Why Is The Tesla Model S So Expensive, And How Can The Price Go Down For The Model 3?

While Tesla Motors Inc. (NASDAQ:TSLA) and its billionaire inventor Elon Musk have captured global attention for mass producing the world’s first luxury electric car that can travel more than 200 miles on one charge, the Palo Alto, California, company’s biggest challenge lies ahead: Producing a Tesla-like car for the masses. The question is how the company will be able to lower the price without cutting its range or trimming the high-tech options that have made the Model S such an attention grabber, and also what contributes to its luxury-level sticker price.

The company says a sub-$40,000 electric car, the Model 3, is coming by 2017 and that it will have a “practical” range. That’s well below the $71,000 starting price of a Model S, not including the $10,000 battery upgrade or any of the options that put the car well into the price of a German luxury car.

“A lot of people think luxury car buyers have higher expectations, but the people in the market for a $40,000 electric car are going to have certain expectations,” Joe Wiesenfelder, executive editor of the automotive pricing and data provider Cars.com, said by phone on Monday. “The question will be if Tesla can lower the price without shedding too many of the expected features. That will be another big challenge . . . But I wouldn’t bet against Elon Musk to figure it out.”

The $5 billion so-called “gigafactory” that Tesla is planning (possibly near Reno, Nevada) with its current battery supplier, Panasonic Corp. (TYO:6752), will help the automaker lower the costs of battery pack production, but the main goal of the factory is to secure the company a dependable supply of batteries to produce 500,000 cars a year by 2020. How much that capacity will also lower costs is unknown. The production price of the individual lithium-ion cells used in the Tesla battery pack is less important than the cost of the battery pack, the cooling system and the electronics built around them.

Tesla battery packs are the most expensive single component of the Model S, with current cost of about $500 per kilowatt-hour. This means about $30,000 of the price of a Model S is the 60 kWh battery pack that delivers 208 miles of range. Musk has said his goal is to reduce the kilowatt-hour cost by 40 percent, knocking about $12,000 off the price.

But that cost savings alone will not be enough to provide a $35,000 to $40,000 Model 3 with at least 200 miles of range by 2017. To top 200 miles in range, the Model 3 will need to be smaller and lighter than the Model S and possibly carry a smaller, lighter battery pack.

The other way Tesla can reduce costs is by cutting out some of the features available in the Tesla Model S. That would certainly be understandable; think entry-level Mercedes-Benz CLA250 compared to the premium S-Class sedan. Wiesenfelder says this is where Tesla needs to be careful because consumers are starting to be more scrupulous about standard high-tech features in regular, everyday cars – including touch screens with user-friendly interfaces, connectivity options and comfortable interiors.

Tesla will have to produce a battery pack that can power a smaller Model 3 for at least 200 miles in range while at the same time offering many of the features that Tesla fans have grown to love.