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.

Yesterday after market close, Tesla released a Form 8-k to clarify Elon Musk’s comments the day prior regarding needing to move equipment from Germany to reach production ramp goals.

Tesla, Inc. is clarifying the following statement made by Elon Musk, Tesla’s Chief Executive Officer, during Tesla’s fourth quarter and full year 2017 financial results conference call held on February 7, 2018:

“[We] expect the new automated lines to arrive next month in March. And then it’s already working in Germany so that’s going to be disassembled, brought out to the Gigafactory and reassembled and then go into operation at the Gigafactory. It’s not a question whether it works or not. It’s just a question of disassembly, transport and reassembly. So we expect to alleviate that constraint. With alleviating that constraint, that’s what gets us to the roughly 2,000 to 2,500 unit per week production rate.”

The “2,000 to 2,500” units per week cited in this comment refers solely to the capacity of the additional automated battery module manufacturing equipment that is currently located in Germany, and not to Tesla’s total Model 3 production run rate or to the capacity of the automated battery module equipment that is already present at Gigafactory 1.  Tesla’s ability to meet its target of 2,500 per week by end of Q1 2018 is not dependent on the additional equipment that is currently located in Germany, as that equipment is expected to start ramping production during Q2 2018.  With respect to battery module production, Tesla’s ability to meet its target of 2,500 per week by end of Q1 2018 is dependent only on the equipment that is already present at Gigafactory 1, as well as the incremental capacity that is currently being added through the semi-automated lines that were also discussed during the conference call.

As stated in Tesla’s Fourth Quarter and Full Year 2017 Update Letter:

“We continue to target weekly Model 3 production rates of 2,500 by the end of Q1 and 5,000 by the end of Q2. It is important to note that while these are the levels we are focused on hitting and we have plans in place to achieve them, our prior experience on the Model 3 ramp has demonstrated the difficulty of accurately forecasting specific production rates at specific points in time. What we can say with confidence is that we are taking many actions to systematically address bottlenecks and add capacity in places like the battery module line where we have experienced constraints, and these actions should result in our production rate significantly increasing during the rest of Q1 and through Q2.”

Tesla claims that they don’t need the new automated line equipment from Germany to reach their 2,500 Model 3 cars/week production rate by end of Q1 2018.  However, at this point, Tesla has lost much of their credibility regarding Model 3 production ramp guidance.

In order for Tesla to regain investor confidence, they need to do what they say they’re going to do.  This means, they need to reach 2,500 cars/week by end of Q1.  I, personally, think this is going to be difficult to achieve.

In the Q1 earnings call, Elon mentioned that having to make a new automated battery module assembly line costed them 6-9 months of time.  So, if they original goal was 5000 cars/week by end of Q4 2017, then that goal is pushed off by a minimum of 6 months.  So it appears that Tesla is aiming for end of Q2 2018 as to when they can reach 2,500 cars/week.  But this is likely an aspirational goal, and perhaps not realistic.  But we will see in less than 2 months.  Tesla will release their Q1 delivery (and production) numbers at the beginning of April.  If Tesla does manage to reach 2,500 Model 3 cars/week by that period, they will dispel all doubt and disappointment regarding the Model 3 production ramp.