Elon Musk isn’t afraid of a challenge. He disrupted banking as the founder of X.com, a direct bank that later merged with Confinity to form Paypal, turned the auto industry on its head by reinventing electric cars as CEO of Tesla (TSLA) -), and he’s planning a trip to Mars as CEO of SpaceX.
He even, somewhat audaciously, bought Twitter, rebranded it “X,” and plans to make it a social media and finance powerhouse.
In short, he knows a thing or two about overcoming roadblocks. Nevertheless, he may struggle to fix the latest problem facing Tesla because it’s largely outside his control.
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Elon Musk’s Tesla Tackles Competitors
Elon Musk has faced many challenges in his bid to turn Tesla into the biggest EV manufacturer.
General Motors (GM) -) and Toyota (TM) -) were once on the cutting edge of EVs, and each had deep pockets, factories, and skilled engineers and workers. Yet, Elon Musk outmaneuvered them by recognizing that the way to win the EV market was to focus on high-performance luxury rather than cost-conscious penny pinchers.
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Tesla’s Model S reshaped the luxury automobile industry with neck-bending 0 to 60 times, top speeds, and track speed records. Elon Musk followed that up with the Model 3, a lower-cost vehicle with similarly impressive performance, and the Model Y, a crossover SUV that’s won favor with so many buyers that it’s become the best-selling car in America.
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Elon Musk will soon disrupt yet another auto category with Cybertruck, its futuristic high-performance pickup truck. The first Cybertrucks are already on the roads, and commercial production is expected to begin within months. Once the Cybertruck is widely available, it may pose the most significant threat to Ford and Chevy’s truck dominance in history..
Indeed, the challenges associated with designing, building, and distributing these game-changing EVs were significant. However, they were totally within Tesla and Elon Musk’s control.
The same can’t be said of the latest challenge facing Elon Musk and Tesla.
Tesla’s Big Problem Is The Government
The product can be great, but demand for Tesla’s vehicles depends largely on people's ability to afford them.
When interest rates were racing to zero worldwide, and governments were pushing easy money stimulus to support economies during COVID, affordability wasn’t nearly as big a problem for Tesla as it is today. Jobs were plentiful, double-digit pay raises were common, and investments in everything from art to Pokémon cards to stocks and cryptocurrencies were soaring.
Nowadays, things aren’t nearly as rosy. The stock market endured a brutal bear market in 2022 that erased gains for many. Jobs remain plentiful, but wage growth has moderated, and importantly, the Federal Reserve’s war on inflation has lifted interest rates on auto loans to levels last seen over a decade ago.
Since March 2002, the Federal Reserve has raised interest rates by 5.25%, increasing borrowing rates significantly. Nationwide, the interest rate on a 48-month new car auto loan was 7.5% in May, up from below 5% in 2021. After years of low-interest rates that helped fuel demand for increasingly pricey vehicles, new vehicle loan rates have climbed back to the highest since the Great Financial Crisis over 15 years ago.
The increase in interest rates, driven by the government’s hawkish inflation policy, coupled with the fact that vehicles have gotten increasingly expensive, means average monthly payments have become a big headwind for the auto industry.
Elon Musk admitted just how big the problem is for Tesla last month.
"When interest rates rise dramatically, we actually have to reduce the price of the car because the interest payments increase the price of the car," said Musk on Tesla's Q2 earnings conference call. "And this is -- at least up until recently, it was, I believe, the sharpest interest rate rise in history. So, we had to do something about that.
Initially, Musk attempted to overcome the affordability problem with price cuts to Tesla’s vehicles. However, prices can only be cut so far without dinging profit and angering shareholders. Tesla may be near that point, given Musk has recently embraced another tactic.
Last month, Tesla announced it would offer 84-month loans for the first time to reduce monthly payments.
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Extending the payback period for Tesla vehicle loans doesn’t save the consumer money. It means paying more interest over the life of the loan. However, it does lower monthly payments, making them friendlier to consumer budgets.
The only problem is this solution is simply a band aid. Musk can only tack on so many additional months of payments before consumers balk.
Ultimately, Elon Musk’s Tesla faces a problem that isn’t his own, without reasonable solutions within his control.
For now, price cuts and longer payment periods help Tesla deliver more units, but affordability will become an even bigger problem for Musk if rates keep rising.
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