The moment that someone drives a brand new car off the dealer’s lot, it is worth considerably less than it was when the buyer was handed the keys. But in the past, depreciation was not as high on the radar screens of auto companies and consumers as it is today. Both the high prices of new cars and financing with very long loans or leases educated both to the perils of fast depreciation.

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Issue: Oct 2004


Keller



Protecting Residual Values

by Maryann Keller

The moment that someone drives a brand new car off the dealer’s lot, it is worth considerably less than it was when the buyer was handed the keys. But in the past, depreciation was not as high on the radar screens of auto companies and consumers as it is today. Both the high prices of new cars and financing with very long loans or leases educated both to the perils of fast depreciation.

Every auto company is aware of the impact of depreciation rates on the appeal of their vehicles. The monthly lease payments for a car that depreciates 50 percent in three years are higher compared to an identically priced vehicle that depreciates by 35 percent over the same period.

Car buyers quickly discover how much their vehicle is worth when they go to trade it in on a new car and, in the worst case, discover that they owe much more on the car than it is worth when it’s wrecked or stolen. Brands that suffer fast depreciation than others have to compensate for the difference with lower prices usually reflected in cash rebates and other incentives as well as dealer discounts off of list prices.

General Motors recently argued that guidebooks’ estimates of residual values should be based upon actual transaction prices rather than manufacturers’ suggested retail prices. That would bring depreciation closer to Japanese makes that would still have an advantage.

There are many factors that impact residual values and the auto companies have some control over most of them. It obviously starts with the desirability of a brand and the pricing relative to the competition that a car justifies in the eyes of the buyer. Too many cars with high depreciation start with the fact that they are over-priced and need rebates or other incentives to bring the transaction price in line with reality. Quality, content, design, performance and other factors all play into the perception and value of a make and model in the used car market. External factors such as gasoline prices have recently depressed the values of latemodel gas-guzzlers, thereby increasing the amount of depreciation suffered by these vehicles. It is that desirability among consumers for particular used cars, stacked up against the supply of those cars that determines depreciation. So the two markets, new and used cars, are linked. The used-car marketplace rather than an individual auto company sets real time values for used cars that impact the perception of brands and new-car transaction prices.

There is no debate that rising incentives immediately reduce the value of late model used cars, but the reason that GM has to put $4,000+ on a car to sell it compared to $1,000+ on a Toyota is a function of gap in value retention between the two.
 
Reducing depreciation rates requires a longterm commitment to vehicle quality. Nothing destroys value faster than frequent recalls or publicity about serious safety problems. Design and engineering has to be viewed as up to date by consumers. In addition, values seem to hold up better with periodic updates of design and engineering rather than protracted lifecycles during which both become outdated.

Appropriately, auto companies have also begun to focus on how their used cars improve their values at the retail and wholesale levels.

In the last few years carmakers have encouraged their franchise dealers to sell certified used cars. Certification has proven to raise the perception of the vehicles with consumers who are willing to pay a premium for these cars. By selling inspected and reconditioned cars through franchise dealers, auto companies are ensuring that potential new-car buyers are likely to have a better experience with their used cars.

The remarketing process itself offers opportunities to influence perception and value of brands in the short term. Domestic auto companies remarket at least 4 million late-model used cars each year in the form of program cars, offlease vehicles, executive cars and repossessions.

In the past, remarketing was often viewed as a means of converting an asset, the car, into cash as fast as possible with little regard to the implications of such an overly simplistic remarketing philosophy. But remarketing can and should be an important part of value preservation of the vehicle. It starts with balancing the supply of vehicles with demand for them in the used car market over a year as well as regionally throughout the country. No matter what channel an auto company uses to sell off their inventory, they need to have an analytical approach to how and where and under what conditions they sell their used cars. Many cars could benefit with reconditioning not only to raise their value in the auction lanes but also to ensure that more of a company’s used cars reflect the quality and condition they want associated with their brand.

With more awareness in auto company headquarters about the importance of residual values as a competitive issue, remarketing seems to provide an opportunity to influence value and brand through the use of data and analysis not heretofore applied in what was largely seen as a mechanical process.

Maryann Keller is a veteran auto industry analyst and author of the books “Rude Awakening: The Rise, Fall and Struggle to Recover at General Motors” and “Collision: GM, Toyota and Volkswagen and the Race to Own the 21st Century.”

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