Cars: Giving 'Em Away? Hardly
By Michael Englund
Does the great "employee discount" auto sales blitz of 2005 represent a fire sale by the Big Three U.S. auto makers? Not really. Through the first half of the year, vehicle makers were pursuing their most aggressive U.S. price hikes since 1997, according to the consumer price index and chain price data for vehicles. Surprisingly, the employee discounts offset only part of the recent increases.
Indeed, prices are still above the growth trend from the past eight years, despite perceptions that "they're giving 'em away" with the current discounts. This leaves open the potential for these promotions to be repeated regularly over the coming years or adopted as permanent with the new model year.
Such a pattern is indeed suggested by General Motors' (GM ) announcement on Aug. 25 that it will extend its discount program through the end of September and include some 2006 large pickup and SUV models.
Obviously, there is no need for fire sales on the new model-year vehicles, which have just come into production, unless GM is comfortable with the discounted prices.
The summer discounting plans came after a sustained period of higher prices in late 2004 and early 2005. New-vehicle price growth in the monthly CPI reports surged to an eight-year high in February of 1.2% on a year-over-year basis. It remained lofty until the discount programs of June and July were put in place, with a resulting drop in the year-over-year price gain in July to 0.3%.
Although near-zero price changes may sound low, vehicle prices previously were falling fairly consistently, at least since 1997, as part of the general downtrend in technology expenses, which allowed costs for most manufactured goods to drift lower.
Vehicle prices have consistently restrained overall CPI inflation, though the run-up in prices through early 2005 contributed to the strengthening in core inflation over the period.
Action Economics' research generally shows that growth in unit volume of vehicle sales has moved inversely with prices, as would be expected, with sales slowing in early 2005 as prices rose.
The quarterly chain price figures are poised to move slightly into negative territory during the third quarter, in response to the employee discount programs. Sales for the quarter as a whole are poised for a big gain, given the strength in monthly unit auto sales through July.
Looking at the longer term, prices moved from a pattern of steady gains early in the last economic expansion to one of zero or negative price movements during the period of 1997-2004. Yet strong vehicle sales volume generally surprised economists and showed virtually no slowdown in the 2001 recession.
Price-reduction strategies through the 1990s were generally led by factory and dealer price rebates that started as "one-time" programs but then evolved into pricing strategies that consumers eventually viewed as expected components of a vehicle's price.
ON AGAIN, OFF AGAIN.
Similarly, economists interpreted these programs initially as desperate marketing attempts to unload inventories but slowly came to accept the moves as a standard part of pricing.
A new twist was introduced after the 9/11 attacks as carmakers adopted "zero-percent financing." Rates charged on auto loans fell sharply, and these lower rates became the on-again, off-again norm through the 2002-04 period.
Perceptions of consumers and economists went through the same cycle, as pricing that at first seemed unsustainable later become an industry standard.
TAKING THE EDGE OFF.
Rates charged on auto loans haven't actually risen after the spike at the start of the Federal Reserve's current cycle of interest-rate hikes in June, 2004, because the loan rates have benefited from the flattening yield curve.
We believe we can interpret the most recent employee-discount programs in the same context as prior factory and dealer incentive programs and zero-percent financing. In each case, the new discounting scheme has become part of the expected price.
In the most recent round, the employee-discount strategy has only taken the edge off an unusually aggressive effort by the auto makers -- at least since 1997 -- to raise prices.
In total, the financial difficulties of GM and Ford (F ) suggest that they are having difficulty facing the emerging industry norm of "sideways" price movement since 1997.
But the recent discounts don't represent unusually low prices for vehicles, at least as measured by government price indicators, which are seasonally adjusted and adjusted for quality changes.
Other auto makers are still thriving, and global capacity is expanding rapidly. This suggests that the sideways price trend may be sustainable for some time to come.
MATTER OF CONTEXT.
The Big Three may well adopt strategies with the new model years that extend the pricing evident in this most recent promotion, whether or not they choose to describe the new prices as employee discounts for marketing purposes.
Either way, the strong sales data for the third quarter should be seen in the context of relatively stable prices for cars and trucks, heavily hyped discount plans notwithstanding. After all, Detroit isn't in the business of giving vehicles away.
Englund is chief economist for Action Economics