Here's the Secret Behind Tesla's Industry-Leading Margins | The Motley Fool (2024)

On Wednesday, Tesla (TSLA -2.25%) reported solid first-quarter results despite the supply chain challenges automakers faced during the period. And among the many impressive metrics in its report, one that should be of particular interest to investors is its industry-leading net profit margin of 17.7%.

Though its margin was boosted last quarter by a higher level of regulatory credits -- subsidies paid to companies that sell zero-emission vehicles -- its margin would still have amounted to a very healthy 14.6% excluding those credits' impact.

Consider how Tesla's margins compare with those of these giant legacy automakers.

TSLA Profit Margin (Quarterly) data by YCharts

The chart above tracks the quarterly profit margins of the top automakers for the five-year period that ended with Q4 2021. Ford's (F 1.69%) average profit margin during this period was 3.8%. And it's important to note that Ford's Q4 2021 margin includes the impact of a gain on its investment in electric truck startup Rivian, which resulted in an exceptionally high result. Excluding that quarter, Ford's average margin drops to just 2.2%.

Similarly, General Motors' (GM 1.70%) average margin for the last five years was 3.7%. Volkswagen's was 4.9%. Toyota generated the best margins among the incumbent major automakers with an average of 7.7%.

So, Tesla's margin of 13.1% is way higher than what automakers generate on average. It was also higher than the traditional automakers' margins in Q4 -- showing that Tesla is outperforming them under current market conditions. Indeed, Tesla doesn't have a long track record in terms of industry-leading margins, but it has topped its peers for the last four consecutive quarters.

Why Tesla's margins are higher?

Among the most likely and obvious factors driving Tesla's recent outperformance on this front is its strong pricing power. Customer interest in its electric vehicles remains high, and demand exceeds supply.

But beyond that, Tesla's operational efficiency and vertical integration could be playing major roles. The company sells its cars directly to customers, sidestepping the dealership model of traditional automakers. Its marketing expenses are negligible compared to billions of dollars a year that other automakers spend.

On a cost-per-car-sold basis, Tesla's advertising expenditures in 2020 didn't even amount to $1 per vehicle. By comparison, Ford spent $468 on advertising for each car it sold in 2020, while ad spend was $394 per car for General Motors. Chrysler, a Stellantis subsidiary, spent $664 per car sold on advertising.

Instead of pouring money into marketing, Tesla has spent liberally on research and development.

Tesla's vertical integration strategy also includes batteries. The company makes some of its own batteries, though it still buys from third-party suppliers. It intends to continue expanding its battery manufacturing capacity, though, and expects that economies of scale will help drive its costs down further. Moreover, it is improving its battery technology. Its newest batteries -- the 4680 cells -- are touted as being more cost effective, able to store more energy and provide improved range, which should help it bring down the total expense of manufacturing Tesla vehicles.

In short, there are several factors helping Tesla generate higher margins than its peers, and it appears likely to keep benefiting from them for the foreseeable future.