The Math of Tesla's price adjustment
Tesla did what feels right. They lowered their prices to pre Covid levels. As a cost leader Tesla is the unique position to set the pace of the auto industry. We expect higher EBIT margins.
The table above summarizes the benefits of Tesla’s price reduction. There are two key drivers here. First, Wright’s Law states that if you keep increasing your production, you lower the cost per unit. In the table, we analyze unit margins. Starting with an average selling price (ASP), we go down the earnings statement all the way to operating margin. Despite the price cut in 2023, we expect a higher operating margin than in 2022. This is driven by Wright’s Law and a general decline in pricing across the supply chain. In other words, the second major driver is deflation. Tesla is the industry leader not only in electric cars, but in the whole automotive industry due to their low cost. Cost leaders dictate the pace of pricing and volume.
If you look at EBIT in 2023, you'll notice that the dollar amount per vehicle is similar, but the margin is higher. Tesla will produce more cars in 2023 and hence increase their dollar profit.
This table shows how crucial cost leadership is. In fact, any company is eventually defined by its cost structure. Tesla is setting the tone for the whole industry. By lowering their price, they will drive volume and dictate suppliers to lower the per-unit price.
Conclusion
Tesla is the cost leader in the automotive industry. Thanks to cost leadership and vertical integration, Tesla can dictate costs across the value chain. This is key. All major components are either produced or assembled by Tesla. They can dictate prices. For suppliers, the question is: either you lower the price or you forgo the volume Tesla is promising you. We predict that Tesla will increase its EBIT margin per vehicle in 2023 and keep increasing the EBIT margin going forward. The volume growth of 50% is achievable even if we assume a recession in the next two to three quarters. Lower prices go a long way. Consumers will respond and adopt Tesla at a faster pace, particularly now when competing ICE OEMs are struggling with the residual values of their ICE cars. January 12, 2023, will enter the history books as the day when the definitive demise of the legacy car industry accelerated.