This week Tesla announced a new Model 3 configuration, shifting the lowest-price Model 3 option from $49,000 to $45,000. The new option has an all-new “mid range” battery pack and is only available in rear-wheel drive.

• This is a sign that Model 3 production has stabilized.
• The timing of lower-ASP configurations is also likely a sign that the company is improving manufacturing yields. This allows Tesla to effectively lower the price while inching overall Model 3 gross margins higher.
• We expect the company will continue to target 20% Model 3 gross margins for the Dec-18 quarter.
• We expect the $35k base configuration to be available within the next 4-6 months, generally coinciding with reaching a production run rate of 10k Model 3s per week (currently about 5-6k per week).
• This change is good for Model 3 demand in Dec-18 and a potential headwind for demand in Mar-18 due to the fading US tax credit.
• Tesla also dropped the $3k “full self-driving” option from the configurator. This is a powerful sign that the company misjudged the timeline to full autonomy. This may result in refunding the relatively few owners that have purchased this option. We don’t see this having a measurable impact on the balance sheet.

Why Limit Configurations?

To reach a 45K base model, Tesla shifted the rear-wheel drive configuration from the long range to a mid range battery. Importantly, you can no longer configure a rear-wheel drive Model 3 with a long-range battery. This is noteworthy, given it is a subtle example of how optimizing for manufacturing simplicity can lay the groundwork for improving output and profitability.

Tax Credit Impact

After the full US tax credit of $7,500, the new lowest-price Model 3 costs $37,500. Previously, the lowest-price model after the full tax credit was $41,500. The US tax credit will begin to fade starting in 2019, first to $3,750 for the first 6 months, then to $1,875 for the remainder of 2019, going away completely at the end of the year. This, coupled with a new lowest-price Model 3 below $40,000, will pull demand into the Dec-18 quarter, potentially resulting in a demand headwind for Mar-18. Tesla will most likely offset some of this headwind by working through the international order book, where they have more control over the mix.

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