Tesla's Referral Program: Smart Move or Sign of Desperation?

On Wednesday, Tesla Motors CEO Elon Musk announced his latest plan to disrupt the auto market. Through Oct. 31, Tesla is offering $1,000 off the Model S sedan to anyone who orders the car through a referral link from a current Model S owner. The person who sent the link will also get a $1,000 credit that can be used for accessories, service center visits, or even another new Model S.

Tesla is rolling out a referral incentive program for its Model S sedan. Image source: Tesla Motors.

Tesla is also inviting anyone who makes five (successful) referrals to the opening of its Gigafactory next year. Anyone who makes 10 referrals can get a top-of-the-line Founder Series Model X SUV for the price of the entry-level model: a discount of about $25,000. And the first to 10 referrals in each of Tesla's three sales regions will get that fully loaded Model X for free.

This is an interesting tactic to boost Model S orders. It's particularly notable because Tesla has repeatedly boasted that Model S demand is so strong that it doesn't need to spend any money on conventional marketing or discounts. So why is it starting to offer discounts now (albeit small ones)?

Reducing selling costsThe official word from Musk is that Tesla is testing this program with the goal of reducing its own selling costs. He stated that it costs about $2,000 extra to sell a Model S to someone in a Tesla store compared to selling it online.

The linchpin of the program is that by getting current Model S owners to work as volunteer salespeople, Tesla can avoid those extra costs and pass the savings on to customers.

More broadly, recruiting current Model S owners to recommend the car to their friends and family could help the company bolster its order book. That's particularly important right now because Model S production is surging and the new Model X SUV will become available this fall.

Management has indicated that Model X sales could surpass Model S sales, pushing Tesla sales in 2016 as high as 100,000 vehicles. By comparison, in 2014, Tesla delivered just 31,655 Model S sedans. With SUVs surging in popularity across the world and the Model S starting to age, it wouldn't be that surprising to see Model S supply surpass demand while the Model X accumulates a big backlog.

Tesla expects robust demand for its Model X SUV. Image source: Tesla Motors.

Getting Tesla owners even more involved in selling the Model S to their contacts could be particularly effective for boosting sales in states that have banned direct sales at Tesla stores.

Not too much riskThe way Musk describes this program, it's a no-brainer. If Tesla is saving about $2,000 per sale when customers order over the Internet, then it makes sense to offer an incentive to people to go straight to the website.

However, there's nothing to prevent someone who gets a referral link from visiting a Tesla store and spending a lot of time with an employee there before going home and using the link for the referral discount. In other words, Tesla may not really be getting the claimed $2,000 savings on every referral transaction.

Still, even if there is some cost to the program, it's well worth it for Tesla to be able to maintain a brisk pace of Model S sales. Based on the car's healthy gross margin, there's plenty of room for Tesla to take a small discount.

On the other hand...Nevertheless, Tesla's referral program is a potentially ominous sign if it means that Model S production is catching up to demand. Obviously, this is bound to happen sooner or later as Tesla boosts production of the Model S and splits the demand pool by adding the Model X. However, if you own Tesla stock, you'd like to see demand outstrip supply for as long as possible.

There is one big advantage to having supply catch up to demand. It means that Tesla could keep vehicles in stock -- as traditional car dealers do -- allowing customers to buy a Model S and drive it away the same day. That could boost sales compared to today, when there's always a backlog.

However, that advantage is offset by an even bigger risk: that Tesla can't move its inventory. If that happens -- or even threatens to happen -- Tesla would probably need to start spending on advertising (to draw in new potential buyers) and discounts (to convince them to pull the trigger).

The worst part is that once word gets out that you've offered a discount, customers tend to wait for the next big promotion to buy a vehicle. That forces you to spend on advertising to convince customers that the upcoming sale is really the best time to buy a car. It's an endless cycle that's hard to break. Indeed, traditional automakers tend to run promotions for even the most popular vehicles.

Only time will tell whether this campaign is just an opportunistic move by Tesla to sell even more cars or the first sign that Model S supply is on pace to overtake demand. With that in mind, investors should keep a wary eye on how Model S order trends evolve relative to production over the next few quarters.

The article Tesla's Referral Program: Smart Move or Sign of Desperation? originally appeared on Fool.com.

Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Tesla 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.