Why Tesla’s Mass-Market Car Should Scare Mercedes and BMW

Luxury shoppers could easily switch to the $35,000 Model 3.

The Tesla Model 3.

Source: Tesla

Audi, BMW, Mercedes-Benz, and Porsche have long dominated the world’s premium automotive ranks, making Germany home to some of the industry’s most profitable car brands. But Tesla Motors, whose Model 3 electric car enticed 325,000 would-be buyers to put down $1,000 deposits during the week of its debut in April, threatens them in a way that Toyota’s Lexus never did. While the Model 3’s stats—200 miles on a single charge, $35,000 starting price—align it with General Motors’ midmarket Chevrolet Bolt, Tesla Chief Executive Officer Elon Musk has said his most affordable car to date should be thought of as competing with luxury mainstays such as BMW’s 3 Series or the Audi A4.

Chart: Share of Tesla shoppers in March who also looked at these brands

Car shopping data suggest there’s more to Musk’s claim than just bravado. Tesla buyers shop German luxury brands more than any other car lines before making purchase decisions, according to automotive researcher Edmunds.com. Almost 30 percent consider BMW, and about 20 percent look at Audi and Mercedes models, while 12 percent shop Porsche, says Edmunds. Compare that with the fewer than 6 percent of Tesla buyers who consider a Dodge, and it’s clear German brands are most vulnerable to customer defections as Tesla grows.

Executives at rival carmakers privately squawk about Tesla’s poor track record of manufacturing delays and persistent financial losses. Yet they can’t ignore that Musk’s products are exciting consumer passions in a way that incumbent automakers haven’t for decades. “The innovation hat is going to move to a new place,” says Håkan Samuelsson, CEO of Volvo Cars. “The decisive factor is what’s happening inside people’s heads,” says Jürgen Pieper, an analyst at Bankhaus Metzler. “Many see in Tesla the innovation they’re missing from the Germans.”

The Tesla advances and the threat of Apple entering the car business have led German brands to show lots of electric concept vehicles recently. But these cars are years away, while Tesla plans to start delivering the Model 3 in late 2017. “Technologywise, things will probably move back to the U.S. to an extent after Europe was the center of premium carmaking for the past 30 years,” says Volvo’s Samuelsson.

That’s in part why Porsche said in December that within five years it will build its Mission E, a fast-charging, four-door luxe sports car that will target Tesla’s Model S sedan. Audi plans to build its electric E-tron Quattro SUV as a direct rival to Tesla’s Model X SUV. And Mercedes is planning four EVs to take on Tesla.

Tesla doesn’t have to sell huge numbers of the Model 3 to begin hurting both demand—and profitability—of traditional luxury brands. That’s because until the German marques launch their competing EVs, they may have to cut prices to avoid losing market share to Tesla or trim production to match lower demand.

Competition from the Model 3 might prompt German carmakers to drop some prices as much as 10 percent to defend their U.S. market share, says Stuart Pearson, an analyst at Exane BNP Paribas. Tesla is aiming the Model 3 at “those looking to spend roughly $40,000 on a car, and that’s the core target market for BMW and Mercedes basically,” he says. “The fact is they don’t really have an answer to the Model 3 until the next decade.”

The bottom line: Tesla’s Model 3 could draw sales from German luxury carmakers’ bread-and-butter vehicles, prompting price cuts.

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