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Tesla's next act: Cheaper electric cars...and a profit?

The electric-car maker will phase out sales of the sporty Roadster and bet the company on the Model S luxury sedan, a difficult transition that pivots on execution and the buzz around electric vehicles.

Tesla Motors can design cool-looking electric cars. Now it has to show the world that it can steer its finances just as well.

CEO Elon Musk said this week that Telsa's iconic Roadster electric sports car will no longer be on sale in the U.S. within a few months, marking a turning point for the company which helped catalyze an industry-wide technology shift to electric propulsion.

The move will cut off Tesla's main revenue source and start a transition to a new product--the Model S electric sedan. Whereas Tesla has still sold fewer than 2,000 Roadsters, the Model S will be made entirely by Tesla at a whole different scale of production in its new factory. That means still-unprofitable Tesla enters a period where it has little room for error as it takes on big changes in how it does business and its underlying product.

"Tesla's real challenge now is on the operational side. They need to switch to an operational model that actually makes them profitable and brings the cash flow to sustain them," said Oliver Hazimeh, the head of the e-Mobility practice at management consulting firm PRTM. "The question is how do they get the scale to make money on this car."

Tesla Roadsters in a California show room. The company expects to end sales of the Roadster this year. Stephen Shankland/CNET

The Roadster, which starts at $109,000, was always geared to the well-heeled buyer who bought the sports car as much for its jaw-dropping acceleration and styling as its green credentials. By making a high-end vehicle, Tesla shattered the image of EVs as under-powered econo-cars or golf carts. It also tapped into a customer base willing to pay a premium for the latest technology, giving the company the funding it needed to break into the new EV market.

Now as it shifts toward the Model S, Tesla is using the same marketing tactic of targeting the high-end auto segment. The first 1,000 Model S sedans to roll off the line from Tesla's California manufacturing plant will be a Signature series priced in the range of $77,000. First deliveries are projected to come in mid-2012.

Then Tesla will begin making three models of the Model S with the price varying according to driving range--160 miles, 230 miles, and 300 miles. The base model will be $57,400 and the 230-mile option will be $10,000 more. It intends to make 5,000 in 2012 and ramp that up to 20,000 in 2013, according to a company representative.

The luxury sedan market is substantially larger than the tiny niche for high-end sports cars. But it's highly competitive, with a number of incumbent automakers which have loyal customers. Tesla's most obvious differentiator--an electric powertrain--adds substantially to production costs: a 300-mile range Model S will have a battery pack that costs on the order of $25,000, said Hazimeh.

Tesla will still be selling its Roadsters in Europe and Asia through the first half of 2012 and it has deals with Toyota and Daimler to supply electric powertrains into next year. But the introduction of the Model S isn't a slam dunk transition to profitability, according to some company watchers.

"To date there is no real evidence that Tesla has a clear path to profitability and I don't see that changing," said Kevin See, an analyst at Lux Research. Any production glitches at its factory, which is slated to start operating early next year, or delays--the Model S has already been delayed--could not only hurt the bottom line but also tarnish Tesla's image, he added.

Tesla also received a $465 million loan last year from the Department of Energy's 2007 program to promote domestic auto manufacturing.

The road to "Gen 3"
For all the challenges ahead, Tesla clearly has people who believe in its vision and the company's ability to pull it off.

The company went public last year, raising more money than it originally anticipated based on strong interest from investors. Earlier this month, it announced that it will have will go back to the stock market for a secondary offering to fund production of the Model X, a crossover SUV built on the same platform as the Model S. Its stock today is at $27, which is off its all-time highs but at the higher end of its historical range.

Indeed, many company observers argue that the company's image, bolstered by the relentlessly optimistic CEO Musk, is one of its greatest assets. The company's cars are seen as cutting-edge, not just because they are electric but because they are high-tech. That's one reason why Musk much prefers comparing Tesla, once a Silicon Valley start-up, to Apple or Google rather than Ford or GM.

Executives at the company say that the Model S will bring the company to profitability because its electric powertrain, which they refer to as the "skateboard design," can be used on multiple models, including a minivan, cabriolet, and the Model X crossover. "The Model X is really just a way of generating potentially twice as much volume in the premium vehicle segment (by) offering a crossover SUV in addition to sedan," Musk said in an earnings call.

Tesla has attracted investments from industry leaders Toyota, Daimler, and Panasonic, which speaks to the company's strong technology and marketing. With Tesla providing electric powertrains to Toyota for its electric RAV4 and a small Daimler sedan, it has a source of revenue and potentially very significant partners. Tesla could, for example, get access to Toyota's suppliers as a way to get to higher scale and bring down production costs, said Hazimeh.

But it's still early days in the industry's move toward electrification, and it's not clear how strong the demand is for all-electric vehicles, which many analysts project to be well less than 10 percent of the market in 10 years. Hybrids are already available in the luxury category and dozens of plug-in hybrids are projected to enter the market in the next three years. Lux's See believes that "incremental electrification," or small batteries to complement internal combustion engines, will be the high-volume market.

"If oil prices really take off, then you will likely see some traction with the plug-in hybrids but we remain very conservative regarding all-electric vehicles because the premium you pay compared to a conventional gas-powered vehicle, or even incremental advances like micro-hybrids and full hybrids. Add in the issue of range anxiety and the open question of battery reliability and electric vehicles have a tough time stacking up," he said.

For company watchers, Tesla's decision to wind down production of the Roadster, which will tap out at 2,500 vehicles, is not a surprise and was planned all along, according to a company representative. The Model S, meanwhile, can almost be seen as a stepping stone to the company's long-term goal of an electric car for the mass market.

Company executives talk about its "Gen 3" product line with a targeted price in the $35,000 range. Given that electric vehicles are cheaper to drive per mile than gasoline-powered cars, that could attract a broader market. But that vehicle is still years away. In the meantime, Tesla will need to execute on its plan and bet that the cachet of sleek all-electric vehicles provides enough fuel into the future.