Tuesday, July 2, 2013

Prices and R&D

According to the news observer.com, Tesla Motors appears to be doing well. Its stock price is up 500% in three years and it is building electric cars as fast as it can sell them. So it is rolling out new, more affordable models. How to price them? I hope this is the reporter speaking and not a company manager,
"Prices for the Model X have not been announced, but Tesla hopes to deliver the Gen 3 at a much lower cost than the Model S because it will spend much less on research and development."

At the time that you are determining prices for an innovative new product, the development costs are all sunk. They are not relevant for pricing decisions.

When determining whether to go ahead with the project, one might consider that, by innovating, the market will bear a price premium. Proceed only if the implied contribution margin for anticipated sales exceeds the development costs. Or the causality expressed above is backward; the additional R&D is lower because the anticipated price is lower.


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  2. I would concur that in any new project initiation, determining whether to proceed with the project, managers would consider that, by innovating, the market will bear a price premium. But spending less on R&D does not guarantee savings the will be passed on the consumers.
    Market demands and consumer preferences are ever changing, so doing less on R&D could result in a shortfall in innovation and consumer interest. Furthermore there are no savings to past on to the consumer if the R&D cost is already spent, thus not relevant to the pricing decisions.
    Notwithstanding, Tesla Motors could possibly lower its price based on the potential increase in demand in the industry. Higher electric car demand opens the prospect to introduce volume discounts to their dealers. According to ccbldg, “Tesla Motors CEO Elon Musk says some competitors are finally taking him up on his deal to share some of Tesla's 200 patents for free” He expressed surprise that despite Tesla's success so far -- it plans on making about 35,000 cars this year -- which no other automakers seemed serious about making long-range electrics”. This niche could yield significant value creation for Tesla. Also since they are the leader in this area, they are position to harness more information on consumer’s interest in electric cars with little or no competition for its rivals. Thus, Tesla could take advantage of price discrimination opportunities among certain group segments.
    Leo Palmer ESC ECON