Price policy for a product is a cross between fairness and what the market can bear. If you are too nice to your customers, your shareholders will not be happy. If you squeeze every last penny out of your customers, they will start to resent doing business with you. Beside these matters, there is the issue of competitive pricing. What is the price of competing products? Established products can charge a premium, new products often have to show a price incentive.
Looking at the China pricing for the new Model 3 SR+, we can see aspects of this at work. With the punishment and retaliatory tariffs in the Trump-induced trade war increasing prices by 25%, Tesla decided to be hard on shareholders and loyal to customers. Part of the tariffs were paid out of the car’s natural margin, dividing the pain of the trade war between company (shareholders) and customers.
With the Gigafactory 3 product pricing, we see a decision based on different criteria. A lower price can get you a bigger part of the market, a higher price will sell less product. The right price will sell as much as you can produce. Of course, it is hard to predict what that price might be.
Another important criterion is the competitors’ prices. In this case, top competitors are the locally produced Mercedes C-Class and BWM 3 Series. In “Chinese Tesla Model 3 Price Crushes BMW 3 Series & Mercedes C-Class Prices,” the Tesla offer is compared to these two models. The Model 3 is a better value proposition for a slightly lower price. The goal is to steal about 250,000 customers from the competition.
The last but not least matter to consider is a decision about margin. The production, when fully up to speed in the new factory, will likely be at a lower cost than in Fremont — thanks to a combination of improvements in the assembly line, an easier-to-produce model, and lower labor costs. The costs of battery cells are likely a bit higher that in Fremont, California, though. For the sake of this argument, let’s suppose they are about the same in net.
The USA price of the Model 3 SR+ is $39,900 at the moment. This is probably just too low for a healthy margin. The imported Model 3 SR+ costs in China about $54,600. In this price, transport and import tariffs are included. With the price of $47,500 halfway between the two prices, Tesla divides the benefits of local production 50/50 between customers and shareholders.
Another aspect is that, during the ramp, the production costs per car can be (a lot) higher than when the line is running at full capacity and at the end of the learning S-curve. In Fremont, that was the reason for producing only the highest specced models at the beginning and accepting heavy losses. In China, with a hopefully much shorter ramp phase, these base models can likely be made at break-even after a very short time, followed by an increasingly attractive margin.
When at full production and if the market is not asking for a lower price via low demand, this can be a very nice extra margin for Tesla — to the tune of $1.875 billion.
Reality is never this rosy. For 2020, though, this can realistically result in an extra margin (higher than SR+ produced in Fremont) of $250 million per quarter — less in the beginning of the year, more at the end. If the SR+ gross margin in Fremont is 25%, the Chinese gross margin should be above 35%.
This is clearly a case of imminent bankwuptcy.