Despite Model X being snazzier than its predecessor Model S, Tesla (NASDAQ:TSLA) has revealed that base Model X will be available for just $80k, which is a mere $5k more than base Model S. Also, the base Model 70D packs impressive specs compared to the high-end 90D which Tesla will sell for $132k. The 70D battery pack will manage to eke 70kWh with a 220-mile range compared to 90kWh and 250-mile driving range for the 90D. Federal tax credits as well as state rebates could lower that cost considerably for buyers. For perspective, Tesla’s older Model S 70D sports a 70kWh battery with a 235-mile driving range.

Falling Battery Prices

When Tesla chief executive Elon Musk launched Model X in September, he said the launch had been delayed by two years because Tesla tried to make it too snazzy. Model X boasts several electric features such as Falcon wing doors and Dual Motor AWD that allows the driver to dynamically shift power from front to rear and vice-versa depending on driving conditions. All other things held constant, the improvements on Model X over Model S would probably have increased costs by around 20k, which in turn would have reflected on the selling price. The fact that the price difference between the two models is so small leads you to suspect that what EV analysts have been saying is true after all--that battery prices have been coming down rapidly.

Battery costs represents the biggest cost component for EVs, and the main reason why your average electric vehicle is much more expensive than a comparable gasoline powered vehicle. But luckily, battery costs have been declining rapidly. When Tesla launched Model S six years ago, EV batteries cost on average $1,000/kWh. Tesla Model S 90D sports a 90kWh battery that would have cost a staggering $90,000 back then. But analysts say that battery costs have fallen to around $400/kWh currently, which implies that the same battery now costs ‘‘just’’ $36,000. Meanwhile, the 70kWh battery that powers Model X 70D probably costs around $28,000. That explains why Tesla has been able to offer a snazzy product at relatively more affordable prices.

Tesla has frequently been ridiculed for its peculiar strategy of starting off with incredibly expensive high-end cars then slowly moving down the ladder. This seems to fly in the face of conventional wisdom that dictates that for a product to become truly disruptive, a company should start with a product that is just minimally viable then offer higher iterations with time. Tesla tries to build products that are almost perfect the first time, which slows down the development process and places the company at risk of a more nimble competitor sweeping the market.

But there is a method to the madness in Tesla’s strategy. Tesla has mainly been building high-end products with a higher margins so as to buy some time to build out an extensive supercharger infrastructure that is necessary before it can finally launch mass-produced cars.

Tesla plans to launch its first mass-produced car, Tesla Model 3, in 2017. Battery costs are estimated to be falling at 14% every year, which implies battery costs will have fallen to around $295/kWh by the time of the planned launch. Tesla says that Model 3 will cost just $35,000, or less than half what the base model Model S costs. Analysts say that for EVs to compete effectively with their gasoline-powered counterparts, battery costs will have to fall to around $150/kWh. At the current rate of decline, battery costs will fall to that level about 6 years from now. But Tesla might be able to shave off maybe two years or so from that date thanks to its giant Nevada Gigafactory.

Targeting Tesla Sales & Profits

There is a possibility that the launch of Model 3 may be delayed by a year or two, and that Tesla might not be able to build it as cheaply as it intends to. Morgan Stanley has warned that Model 3 might end up costing as much as $60,000 due to production difficulties. But ultimately the fact remains that Tesla is moving in the right direction by making its vehicles more affordable, which is a critical factor if it is to achieve its ambition to sell in volumes. And high volumes are necessary for the company to achieve profitability.