Our domestic auto manufacturers have long been criticized for their seemingly indiscriminate use of rebate programs to entice sales. Originally a tool reluctantly used to generate some buzz through slow sales periods, these programs have become as commonplace as Tom Cruise's controversial antics and show no signs of slowing. Many industry analysts have continually warned that such programs not only erode residual values and consumer confidence, but also tend to be "one way" campaigns -- meaning once you start, you can't stop.
The Mac Daddy of all programs was launched by GM under the guise of the Employee Discount Program and was originally just that -- a regional (Detroit) program intended for the hordes of actual GM employees as a small-scale sales tool. The success of the program at that level led to someone saying, "Why not extend this program to everyone?" Next thing you know, we have an all-out domestic price war, with both DaimlerChrysler and Ford also giving up what was left of their puny margins in the interest of moving some cars.
There is certainly no question that this has to be one of, if not the most, effective of such discount programs in history. In the month of June GM sales surged by 41%, taking their monthly North American market share from slightly over 25% to just over 30% (their best month in 19 years). I personally spoke with several dealership owners who confirmed that they were experiencing sales increases of 80 to 100%. It is really no wonder that GM quickly decided to extend the program for at least another month.
Rebates: The nature of the beast
To a customer, a rebate looks simply like a slice right of the top of their final bill (before tax, title, and fees, of course). Upon further inspection, however, the "cash back" game can as complicated as a tax code. Earlier this year GM instituted a price reduction to make its products more competitive before any specific discount programs were implemented. To do this the company doesn't simply take a chunk off the top and hope that increased sales make up for the lost profit. The proverbial "chunk off the top" is partially offset by other internal changes; for example, the company changes the standard vs. optional equipment on certain models, allowing it to lower the overall price. Optional equipment and features generally have higher margins than the standard stuff, meaning that in the long run a company could theoretically end up breaking even.
This is nothing new, and certainly not unique to GM. For that matter, this is certainly not meant to be some type of exposé. For the majority of people, the bottom line is that buying from one of the big three is less expensive (by up to $5,000 or more on some models) today that it was in May, which is a good thing. What happens to the guy who comes in to buy his new Malibu the day after the program officially ends is what worries me.
Even if the Europeans and some of the Asian automakers tend to shy away from the rebate game, almost all manufacturers must deal to some degree with the concept of "incentive pricing" -- or the margin a manufacturer allows a product's price to move as part of its current promotion -- whether it is in the form of a rebate, cash back, or even reduced financing rates. Generally this amount can range anywhere from a couple of hundred dollars to several thousand for some slow-moving models, but it should not be confused with a company's "holdback" -- the minimum allowance between the manufacturer and the dealership that sells the car.
The flexibility in pricing, rebate allowance, options and financing allow manufacturers to tailor their pricing and margins at the regional level to move certain models, which may be selling slowly in certain areas. This all-out "pay what the employees pay" program is really taking it to a whole new level. Side effects of this short term sell-off come in a variety of forms and can come back to haunt automakers down the road.
For example, the more a price is reduced through any type of discount, the more downward pressure there is on a car's residual value, or the amount a vehicle is worth at the end of its lease/financing. Such pressure can wreak havoc on consumer confidence in an entire brand, and has implications when the customer comes back to trade in for something new. With lower residual values, the value of the car drops quicker, meaning that a customer will be "upside down" (the market value of the car is less than what he or she owes on the loan) quicker than normal. When a customer goes to trade in the car, it will be that much more expensive.
Additionally, other manufacturers can't afford to sit idly by while the Domestics bump their summer sales and must also look for ways to remain competitive. Currently it seems that several of them are choosing a cost-cutting strategy tied to "free scheduled maintenance" programs. By taking free maintenance away, the companies are able to keep their prices competitive. But the consumer ultimately loses out by having to pay more for extended service contracts, or simply going without.
The problems don't end with the customers, however. While few people actually care about the well being of salespeople, such a program has an effect on them as well. The lower margins offered by manufacturers take away the negotiating cushion a dealership (or salesman) has to work with. Instead of making a percentage of the profit, every deal by default becomes a "mini," meaning the salesperson gets a preset minimum payment for each vehicle sold. Certainly this makes things harder for them, and at the end of the day you still need to have a happy and effective sales team to sell cars. Many such salespeople may be inclined to find more lucrative work, adding to the already high turnover rate.
Customers and salespeople aside, these companies may be simply delaying the inevitable slowdown that must follow a frenzy of activity. What can you possibly offer next? Who in their right mind will buy a car this fall at the higher prices once the program is over? What do you do until the next "big sales event?" And so commences the rebate cycle of death.
To put this situation into a context that is easy to understand, extending this summer's discount program, and Ford and DaimlerChrysler's decision to jump on the bandwagon, is the equivalent of those last few beers you may have had after a full day of drinking on the Fourth of July. Sure they seemed to make sense at the time, but it's after that one-too-many that most people make an ass of themselves, ensuring not only a hangover but likely some embarrassment to boot. What is the aspirin going to look like this time? Who knows, maybe in the fall the companies will invite us in to build the cars ourselves and just pay for the parts.
Price in the most important specification for any product. GM finds that cutting prices improves volume. I don't see anything wrong with pricing the product at a level that sells it. Especially GM who lacks exciting cars. The big SUV and pickup truck business isn't going to do very well with gas at $2+ a gallon. After sales of Avalanche and Silverado and Suburban and Escalade drop off, what does GM have left that any one really wants to own? If you cannot compete with desirable cars, compete on price.
Posted by: David J.Starr | July 15, 2005 at 05:55 PM