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Thanksgiving was apparently the right time for Tesla (NASDAQ: TSLA) to announce that it was lowering its prices in China: right here. Apparently, the price reduction is between 12% and 26%, depending on the model, to at least partially offset China's new higher tariffs on US car exports: Tesla reduces Chinese car prices to absorb effects of tariffs of commercial war.
Tariffs obviously disrupt the economic planning of all market players, including car manufacturers such as Tesla. If tariffs are raised unexpectedly and soon after, the manufacturer's costs increase.
Over the long term, a car manufacturer's tariff costs can be mitigated by locating production behind tariff barriers. In the short term, this favors – relatively speaking – car manufacturers who already have a more global footprint. For example, a manufacturer with plants in Europe, North America and China will be able to move more quickly to producing individual models than a manufacturer with fewer manufacturing sites, perhaps as few as only one.
The reconfiguration of production accordingly (location) of course reduces the efficiency of manufacturing, as economies of scale. However, if this is ultimately to be done through price increases, it is best to move this production as quickly as possible, instead of having to bear these costs while taking years to build the new plants.
This, of course, brings us to Tesla (TSLA). Unlike big builders like Volkswagen (OTCPK: VLKAF), Tesla manufactures all of its cars in one country – the United States. In fact, they are all manufactured in one plant, in one state.
All this can change in a few years if Tesla is able to build one or more factories elsewhere. Until then, Tesla is "trapped" from the point of view of the tariff, because it can not move production.
At this point, an example of a manufacturer with such a capacity is Volvo Cars, which is owned mainly by Geely (OTCPK: GELYF). It has several factories in Europe and China, as well as one in the United States.
Earlier this year, to circumvent the US tariff on Chinese cars, Volvo transferred exports of a particular model from China to the United States, replacing them with those of Europe, which applies a tariff reduced by 2.5% for imports to the United States. Most cars sold by Volvo in the United States came from Europe anyway, so it was not a big deal for Volvo. Chinese production has just been diverted to … China (and Europe). This is the kind of luxury that a car manufacturer such as Volvo has, but not Tesla.
This fall from 12% to 26% of the Tesla price in China raises all kinds of logical questions:
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Why not sell these Tesla cars elsewhere?
According to legend, Tesla is a constrained production and not a limited demand. If that were true, why is not Tesla just content to turn his production to China and sell those cars to other countries? Tesla's insistence to abandon these lower-margin cars (a loss?) In China should tell you something about the state of Teslas' global demand.
2. Why not reduce the price of Tesla in the United States by $ 3,750 in January 2019?
In terms of excuses for price reduction, a significant one will be presented in just over a month: the halving of the US federal tax credit (grant) from $ 7,500 per car to $ 3,750. This is actually a tax increase on all Teslas products sold in the United States. We could say that they have the same effect as a tariff. Why does not Tesla cut its US price on January 3rd by $ 3,750? Hey, why wait – why not do it right away? And why would not all other builders do the same thing?
3. Why do not all car manufacturers reduce their prices in China?
As for the cars that are actually exported from the United States to China, Tesla is not the only one. While automakers such as General Motors (GM) and Volkswagen manufacture cars in the United States, some cars, such as the Ford (F) Raptor, are exported from the United States to China. If Tesla has seen fit to reduce its price in China from 12% to 26%, why would not the other manufacturers do the same? I mean, if it's such a good idea …
Of course, I am sure that someone can find here and there an isolated example of a builder who chooses to absorb a tariff increase. The reason they differ from Tesla is that they are much larger companies and that these exposures represent a much smaller percentage of the total than Tesla in China. They also have a shorter path to bypass tariff barriers, so these price cuts would "settle" faster than a company that has not yet started building a plant behind the tariff wall. .
4. Why do you need ANY excuse to reduce prices on Teslas, anywhere, at any time?
If you reduce your prices in China from 12% to 26% because your costs are suddenly too high – whatever the reason – why not just lower your prices for all cars sold everywhere, because your costs are usually too high or for no particular reason at all? Well, if the goal is to sell more cars, just lower the price of each Tesla to $ 30,000. Or $ 20,000. Or … you understand the point. Tesla would get millions of deposits it could use to convince the capital markets to raise more money, which is … a variation of what it did in the first half of 2016 with the Model 3 deposit bonanza and the capital increase that followed.
In other words, of all these analogies: what is the limitation principle here? If you extrapolate from this drop of 12% to 26%, where does it end?
Lesson: There is no free meal in the discounted prices
Customs duties are a neutral cost for all parties involved – producers and consumers. The basic economy 101 teaches us that. In this case, Tesla is more secure than its competitors because it manufactures cars only in one factory, in one country. As such, there is no doubt that Tesla has to sell fewer cars or lose more dollars than it could otherwise have earned.
Tesla chose to try to restore at least a small part of its low sales by absorbing the cost of the tariff. This will be a decisive blow to his margins. I will leave it to someone else to accurately estimate the impact this will have on Tesla's bottom line, but the direction is clear: whether it's automotive or whatever – could just reduce prices from 12% to 26% without negative consequences, then everyone would do it all the time.
So no, it will not help either the net results of Tesla.
Disclosure: I am / we are short TSLA.
I have written this article myself and it expresses my own opinions. I do not receive compensation for this (other than Seeking Alpha). I do not have any business relationship with a company whose actions are mentioned in this article.
Additional disclosure: At the time of submitting this article for publication, the author was short TSLA. However, positions can change at any time. The author regularly attends press conferences, the launch of new vehicles and equivalent courses, organized by most major car manufacturers.
Editor's Note: This article deals with one or more securities that are not traded in a major US market. Please be aware of the risks associated with these stocks.
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