Tesla's Problematic Pricing Strategy

Pricing Strategies and Decisions
Pricing Strategy Management
Pricing Policies, Processes and Methods
Policies used to manage Tesla’s pricing strategy. Currently Tesla is not only benefiting by but is actually relying on government subsidies to sell its cars. Subsidies come from electric vehicle (EV) tax credits that purchasers are able to obtain whenever they buy a Tesla. The problem is that these credits are only given to consumers for a set duration. Once the government ends the subsidy, sales drop drastically, as has been in the case in Hong Kong where tax incentives basically were the whole of Tesla’s pricing strategy—and once the tax incentives ended, sales were decimated. Currently in Norway, which is Tesla’s biggest European market, consumers pay no import tax or any of the purchase taxes that apply to non-EV cars—which is a big incentive (Tesla 10-K, 2018, p. 22). In the Netherlands, sales are soaring this year because the tax incentive there is ending and companies want to obtain a Tesla Model S under the current tax rate of 4%, which is climbing to 22% in 2019. Unless something happens to keep these incentives in place, Tesla’s luxury EVs may be unaffordable to its target market. The same problems are being encountered in the U.S. and in Canada, where Tesla has recently sued the government for discrimination in ending its incentives program before Tesla buyers were able to take possession of their Model 3 orders (Tesla 10-K, 2018).
Price-setting process Tesla uses. Currently Tesla’s price-setting process is based on reflecting the value and integrity of the product. Tesla’s EVs are marketed as luxury vehicles: even the Model 3 is marketed as a luxury EV for the middle class. For that reason, Tesla does not offer discounts on new cars or negotiate its prices: “We market and sell our vehicles directly to consumers through an international network of company-owned stores and galleries which we believe enables us to better control costs of inventory, manage warranty service and pricing, maintain and strengthen the Tesla brand, and obtain rapid customer feedback” (Tesla 10-K, 2018, p. 5). 
Is it sustainable and profitable? For the Models X and S, yes, this method is sustainable and profitable—so long as the EV tax incentives are available to buyers—but as recent history has suggested, once those incentives fall by the wayside, Tesla may see revenues decline drastically. That is one reason there is so much urgency to get the Model 3 to market. It is meant to be a base model EV priced at $35,000 and CEO Elon Musk has even recently stated that Tesla will offer a $25,000 within 3 years. The problem here is that at these prices, Tesla would be losing money. The manufacturing costs are too high and the margins virtually non-existent—which is why no Model 3’s are currently being sold at their base price of $35,000. Tesla cannot afford right now to lose money on sales.
Differentiating between incremental and avoidable costs. Incremental costs occur for Tesla when it seeks to expand operations in order to meet target productions goals. For example, it had to increase operations to 24 hours a day, 7 days a week in order to meet its production goal of 5,000 EVs per week. It had to build a tent to facilitate operations and it absorbed substantial incremental costs as a result. These costs could have been avoided, moreover, by examining the options and choosing lower cost option in the differential cost analysis. Tesla easily could have dropped its production goal: the avoidable costs of ramping up production at the facility were not necessary and did nothing for the long-term outlook of the company. The difference between incremental costs and avoidable costs is that the former are necessary and must be absorbed by the company whenever it seeks to do something like increase production to meet market demand; the latter are costs that could be avoided by choosing a less costly option in order to meet, for example, market demand.
Contribution margin for Tesla’s three top-selling products. Tesla aims at a margin of the mid- to high-teens for its EVs. Contribution margin for its Model S, Model X and Model 3 is pegged at 20%. Tesla aims to deliver far more cars than it did in 2017, which was approximately 100,000 EVs. However, with demand flagging due to backlog and tax incentives ending, Tesla’s window of opportunity could be closing.
Why Tesla should invest in a breakeven analysis. Tesla must invest in a breakeven analysis in order to identify the exact number, model and make of EVs it must sell in order to be profitable. With creditors calling and a potential bid to take the company private, Tesla has to be able to show to investors the precise point at which it becomes profitable. As LeBruto, Ashley and Quain (1997) point out, the contribution margin aspect can be used to enhance the financial results of a company—and that is something investors will want to know about.
Pricing Decisions
The Impact of Pricing Decisions on Tesla’s Overall Marketing Strategy
Challenges Tesla could face when implementing a new pricing strategy. Tesla has been relying on tax credits and incentives to drive sales. It has been able to preserve its high margins thanks to these incentives. What happens when the incentives disappear? Will customers still be willing to pay a price that reflects the quality and integrity of the product? However, if Tesla were to reprice its luxury EVs, it would face drastically lower margins, which would suddenly make it less valuable to investors who see its small sales number comparable to a company like Ford’s because of significantly higher margins that the former maintains.
Strategies used by competitors. Ford, on the other hand, makes use of the “low price, high volume vehicle” pricing strategy for mass marketing (Hardman, Shiu & Steinberger-Wickens, 2015), which other auto manufacturers do as well—from Honda to Toyota. Even in the EV market there is competition to bring an affordable low-cost EV to the middle class.
The solution for Tesla in reacting to the actions of its competitors will inevitably be to slash margins, which is what Musk appears intent on doing with the Model 3. However, if Tesla draws on Porter’s theory of competitive forces, it may not need to change anything so long as it can maintain its brand appeal and continue to differentiate itself. As Wright (1987) notes, “Porter reasons that firms which compete through differentiation and focus strategies would observe higher returns on investment with smaller market shares” (p. 95). Because of competitive forces, Porter suggests numerous avenues to profitability that relate to pricing: (a) the low-cost pricing strategy—the lowest cost competitor wins the market; (b) the differentiation strategy which is currently Tesla’s—i.e., the company that provides a product or service that is unique wins the attention; and (c) the focus strategy—i.e., the company that focuses on the specific target demographic while forgetting the rest of the market wins the niche. Tesla could also occupy this space to best competitors and thus protect its margins. However, it will need to demonstrate that consumers are willing to pay more for the Tesla Brand—without tax credits.
Best method for managing competitive information and current trends in pricing. Managing competitive information and current trends in pricing should be based on Big Data collection and analysis. Strategic intelligence based on data collection and analysis is the best way to collect, manage, process and understand what current trends in pricing are revealing.
Importance of accurate measurement of price sensitivity of consumers. Still, Tesla must have an accurate measurement of price sensitivity of consumers. Considering that it is only now going to have the opportunity to discover how sensitive consumers are to the company’s current pricing strategy as tax credits in the amount of $7,500 disappear, Tesla is going to go through a period of serious self-evaluation. If consumers reject its luxury EVs as a result of a loss of tax breaks in purchasing them, the company will be forced to admit that the brand itself is not sufficient enough to overcome low prices offered by competitors. Differentiation, in other words, will not work: it may have to focus more on low-cost, low-price models—beginning with the Model 3.
Ethics and the Law
Potential Ethical and Legal Implications Related to Pricing
Tesla has been advertising a Model 3 to consumers starting at $35,000 and has even taken prepayments—yet it has not delivered on the base model, primarily because it is not affordable for the company to produce them at this time. Tesla has been conducting itself questionably in terms of ethics and the law. Its advertising schemes, constantly promoted by Musk himself have finally come under the attention of the SEC, which is investigating the company’s claim that it had funding secured for going private. Musk made the claim over Twitter—and it is one example of the way the CEO will make bold claims and predictions without backing them with substance. The Model 3 has been advertised similarly—many promises but little delivery. Legal implications likely to follow if Tesla fails to deliver on the base model EV include law suits for false advertising.


References
Hardman, S., Shiu, E., & Steinberger-Wilckens, R. (2015). Changing the fate of Fuel Cell
Vehicles: Can lessons be learnt from Tesla Motors?. International Journal of Hydrogen Energy, 40(4), 1625-1638.
LeBruto, S. M., Ashley, R. A., & Quain, W. (1997). Using the contribution margin aspect
of menu engineering to enhance financial results. International Journal of Contemporary Hospitality Management, 9(4), 161-167.
Wright, P. (1987). A refinement of Porter's strategies. Strategic Management
Journal, 8(1), 93-101.
Tesla 10-K. (2018). Retrieved from
https://www.sec.gov/Archives/edgar/data/1318605/000156459018002956/tsla-10k_20171231.htm