EV Price Reductions Make Headlines But Will They Impact Demand?

The recent announcements of price reductions of the Ford Mustang Mach-E and the Tesla Model Y and other electric vehicle (EV) models in the U.S. marketplace are likely to be among a long series of EV price reductions to accomplish a number of both short- and long-term goals. But unlike the price setting and adjustments we are accustomed to in the traditional internal combustion engine (ICE) auto industry, the impact of announcements like these for EV demand and U.S. manufacturing is far less important than the long-term evolution of the industry.

The economics of a decade-long transition from the ICE to the EV industry will be a very unique and uncertain transformation, and pricing and margins will be a continuously evolving story. Similar to our recent conversions from landlines to cell phones in communication and broadcast TV to streaming in entertainment, the unfolding story in transportation will be driven by many factors beyond price including domestic and global competition, battery and component pricing, consumer acceptance and switching costs, infrastructure availability, fuel prices for both oil and electricity, tariffs and government incentives and regulation directly in EV markets and indirectly in energy and infrastructure. While cost reductions of batteries and semiconductors continue from pre-pandemic levels, it is uncertain where costs for these critical materials will settle and long-term margins on vehicles become something that is predictable.

Traditionally, a price reduction like this happens in autos when two competing brands with excess supply need the reduction to help "inventory reduction" at the dealership level. And typically, they would be necessary for models sold in market segments where the price is a more important factor. And typically they would be necessary for models where demand was significantly lower than supply capacity. Neither is the case for the Mach-E or Model Y so it is likely that this announcement may be primarily driven by the desire to have more trim levels of both vehicles qualify for the full $7,500 tax credit of the recently enacted Inflation Reduction Act, which caps the MSRP at $60,000.

But what is also important to remember is that the price cap qualification for the tax credit is based solely on the MSRP of the vehicle and not the actual price paid by the consumer. The net effect may be to have the vehicle listed as "eligible for the tax credit" to brand awareness and dealership traffic, but the consumer may end up in a bidding war for limited vehicles and end up with less net credit. (Note that at the time of writing, it still is not clear which vehicles qualify for the full $7,500 credit, as the IRS has not yet released the rules covering the $3,750 half of the credit from battery composition and sourcing.)

In both cases, the MSRP of the EV vehicle still lands well above the average of about $49,000 for a new ICE, according to Kelley Blue Book. So while lower prices for a new vehicle are always good news in the minds of the consumer, the price-conscious new auto buyer is not yet likely to make that decision about EV or ICE based on price alone.

As we saw with GM's advertisements in the 2023 Super Bowl, the larger driver of demand may be less price and more about the consumer's answer to the question they posed: "Why not an EV?" That initial EV purchase by an ICE consumer is the critical driver of demand in the industry and that demand will drive capacity and volumes, which will have a far more durable decrease in price. The investment by GM in those ads reflects the need to grow the size of the EV industry "pie" in addition to the size of the "slice" they capture in market share.

And a final factor in pricing announcements is that the choice of an initial EV purchase over an ICE might involve a lot of brand switching by the consumer. Why be loyal to a company when the technology behind the product was not developed by that company? What is also important to auto dealers is the ability to counter perceptions that the competition is lowering prices and giving better value, so the timing of the announcement by Ford so soon after the Tesla announcement is significant.In a fledgling industry like EVs, consumers are more likely to switch brands so the manufacturers also want to maintain that much more beneficial long-term perception of brand value relative to competition even at the short-term cost of reduced margins.

And in both cases, the price reductions are for a theoretical base model MSRP for each vehicle, and it is likely that consumers will be offered only more expensive models with higher-end trim and option levels. And in the case of Tesla, many of the models are now priced more than 40% less than the same models were just a few years ago when the competition was much less. In that environment, continued price reductions might actually encourage consumers to postpone purchases.

Overall, the recent decline in EV prices was expected and will likely continue and result in a positive impact on the long-term outlook for U.S. manufacturing. But what is uncertain is the effect of the complementary decline in ICE and the parts, components, refinery, fuel and other industries associated with traditional automotive manufacturing.

For the final assembly companies, there will also be a long and difficult period of demand forecasting and supplying both markets with the quantities they need at prices that will deliver profitable operations margins. As the demand for EVs increases, the U.S. manufacturing sector will be making large investments to ramp up capacity toward the production of EVs and related components and infrastructure at the same time they will be reducing capacity in traditional ICE industries. Like the original shift from "horse and buggy" to "motor cars," the transition will be measured in years and driven by factors far more important than just price.

(Richard Kilgore is an instructor in the Online Management and Business Administration program at Maryville University.)