Tesla Model 3 demand startled everyone, even Musk; now what?

To say that the auto industry has been startled by the volume of deposits put down on the Tesla Model 3 would be an understatement.

The number of potential buyers worldwide who have sent Tesla Motors $1,000 to reserve a place in line to buy the car is now approaching 400,000, said longtime executive Diarmuid O’Connell.

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And at least one financial commentator has asked whether the total could be as high as 1 million by the time the car enters production.

The number of deposits even startled CEO Elon Musk, as his flurry of tweets after the March 30 unveiling seemed to indicate.

And the massive deposit queue imposes some new challenges on Tesla, on top of several huge hurdles it already has to overcome between now and the start of Model 3 production.

First, the new hurdles that have arisen since the Model 3 unveiling.

Higher volume requires more cash

Elon Musk tweeted the day after the launch event that the company was going to have to rethink its production planning for the Model 3.

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Definitely going to need to rethink production planning…

— Elon Musk (@elonmusk) April 1, 2016

It remains to be seen whether that means ramping up higher volume production to meet initial demand or adding more capacity over time to give Tesla a total capacity greater than that 500,000-by-2020 volume Musk previously projected.

But either plan will likely require larger capital expenditures sooner than Tesla had projected just last month, before the Model 3 hoopla.

Certainly, $400 million in deposits is nothing to sneeze at, and Tesla already has several empty factory buildings at its Fremont, California assembly plant.

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But projections for increased Model 3 production, with the associated capital costs — and how those costs are spread over the coming years — indicate that Tesla will almost surely be spending more cash and faster than previously expected.

In other words, a Tesla capital raise is more likely now than it was when the topic was discussed after the release of 2015 financial results in February.

Will reservation holders wait for their cars?

Few electric car advocates or financial analysts expect that Tesla will begin its first production of the Model 3 late next year, as it has committed to do.

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The company could surprise naysayers, but thus far, it hasn’t come within even a year of meeting the originally announced production date for any vehicle it has sold.

History also shows that, quite sensibly, Tesla tends to ramp up production gradually to address feedback from the earliest buyers and keep early build quality as high as possible.

That means that of the 400,000 current depositors, at least 350,000 of them likely have no chance of getting a Model 3 until 2019, more probably, 2020 or later.

How long they will be willing to wait is a huge open question.

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The competition noticed

Certainly Tesla’s following and the allure of the Model 3 have shocked the industry.

And thus far, the company seems to have largely overcome initial quality hurdles that early owners faced.

But buyers who want a 200-mile electric car will have several choices from more established car makers by 2019.

CHECK OUT: Is Chevy Bolt EV’s Main Mission To Marginalize Tesla Electric Cars?

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Those cars clearly won’t have the Tesla cachet, but GM, Nissan, and BMW will likely all have a track record of producing reliable battery-electric vehicles by then.

How many Model 3 depositors want to buy a 200-mile electric car for $35,000, and how many only want a Tesla?

Will the former group be willing to postpone their Model 3 purchase and start with a 2017 Chevrolet Bolt EV, a 2018 Nissan Leaf, or future 200-mile electric cars from Volkswagen, Hyundai-Kia, or other makers?

Today, no one knows.

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But you can be very sure that the legacy automakers are all looking at that question — and asking what it would take to get their answer to the Model 3 or Bolt EV in the market sooner than planned.

And the lithium-ion cell makers they will be buying from are doing exactly the same.

Those factors add to the ongoing challenges that Tesla and its advocates have long known the company is facing.

Increasing total volume by 10x isn’t trivial

The Tesla “secret master plan” published years ago envisioned that the third-generation car would be the high-volume entry to bring electric cars to mass buyers.

And thus far, the company is tracking against its master plan.

So it’s not like Tesla didn’t know it would face the hurdles of scaling up volume from 50,000 to a projected 500,000 cars a year.

ALSO SEE: Tesla Model 3 depositors vs Chevy Bolt EV: sea change or double standard?

But as any plant manager or automotive production engineer can tell you, the challenges of getting a new production line up and running are many and costly, in terms of both time and money.

More challenging yet is that for a $35,000 car there’s far less leeway to spend a few dollars fixing a problem than there is for one that starts at $70,000.

Luxury buyers aren’t terribly sensitive to the addition of a few extra dollars to the final sticker price, but that’s not at all the case with mass-market buyers.

Cause for optimism, however, can be found in Musk’s frequent admissions that the Model X was overly complex and that the company might not design it the same way if it had the car to do over.

That’s a reference to the unique, complex, costly, and very hard-to-manufacture falcon doors. They make the Model X distinctive, but they clearly delayed it by months, if not years.

If Tesla really has learned its lesson and will keep the Model 3 simple, it now has eight years of manufacturing wisdom under its belt.

Mark the outcome of this one as yet-to-be-determined.

Model 3 pricing must be carefully calibrated

Musk has said the company expects to be building 500,000 cars a year by 2020, almost exactly 10 times its 2015 delivery of 50,557 vehicles.

But with Model S prices starting at $72,700, including delivery, Model S and Model X vehicles are clearly luxury cars that are available to only a tiny portion of the global market.

If a reasonably equipped Model 3 can indeed be purchased for $35,000, that puts it just slightly above the average U.S. new-vehicle transaction price of about $33,000.

Model S sales seem to indicate, however, that Tesla buyers have a heavy hand on the options list.

Musk has said the mix of Model S options was higher than the company had projected, leading to higher average sales prices.

But if things like Supercharger DC fast-charging capability, Autopilot software, that sexy glass roof, and other selling points are all extra-cost options, a more desirable Model 3 could arrive with a price tag closer to $45,000 or even $50,000.

If depositors who expect that the Model 3 they saw introduced two weeks ago will cost $35,000 learn that the $35,000 version comes with less equipment, lower performance, or other drawbacks, many could become disillusioned.

Pricing affects volume, drastically

As Salim Morsy of Bloomberg New Energy Finance has pointed out, there’s only a single sedan priced above $35,000 that sells even 100,000 cars per year in the U.S.

That’s the BMW 3 Series, which has 30 years of reputation behind it, not to mention a huge marketing budget.

But if Tesla builds 500,000 cars a year in 2020, let’s say half of those are intended for the U.S.

Even if the Model S and Model X each sell 50,000 a year in the U.S., the Model 3 would have to sell 150,000 in the U.S. within two or three years after its launch.

Few, if any, Model 3s will benefit from tax credits

By 2020, Tesla will have reached its cap of 200,000 sales under the current federal incentive for electric car purchases.

That means that the Model 3 will remain a $35,000-plus car, not one that is $10,000 lower than sticker after California incentives are applied.

There are numerous $25,000 sedans that sell 250,000 units or more a year in the U.S. But the Model 3 won’t be in that group.

That makes it vitally important that Tesla hit its price target and that Model 3 prices fall over time, rather than rising, as Roadster, Model S, and Model X prices have.

This story originally appeared on Green Car Reports. Copyright 2016