Tesla’s Model 3 Could Destroy Elon Musk’s Company

It won’t hit the road for two years, it won’t be as cheap as promised, and it will be plagued with problems.

Way back in 2006, Tesla Motors CEO Elon Musk laid out his vision for his electric-car company in a blog post promising that its six-figure luxury cars would be succeeded by increasingly affordable vehicles. Ten years later, it’s here in the form of the Model 3.

Musk described the vehicle at its unveiling in California on Thursday night as “the final step in the master plan, which is a mass-market, affordable car.” Already, 115,000 people have plunked down $1,000 deposits to order the car two years before it’s available.

Public enthusiasm and anticipation are once again being driven up to levels the rest of the auto industry could only hope to generate.

Beyond the hype there are a number of warning signs that indicate this intense excitement may ultimately lead to disappointment and even Tesla’s ruin.

Tesla plans on launching the Model 3 in the last quarter of 2017, and given the firm’s consistent inability to meet its previous self-imposed deadlines, it seems more than likely that the people lined up today won’t actually take delivery of their Model 3 until well into 2018. It’s highly unusual for an automaker to preview a production vehicle so far from its actual launch date for a variety of reasons: as Musk admits, the car is likely to change during the next two years of development work. In the meantime, a heavily hyped but unavailable car could cut into demand for Tesla’s existing models. With Tesla’s cash reserves falling below $1 billion and dwindling fast, the company might not survive long enough to launch the car people are currently lined up for.

So why is Tesla running a risk that every other automaker so studiously avoids?

Two plausible explanations come to mind. First, Tesla is racing to beat competing electric vehicles to the market. General Motors has already begun pre-production of its Chevrolet Bolt EV, which appears to compete directly with the new Model 3 on price point ($37,500 before the tax credit) and driving range per charge (200 miles). Perhaps Tesla wants to be seen as being the first company to bring an affordable EV to market, even if the Model 3 doesn’t hit sales showrooms until well after the Bolt (and potentially Nissan’s forthcoming next-generation Leaf EV as well). After all, a huge amount of its astounding brand power comes from the not entirely justified perception that Tesla alone is pushing electric cars into the mass market.

But there’s another, more troubling explanation for Tesla’s rush: The company needs more cash to actually complete development of the Model 3 and bring it to market. Tesla has been burning cash at a remarkable rate over the last year in order to ramp up Model X production and develop the Model 3: As of the end of last year, it was down to its last $1 billion in cash (maybe $1.2 billion, rounding up). Given its deep operating losses (it burned nearly $1 billion in cash in 2015 alone), that burn rate is too high to survive until 2018 while completing development work on the Model 3 and ramping up the sales, service, and Supercharger infrastructure needed to handle the expected new influx of customers. Even the $115 million in deposits collected won’t make a dent in Tesla’s capital requirements.

But the spectacle of hundreds of thousands of preorders for car that’s still years away from delivery will almost certainly boost Tesla’s volatile share price high enough to support a secondary equity offering without causing an exodus of existing investors. If the next 48 hours turn into the media circus everyone seems to expect, Tesla will be able to raise the billions it needs from an investor base that will be more convinced than ever that Tesla has built the brand power to make itself the Apple of automobiles, with corresponding Apple-like profits to come.

No automobile manufacturer will ever deliver the kinds of eye-popping margins Apple has achieved, though. Just because Tesla is based in Silicon Valley does not mean it is exempt from the capital-intensive, low-margin reality of the automobile manufacturing business.

But investors aren’t the only ones setting themselves up for disappointment: The biggest letdown ahead awaits the longtime Tesla fans who hope that they may finally be able to stretch the family budget just enough to buy the affordable Tesla they have been waiting for since 2006. In order to bring the cost of a Model 3 below the $35,000 mark, buyers will need to qualify for a $7,500 federal tax credit—but that credit begins to expire after Tesla sells 200,000 qualifying vehicles. At current sales projections, Tesla will run out of those tax credits sometime in 2018—just as Model 3s start rolling off production lines. In order to be one of the lucky few to qualify for those few remaining credits, the Tesla fans most in need of the financial assistance are camping out in front of stores to claim their shot at getting a truly affordable Tesla before the credits expire.

Unfortunately for these fans who most represent Tesla’s mission to make electric cars affordable to more than the super-wealthy, the remaining Tesla tax credits are likely to be all gone by the time their Model 3 gets built.

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Tesla is giving current Tesla owners (who have already bought a six-figure Model S or Model X) priority status on the Model 3 reservation list. More importantly, Tesla is pursuing its existing strategy of prioritizing the production of fully loaded Model 3s, meaning the initial production run of the “affordable” Tesla will on average sell for well above the base price. In other words, those credits that are left by the time the Model 3 makes it into production will go to either existing Tesla owners (by definition, wealthy people) or new buyers who have enough to spend on a fully specced Model 3 that could approach the Model S’s $80,000 base price. The new, downmarket buyers who have waited patiently for Tesla to deliver its long-promised affordable electric car are likely to be stuck paying full price for a bare-bones version of the Model 3, with little to no help from the federal subsidy. But because their need is the greatest, these desperate fans have the strongest motivation to line up at Tesla stores and put down $1,000 for a car they have never seen and may never be able to afford.

This cynically exploitative strategy may come as a surprise to anyone who has bought into Tesla's remarkably durable media halo, but behind the “save the world” headlines and unabashed Elon Musk worship there have long been signs that Tesla is not living up to its “save the world” image.

The company has failed to deliver on some of its biggest promises, such as the promise that all Tesla Superchargers would be solar-powered and zero-emission net energy generators. Behind the gushing praise for the Model S (which is undoubtedly an impressive car in many respects), massive quality problems lurk. Surveys and feedback at forums show that the majority of Model S drive units have already needed to be replaced, and some like Edmunds.com have had to replace the drive unit on their Model S multiple times. Problems with sunroofs, door handles, window seals, and other issues fill Tesla owner forums but go largely unreported by the fawning press corps. Fans have even begun generating delivery checklists that are more extensive than those done at the quality-control phase in traditional car factories, so buyers of Tesla’s six-figure luxury cars can do the quality assurance that Tesla apparently can not.

Counterintuitively, these rampant quality problems are better tolerated by high-end car buyers than everyday drivers. Anyone who can afford a six-figure Model S or Model X will never be at the mercy of a single car, and likely has a number of alternative vehicles to drive if their prestigious electric car needs to be repaired. By contrast, anyone hoping to replace the family workhorse with a Tesla would find the level of quality problems—not to mention Tesla’s limited service and recharging infrastructure—an unacceptable downgrade from the high levels of quality and reliability achieved by modern mass-market cars with internal-combustion engines.

What’s more, these quality problems are likely to dramatically expand as Tesla boosts production from 50,000 vehicles in 2015 to 500,000 vehicles in 2020. Building expensive cars at low volume is like playing the auto industry on “easy mode,” from both a production quality and a customer-satisfaction perspective. Moving into mass volume and lower price points will dramatically exacerbate all of Tesla’s existing (but undercovered) problems, and anyone who buys a Tesla as their family’s single car is asking to find out just how badly these problems scale.

Of course, nobody lines up to buy any product they’ve never seen before out of pure reason. Musk has made a bold play at marketing Tesla as a luxury company by necessity with a “real” mission to bring its slick looks, speedy performance, and Silicon Valley prestige to the mass market. The lines currently stretching out of Tesla stores are proof that it has worked, but with the Model 3, the tension between Tesla’s reality as a troubled, overvalued luxury car company and its mythos as a messianic, green-car profit powerhouse will be put to its ultimate test. Unfortunately for the fans who most believe in the myth and who may be putting their personal financial well-being at risk, reality seems far more likely to win out.

The good news is that Musk’s mythos-building has been so effective that he’s pushed more pragmatic, capable competitors to capitalize on the electric-car enthusiasm that Tesla has unleashed. If you just want an affordable, premium electric car there’s no need to put down cash or wait in line. By the time the Model 3 actually starts being produced, you’ll be able to buy one from a variety of competitors that won’t require you to do or expect anything different than you would when buying any other car. Those who just want a zero-emissions car without a lot of risk and hassle can skip the Model 3’s long lines and uncertain outcome. The revolution is already on the way.