Pricing Power & Margin Strategies for the Automotive Industry
If you've shopped for a new car in the past couple of years, you have probably noticed empty showrooms, rising MSRPs, long waiting list, an unusual absence of rebates, and occasional dealer markups. Supply chain disruption, chip shortage, and inflations are pushing vehicle prices to historical high.
According to Edmunds.com, the new vehicle average selling price in 2022 is estimated to reach 47k USD, 10.9% higher than 2021 which was already 8.8% higher over the 2019 average price. Apparently, besides the factor that the demand and supply are imbalanced, OEMs have been all in to secure the pricing power to enhance their margins while revenues were going down due to the declining volumes.
Carmakers applied profit maximization strategies based on three distinct elements and it drove average selling price of vehicles up. First of all, carmakers steered components available towards most the profitable models in the portfolio. Several OEMs decided to secure the production of large crossovers, SUVs and trucks and minimized production of slow selling or low margin models including C-segments crossovers and sedans. This came along with frozen new launches (costly to manage) and a focus on higher trim versions and costly features to maximize profit on vehicles made available for customers.
Secondly, strategic element is based on the pricing power, this time based focused on direct or online sales. Contactless sales have opened the way to online sales for both OEMs and Dealers, leaving no room for negotiation. The full transaction is done through the Internet and the customer can only accept published prices.
The third element is also related to pricing power. In the current market situation where OEMs are not concerned about how many cars they can sell, but how many they can produce, they are less exposed to competitiveness risks involved when increasing prices. The entire market has been moving up pricewise for the past two years. Therefore, the industry has cut discounts and rebates policies to turn inventory around faster. Consumers are held hostage of this situation. Since September 2016 down to the beginning of the COVID pandemic, sales were driven by discounts, zero percent financing, and attractive long-term leases. These commercial strategies had helped maintain sales at exceptional levels even considering the decline in volumes seen in 2018 and 2019.
In the U.S., rebates could exceed $5,000 before the pandemic. Today, discounts are between
$500 and $2,000 at the highest and are linked to standard rebate programs (friends and family, veteran, etc.). Some dealerships are even adding markups for the rarest or most sought-after models, which can go as high as $50,000 on some luxury models. In May 2022, the average selling price in the US was $721 above MSRP, according to Edmunds.com. Most manufacturers are stepping up to combat dealer markups by threatening to reduce volume allocations to those adding to the sticker price. But this is not easy to manage.
Some new car dealers have been auctioning off freshly delivered vehicles that have not already been reserved by a customer. All in all, this pricing power strategy puts manufacturers in a good spot as they can sell at full MSRP (the pricing power).
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These strategies have helped carmakers’ financial figures with high margins despite decreasing volumes. But it comes with side effects that will likely hurt the market in the long run. Firstly, pricing power and higher segment positioning tend to limit new car market access to the sole household able to afford higher prices. Secondly, new and recent vehicle scarcity is pushing prices up in the used car market making it more financially demanding for households in the market to replace their vehicles. Even though vehicles hold their value better over time as demand exceeds production, secondhand vehicles price increase is making inflation more rampant. Last but not least, as of the 2008 recession, used car market has become more active with consumers stretching life cycles of vehicles already in the market. This may benefit dealer services and aftermarket with more maintenance and parts, but it also increases the average age of the fleet and prevents increasing the number of vehicles equipped with the latest safety and fuel efficiency innovations.
OEMs good results and pricing power strategies are now facing the dire and difficulties from Tier suppliers who are under the pressure of increasing material costs. Carmakers will not be able to keep away the cost increase pressure coming from their suppliers. Toyota already considers dropping price productivity negotiations for 2022. It indicates the awareness of the upcoming difficulties for the supply chain if price increased are not shared, and ultimately applied to the sticker prices and passed along to the end customer.
However, prices cannot be perpetually pulled upwards at the current rate, especially since market trends lean toward new technologies (ADAS, connected services) and electrified powertrains also pushing list prices well beyond what customers can afford (government subsidies do not cover all the extra costs). The market can’t continuously drift towards wealthier or more indebted customers. The current market carries a risk for households with loans on vehicles with overinflated prices. Repossession has increased by 11% since 2002 and it doubled from 2% to 4% for prime borrowers. In the meantime, Dealers have lots full of overpaid and overpriced used cars. This entails high financial risks as some expect the current bubble to deflate in the upcoming months with the increasing risk of a recession.
However, as the price of new cars increased, all prices moved up and may have permanently pushed used car prices to a new normal
The industry moved away from critical mass strategies. OEMs are now focusing on value, and the current market situation has open the way to more pricing power and margin strategies. However, volumes remain critical in the long run, especially with material price increases, factory idling costs, and technology shifts. The remaining question is to know how long supply chain disruptions are going to last, so the industry and go back to a more normal and sane market situation.
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