How Tesla Motors, Inc. May See Big Profits From Selling Used Cars

There are huge questions looming about how Tesla and its vehicles will fare in the used-car market. Ever since Tesla Motors and Elon Musk both guaranteed the resale value of sales of its Model S last April, investors have been keenly interested in all matters related to aftermarket sales of Tesla vehicles. Fortunately, we're starting to get some color on what the used-car market for Tesla vehicles could look like and the company's involvement in it -- and it's looking good.

Model S. Image source: Tesla Motors.

Why Tesla needs to excel in the used-car market
"Tesla Motors ... announced today that, in partnership with Wells Fargo and US Bank, it has created a revolutionary automotive financing product that provides the best elements of ownership and leasing to Model S customers," read a press release the company filed last April. The move was both surprising and innovative. It reassured both banks and consumers that the yet-to-be-proven residual value of Tesla's electric vehicles would rival that of Daimler's iconic Mercedes S-Class.

But there was a catch. For this new automaker to serve up this sort of confidence in the residual value of Tesla's Model S, both the company and billionaire Elon Musk had to stand behind the guarantee "to give customers absolute peace of mind about the value of the asset they are purchasing."

While this move helped Tesla secure financing partnerships with Wells Fargo and US Bank, and convince consumers that the residual value of these cars coming from an automaker entirely new to the scene would actually hold up, it also put Tesla and Musk in a risky situation.

The ultimate concern? What if something goes wrong with Tesla's vehicles and the company is forced to buy back used Model S sedans at a price above their market value? The company would then be forced to resell the vehicles at a loss.

Fortunately, this doom and gloom potential outcome looks unlikely.

Tesla's aftermarket plan could be extremely lucrative
Tesla's plan to profit from used Tesla sales, Automotive Newsexplained on Monday, is to develop a certified pre-owned program "to compete with those offered by luxury brands such as BMW and Mercedes-Benz" that will enable Tesla to sell the Model S secondhand.

An effective CPO program, Automotive News says, could have two major benefits for Tesla:

With a used-car program, Tesla will be able not only to reach a new segment of the market at a lower price point, but also to tap into the most lucrative part of the retail business. Used-car departments at U.S. dealerships averaged a 12 percent profit margin in 2013, triple the profit of new-car departments, according to data from the National Automobile Dealers Association.

Of course there will still be several challenges. First, Tesla will need the real estate and staff required to run an effective CPO program. Since Tesla sells cars directly to consumers without the help of dealers, this could require substantial investment. Second, Tesla may have a tough time juggling the legal implications of a CPO program that doesn't involve dealers. Finally, Tesla will need the residual value of its vehicles to hold up to an amount equal to or greater than the residual value it promised.

Tesla retail store. Tesla sells its vehicles directly to consumers, opting to skip over dealerships. Image source: Tesla Motors.

Tesla will need to be prepared to honor its residual value promises to customers when the first three-year price guarantees become eligible for buyback in April 2016. But the first opportunities for an effective CPO program, however, could come sooner: when Tesla launches the Model X SUV next spring and some owners opt to trade in their Model S. And by 2017, Tesla's CPO program will need to be running full throttle, as the first business and consumer leases for the Model S will expire.

As the days of aftermarket Tesla sales draw nearer, the company's promising CPO program, along with early signs of a strong residual value of a Model S, are beginning to make the once-risky move by Tesla to provide peace of mind to customers and financing banks look more like an opportunity -- an opportunity to reach lower price points with a stream of trade-ins and to beef up the company's bottom line with a potentially lucrative CPO program.

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Daniel Sparks owns shares of Tesla Motors. The Motley Fool recommends BMW, Ford, Tesla Motors, and Wells Fargo. The Motley Fool owns shares of Ford, Tesla Motors, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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