There appears to be a narrative amongst Tesla skeptics where the quantity of cars Tesla produces is compared to major auto makers to minimize Tesla’s achievements.  Today I’ll dive into this and show why the narrative is incorrect.

Let’s take Ford as an example.  They recently filed their 2017 annual report.

In the annual report, Ford says, “In 2017, we sold approximately 6,607,000 vehicles at wholesale throughout the world.”

Ford’s 2017 automotive revenue was 145.6B, which means that the average revenue per vehicle was roughly $22,000.

Ford’s gross margin on automotive in 2017 was roughly 10%, and their profit margin (before taxes) was roughly 5%.

So let’s put this into perspective.  For an average priced $22,000 car the Ford sells, their gross margin is $2,200 and their profit margin is $1,100.  On average Ford makes $1,100 per vehicle.

Now, let’s look at Tesla and the Model 3.

Tesla is aiming for 25% gross margin on the Model 3 and mid-teens profit margin (let’s say 14%).  The average price of the Model 3 is projected at around $42,000 (but might even be higher if people go with more options).

In this case, the average gross margin on a Model 3 would be $10,500 and profit margin would be $5880.  Compared to Ford’s average vehicle profit margin of $1100, the Model 3 would be 5x as profitable.

In other words, one Model 3 is worth in terms of profits the equivalent of 5 Ford vehicles.

So, if Tesla can sell 500,000 Model 3 and 500,000 Model Y (their small SUV due in 2020) annually, that would be 1M vehicles at an average of 5x the profitability of Ford’s vehicles.  So the equivalent would be 5M Ford vehicles.

Let’s add in the Model S/X to the mix.  Let’s say Tesla can achieve 30% gross margin, and a profit margin of 18%.  (Note: historically gross margin for the Model S/X has been around 25% with the past 2 quarters lower due to Model 3 ramp.  They can likely reach 30% gross margin with their new model refresh that will easier to manufacture).  Profit margin on each S/X would be $16,200 (if we assumed a average sale price of $90k).  That’s almost 15x as profitable as the average Ford vehicle.

So, 100,000 Model S/X would be the equivalent of 1.5M Ford vehicles in terms of profit.

Combine 1M Model 3/Y and 100k S/X and you have the equivalent of 6.5M vehicles from Ford.

Let that sink in.  If Tesla can achieve what they’re aiming for, then just 1.1M of their vehicles would produce the same profit as 6.5M vehicles from Ford.

And Tesla would just be getting started.

Yesterday I shared why I think Tesla’s Model 3 production ramp will take a bit longer than even Tesla is forecasting and hoping for.  Today I’ll share some thoughts on why I think Tesla will get production under control and why ultimately the Model 3 will be a huge success.

Let’s take the following three important goals:

1.  To make the best quality and performing car in the luxury compact sports sedan market at a competitive price

2.  To make a healthy 25% gross margin on the Model 3 at volume production

3.  To reach volume production of 5000 cars/week quickly as possible

I would argue that ramping production to 5000 cars/week as quickly as possible is actually not the most important goal, but rather is the least important goal among the three.

The most important goal is to make the product the best in class.  And I think Tesla has achieved this.  In fact, the Model 3 is so stellar of a car, I think other manufacturers will be chasing the Model 3 for many years to come.  The Model 3 is a pure dream to drive, and in almost all ways is a better car than it’s competitors (BMW 3 series, Audi A4, Lexus IS, etc).

Ultimately how good the car compared to its competition will determine demand, and demand will determine the volume that Tesla will ultimately be able to sell, which will grow revenue and profits for the company.

The second most important goal is to be able to make a healthy 25% gross margin on the Model 3 at volume production of 5000 cars/week.

The reason this is important is because it makes no sense for Tesla to make 5000 cars/week if they’re going not going to be able to make money off of them.  While achieving gross margins of 15% might allow them to scrape by with a 5% profit margin per car, an even healthier 25% gross margin will allow Tesla to accrue significant profits over time.

The last, but not least, important goal of the three I mentioned is to reach 5000 cars/week as soon as possible.  Now, this goal is important because if they take too long to reach full volume production it could cause problems with cash flow since production and gross margins isn’t optimized at lower levels of production.  Thus, Tesla would be forced to raise funds, which doesn’t seem like it would be a problem because Tesla has a large market cap and they could issue common stock even if they couldn’t access the debt market.  However, in the real world anything can happen, and because of that slow Model 3 production is a financial risk to Tesla, albeit not a huge one at the present in my opinion.

So, there you have it.  While Model 3 production is important, it’s the least important of the three most important goals for the Model 3 that Tesla needs to achieve.

At this point Tesla has been extremely late on delivering their promised Model 3 production goals.  Initially, Tesla said they would reach 5000 cars/week by the end of Q4 2017.  However, they pushed that back to end of Q1, and then to the end of Q2.

In the most recent shareholder letter Tesla used timid language when saying they are still “targeting” a production goal of 2500/week by end of Q1 and 5000 cars/week by end of Q2.

However, at this point, I think we need to assume that the production ramp is more challenging than Tesla had expected, and that these production goals will also be pushed back.

I think it’s going to be difficult to reach 2500 cars/week.  One reason is that they previously shared that they were going to reach 1000 cars/week by the end of January.  I was expecting them to share that they reached that goal in last week’s shareholder letter or the conference call.  But they didn’t.  To me, it shows me it’s likely that they haven’t reached the 1000 cars/week goal yet.

While they could still theoretically do some crazy overtime to reach 2500 cars/week in the last week of March to reach the goal, I think even that might be out of reach.

Furthermore, 5000 cars/week by end of Q2 seems like an unrealistic goal as well, especially considering that they need to have all systems, including a new parts conveyance system, churning at optimal speed to reach that goal.

Overall, I think Tesla is working hard to overcome production challenges, and they ultimately will, but perhaps a little later than what is hoped for.