Why Did Tesla Just Cut Model 3 Prices?

In a surprise move, Tesla (NASDAQ: TSLA) has cut the prices of some higher-level options on its compact Model 3 sedan — and it will soon open ordering to everyone in the U.S. and Canada who has placed a reservation.

What’s this about?

Tesla has spent much of the last year working to scale up production of the Model 3. Image source: Tesla, Inc.

What Tesla said: Price cuts and open ordering

Tesla announced two sets of moves.

First, the company will soon invite all remaining Model 3 reservation holders in the U.S. and Canada to order their vehicles. (“Reservation holders” are those who’ve put down $1,000 deposits toward a Model 3.) Until this week, Tesla had been inviting relatively small batches of reservation holders to order.

Second, Tesla has cut the prices for the recently announced Dual Motor and Performance versions of the Model 3. As of right now, the Model 3 is offered in 3 versions:

  • Long Range with Premium Interior, priced at $49,000 (unchanged).
  • Dual Motor All-Wheel Drive, now priced at $53,000. (That’s a $1,000 price cut. Dual Motor was previously a $5,000 option, so $54,000 total.)
  • Performance, priced at $64,000 — but minus some of the previously announced equipment, most of which can be added back in via a $5,000 Performance Upgrades package. (Originally, the Performance model was priced at $78,000 and included every available option.)

The price cuts will be applied retroactively to cars that have already been ordered, Tesla said. At least one Model 3 Performance has been completed, according to a tweet from CEO Elon Musk.

Why is Tesla doing this?

Let’s start with what we know about Model 3 supply and demand.

We know that Tesla has shipped about 38,000 Model 3s since production began last year, according to Bloomberg estimates. At least in theory, there’s still a long line of buyers waiting: In its first-quarter shareholder letter, Tesla said that it had over 450,000 reservations for the Model 3 still pending, including folks who had ordered but not yet received their Model 3s.

We also know that Tesla has been working very hard to boost its production of Model 3s, in a frantic effort to hit its long-standing goal of making 5,000 units in a single week. It’s possible that Tesla has its production line running well enough that it feels it can take orders from everybody still in line. And my Foolish colleague Daniel Sparks has argued that there are several reasons to think that Model 3 demand will be strong for a while.

That certainly sounds bullish. But there are a couple of things we still don’t know. For starters, how many of those reservations are converting to orders? Related: How many of the folks holding reservations are waiting for the promised $35,000 version of the Model 3, with a simpler interior and a shorter-range battery?

Tesla probably has a pretty good idea of what the answers are to those questions. It may well feel confident that it can fill any orders it gets after opening things up to all reservation holders — but it may know that the total number of orders for the Model 3 variants it’s offering now won’t be all that high.

The price cuts on the Dual Motor and Performance versions add some weight to that argument. It seems likely that Tesla was disappointed by the early level of demand for those higher-priced (and higher-profit) trim levels, which were first announced last month.

Add this all together, and I suspect the real story here is that Tesla hasn’t been happy with either the conversion rates overall, the “take rates” of the Dual Motor and Performance versions, or both.

In other words, Tesla might well have a demand problem.

There’s also some evidence that Tesla has been losing buyers from that long line of reservation holders. Second Measure, a company that analyzes anonymized credit and debit card purchases, released a report early in June estimating that 23% of U.S. Model 3 reservations had been refunded.

That’s a big number, but given the amount of publicity around Tesla’s production woes, the quality problems we’ve seen on early Model 3s, and the number of competitors coming from rival automakers, it seems possible. In addition, there’s probably a substantial set of reservation holders who aren’t asking for refunds, but who plan to wait until Tesla addresses the quality and manufacturing issues before ordering.

None of that is bullish for a cash-strapped automaker with big debt payments looming.

There may be some window dressing happening, too

A few folks on Twitter raised another thought — Tesla might be trying to give its cash balance a little boost before the quarter closes.

Reserving a Model 3 requires a $1,000 deposit, which Tesla holds and reports as cash. Ordering a Model 3 requires a second deposit of $2,500. If it can get a rush of orders before the books close at quarter-end, it can show a higher total level of deposits in its second-quarter earnings report.

That might help mitigate the impact of what’s likely to be a grim-looking report, given Tesla’s still-ongoing manufacturing woes.

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John Rosevear has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Tesla. The Motley Fool has a disclosure policy.

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