The most important vehicle in the Tesla Inc. portfolio is on the horizon, but it’s not the upcoming Model 3 small sedan.
It’s the Model Y, a compact crossover expected to debut in a few years at a price well below the Palo Alto, Calif. electric car company’s six-figure Model S sedan and Model X SUV.
The Model 3 is expected to launch this year into a market where more than 62 percent of U.S. sales in February were crossovers, SUVs and pickup trucks. Like a wide variety of sedans – from budget-minded Toyota Corollas to luxury German cruisers – the Model 3 faces the headwinds of consumer preference. Americans like larger vehicles.
That’s why a Morgan Stanley Research analyst report earlier this month pegged the eventual Model Y as the vehicle most likely to become Tesla’s best-selling model. When the Model Y hits the market, it has the potential to transform the brand into a mass market automaker from a niche player.
“Fundamentally this is a super important vehicle because this is what Americans are buying,” said Michael Ramsey, an analyst with Gartner Inc. “The sedan is essentially being eaten alive by the compact crossover.”
Through February, the auto industry reported U.S. sales of over 1.5 million trucks, SUVs and crossovers, according to industry research firm Autodata Corp. These vehicles already account for 62.5 percent of sales, an increase over the 57.9 percent share it reached during the same period a year earlier. The segment ended 2016 with almost 60 percent of all vehicle sales.
Tesla is currently preparing for production of the Model 3, slated as its entry-level compact sedan. The Model Y is a few years from being released, Tesla Chief Executive Elon Musk tweeted last week.
@varunfatehpuria Oh Model Y is coming too in a few years. Kinda have to.
— Elon Musk (@elonmusk) March 24, 2017
The Morgan Stanley report estimates the Model Y will be key to Tesla’s future ride-sharing program, called Tesla Mobility. The company will also benefit from the higher profits crossovers and other light trucks deliver because customers are willing to pay a premium for larger vehicles. The Model 3 and Model Y will share a platform to ease production costs.
Growing Pains Ahead
Tesla delivered 73,630 vehicles globally in 2016, but in an August call with investors, Musk predicted the Model Y alone will command sales between 500,000 and 1 million vehicles annually, globally.
“It's the obvious priority after the Model 3,” Musk said.
If Musk’s prediction holds true, the Model Y would be a smashing success. Last year the best-selling SUV in the U.S., the Honda CR-V, sold 357,335 vehicles, according to Autodata.
Tesla will face hurdles as it seeks to expand. Besides ramping up production far above its current level, it will have to address quality issues, analysts said.
The automaker’s Model X SUV, for example, “has been plagued with malfunctions, including its complex Falcon-wing doors,” Consumer Reports wrote in its annual auto reliability report, published in the magazine’s December edition.
Other problems with the vehicle included locks and latches, power equipment, in-car electronics and the climate system, Consumer Reports wrote.
The Model X scored just a 12 in Consumer Reports’ reliability rankings of luxury mid-sized SUVs, the lowest score of any auto in that category. The top vehicles were the Lexus GS with 90 and the Audi Q7 with 87. The Model S scored 44 in the ultra-luxury car segment. While that was well above the 20 earned by the Mercedes S class, it was still far below the the Lexus LS, which scored a segment-leading 87.
An analysis earlier this month by automotive consulting firm J.D. Power found that “with each vehicle (Model S and Model X) pricing in at well over $140,000 (as evaluated), the level of body panel gaps, poor fitments, damaged trim pieces, and general misalignment was quite surprising.”
But Tesla owners are passionate supporters who typically overlook foibles they wouldn’t forgive with other luxury vehicles, said Kathleen Rizk, director of global automotive consulting at J.D. Power.
That may not last when Tesla makes the switch to customers who rely on their vehicles for everyday transportation.
“Tesla has a big test coming up,” Ramsey said.
The company is leaving behind early adopters and moving into a mass market that will use the Model Y as their primary vehicle and won’t be able to go without it while it’s undergoing repairs that take extended periods of time, he said.
“Tesla has a lot to prove to show it can actually pull this off without making a mess,” Ramsey said.
Road Map to Success
The Model 3 will be the first test. The sedan will demonstrate whether Tesla can produce affordable cars for a wider audience, analysts said.
“I think that if the Model 3 sees too many stumbles, it will make the Model Y more difficult,” said Stephanie Brinley, an analyst with IHS Markit.
And the company will have to ramp up production, hire more employees and perhaps seek new outsourcing partners even to get Model Y off the ground, Brinley said.
“You’re basically doubling your volume by adding the Model Y and that’s a big jump,” she said.
Tesla has traditionally shied away from marketing and advertising, and sells vehicles directly to consumers, rather than through dealerships. If the company hopes to cast a wider customer net, it may need to change, Brinley said.
Even if there are hiccups, Tesla has the ability to make the Model Y a success.
Ramsey said that investors are willing to give Tesla the benefit of the doubt because of its strong brand and unique technology. This week the Chinese company Tencent Holdings Ltd. paid $1.78 billion for a 5 percent stake in Tesla, providing an infusion of cash in the lead-up to the Model 3 launch.
Brinley said that Tesla can learn the marketing and build the infrastructure it needs to make the Model Y a success.
“None of that stuff is impossible,” she said. “I think everything they’ve done up until now, and everything they’ll do over the next couple of years, will help them learn and grow and improve.”
Editor's note: An earlier version of this article incorrectly reported that the Nissan Rogue was the top selling SUV in the U.S. in 2016.