Tesla Cuts Prices Again. It's Not Good News. -- The Motley Fool

Earlier this month, Tesla (NASDAQ:TSLA) reported that it delivered a record 95,200 vehicles during the second quarter, bouncing back from a dreadful start to the year. (Deliveries totaled just 63,000 in the first quarter.) It also said that its order backlog increased last quarter. While Tesla hasn't released its full quarterly earnings report yet, this update seemed to indicate that the electric vehicle pioneer was getting itself back on track.

However, Tesla rolled out yet another series of price cuts and options adjustments earlier this week. This renews questions about the strength of demand. Furthermore, these changes could have other negative short-term and long-term impacts on Tesla's business.

In the latest update to its lineup, Tesla dropped the standard-range versions of the Model S and Model X again, after reintroducing them earlier this year. It has also reduced the price of the long-range variants. On balance, this means that the entry-level Model S price is about $5,000 higher in the U.S. today than it was a week ago. The increase was about $4,000 for the Model X. Customers buying the pricier performance package now get "Ludicrous Mode" included, rather than having to pay $20,000 extra for that option.

The price of the cheapest Model 3 variant available for online ordering decreased by $1,000 to $38,990. (The $35,000 base model is still available "off-menu" by phone.) The prices of several other options (or option packages) have been adjusted as well -- downwards, for the most part.

Tesla explained these moves as follows: "We are also adjusting our pricing in order to continue to improve affordability for customers. Like other car companies, we periodically adjust pricing and available options."

In reality, Tesla is changing its pricing and options at an unprecedented clip. By mid-March, it had already implemented four price changes this year, and there have been more adjustments since then. These frequent pricing changes are bad news for Tesla bulls.

The most obvious risk for Tesla is that its price cuts will undermine its profitability. Tesla posted an ugly $702 million net loss in Q1 2019 after being solidly profitable in the second half of 2018. Automotive gross margin, excluding zero-emission vehicle credits and stock-based compensation, fell to 20.3% in the first quarter from 24.7% a quarter earlier.

The sharp drop in Tesla's deliveries drove part of that decline. However, Tesla acknowledged that price reductions and an unfavorable mix shift also contributed to its gross margin erosion.

The unfavorable mix shift continued last quarter, as the company began delivering the cheapest version of the Model 3 and sales of the pricier Model S and Model X continued to plunge. Price changes also put downward pressure on gross margin. As a result, most analysts believe that Tesla lost money in Q2 despite delivering a record number of vehicles.

It's true that in the latest round of adjustments, the entry-level prices for the Model S and Model X increased significantly. However, those starting prices are actually just $790 higher than they were in late April -- only customers are now getting a long-range battery rather than a standard battery for roughly the same price. That's great for buyers, but bad for Tesla's profitability.

The endless stream of price changes this year is also having a more subtle negative impact on Tesla. For many years, the company distinguished itself from traditional automakers by not discounting its cars. As a result, customers could feel confident that they were getting a fair price when buying a Tesla, even though they were shelling out a lot of cash.

Today, with prices seeming to change every month -- sometimes dramatically -- customers don't know what the "fair" price is for any given Tesla vehicle. One recent repeat buyer was furious after Tesla staff urged him to buy his fully loaded Model 3 before the federal electric vehicle tax credit fell by $1,875 on July 1. He followed their advice -- but then Tesla cut the price of his car by more than $6,000 last week.

In the short run, highlighting an upcoming tax credit drop to drive sales and then cutting prices shortly after the tax credit declines to boost sales further is actually a clever way to sell more cars. But in the long run, the effects might not be so positive. In addition to angering customers who find that they overpaid, Tesla is confusing potential future buyers about what to expect with regard to pricing.

This could hurt sales in two ways. Potential buyers who expect further price cuts may hold out for those price cuts to materialize before ordering a vehicle. The expectation that prices will keep falling will also hurt trade-in values and drive up lease rates for Teslas.

Falling battery costs and increasing economics of scale should allow Tesla to reduce its costs over time -- perhaps quite significantly. The company's ongoing moves to streamline its vehicle lineup will also reduce its costs by simplifying production. As a result, in the long run, Tesla should be able to turn a profit even with lower prices.

However, Tesla appears to be cutting prices too quickly relative to its cost reductions. Moreover, it has turned pricing into a game, which could confuse potential customers and even anger people who valued the company's no-haggle pricing policy. As a result, Tesla still has more work to do to stabilize its business.

Source: Fool.com

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