Profit Margins Are Eroding Fast - Brief Article

Automotive Industries, June, 2000 by Maryann Keller

European and Oriental makes have finally figured out how to win American buyers. And the domestics don't have a truck boom to protect them anymore.

With new passenger vehicle sales in the U.S. at an all-time record pace in the first half of the year, profit margins on most models have eroded. Only a few vehicles now wear retail prices at or above MSRP. The short list includes the Honda Odyssey, Chevy Suburban, Chrysler PT Cruiser and an assortment of low-volume specialty and luxury models.

How can a market soar to a 17 million annual sales rate and, at the same time, see incentives and promotions swell to near giveaway levels? The reason is white-hot competition.

Margin erosion is occurring across the board, with stalwarts such as Honda Accord and Toyota Camry sedans selling at prices within a couple of hundred dollars of dealer invoice. Less popular models are often transacted at or below invoice. (The coupe versions of both Japanese makes are commanding much higher margins.) On top of that, automakers are giving customers rebates, cheap loan rates or subvented lease deals, which promise to flood the used-car market and create future losses for the manufacturers. No wonder that a fixed-price make like Saturn has a tough time competing in an environment where the competition's transaction prices are dropping!

What about the profitable SUV and minivan segments? These former gold mines are also under pressure. Some relatively new models, like the Ford Excursion, are selling at invoice or within a few hundred dollars of dealer cost. Again, there are exceptions such as the Explorer Sport Track. While the run-up in gasoline prices might be taking the sales momentum out of the worst gas-guzzlers, the reality is that supply exceeds demand in nearly every light truck product sector. When that happens, margins compress.

General Motors, Ford and Chrysler were the beneficiaries of a light truck boom, which fattened their corporate bottom lines for nearly a decade. But rising gas prices, combined with improvements in passenger car design and engineering, have slowed the growth of light truck demand. against a background of increasing import and domestic supply, it promises to put more pressure on retail margins over the next year.

Every automaker is convinced that they have the brand recognition or product differentiation to elude the emerging profit compression. Over the next few years, more than 500,000 units of new light truck capacity comes on stream into a decidedly less favorable marketplace.

It isn't just that there is too much capacity and total supply of light trucks. Rather, it's the headway that specific makes have made in recent years that has put more pressure on the overall market. Every auto company in the world sees the U.S. as one huge, open and lucrative marketplace. With limited sales growth at home, they are putting together better product portfolios that work with American consumers.

For example, in 1996 Volkswagen sold just over 130,000 vehicles in the U.S. This year the carmaker is on track to retail about 400,000 units, most of them selling with above-average profit margins for dealers. That represents nearly 300,000 units of demand taken out of the domestic manufacturers' share. Likewise Korean car sales, which just crossed the 100,000-unit mark in 1996, will exceed 300,000 units this year. While most of those cars are at the opposite end of the profit spectrum from VW, they still represent a growing supply of product for this market. And it won't go away when demand softens.

In the lucrative luxury car segment, the Germans and the Japanese are emerging preeminent. The once-dominant Cadillac brand is likely to be surpassed this year by Lexus, BMW and Mercedes -- if they can get enough product here to meet demand.

Make no mistake: the long-awaited profit margin squeeze is at hand. This time, however, it's going to be hard to offset lower margins on cars with more sales of light trucks.

Maryann Keller is president of auto services at Priceline.com.