The Shortino family of Lodi, N.J., may never buy another car. Joe, a construction worker, and Johanna, a part-time clerk, decided three years ago to dump their aging Datsun and lease a new Cadillac Eldorado for $550 a month. When their lease expires in May, the couple, who earn about $40,000 a year, will likely turn in the Eldorado for a new Caddy. Daughter Samantha, meanwhile, recently graduated from college and leased a Geo Storm subcompact for $240 a month. "We're pleased," says Johanna. "We'll probably lease more cars--mostly to save on the downpayment."
The Shortinos are part of a trend that is transforming the U.S. auto market. Once, doctors, lawyers, and small-business owners were about the only folks who leased, because they could deduct part of the cost as a business expense. But today, millions of middle Americans are following suit for everything from BMWs to pickup trucks. One-fourth of all cars and trucks sold in 1993 went out the door under lease. All told, that was $43 billion worth of vehicles, according to CNW Marketing/Research in Bandon, Ore.--quadruple the 1984 figure. By the end of the decade, some auto executives predict, half of all cars and trucks will be leased. The proportion is already 60% of new cars in upscale areas such as Marin County, Calif. Nationwide, more than half of luxury cars are moved this way--led by the Jaguar XJ models at nearly 90%.
ACCORD BUSTER. In fact, the industry may have found a more potent marketing tool than the rebates of a decade ago. About 75% of car buyers need some sort of financing, and with interest on car loans no longer deductible leasing's relatively low monthly payments are enticing. They helped pull the industry out of its steep recession of the early 1990s and helped Ford's Taurus topple Honda's Accord as America's best-selling car in 1992. The Japanese learned from that. Now, they're using leases to offset the shock of higher prices forced by the strong yen. "Leasing provides great camouflage for price increases," says Richard D. Recchia, executive vice-president at Mitsubishi Motor Sales of America. Altogether, estimates CNW Vice-President Art Spinella, leasing's allure sparked sales of an additional 945,000 cars and light trucks in 1992, the most recent year for which figures are available, boosting the U.S. total to 12.9 million.
Beyond that, leasing may restore a measure of the fierce brand loyalty carmakers enjoyed in the '50s and '60s. Instead of merely selling a car and waving bye to a customer, auto makers are trying to strike up relationships. "It's a fundamental change," says J. Michael Losh, General Motors Corp.'s vice-president for North American marketing. Ford Motor Co. officials say their two-year leases leave consumers so satisfied that nearly 50% come back for another Ford--twice the rate among traditional buyers. That's money on the bottom line for an industry that spends $500 per car in advertising to lure customers from rivals.
Leasing is having ripple effects on other car company operations. The auto makers' finance arms--the vehicles for leasing--are luring business away from banks and other finance firms. Products are getting more frequent face-lifts and new features to keep customers coming back. Some executives even believe leasing may help tame the industry's notorious boom-and-bust sales cycle. They figure lessees can't defer new-car decisions the way most owners can--though about one-third now buy their vehicle rather than opt for a new one.
Wow! What's the catch? Well, for one thing, leasing isn't for everyone. Drivers face stiff penalties--up to 15 cents a mile--if they go over the typical 12,000- to 15,000-mile annual limit. Those who are rough on vehicles can be stunned by hefty bills for excess wear. Customers build no equity--and may be lured into owing monthly car payments for life. "When all things are considered, it is generally better economically to buy than lease," says William Dunn, a tax expert at Coopers & Lybrand.
For carmakers, meanwhile, lease financing is inherently dicier than bankrolling a purchase. The carmaker's finance arm typically buys the vehicle and rents it to the driver. To set monthly payments, it uses past used-car values to estimate the vehicle's worth, or "residual value," at the end of the agreement. If it guesses high, the accumulated lease payments won't have made up the difference between the used car's value and the original purchase price--and the lessor can lose thousands on just one car. "Setting a residual value is hardly a science," says Paul Getman, an economist at the Regional Financial Associates, an economic consulting firm.
POTENTIAL TRAP. The biggest uncertainty is what effect the rising flood of cars coming off lease will have on used-car prices. Carmakers "will surely do this to excess if we're not careful," warns Recchia at Mitsubishi--which is trying leases to jump-start sales of its new Galant sedan. Victor H. Doolan, who heads BMW of North America, is wary of short leases: "You start to compete with your new cars," he says. To hedge their risks, the carmakers are mounting aggressive efforts to refurbish and remarket returned cars. But it's so early in the game that "nobody knows if there's strong enough demand for three- to four-year-old luxury cars," says CNW's Spinella. Moreover, if carmakers that jump in then sour on leasing, bailing out quickly could be marketing hell.
For now, there's one other drawback: Competition on leases isn't great for margins. Some carmakers pay hefty subsidies to their finance companies to keep monthly payments down. Those are the '90s equivalent of 1980s cash rebates, and they're generally used to pay part of the interest or artificially boost the vehicle's residual value. At Ford, which last year leased more than 20% of its cars and light trucks, that cost about $1,340 a pop in 1993's fourth quarter, figures John V. Kirnan, a Salomon Brothers Inc. analyst. Ruthless competition among luxury carmakers has forced some brands, such as Nissan's Infiniti, to offer subsidies of up to $10,000 on top-end models, says Dick Biggs, president of Biggs Automobile Leasing Corp. in Roswell, Ga.. "It's competition over how to reduce the monthly payment," says Mitsutaka Kurumisawa, a Nissan planning executive.
That's because the leasing boom is fueled by a stark reality: Many consumers can't afford today's wheels. In 1993, the average price of a car was $18,100, a 69% jump in 10 years, according to the National Automobile Dealers Assn. Family earnings, meanwhile, have lagged behind. Based on median household income, consumers now spend about 26 weeks of wages on a new car, up from 22 a decade ago. In the 1980s, carmakers cut payments by extending loans to five years, but that backfired: Consumers often tired of their cars in two or three years, only to find they owed more than the cars were worth.
Leases skirt the affordability problem more neatly. Consumers don't have to tie up much cash in a downpayment, though paying more to start lowers the monthly rate. There's usually a security deposit of one monthly payment, but that may be waived for repeat customers. Most important, lessees pay only for the portion of a car's value they use. A $36,950 1994 Infiniti J30 will be worth about $19,580 in three years. That means the customer pays the difference: $17,370. Monthly payments for a three-year lease are $399, compared with about $648 for a five-year loan. So leases let some consumers drive spiffier cars than they could otherwise. And carmakers are playing that up: "For those with more sense than money," promises an ad for a $399-a-month lease on a Saab 9000CS.
Ford's customer surveys also show that those with short-term leases are twice as satisfied as traditional buyers--and thus more loyal. The goal is to build a strong repeat business--then dial back on subsidies, says Robert L. Rewey, vice-president for North American sales. So far, so good. Last year, the company's lease business, covering most models from the Lincoln Mark VIII luxury coupe to the Ford Escort, skyrocketed 65%, while industry leasing volume grew just 16%. Since 1990, when Ford began promoting the tactic, its share of the U.S. car and truck market has jumped nearly two points, to 25.5%.
FAMILIAR FACES. Some dealers are doing even better than that. Tasca Lincoln/Mercury in Seekonk, Mass., has experimented with leases since 1982 and in the past five years offered only two-year contracts in a joint-research deal with Ford. In 1993, some 75% of customers chose that option, says owner Robert F. Tasca. Since 1989, a healthy 62.3% of Tasca's customers have returned for another car--the highest rate among Ford's 5,000 dealers. That has helped triple Tasca's share of his Providence (R.I.) market in the past decade, to 16%. It has also cut sales staff defections, easing one of a dealer's headaches. Turnover plummeted to just 5% a year in 1993, vs. 125% among other dealers in his market. "I got a headstart on the world," Tasca brags.
Now, other carmakers are giving chase. Committed to a value-pricing program and wary of the low residual value of many of its models, GM has been slow out of the gate. But eight months ago, General Motors Acceptance Corp., the No.1 carmaker's huge finance arm, expanded an effort to teach GM salespeople about leasing. GMAC hired 100 trainers in addition to 600 already in place at regional offices and GM's marketing divisions. Now, such divisions as Cadillac are subsidizing leases on some models, such as Eldorados, to match Lincoln's low monthly payments. "It's important for us to be competitive," says Losh, who figures that the proportion of vehicles GM leases could double, to about 25%, in the next few years.
As they try to fend off a resurgent Detroit, Japanese carmakers are throttling up, too. The strength of the yen has forced their prices $2,000 to $3,000 above those of comparable domestic models, hammering sales and costing the Japanese 1.3 points of market share in 1993 on top of two points in 1992. The obvious cure: Lease more, fast.
For the moment, the Japanese have one advantage: Their reputation for quality bolsters residual values, so despite higher prices, their monthly payments are competitive. A 1994 Toyota Camry LE will be worth about 47% of its $22,263 sticker in three years, according to the independent Automotive Lease Guide, vs. 43% for a '94 Taurus LX costing $19,420 new. That means a three-year lease customer must pay for $11,800 of the Camry's value, vs. $11,069 for the Taurus. Toyota can easily make up the $731 difference with, say, lower interest charges.
The gap is narrowing, however, as Detroit pulls even on quality. For instance, as recently as 1991 the difference in residual value between the Camry and Taurus was 10 percentage points. If the disparity disappears, as is certainly possible, the Japanese could lose their leasing edge.
In the meantime, leasing is leading to faster product makeovers Ford officials worry that returning lease customers might look elsewhere if the company's vehicles haven't been changed. So the company is making sure its cars offer something new every two years--different colors, sleeker exteriors, new dashboards. This turns up the heat on Ford's inefficient engineering operations.
The effort to boost customer loyalty is also steering carmakers toward greater cooperation with their dealers and finance arms. Where finance companies once made loans and walked away, now, at GM, Ford, and other companies, they're alerting dealers a few months before a customer's lease expires. That gives salespeople a headstart on talking up new products. Marketing departments are slipping promotional material into the bills sent out by finance arms.
FEWER HEADACHES. Relationship marketing, the effort to form bonds between customer and company, has been one of Detroit's glaring weaknesses. But as auto executives survey the more than 600 well-designed, high-quality vehicles on the market, they're deciding that pampering customers may be the only way to thrive. "Leasing is a good weapon in the arsenal of the relationship manager," says marketing expert Don Peppers, co-author of The One to One Future. Lease customers usually have fewer headaches, since new cars tend to be problem-free. It will take more than that, however, to build long-term loyalty. Carmakers need to get dealers to deliver better price and quality on maintenance and repairs, says Don E. Schultz, a marketing professor at Northwestern University. Dealer service "is the weak link" in car marketing, he says.
Another challenge for manufacturers is learning how to run a used-car business. Toyota Motor Corp.'s Lexus luxury division, for instance, has 9,000 1991-model cars coming off lease this year, most of them top-of-the-line LS400s that originally sold for about $40,000. To make sure their prices hold up, Lexus has an aggressive program. Returning cars get a thorough inspection, new tires, repairs, and an extended six-year, 70,000-mile warranty. Other carmakers, including Ford, Mercedes, and BMW, have similar programs. BMW will even warranty some repairs, such as major drive-train work, on cars with up to 102,000 miles.
So far, consumer leasing is largely a North American phenomenon. Jaguar, which leases more than 70% of the cars it delivers in the U.S., leases just 16% in Britain. That's mainly because lease payments are subject to a 17.5% value-added tax. Besides, most European consumers like to buy. In Germany, 20% of cars are leased, but virtually all of them by companies. Still, recession-wracked Europeans are trying the idea: "It's the wave of the future," says C. Len Hunt, director of British operations for Jaguar.
RESERVE FUNDS. Not every company is a leasing fanatic. Chrysler Corp isn't, for instance. Bolstered by sales of new models such as the Dodge Ram pickup, the company earned a record $2.4 billion in 1993, before accounting charges. Because of that, and because until late last year its junk-level credit rating locked it out of the capital markets that provide lease financing, Chrysler leases only 8% of its vehicles. Company executives also feared that a swing in used-car values could wipe out profits on leases. "We thought Ford was taking a big risk," says Thomas J. Osborn, planning director for Chrysler's marketing staff--which is still watching to see if the gamble pays off.
Companies with the most experience in leasing downplay the downside. Ford Motor Credit Co. sets aside reserves to cover any unexpected slump in used-car values, just as it does for buyers who default on loans. And when Ford or Lincoln executives ask for an unrealistically high residual value on a specific model to achieve an attractive monthly payment, the divisions have to cough up the difference up front--in cash. "We're not talking about something that's betting the company," says Chairman William E. Odom. Analysts who have studied leasing, such as J. P. Morgan's David Bradley, tend to agree.
Likewise, some industry executives believe the worry about a used-car glut is overblown. About 15 million used cars are sold each year by new-car dealers, according to NADA. Used-car dealers and individuals sell millions more. The cars coming off lease will be a diverse group of products returning in a fairly steady flow throughout the year. "It's a very manageable situation," says Peter E. Gerosa, general sales manager at GM's Cadillac division. The real test, however, will come later this decade as leasing starts to approach 50% of the market--and perhaps 7 million cars and light trucks come back each year.
Until that day of reckoning, some of the biggest winners will be car dealers. When consumers move up to classier wheels, dealer profits improve. And because the focus is on monthly payments, rather than sticker price, lease customers tend to dicker less than buyers, which means heftier margins. Lease customers are also more apt than traditional buyers to return to the dealer for maintenance. Perhaps the biggest boon is that vehicles coming off lease are a good source of late-model used cars. Increasingly, used cars are more profitable than new ones. Tasca, the Massachusetts Lincoln/Mercury dealer, once made a quarter of his money in used cars; now it's 62%. "That two-year trade coming back is gold," he says.
The big losers will be banks and independent finance companies that once handled a chunk of the leasing business. A few, such as General Electric Capital Auto Lease Inc., are forging alliances with importers. But others, such as Chase Manhattan Auto Finance, are getting squeezed out as brawny captives such as GMAC muscle in with cheap money and subsidized leases. Foreign makers such as BMW, which once used U.S. banks, are setting up their own finance companies. "If you do the banking business, the whole thing will be more profitable," says Karl H. Gerlinger, formerly chief of BMW's U.S. operations and now head of sales for Central Europe.
WEEKEND WANDERERS. To keep building momentum, auto makers are concocting new schemes. In January, Ford completed test-marketing in Las Vegas on a 12-year lease that gives customers a new car every two years for a fixed rate--and leaves them owning the last one. The company is still considering whether to do that nationwide. Ford may also cook up a deal for urban residents who want to lease a car only on weekends. Mercedes-Benz is eyeing a plan to allow customers to swap vehicles in midlease--in case they want a convertible in the summer, for instance. Some companies are even contemplating a "traveling salesman special" by which the customer would pay for, say, 30,000 miles of use, however long that took.
Such ideas are a tacit admission that the surge in car prices won't abate. They'll likely rise $1,500 or more in the next two years as carmakers comply with government regulations on emissions and safety. With income growth stuck in low gear, more consumers may decide that leasing is the least painful route to a new car. "The only thing I don't like is the monthly payments," gripes Johanna Shortino. That's the bummer: For some, the bliss of life without a car payment may be gone for good.
HOW LEASING HELPS CARMAKERS...
-- Brand loyalty and customer satisfaction grow
-- Direct-mail marketing is more effective
-- The industry's sales roller coaster smooths out
-- Dealers get a steady supply of good used cars
-- Attracts younger buyers to luxury brands
-- Unlike rebates, leasing masks marketing incentives and doesn't undermine
...AND COULD HURT THEM
-- A flood of vehicles coming off lease could depress used-car prices and steal from new-car sales
-- Finance arms face greater uncertainty than with sales because profits depend on predicting what a car's value will be when its lease expires
-- Handling leases requires more labor at the finance company, boosting staffsTOYOTA COROLLA 27%
MONTHLY FOR 3 YEARS, $500 DOWN
FORD F-SERIES 21%
MONTHLY FOR 2 YEARS, $1,500 DOWN
JAGUAR XJS 88%
MONTHLY FOR 3 YEARS, $2,500 DOWN
CADILLAC SEVILLE 49%
MONTHLY FOR 2 YEARS, $2,200 DOWN
INFINITI J30 46%
MONTHLY FOR 3 YEARS, $2,450 DOWN
of unit sales
that are leases.
Sticker prices are for typical models. Actual lease
David Woodruff in Detroit, with Larry Armstrong in Los Angeles, John Templeman in Bonn, Julia Flynn in London, and Christopher Farrell and Jon Berry in New York