Debate over the profitability of Tesla electric cars has raged for years among its fans and detractors.

Tesla supporters point to financial data from the Silicon Valley automaker to support the idea that it makes money on each car it sells.

Skeptics point out that save for two marginally profitable quarters, one in 2009 and another this year, Tesla Motors has consistently lost money for more than 10 years.

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Yes, supporters reply, because it's investing in its future growth and products, most significantly the gigafactory battery plant that will enable it to start high-volume production of its lower-cost Model 3 sedan.

Sure, the detractors riposte, but every car company has to do that—and the legacy automakers are largely making handsome profits these days.

Now, Tesla's need to make profits while selling only electric cars is the topic of a worried note from financial firm Merrill Lynch and its industry analyst Ryan Brinkman.

2017 Tesla Model S

2017 Tesla Model S

As summarized last week by Barron's, the concern is simply that as more and more carmakers make plans to produce electric cars in greater volumes, Tesla becomes more vulnerable.

That's because it will have to start delivering consistent profits as Model 3 production hits high gear, meaning every electric car it sells must not only be profitable to build but also contribute to future growth and investment needs and to profits on top of that.

Meanwhile, legacy automakers making money on gasoline vehicles can—and will—use a portion of those profits to subsidize sales of enough electric cars to comply with stiffer future regulations.

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That will let them undercut Tesla on price.

Such internal subsidies among model lines are supported by at least one notable case study: that of the original Toyota Prius hybrid-electric car, launched in Japan in 1997.

Today, the Prius is known the world over as the definitive hybrid vehicle, and a paragon of fuel efficiency across all of its models.

2001 Toyota Prius Sedan

2001 Toyota Prius Sedan

Toyota lost money not only on the entire first generation of Prius hybrids through 2003, but on a year or two of production at the start of its second generation, through 2009.

The Japanese carmaker has never said how much it lost, but industry analysts put the number in the billions, perhaps as high as $15 billion—funded by profits from its conventional model lines.

Of course, Toyota now owns half or more of the global hybrid market, plus an image for highly fuel-efficient cars that's not necessarily justified by the rest of its lineup. It will soon cross total sales of 10 million hybrid vehicles worldwide.

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Legacy automakers can use that kind of internal subsidy to let them sell enough plug-in electric cars to meet increasingly stiff emission limits across different global markets.

As Brinkman writes:

We expect it will become increasingly more difficult for Tesla to profitably compete against an improving array of electric vehicles from automakers which are pricing such vehicles with the aim not to turn a profit but rather to sell in sufficient volume to subsidize the rest of their more lucrative portfolios of internal combustion engine vehicles from a regulatory compliance perspective.

In other words, Tesla must make a profit selling its electric cars while competing against companies that can price their battery-electric vehicles without regard to making money on them.

Tesla Supercharger site with photovoltaic solar panels, Rocklin, California, Feb 2015

Tesla Supercharger site with photovoltaic solar panels, Rocklin, California, Feb 2015

Tesla fans will say its cars' style, brand image, low battery costs, and access to a growing Supercharger network, plus some undefinable Tesla mojo, will ensure success—and thereby profits.

The company's shareholders no doubt hope that is all true.

But it is clear that Tesla operates at a significant disadvantage because it doesn't have profitable gasoline cars to subsidize its electric offerings.

Game on.


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