Should you buy a Tesla Model 3 or a Model S?

If you’re in the market for a Tesla sedan, then you might be wondering if you should buy a Model 3 or a Model S.  Nowadays, a used Model S (ie., 4-5 years old) can be as inexpensive or even more inexpensive as a Model 3.  However, with a used Model S, the car might be out of warranty and you might not have the latest features like Autopilot.

In my opinion, the Tesla Model 3 is the preferred car unless you really need or want the Model S.  The Model S has more cargo room so is much better for road trips, especially if you have a family.  Even though the Model 3 has more cargo room compared to its competitors, the Model S is in a class by itself in terms of cargo room.  The rear hatchback design and fold-down seats (the Model 3 also has fold-down seats) allow one to pack a ton in the back.  With my 2013 P85 I was able to haul home a 70″ TV in the box… that’s right, the whole box fit into the car which is quite amazing.

The Model S also is a more smooth and comfortable ride on the freeway.  So if you’re doing a lot of freeway driving, especially if you have a very long commute, then the Model S might be the preferred choice.  In my own tests, I found my 2013 Model S P85 to be about 2dB quieter than the Model 3 as well.

The Model S is also more prestigious and eye-catching.  It’s a larger car but also the design intent of the car is more flashy than the humbler, less conspicuous Model 3.  So, if you’re looking for a prestigious car, then the Model S is the way to go.

However, if you’re not taking road trips with your family and don’t have long freeway commutes, then I was generally suggest the Model 3 is the way to go.   The Model 3 is a dream to drive with superb handling and performance.  It’s got everything a Tesla needs to have, including a 15″ center screen with navigation and media.  Autopilot is fantastic and is only getting better with software updates.  And the Model 3 is a more efficient car, meaning with less energy you’ll be able to go farther.

The amazing thing about the Model 3 is that it does not feel cheap compared to its much more expensive bigger brother, the Model S.  The Model 3 feels like driving the future, and it’s by far the best car in its class.

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.