The secret behind Tesla’s 30% gross margin

Posted on : 2021-10-25 16:56 KST Modified on : 2021-10-25 16:56 KST
The company's Q3 sales rose 58% year-on-year despite a 6% decrease in average selling price, allowing for high margins for the electric vehicle manufacturer
Tesla’s factory in Texas, US (provided by Tesla)
Tesla’s factory in Texas, US (provided by Tesla)

Manufacturers of vehicles using internal combustion engines say large investments funded by revenue from selling gas and diesel vehicles can make up for the deficit incurred by the production of electric vehicles (EVs).

This is why governments worldwide offer huge subsidies to buyers of such eco-friendly vehicles, which are not profitable for manufacturers, to expand the supply of EVs.

US-based Tesla, the world's largest EV maker, however, has broken this paradigm in the sector. Its recent report on its third quarter performance refutes the idea that the company cannot earn huge profits by selling EVs.

Gross sales margin that outstrips that of luxury automakers

Tesla's car sales in the third quarter rose to an estimated US$12.1 billion, up 58% or US$4.4 billion won from the same quarter last year, as the number of units sold from July to September this year was around 240,000, up 100,000 over the same period.

A noteworthy detail is that automotive gross profit — overall sales minus manufacturing costs — surged 74% over the same period. The automotive gross margin of such vehicles — the ratio of gross profit divided by sales — also rose from 27.7% to a record-high 30.5%, meaning Tesla earned a profit of around US$25,000 for every roughly US$90,000 vehicle it sold.

Im Eun-young, a senior analyst at Samsung Securities, told the Hankyoreh over the phone, "The gross sales margin of 30% is higher than those of German luxury carmakers BMW and Mercedes-Benz, and this standard is exclusive to the best luxury automakers like Porsche and Ferrari."

Germany-based Daimler AG, which owns Mercedes-Benz, had a gross sales margin of 23% in this year's second quarter, while Toyota — nicknamed the "master of cost reduction" — had 21% and Hyundai Motor only 19%.

The average selling price (ASP) of Tesla EVs is also falling. The figure fell 6% in a year from around US$54,000 in the third quarter last year to around US$50,000 in the same quarter this year. This is because the Tesla Model S and Model X — each priced around or over US$90,000 — saw their share shrink to about 4% of overall sales, but the lower-priced Model 3 and Model Y saw jumps in sales.

Despite this, the company's profit margin improved because manufacturing costs decreased significantly more than sticker prices. Over the cited period, the cost per unit decreased 12% from around US$40,000 to roughly US$35,200.

The Tesla report said, "Our operating margin reached an all-time high as we continue to reduce cost at a higher rate than declines in ASP." Thus, cost cutting seems to be the secret to achieving high profitability.

The "economy of scale" effect and a low-cost plant in China

How did Tesla earn such a high margin by selling electric vehicles, which are traditionally money losers?

The first factor is its economy of scale. In industries with a large proportion of fixed costs such as facility investment and development expenses such as cars, profits surge when sales increase due to the profit-leverage effect, in which the manufacturing cost per unit falls with high sales volume.

Tesla makes four models: the Model S, Model X, Model 3 and Model Y. Lower production costs are made possible through efforts like cutting the unit price of parts and maintaining fixed costs due to rising sales. Makers of cars using internal combustion engines that entered the EV market late face different circumstances, however. Until sales of electric vehicles reach a given scale, losses are inevitable due to massive investment costs.

Tesla’s factory in Shanghai, China (provided by Tesla)
Tesla’s factory in Shanghai, China (provided by Tesla)

Koh Tae-bong, head of research at Hi Investment and Securities, said, "The profitability of EVs basically depends on the scale of output using the EV-only framework [platform] developed by the manufacturer," adding, "Tesla will produce about a million units this year, resulting in economies of scale, but Hyundai is only capable of doing the same by 2025."

Also helping Tesla's margins is the company's expansion of factories in China, where labor and logistics costs are relatively cheap. Output capacity at the automaker's Shanghai plant, which went online in late 2019, is 450,000 units, and production there growing enough to cover the recent scale of exports to Europe.

The magic of "giga casting"

Analysts point to another factor behind Tesla's high profit margin. Park Hyung-keun, a senior researcher at POSCO Research Institute, said, "Through vertical integration by directly being involved from floor design to parts supply and demand, production and service, Tesla has helped reduce costs by raising the degree of its parts integration and cutting overlapping costs."

Tesla's unique structure of vertical integration, ranging from the development of semiconductor chips, software and batteries for electric vehicles, to charging, unmanned driving and insurance services, helps lower costs. Its “do-it-all” approach simplifies the automotive production process in a manner resembling that of electronic products. In contrast, other automakers actively utilize production outsourcing to diversify vehicle quality risks and raise output efficiency.

A leading example is Tesla's “giga” aluminum die-casting process. A Giga Press weighing more than 1 giga pound (400 tonnes, or around 900,000 pounds) stamps the entire rear chassis of a car with a large aluminum alloy. About 70 metal plates can be welded to the chassis, but giga casting can simplify the process and slash production costs by about 40%. This is why Tesla electric vehicles have recently reduced panel gaps issues — defects caused by misaligned steel plate seams.

The company plans to expand the use of giga casting, which it began applying last year, to the front of its EVs.

By Park Jong-o, staff reporter

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