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Photographer: Jasper Juinen/Bloomberg

Tesla Will Get Trampled by the Mass Market

Edward Niedermeyer, an auto-industry analyst, is the co-founder of Daily Kanban and the former editor of the blog The Truth About Cars.
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When Tesla confirmed that it will sell its new Model 3 for as little as $35,000 -- $25,000 with government subsidies -- it seemed like a step toward realizing the "secret master plan" that founder Elon Musk laid out a decade ago: "To enter at the high end of the market, where customers are prepared to pay a premium, and then drive down market as fast as possible to higher unit volume and lower prices with each successive model." 

If so, what explains the company's dismal earnings report on Wednesday and the 40 percent plunge in its shares this year?

Perhaps it's because investors finally understand that the company is going to struggle mightily to ramp up production to the scale required to compete outside its luxury niche. Think about it: If even with all its hype and brand prestige it can't make money on its high-price, low-volume Models S and X, why should anyone expect Tesla to do so on a new car that starts at half the price? The real question is whether it should even be trying to.

Even with an ambitious goal of building 500,000 cars a year by 2020, Tesla would only have a fraction of the scale enjoyed by its competitors in terms of global products and platforms. And a huge amount of each unit's cost would still be tied up in expensive batteries, where savings are going to be very difficult. Tesla will have to cut costs to the bone to reach the targeted price for Model 3, meaning all the features that surprised and delighted consumers in the Model S -- long range, rapid acceleration, a high-tech interior and innovative design-- will be lost.

And whereas Models S and X have gone unchallenged on the electric-vehicle market, established automakers with scale and profit margins that Tesla can only dream of are preparing vehicles that will take on the Model 3 directly. How will Tesla maintain its hype and prestige if its $35,000 car feels less luxurious than a $20,000 gasoline car … or even a comparably priced electric Nissan Leaf or Chevrolet Bolt?

On the off chance Tesla can build a lower-cost car that lives up to drivers' quality expectations, scaling up production to half a million units a year will only exacerbate all of the problems it is having now at 50,000. Tesla owners fill Web forums with complaints about Model S defects and fit-and-finish problems, which will scale at least as fast as production volume. (Consumer reports demoted the car's reliability to "worse than average" in October.) The already long lines at Supercharger stations will grow, stranding even more drivers waiting for a charge. The firm's lack of dealerships to provide sales and service, along with its abysmal customer communications, will further dampen driver enthusiasm. Abandoned by erstwhile partner Toyota, the undisputed master of high-volume production and service quality, Tesla stands little chance of handling these scale-driven challenges effectively.

As it produces at higher volumes and sells at lower prices, Tesla will learn one of the most counter-intuitive truths of the car business: Mass-market consumers are actually harder to keep satisfied than luxury buyers. Cars like the Model S are bought by enthusiastic customers who are attracted to its unique design, performance and brand image -- and who typically have other cars they can drive if their beloved machine breaks down. Buyers of affordable sedans are more dependent on a car's quality to serve their everyday needs, yet also more able to replace a defect-plagued model with a competitive make. If you are disappointed by your Accord, it's pretty easy to trade it in for a Camry, and vice-versa. Tesla's experience with well-off, enthusiastic early adopters does not prepare it well for the competitive realities of $35,000 and under.

This dynamic explains why mass-market cars are as unsexy and appliance-like as they are: The most successful manufacturers put far more focus on refining production processes than on breathtaking design or gee-whiz gadgetry. Tesla's culture is the opposite. Its quality problems, supply-chain challenges and repeated production delays are offset only by its ability to inspire passion for its products. This kind of company can succeed, even thrive, building expensive and highly sought-after cars at low volume. But Tesla's strengths as a company don't translate well into mass-market products, and its weaknesses are precisely the kinds that tend to bring high-volume manufacturers to their knees.

Tesla may feel it has already invested too much into Model 3 to turn back now.  But giving up its dream of selling large numbers of an affordable car seems much easier than remaking the company's entire cutting-edge culture into that of a pragmatic, Toyota-like mass producer.

Musk has already built a brand that is the envy of every luxury car maker, and rather than put that accomplishment at risk maybe he should build on its strengths. Across the car business, automakers are giving up on the capital-intensive, low-margin business of affordable sedans. Tesla is far better off finding a sustainable niche as a Silicon Valley Porsche than chasing its founder's hubristic goal of bringing electric cars to the masses.

Tesla Gaining Speed: Shares Jump on Deliveries Forecast
(Corrects number of Teslas delivered in 2016 in sixth paragraph.)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Edward Niedermeyer at edward.niedermeyer@gmail.com

To contact the editor responsible for this story:
Tobin Harshaw at tharshaw@bloomberg.net