reasons for Wright's Law can be complex and abstract but are generally attributed to economies of scale where fixed costs, like design or equipment, can be spread over a larger number of goods. These economies of scale do not just apply to the firm directly producing the final product but also applies to it's entire supply and distribution chain. Even fairly abstract costs like site permitting and employee training get spread over the larger number of produced units. You can almost think of it as "well the factory has already been built and we have 'recovered' its cost so now every additional unit we produce is effectively 'free' from a factory cost standpoint". That's kind of a rudimentary way of thinking about economies of scale but might be helpful for non-finance folks.

This concept is incredibly important to understand how Elon and his team are thinking about pricing and production.

In order for Tesla to bring the cost of producing vehicles down, Tesla needs to produce as many vehicles as possible in the shortest time possible. Elon thinks long term. He is more concerned with "maximizing the area under the curve" than he is about next quarter, or even next year's, profits. The faster they can hit 20 million vehicles per year of production then the faster wright's law kicks in and the more prices fall.

For this reason, as long as producing a car adds contribution margin, meaning it does not have negative gross margin, then it's beneficial to produce that car in the long term. Once Tesla hits some steady state of production, let's say 20 million vehicles since that's what they're targeting, then sales will stay steady and costs will drop. Gross margins should, in theory, increase from that point forward.

The above mechanics are basically a certainty. What isn't certain is whether or not other entrants will put downward pressure on what Tesla can charge which eats up their gross margin. This is what Wall St. means when the call Tesla "just a car company". They are betting on Tesla's margins converging with other automakers' margins because other automakers will match their cost structure and charge lower prices than Tesla because they would be willing to take lower margins. Tesla would then have to compete with these lower prices by reducing their own prices. This is how competitive markets play out. In my opinion, no legacy automaker has a chance in hell of matching Tesla's cost structure but new entrants or Chinese automakers could.

At the end of the day, Tesla's mission is to sell as many cars as possible and the best way to do that is to produce as many as possible. You, as an investor, need to decide whether you think they will be able to produce high margins when they hit steady state sales/production or whether other automakers will match their cost structure and cause margins to converge around some lower percentage.

Would love to hear intelligent thoughts on this.

Edit: in addition to economies of scale, companies also find ways to increase efficiencies in workflows and processes and reduce waste.

Comments

If want to sell as many cars as possible they wouldn't be dragging their feet on Mexico/new factories... and they'd educating people buying more expensive gas cars about the cost and advantages of Teslas (so they didn't have to kill margins to move cars, which slows long-term production growth)

Author
Account Strength
90%
Account Age
14 years
Verified Email
Yes
Verified Flair
No
Total Karma
4,085
Link Karma
251
Comment Karma
3,243
Profile updated: 2 days ago

Subreddit

Post Details

We try to extract some basic information from the post title. This is not always successful or accurate, please use your best judgement and compare these values to the post title and body for confirmation.
Posted
1 year ago