How Tesla Overcame “Fundamental Cost Disadvantage”

Electric vehicles are here to stay, and while many automakers have struggled to turn profits on the zero-tailpipe-emission products so far, Tesla has come a long way to reach profitability and sustained cash flow. Tesla has overcome the cost disadvantages facing most automakers through a few different strategies, as pointed out recently by CEO Elon Musk.

Musk recently tweeted about the “fundamental cost disadvantage” facing most automakers in the industry, noting that it’s one of the rare auto manufacturers to reach sustained cash and profits, as was recently detailed by The Street. Tesla’s innovation of cars into smart technology and its overall design and consumer appeal play roles in the automaker’s success, but it really comes down to its profit margins and cash flow, according to Musk.

One report from ZT corporate analyst Azhar Hirani showed that global profit margins for major automakers from 2015–2020 averaged 7.5 percent, though premium car brands tend to reap the highest profits.

“Profitability varies from company to company, but generally, premium car brands, like BMW, will observe higher profit margins than general and budget brands,” Hirani said. “There are, however, exceptions to this rule, such as Volkswagen and Toyota, which both show potential for profitability.”

Tesla went from selling the luxury-level Roadster to gradually selling cheaper and cheaper cars to eventually become cash positive, as Musk explained in the company’s first Master Plan. Musk has also pointed out how difficult production is in the auto industry, let alone production with positive cash flow — a problem many startup and legacy automakers alike are currently facing in the transition to EVs.

Ford’s CEO recently announced that he doesn’t expect the company’s EVs to become profitable until 2025. Companies like Lucid and Rivian are selling low volumes of vehicles at low margins, and they’re expected to continue posting losses until production ramps up.

“Large incumbent carmakers sell their cars at low to zero true margin,” wrote Musk in September 2021, as was reposted by a Musk fan account on February 11. “Most of their profit is selling replacement parts to their fleet, of which [70-80 percent] are past warranty. Like razors & blades.”

“New car companies lack this advantage. Also lack sales & service infrastructure,” Musk added.

The initial point was reiterated later in the thread by Musk himself, who responded by calling these low margins the “fundamental reason” why Tesla became the first automaker in roughly a century to garner an ongoing cash flow.

“This is the fundamental reason why Tesla was the first new American car company to reach sustained positive cash flow since Chrysler ~100 years ago,” Musk wrote in response to his initial quote. “The product has to be compelling enough to overcome a fundamental cost disadvantage.”

Tesla seems to have managed to overcome that cost disadvantage, at least based on its financials.

The automaker boosted free cash flow by 51 percent in 2022 to $7.6 billion. Additionally, the automaker did so while investing huge amounts of money into new production sites in Austin, Texas, and overseas in Grünheide, Germany. Overall cash and investments rose $1.1 billion sequentially in Q4 up to $22.2 billion, as The Street points out.

“We have sufficient liquidity to fund our product roadmap, long-term capacity expansion plans and other expenses,” Tesla said at its Q4 2022 earnings call on January 25. “Furthermore, we will manage the business such that we maintain a strong balance sheet during this uncertain period.”

Originally posted on EVANNEX. Written by Peter McGuthrie