Tesla’s Software Upsell

Tesla recently launched a newly revamped base model to its Model S at a lower price. The S60 costs $8,500 less than the S75, the difference being the capacity of the battery. What makes this a bit unusual, however, is that the battery hardware is identical between the two models. What the S60 lacks is software to allow the battery’s full capacity to be used.

If you don’t want the extra capacity, you don’t pay to access it. And if you change your mind later, you can get the upgrade through a remote software install. An upsell on the road!

Customer Segmentation

The automotive industry is no stranger to upselling, of course. Dealerships nudge customers toward vehicles at the top of their price range rather than more budget models. And once a customer chooses a certain model, optional vehicle add-ons can drive the price up even higher.

Both of these are effective because of anchoring and sunk costs. A few thousand dollars is a lot of money in everyday life. But if you’ve already committed in your mind to a $30,000 purchase, those few thousand extra begin to look much more manageable — and a few hundred dollars more for an option? Well that feels practically free.

$8,500 on the lot (or $9,000 to upgrade your S60 after the fact) is a good chunk of change. But when you’ve already sunk $66,000, it doesn’t feel quite so bad. And there is a real, tangible benefit: an extra 40 miles per charge.

Multiple models and multiple options for each model allow customers to segment and upsell themselves according to what they value and what they are willing to pay. This is classic customer segmentation.

What Tesla has changed for the automotive industry is now that upselling process can continue long after the purchase of the vehicle. If you buy a S60 then get a better-paying job with a longer commute, you can choose to upgrade with essentially no additional cost to serve for Tesla. And spacing out the payments for the vehicle and later the capacity may make the original vehicle purchase more palatable for the consumer.

The key illustration is the separation between cost of inputs and price earned. The physical materials are the same between the S60 and the S75, yet the value delivered is different. The price between the two is $8,500-$9,000, while the marginal cost to Tesla is essentially zero.

Perception is Reality

This may seem unfair to many people, who expect to see a connection between the cost incurred by the company to the price it charges. Something feels fundamentally different about Tesla’s approach, which as Bloomberg puts it, “is testing whether customers will be willing to pay thousands of dollars more for permission to take full advantage of the equipment that’s already on the car.”

It’s an open question. Obviously, people are used to paying more for some items with very low marginal costs, such as software licenses for personal computers. The difference between the S60 and the S75 comes down to software, as well. But does that feel the same to consumers?

And how does that perception depend on the description used? My guess is that many more people would feel favorably about paying for “software that enables full battery capacity” than paying to remove “software that caps battery capacity.”

The messaging is going to be critical. With the flip of a switch and at zero cost, Tesla could increase the battery efficiency of every S60 by 20%, lowering energy usage and power plant emissions. So, is Tesla enabling more people to buy its products by lowering the base price, or is it stunting its own technology in the name of upselling?

The overall effect is one of tying price closer to usage. If you don’t want to use the increased battery capacity, you don’t pay for it. Whether for production and assembly simplicity or for the upsell opportunity, Tesla will give you the same battery regardless. For mass-market consumer vehicles, this is unprecedented. If Ford could charge to vary the size of your fuel tank years after selling you the vehicle, they probably would.

This type of segmentation may seem unusual now, but as software invades more areas of our lives and the IoT (internet of things) takes off, producers and consumers are going to see many similar situations in the near future.