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Making Their Cars Too Expensive For You: Well Played, Tesla

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Many people criticize the introduction of electric cars by companies like Tesla Motors (NASDAQ: TSLA) for their high prices, which make the wealthy the only ones who can afford them. Those people claim it makes Tesla elitist, and makes the company looks more like a Mercedes-Benz than a Toyota. But instead of criticism, the automaker deserves praise for this business strategy. After all, it's the one that gives the company a chance to survive.

A wonderful vision
Those who complain of the pricing of Tesla vehicles often call for Tesla to produce an electric car that the average Joe could afford. While the image of everyone being able to buy themselves a high-performance, 300-mile-range Tesla looks nice, Tesla Motors is a for-profit corporation, not a charity. Ironically, the best way to create a future like this is to not make this affordable car now. Making a car with these capabilities for the $20,000 range would bankrupt Tesla and end the automaker's potential of ever becoming successful enough to build additional models.

It's not that Tesla does not want to produce these cars. Tesla CEO Elon Musk has been a strong advocate for an EV-based future, but even he recognizes it will take time to develop. For Tesla to become a major automotive player, first it will need to begin financing its operations with profits and sales revenues instead of continuous stock offerings and debt financing. Tesla has already planned how to accomplish this while mitigating the impact of the company's inherent weaknesses as an automotive startup.

Scale is not a strength (but it doesn't need to be!)
In the automotive world, mass production significantly reduces manufacturing costs per vehicle, and it's been a key component of bringing the automobile to the middle class. Companies like Toyota (NYSE: TM) build millions of vehicles -- everything from compact cars, to full size cars, to pickups and SUVs. But few Toyotas exceed the $40,000 level, much less the $50,000 level, for the model's base price. (I am well aware of the Toyota Land Cruiser and its higher starting price but the vast majority of Toyota sales are not Land Cruisers or vehicles priced like Land Cruisers).

As the sale price moves higher, the profit made on each vehicle increases, and thus the number of vehicles needed to break even drops. Toyota relies on selling a large quantity of cars, but Tesla does not have the production capacity to directly compete with such an automotive giant.

With this in mind, it makes complete sense that Tesla's first vehicle was a $100,000 electric sports car. As a start-up, the automaker did not have the same factories or mass production capabilities as automakers like Toyota. This required Tesla to build a super-expensive car to begin operations, as it would be the only type of car the automaker could produce at a profit.

Tesla is ramping up production with its Model S sedan, but it's primarily concerned with its ability to produce cars at the expected rate, not with whether there will be buyers. The automaker has already sold out more than half of its first year of expected production to buyers putting down $5,000 deposits. At about half the price of the first Tesla Roadster, the Model S shows how Tesla is already expanding into lower price segments. The debut of its next model, the Model X, continues this trend with an even lower expected price.

Survivor: auto start-ups
Followers of automotive history will notice that starting a successful car company is very difficult. There were thousands of automotive failures in the early 1900's, along with Tucker, Bricklin, DeLorean, and Yugo later in the century. But Tesla is doing it right. By starting at the top and working its way down, the automaker is able to generate revenues and build a brand name while it accumulates capital to bring mass production on line. So far, Tesla has reduced the starting price of its cheapest offering by 50% in only four years, with an even cheaper Model X ahead. Few of us could afford the first Tesla; some of us can afford the Model S; but if the company is successful, maybe one day we can all afford a Tesla. 

TulipSpeculator1 owns shares of Tesla Motors. The Motley Fool owns shares of Tesla Motors. Motley Fool newsletter services recommend Tesla Motors . Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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