Brake on Prices Has Car Buying at 1980 Level
For the last 50 years, with seasonal regularity, U.S. auto makers could be relied upon for one thing: hiking car and truck prices every fall when they rolled out their newest models.
But something funny is happening today on the way to dealer showrooms. Auto prices are no longer accelerating. In some cases, prices are declining. And that’s before rebates are deducted.
The price cuts--along with rebates, cut-rate loans and discounted leases--are making cars more affordable today than any time since 1980. This is aided by recent gains in household incomes and continued low inflation.
“The Big Three are beginning to resemble OPEC,” said William T. Wilson, an economist at Comerica Bank in Detroit. “They just keep cutting prices.”
The sticker reductions are creating a buyer’s market for consumers, who since the end of World War II have been force-fed hefty annual price increases even on new models that had barely changed from the previous year.
Detroit is applying the brakes on prices as it books record profits while undertaking massive cost cutting. The new pricing arithmetic is a response to global forces, including the weak yen and a worldwide vehicle glut, as well as changing consumer behavior, such as a decline in brand loyalty.
With competition keen, the expectation is that auto prices will continue to decline for as long as the current economic conditions of steady growth and low inflation remain intact.
“We are in the midst of a significant long-term change in auto pricing,” said Wesley Brown, analyst for auto consultant Nextrend Inc. in Thousand Oaks.
Just this week, one of the Big Three, Ford Motor Co., said it will lower vehicle prices an average of 0.3%, or $61, for the 1999 model year beginning Oct. 1. The announcement marked the first time Ford has lowered overall prices in more than 30 years.
Chrysler Corp. in late July announced that 1999 model prices will rise just 0.1%, or $19, on average this year. General Motors Corp., after raising prices just 1.3% last year, the lowest increase in 10 years, is expected to hold the line on prices for 1999.
Japanese and European auto makers, which have led the way as aggressive price cutters for several years, are maintaining most prices at current levels or lowering them on key new vehicles, such as Mitsubishi’s mid-size Galant sedan.
To be sure, the price cuts are modest. But they are a welcome change for consumers after years of routine increases of 2% to 3%, and sometimes more, at the beginning of each model year, followed by occasional midyear price increases. Also, more new models are coming more fully equipped without higher prices.
Of course, not all vehicle prices are falling. The Big Three are raising prices on the most popular light trucks, particularly new sport-utility vehicles and extended-cab pickups, while lowering them on less-in-demand passenger cars. Ford, for instance, is dropping car prices 1.7% and raising truck prices 0.5%, on average.
New vehicles are still expensive and out of the reach of many consumers. The average vehicle goes for nearly $20,000. Some big sport-utility vehicles, priced at $30,000 to $40,000, are clearly luxury purchases.
Still, in Detroit, worries about sticker shock and an affordability crisis are now giving way to growing concerns of a deflationary spiral and a prolonged buyer’s market with consumers calling the shots.
“Vehicle price deflation is here to stay for some time,” Wilson said. “It’s similar to what we see in personal computers and semiconductors.”
Passenger cars are at their most affordable level in 18 years. It takes about 25.5 weeks of median family income to buy the average car, Comerica Bank reports. That level hasn’t been seen since 1980, when it took 23.5 weeks of income, and is down from a peak of 30.3 weeks in 1991. (Comerica does not measure prices of light trucks, which now account for 47% of the market.)
Improved affordability is a function of moderating car prices as well as greater income gains. In this year’s first quarter, median family income rose at twice the rate of car prices, which were held down by rebates and low interest rates on loans.
The move to lower prices began in the early 1990s. European auto makers found themselves undercut in the luxury segment when Honda, Nissan and Toyota entered the U.S. market with high-quality, but more affordable, models. Mercedes-Benz and BMW responded by redesigning their products, cutting costs and slashing prices dramatically; both rebounded strongly.
At the same time, the Japanese saw their U.S. market share threatened by a strengthening yen, which made their vehicles more expensive in this country. They undertook to shield themselves from currency swings by producing more vehicles in North America, simplifying designs and reducing operating costs.
Toyota, for instance, reduced the price of its flagship U.S.-made Camry mid-size sedan by $1,600 in 1997. Honda followed suit with a less-expensive though larger, better-equipped Accord sedan in 1998.
The two auto makers are also now benefiting from the weak yen, which has fallen to an eight-year low because of the prolonged swoon of Japan’s economy. The weak currency provides them greater pricing flexibility, as much as $3,000 a car, allowing them to lure buyers with discounts without hurting profit.
Competition is further intensified by a glut of global production capacity. It is estimated that auto makers worldwide can produce 20 million more vehicles than consumers want to buy. In North America, there is 25% more production capacity than demand warrants, Merrill Lynch & Co. estimates.
The situation could get worse as Korean and Japanese auto makers look to divert production from slumping Asian markets to the United States and Europe.
Cutthroat competition is evident in rebates being offered to U.S. car buyers. In the second quarter, the Big Three averaged incentives of about $1,500 a vehicle in the form of rebates, low-rate loans and subsidized leases--up about 50% from a year ago.
By lowering sticker prices, auto makers are acknowledging what has been going on in the marketplace for some time: Consumers have become more cost-sensitive and unwilling to buy at list price.
“The auto makers are just admitting that people don’t pay the sticker price,” said Jim Hall, analyst with AutoPacific Group.
Ford, for instance, is lowering the price of its 1999 Taurus LX sedan by $1,000 to about $18,000. The decrease comes as the company is offering a $750 rebate on the 1998 model. So the price drop is really only $250.
But even with lower prices, it is unlikely that rebates will go away any time soon.
“The industry has trained consumers not to buy unless they get a deal,” said George Magliano, analyst with WEFA Group in New York.
Lower prices may also reveal weakness in the auto market, which has had healthy sales for six years. Auto makers have maintained the robustness with extensive rebates, low-rate, long-term loans and attractive leases with low monthly payments. Now companies are dropping prices to stimulate sales.
“The underlying market is much weaker than it should be,” said Jeremy Anwyl, president of Marketec Systems in Santa Ana. “They keep buying future business, but it will soon catch up.”
The auto makers acknowledge that lowering some prices has proved a good way to boost sales. When Ford dropped the price on the Mustang sports car last year, sales jumped 29%.
Pricing may be what separates the winners and losers going forward. With vehicle quality improving among all brands and design becoming more pedestrian, brand loyalty is waning. Pricing could become a major factor that differentiates one brand from another, analysts say.
The auto makers that can be most aggressive on pricing will be the ones that are most successful in cutting costs. In making its announcement Monday, Ford said it was able to lower prices without hurting profitability because of efficiency gains, improved quality, which reduces warranty bills, and other cost reductions.
Ford reduced operating costs by $3 billion in 1997 and another $1.3 billion in the first half of this year. GM and Chrysler are engaged in similar programs that are also reaping major savings.
Lloyd Hansen, Ford’s controller of marketing and sales operations, said Ford expects to continue trimming costs as it becomes even more efficient.
“As long as we reduce our absolute costs,” he said, “we don’t have to raise prices.”
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Auto Affordability
Cars are more affordable today than at any time since 1980, according to an affordability index compiled by Comerica Bank. The index measures the number of weeks of median family income it takes to purchase the average passenger car.
‘98: 25.5 weeks
Source: Comerica Bank, Detroit
