Model S dominated the U.S. luxury market last year. Image source: Tesla.
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You've probably heard the basic premise by now. Tesla's forthcoming Model 3 will be unveiled next month, go into production in late 2017, cost about $35,000 before incentives, and appeal to the mainstream as an affordable electric car. Elon Musk's goal of getting Tesla to 500,000 cars per year by 2020 is predicated largely on the Model 3.
It may surprise you, but the Model 3's addressable market opportunity is actually bigger than you think.
What we knowFor starters, consider the U.S. sales figures that Tesla recently shared as part of its fourth-quarter earnings release. The Model S rose to become the No. 1 seller within the U.S. market for large luxury vehicles, overtaking the Mercedes-Benz S-Class for the first time.
U.S. sales of large luxury vehicles. Data source: Tesla, company reports.
Tesla grew to grab over 25% of the market, while all of its direct competitors saw unit sales declines. All of these vehicles start around the same $70,000 as the Model S.
Fred Lambert over at Electrek compiled a similar table for U.S. midsize luxury vehicles to compare the market that the Model 3 hopes to crack.
U.S. sales of midsize luxury vehicles. Data source: Electrek.
These cars are all comparable to the $35,000 starting price point that Model 3 is targeting, and it's over 5 times as large in the U.S. alone. As if that wasn't enough, there's another very important factor to consider.
Moving on upTesla has demonstrated a unique ability to attract buyers from lower market segments. We saw this play out with the Model S in a meaningful way.
Tesla has even been winning over Prius customers. Image source: Toyota.
Model S has grabbed a whole lot of Toyota Prius buyers. A couple years ago, market researcher IHS Automotive estimated that Tesla was winning over Toyota owners more than any other car brand, comprising roughly 16% of Model S sales. This figure was derived from analyzing vehicle registration data. On a 2013 conference call, former CFO Deepak Ahuja noted that about 10% of Model S buyers were coming from the Prius. This makes some sense since both cars appeal to environmentalists, but they're worlds apart in price.
Last year,Jefferiesconducted a survey of Model S owners to see what type of car they were coming from. A whopping 70% of respondents (n = 145) were coming from cars that cost less than $60,000. Nearly 40% had previously owned a car that cost less than $40,000.
Tesla is able to do this because the Model S value proposition is not based purely on luxury. (Quite the contrary, since the Model S is undeniably less luxurious than many of its direct competitors, particularly European models like the S-Class or 7 Series.) Tesla's premium is about the underlying technology, not necessarily the luxury. This is how it can appeal to historically non-luxury buyers.
How this applies to the mass marketIf Tesla is able to do this again with the $35,000 Model 3, then we're actually talking about a much bigger part of the market. Model 3 could potentially appeal to buyers in the $20,000 to $25,000 market segment, even before you factor in incentives (since those will likely begin to phase out shortly after launch).
Unlike the $70,000 luxury market, gas savings have a very meaningful impact on the purchase decision here. While a buyer will likely never recoup the premium associated with a Model S through gas savings, that's a very real possibility for a $35,000 car (depending on how long you own it) even with gas prices at multiyear lows. For example, going electric would save about $3,750 over five years right now compared to a car getting 20 mpg (assuming the national averages of $1.72 per gallon and $0.12 per kWh and 15,000 annual miles). If oil prices recover from their lows, the savings increases rapidly.
If the Model S was already poaching from non-luxury brands like Toyota (among others) despite a massive price differential, how much more effective would the Model 3 be at winning customers over when that price differential shrinks in a major way and fuel savings alone can recoup a decent chunk of the premium? And you thought Prius sales were already under pressure (down 11% last year).
All of a sudden, we're now talking about Model 3 potentially competing with the Camry and Honda Accord and other non-luxury sedans. Now that is a huge market (Camry and Accord alone sold a combined 784,742 vehicles in the U.S. in 2015).
The road aheadOf course, this is just the opportunity. How well Tesla captures this opportunity will inevitably depend on execution and competition.
Chevy's Bolt will beat Model 3 to market. Image source: Chevrolet.
On the execution side, ramping up production to those levels is a massive undertaking in terms of capital requirements and operational prowess. Tesla has never produced cars on this scale, but Model 3 is being designed specifically "for ease of manufacturing." We don't know how Tesla will price the options and add-ons, which could increase the Model 3's price substantially, and the company undoubtedly has a lot of work ahead of it to hit both its target price point and launch timing, so there is plenty of uncertainty and risk ahead. No doubt about it.
When it comes to competition, General Motors' Chevy Bolt is the next closest competitor on the horizon, at least on paper. WhileI don't consider the Bolt and Model 3 to be direct competitors, there will be an inevitable overlap in the prospective buyers. Bolt will have a head start though, since General Motors is very likely to hit its late-2016 launch thanks to plenty of experience manufacturing at scale. Since the auto market doesn't move particularly fast due to long upgrade cycles, a one-year difference in launch is probably manageable. Tesla customers are also known for their ability to wait, enduring years of Model X delays. But Tesla welcomes the competition, and just wants us all driving electric cars anyway.
The article Tesla's Model 3 Market Opportunity Is Bigger Than You Think originally appeared on Fool.com.
Evan Niu, CFA owns shares of Tesla Motors. The Motley Fool owns shares of and recommends Tesla Motors. The Motley Fool recommends General 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.
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