With the battery design, manufacturing, and integration enhancements outlined during its battery day event conducted in late September, Tesla (NASDAQ:TSLA) says that it could reduce the cost per kilowatt-hour (kWh) of batteries by as much as 56% over the next few years. Is this a big deal? Sure is! Using our interactive dashboard How Tesla’s Battery Costs Impact Its Gross Margins we estimate that a 56% reduction in Tesla’s battery costs could boost Automotive Gross Margins by 800 basis points, all other factors remaining equal. Tesla’s automotive gross margins are already among the best in the industry at about 21% in 2019, versus about 17% for Toyota – one of the most efficient automakers, and 10% for GM. (How Does Tesla Compare With Toyota?) By realizing these battery-related improvements and doubling down on software sales, Tesla could boost gross margins to 30%+ levels, rivaling the roughly 32% Hardware Gross Margins of Apple – which is a benchmark of sorts in the hardware industry. 
Tesla’s Battery Costs Per Vehicle
According to Bloomberg New Energy Finance (BNEF), the industry average battery costs (for both battery cell & packaging) declined from $288 to $176 between 2016 and 2018. We estimate that Tesla’s battery costs are about 20% below the industry average, driven by the company’s higher volumes and battery chemistry. This means that Battery costs for Tesla vehicles likely declined from around $230 per kWh in 2016 to $127 in 2019. Assuming that the average Tesla vehicle has a 70 kWh battery, this could imply that Tesla’s battery cost per vehicle has declined from $16k in 2016 to about $9k in 2019. Considering that the average selling price for Tesla vehicles has declined from $83k in 2016 to $57k in 2019, due to a higher mix of lower-cost Model 3 vehicles, we estimate that Tesla’s Battery Costs As % Vehicle Price dropped from 19.4% in 2016 to roughly 15% in 2019. Tesla’s Battery Costs As % of Cost of Goods Sold likely dropped from 26% in 2016 to 19% in 2019.
How Battery Cost Declines Benefit Tesla’s Margins
If battery costs were to decline by about 56%, as Tesla indicated during Battery Day, per kWh costs would fall from an estimated $114 in 2020 to about $50. This could reduce the cost of a battery pack to just $3,500 per vehicle, down from the $8,000 we estimate currently – a saving of about $4,500 per vehicle. At an average selling price of $54k, this would translate into an incremental gross margin of about 800 basis points. That said, it’s also possible that Tesla could actually pass on the benefits of its battery cost improvements to customers to lower the cost of its vehicles. This way, the company could increase its installed base of vehicles and better monetize its software-related sales and upgrades.
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