Autos: Those Price Breaks Are Habit-Forming

Detroit's incentives may be here to stay, and now Japan is sweetening its deals, too

Nice try, GM. In December, the Motown giant dialed back some of the 0% financing deals it has used to fuel sales over the past few years. Having sparked an industrywide incentive war after the September 11 terror attacks, General Motors Corp. (GM ) decided it was time to stop offering 0% loans on popular pickups and sport-utility vehicles. Its hope: to wean customers off the costly deals and make more money on each car.

INSTANT CAVE-IN. It took all of one month to dash that dream. The moment sales softened in early January, GM blinked -- slapping 0% financing back on most of its lineup. Nor was GM alone: Ford (F ), Chrysler (DCX ), Toyota (TM ), and others have also ramped up discounts. But the industry's 1% sales slump in January is only partly to blame. Thanks to Detroit's generosity over the past two years, buyers are now conditioned to expect big discounts. And even if Detroit wanted to pull back, Toyota Motor Corp. and its Japanese rivals have started discounting more aggressively. "Auto makers won't be backing off incentives anytime soon," says Bank One Corp. (ONE ) chief economist Diane C. Swonk. "They'll do what they can to sweeten them."

The sweetening is already well under way. GM's January about-face boosted its average per-vehicle incentive to $4,431 -- $100 over what it forked out in December. And Chrysler Group is offering one of its richest deals yet: a $2,000 rebate on top of 0% financing for many of its new models. That deal helped push Chrysler's January sales up 9% even as GM's and Ford's softened. Overall, auto makers spent an average of $3,775 per vehicle on incentives in January. That's up only slightly from December's $3,751. But it's an abrupt reversal of the drop from November to December, when average incentives fell nearly $200 per vehicle.

The carmakers -- especially the Big Three -- are trapped in a vicious cycle. It's no secret that drivers have now come to expect big discounts. But there's another force at work, too: As people start trading in all those cars purchased with fat rebates, many are discovering that their cars are worth less than the balance of their loans. Why? For one thing, the sales and leasing of tons of discounted vehicles over the past few years has wreaked havoc on the used-car market. A three-year-old model is now worth 42% of its original price, vs. a 53% residual value in 2000, says consultant Automotive Lease Guide LLC. And carmakers' generously long loan terms -- 60 months is not uncommon -- mean that three years into their loans, when many people trade in their cars, they have little equity built up. So to get the new sale, dealers have to offer sufficiently rich rebates to pay off the loan -- or most of it.

INTO THE FRAY. Then there are the increasingly discount-happy Japanese. Since GM kicked off the price war 2 1/2 years ago, Toyota, Honda, and Nissan have been far stingier with incentives than their Detroit counterparts. But in recent months, they have started to jump in. In December, even as GM and Ford raised prices slightly, Toyota, Honda (HMC ), and Nissan (NSANY ) all pushed up incentives to goose sales.

Toyota, the biggest of the three, has been by far the most aggressive. While it offered incentives worth just $2,169 per vehicle a year ago, that number is now up to nearly $2,900. Analysts attribute Toyota's deep discounting to the fact that it has few new cars to draw buyers this year; it is replacing just 11% of its U.S. sales volume with new models, compared with 17% at GM and 20% at Honda. "Toyota could actually lose a little market share this year," says Art Spinella, president of CNW Marketing Research Inc. "They will fight to keep it." In other words, this is one price war that could well get worse before it gets better.

By David Welch in Detroit

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