NEW YORK (MainStreet) — Tesla has recently confirmed it will launch a program to offer certified pre-owned vehicles, which would allow customers to buy the electric cars at lower price points. That’s great news for consumers who can’t afford a new Model S at $70,000 base (over $90,000 with options) or the much-anticipated Tesla “D” product set to be announced today.
But as attractive as it is for car buyers to get a warranty-backed Tesla on the cheap, the move is mostly a gambit for CEO Elon Musk and his company to gain market share. Of course, the strategy is not without risk for the automaker.
This CPO offering is all part of Tesla’s long-term strategy. Back in April 2013, Musk announced that customers who had financed a Model S could return the car three years later for 50% of the original base price and 43% of any options, a guaranteed residual based on the Mercedes S-Class.
That means about 20 months from now, there will be a lot of used Model S’s to re-sell and an opportunity for new customers to gain entry to the company’s offerings.
“This step is a natural progression of the Tesla brand,” said Scott Upham, president of Valient Automotive Market Research. “Due to the high degree of technical expertise required for maintaining and now certifying these complex vehicles, consumers are willing to pay a premium price for the pre-owned certified accreditation from the manufacturer themselves.”
CPO premium vehicle sales are a major source of profits for dealerships in the U.S., said the Center for Automotive Research’s chief economist Sean McAlinden, and because Tesla is its own dealer, the company does not have that additional revenue siphoned off on the retail level.
“Dealers can cherry-pick the best low mileage trade-ins and off-lease vehicles and sell them with remaining warranties for better margins than the original new vehicles,” McAlinden said. “The automakers benefit little from this. But Musk is his own dealer.“
Per the data from the National Automotive Dealership Association (NADA), the gross margin on used vehicle sales has generally ranged between 12% and 13% over the past two years. Given Tesla’s direct sales model, the margins from used vehicle sales would be wholly captured by the company.
“These levels are nothing to shake a stick at,” said Michael Schultz, an industry analyst at the Center for Automotive Research.
New Customers, New Conquests
By offering this lower budget option, Tesla is looking to expand its tentacles in the market place.
Tesla is already widening its fleet, with the Model X SUV to hit dealerships in early 2015 and an entry-level sedan (said to be in the $30k range) to arrive later next year. This CPO offering just adds another dimension.
“It will help the brand…because it will be expanding their product portfolio,” said Tom Libby, a consultant focused on consumer loyalty at IHS Automotive. “Whenever you take action like that, you broaden your target market.”
Of course, Tesla is going to make the majority of its money on vehicles that come hot off the assembly line, not on these pre-owned cars. But if the CPO strategy works as a marketing mechanism to attract buyers of new Tesla cars in the long run, it could be a more effective cash-cow.
“If this strategy has a rub-off or a residual effect on their new car business, that would be the benefit,” Libby said.
And though gear heads aren’t necessarily going to suspend their intentions to purchase a new Audi A5 or BMW 3-Series in order to pin down a used Tesla, the lower price point for CPO vehicles may, indeed, result in some business snatched from other automakers.
“Within the higher end of the luxury vehicle segment, we see this as a competitive strike against American luxury brands and Japanese brands including Acura, Lexus and Infiniti,” Upham said. That said, given the customer and loyalty at Mercedes-Benz, Audi, and BMW, Upham does not believe Tesla’s program will take market share away from those brands.
On the downside, though, there’s some possibility for Tesla’s self-cannibalization.
“The question for Tesla is whether the CPO vehicles will bring in a net higher number of new buyers of CPO vehicles or if the used vehicles simply divert more potential new Tesla buyers,” said Steven Szakaly, chief economist NADA. “For any small scale producer, it will be important to not eat into new vehicle sales.”
How Much Is It Going To Cost?
The success of Tesla’s CPO program depends largely on the price point it finds for these resold Model S’s. The price of a CPO Tesla depends on many factors including the individual vehicle’s service record; mileage; wear and tear; and other functional, performance and aesthetic criteria.
Though no price has been announced, the fact that Tesla has promised to buy back Model S’s for 50% of the base price sets the break-even price of CPO vehicles at $35,000, without any options.
Looking to EVs like the Nissan Leaf and GM’s Chevy Volt can provide further basis for estimating the Tesla Model S CPO pricing. Generally speaking, EV depreciation has been much worse than non-EV depreciation, according to Laurence E. Dixon III, senior manager of market intelligence at NADA. That’s the result of uncertainties people have with regard to electric vehicles – namely, range anxiety and hesitation over new technology.
Certifying EVs helps to mitigate some of these challenges by reducing consumer fears and lowering monthly payments with more reasonable interest financing available through a CPO program; however, EVs still don’t maintain as much of their original value. The depreciation for the auto market as a whole has been 12.5% so far this year, while the 2012 Volt and Leaf both saw steeper 23% depreciation values. Here’s how the numbers stack up:
- Base MSRP for the 2012 Chevy Volt Base model - $39,145
- NADA Average Trade-in value for October 2014 - $13,925
- Retention = 36%
- Depreciation for 2014 (calculated as average trade-in value in 2013/ATV in 2014 year-to-date) = -23%
- NADA’s Certified Pre-Owned premium = $1,050
- Base MSRP for the 2012 Nissan Leaf SL - $37,250
- NADA Average Trade-in value for October 2014 - $11,275
- Retention = 30%
- Depreciation for 2014 (calculated as average trade-in value in 2013/ATV in 2014 year-to-date) = -23%
- NADA’s Certified Pre-Owned premium = $900
Note: The buyer should have received a $7,500 federal tax credit. This effectively reduces the new purchase price by this amount and thus raises the retention figure, making it not nearly as bad.
The typical residual value for a vehicle at the end of a two-year lease is about 50%, said Schultz from the Center for Automotive Research; for a three-year lease, which is what Tesla’s residual guarantee applies to, the typical value is more toward 35%. The Volt and Leaf in the above numbers demonstrate a residual value in the 35% range after two years, not three. That demonstrates the faster depreciation of EVs and throws a wrench in Musk's resale figuring.
Though Tesla wants to promise a 50% buy-back after three years, a further glance at ALG data for the expected 36-month residuals for EVs demonstrates Tesla’s plan could be flawed.
- 2014 BMW i3 (with range extender), 38%
- 2014 Cadillac ELR, 33%
- 2014 Chevrolet Volt, 45%
- 2014 Lexus 450H, 44%
- 2014 Nissan LEAF (SL trim), 33%
If Tesla is buying a car back from customers for more than it can sell it for – or at least for more than it’s worth – the strategy is not water-tight.
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“Of course, Musk could sell refrigerators to arctic native peoples,” said McAlinden of the Center for Automotive Research, in a vote of confidence for the viability of Tesla.
Risks That Reward the Customer
Despite the appeal Tesla has for customers, the arithmetic on resale prices is pretty tricky for the corporate side of the automaker.
As it stands, the re-buy price that Tesla will pay to consumers trading in their cars has been baked the company’s numbers, giving Musk a base cost on which to frame his margin, said McAlinden. If Musk can’t turn a profit by selling cars for more than he’s rebought them for, it may take an act of legislative benevolence to give Tesla a boost.
“Maybe [Musk] can horn-swoggle some more subsidies from the governments on a used car,” said McAlinden.
But even then, that’s to say nothing of tertiary factors that could make the residual value of CPO Teslas still lower.
There are a number of risks.
“How long will the $30,000-in-cost batteries be good for?” asks McAlinden. “What will be the warranty on that part of the car? What happens when California, where over 33% of Teslas sell, runs out of HOV stickers, and what if the ZEV [Zero Emission Vehicle] credits per Tesla fall again in California?”
These are all factors that could deter a potential buyer from purchasing a pre-owned Tesla. As a result, the CPO price would have to be a lot lower to attract a consumer.
What’s more, as gas prices become less expensive, EVs have less appeal in the market place and thus can’t command a higher price point based on potential savings for customers.
“Frankly, now with gas prices where they are…it’s more difficult for [Musk],” IHS’s Libby said.
The competition could also be tough for Tesla. By 2017, we’ll see 17 to 19 Tesla-like plug-in luxury cars for sale, according to Jeff Shuster, senior vice president of forecasting at LMC Automotive.
And beyond general EV anxiety and lack of understanding about how well these vehicles hold up as they switch users, the fast-paced innovation of technology in the automotive industry could also add a wrinkle to the mix.
“Beyond consumers’ perhaps overwrought worries of battery performance degradation, there is also the, albeit unlikely, downside risk of a breakthrough in vehicle electrification technologies which would result in a certain level of technological obsolescence and detract from electrified vehicle residuals,” said Schultz, from the Center for Automotive Research.
Of course, consumers are more likely to overlook potential negatives to get their hands on a cheaper Tesla. The company’s burden is, indeed, the average American’s gain.
“This product appeals to a very select group of people,” said NADA’s Szakaly. “Those people are going to overlook some of those consumer negatives, because they want a Tesla…It’s not a mass market car. It’s a status symbol. And so it doesn’t have the same consumer thought process as a Ford Fusion or Chevy Malibu. It’s a statement car.”
--Written by Ross Kenneth Urken for MainStreet