A few years ago, Tesla flipped a magic switch and gave some of its Florida drivers an extra 30 miles of range in order to escape the wrath of a pursuing hurricane. It turns out that all Tesla vehicles have the same range, but the amount of range you see depends on how much money you spent.
Tesla limits the range of its lower-cost vehicles in order to increase customer accessibility to its vehicles. It has to do with an economic principle known as willingness to pay and allows more people to be able to afford a Tesla and increase profits. This is a form of price discrimination.
This economic concept known as price discrimination is not uncommon, and Tesla isn’t the only company that does it. Many people disagree with the practice. Read on to decide for yourself if Tesla’s reasoning for limiting your range is acceptable.
This Is Why Tesla Limits Your Range
The simplest answer to why Tesla limits the range of some of its vehicles is because it increases accessibility and thus increases sales. Doing so allows them to offer the same product at different price points. Instead of producing two different batteries, Tesla uses the same battery for all of its vehicles and limits the range on the cheaper models.
This saves money on production and allows Tesla to potentially make more money later. If you purchased the cheaper model and decide you want to upgrade, you do not have to return the vehicle for another one. You pay for the upgrade, which is about $9,000.00, and Tesla releases the remaining 20 percent of the range of your vehicle.
This may seem shrewd, but it is a common practice in the business world. Another common example of this practice occurs with computer software. There is often a “student” version of a software that is free in some cases, but is more often offered at a reduced price. The software in the “student” version is limited, like the cheaper Teslas.
In economics, this is known as price discrimination. This practice is becoming increasingly popular as more and more products that once only consisted of hardware components are being run by advanced software. Companies like Tesla do this for a variety of reasons:
- It increases the number of customers that have access to their products
- It creates distinct levels of the product while minimizing production costs
- It generally increases profitability and sales overall
- It caters to customers’ willingness to buy (more details on this later)
Tesla is not the first, nor will it be the last, company to use price discrimination to increase their revenue and customer base. As mentioned above, this practice is not new to the sales world. This practice may seem to only benefit the seller, but it can actually benefit the buyer as well.
The Storm That Uncovered The Secret About Tesla’s Battery Range
In late 2017, Hurricane Irma was looming over the state of Florida, prompting statewide evacuations as Florida’s citizens sought shelter by heading north. At one point, some Tesla owners noticed they gained an extra 30 miles in range. Once the storm settled, it became clear that Tesla had magically given its more affordable vehicles a range boost.
The selfless gesture was undoubtedly appreciated at the time, but it did not take long for people to question how it was possible for Tesla to just give these vehicles more miles. Drivers of Tesla’s cheaper models found out that their range was controlled by software, not by the vehicle’s hardware. It was previously thought that battery capacity determined range.
In 2017, Teslas were available with a 75KwH battery or a more affordable 60KwH battery. The reality was that both vehicles had the 75KwH battery and Tesla used the vehicle’s software to allow the cheaper vehicles access to only 80 percent of the available range. Increasing the range was, in fact, as easy as just flipping a switch.
This realization led some owners of Tesla’s more affordable models to become frustrated. If they had the same battery as the more expensive models, they felt they should be able to use it to its full potential. Tesla replied by saying these customers could purchase an upgrade for their vehicle in order to gain the added range.
How Does Price Discrimination Work?
The sales strategy behind price discrimination states that, by charging what they think a customer can afford, they can increase sales. This relates to another economic concept, known as willingness to pay, which will be discussed later on. For now, the important thing to understand is that in most cases, the product being sold is the same.
The strategy of price discrimination is founded on the notion that customers from different socioeconomic groups will pay different prices for a product based on how much they can afford and the value they place on the product. This allows more people to access the products they desire. There are three forms of price discrimination:
- First-degree price discrimination, also known as pure or perfect price discrimination
- Second-degree price discrimination, which relates more to the volume of the purchase, not the group a buyer belongs to
- Third-degree price discrimination, which is the most common form of price discrimination
Price discrimination is used when it becomes clear that more profit can be earned by segregating the buyer markets into different groups based on their characteristics. These groups are not always based on income. Other examples of price discrimination grouping include the private versus public sector or domestic versus foreign markets.
Price discrimination is used to increase profits, expand customer bases, and in some cases, as a marketing strategy. For example, if a college student uses a software all throughout their studies, they are likely to choose that software when they graduate and enter their chosen profession. They do not mind paying more for the familiarity.
The Degrees of Price Discrimination Explained
As mentioned, there are three types of price discrimination. The level utilized by a buyer often depends on their goals as much as it depends on the customer market(s) they are going after. Grouping customers into different markets can be based on things such as age, income, or location. Grouping can also be based on how the product will be used.
The table below breaks down the three different levels of price discrimination as well as offers a summary of how and why a particular level would be utilized by a seller.
|Degree of Price Discrimination||Also Known As||Details||Real-World Examples|
|First-degree price discrimination||Perfect, pure, or personalized price discrimination||In first-degree price discrimination, a business sells its products at the highest price possible based on each individual customer’s willingness to pay.||This type of price discrimination is usually employed by businesses that offer client services. A professional writer, for example, will change their rate for each client in order to make the sale.|
|Second-degree price discrimination||Menu pricing, quantity pricing, or personalized price discrimination||Second-degree price discrimination involves offering different price points to customers based on the volume they purchase.||This type of price discrimination is usually seen in the private sector. For example, restaurants pay less for bulk produce than normal consumers do at the grocery store.|
|Third-degree price discrimination||Group, or categorical price discrimination||Third-degree price discrimination involves creating different price levels for the same product based on consumer grouping.||This level of price discrimination is common when a seller seeks to increase its accessibility. A simple example of this is sporting events, where the range of seats depends on how much a customer values being close.|
Tesla is not the only company to employ price discrimination strategies to promote accessibility and increase its bottom line. Other industries well known for utilizing price discrimination include the airline industry, the entertainment industry, and the software industry. Price discrimination is not limited to just offering different prices to consumers.
Price discrimination can occur in the form of coupons, membership perks, discounts based on age or career choice, and loyalty incentives. Technically, when military members or seniors receive discounted prices, it is considered price discrimination. Price discrimination is also happening when buyers save by purchasing in advance.
What is Willingness to Pay?
The economic principle known as willingness to pay, or WTP, is one of many considerations made by sellers when they are trying to determine the best price at which to sell their product or service. The first consideration when determining the price of a good is to determine its cost of production, which includes material cost and labor.
The concept of willingness to pay is based on the theory that consumers place a value on a product or good that will determine the maximum amount they are willing to spend on that product or service. The WTP price is expressed in the highest amount a customer will spend on a product. They may want to pay less but will not pay more.
Companies usually represent their customer’s willingness to pay as a single dollar amount or a range of prices. The goal is to determine the highest possible amount they can charge for a good or service without impacting sales or alienating their customers. Once calculated, the WTP usually represents the price customers will not go over.
What Determines Willingness to Pay?
Willingness to pay will always vary drastically between customers. This disparity is caused by characteristic differences in the consumer population. These differences are grouped into two different categories, intrinsic differences and extrinsic differences. Examples of extrinsic differences are:
- Income level
- Education level
The extrinsic differences that impact a consumer’s willingness to pay are usually easy to observe and can normally be determined without a need to ask the consumer. The intrinsic differences that impact willingness to pay usually need to be discerned by communicating with the customer. Examples of intrinsic differences include:
- The customers level of risk aversion
- Customers desire to fit in with popular groups
- Values or virtues held by the customer (things like the environment, product sourcing, or political stances)
There are other factors that impact customers’ willingness to pay, and very rarely will a customer’s willingness to pay be constant. For example, paying more for organic food may not resonate with someone until they realize the potential impact on their health. Urgency can also impact WTP. This is why people often pay more for last minute flights.
Tesla’s Approach to Pricing
Tesla’s price discrimination policy would be classified as third-degree price discrimination. In order to increase access to their vehicles, as well as pad their profits, Tesla has separated their customer base into groups based on their socioeconomic status. This allows people with less income to still own a Tesla.
Tesla does this by selling the same vehicle battery (hardware) to all of their customers. They just use the software elements of their product to artificially reduce the value of the cheaper model. This reduction manifests itself in the reduced range of those vehicles. The cheaper vehicles only use 80 percent of their available range but can be upgraded.
Tesla’s decision to merely limit the capacity of their product caters to the willingness to pay of their two subgroups of customers. In doing so, it is clear that Tesla has identified differences in each subgroup’s motivation to purchase. Tesla’s customers are first grouped by their income, which is an intrinsic motivation factor.
The extrinsic motivation factors are different for the two groups. Those that can only afford the cheaper models are more motivated by their desire to help the planet. They are less motivated by the brand power and status that attracts Tesla’s high-end consumers. This is not to say that each group is ignoring the other factors.
Is Tesla’s Price Discrimination Policy Unfair?
Determining whether Tesla’s pricing policy is fair or unfair is largely subjective. There are valid arguments for both stances. Some may believe that all Tesla models should offer the full range of their batteries. The counterargument to that stance is to point out that if Tesla made two different batteries, that stance becomes null.
The fact is that Tesla is a business first. Businesses must make decisions based on profitability. Producing two different batteries would increase their production costs. It would also disallow them from simply selling software upgrades to their customers that started with the affordable model and now have the means to pay for the added range.
Another important fact is simply that price discrimination is not against the law. It is an economic principle employed by many other businesses. By offering different models, Tesla is increasing its consumer market and its sales. By allowing customers to pay for a simple software upgrade, they are saving themselves and the customer money.
It is also important to consider the reasons people buy Teslas. Some customers are motivated by the brand image and status associated with driving a Tesla but most customers (even those who value the status aspect) purchase Teslas due to their impact on the environment. Being electric, Teslas reduce greenhouse emissions.
How Tesla’s Price Discrimination Policy Benefits Everyone
Despite the belief held by some who would argue that Tesla’s price discrimination policy unjustly favors the companies wealthier customers, it is difficult to ignore the benefits of Tesla’s pricing policy. There are a few parties that benefit from this practice. They include:
- Tesla as a company (in the form of increased sales, a reduced production cost, and a larger customer base)
- The consumer (this means that more people can afford to drive a Tesla, regardless of their motivation to do so)
- The environment (Tesla’s vehicles have a significant impact on greenhouse gas production. The more Teslas there are on the road, the fewer greenhouse gas emissions there will be going into the atmosphere)
Tesla utilizing price discrimination strategies to increase sales and promote accessibility arguably has more pros than cons. More people can afford to purchase a Tesla because a more affordable option is available. This allows less affluent people to support a brand and/or cause they believe in. They can always increase the range later.
Those consumers who are motivated by the status associated with Tesla still feel they are getting what they paid for. Not only do they get more range by paying more, but they can also upgrade other aspects of their Tesla. They can upgrade the interior or the sound system. They can even pay for a software update that increases their speed.
The reason Tesla limits the range of its vehicles is motivated by two different economic principles that relate to each other. These principles are known as “price discrimination” and “willingness to pay.” By employing these strategies effectively, Tesla increases its profitability and the size of its customer base.
There are arguments against price discrimination, but it is difficult to argue against the outcome. Price discrimination policies allow more people to purchase Tesla vehicles. This impacts Tesla’s bottom line and, in this specific situation, has the added benefit of promoting the health of the planet.