For several weeks, Automotive News and other publications - including The New York Times, the Kiplinger Washington Letter and USA Today - have reported that consumer leased vehicles are coming off-lease and returning to the market in such numbers that their volume is causing an erosion in used-car prices.
Now a manufacturer is reported to be paying its dealers hefty incentives to keep off-lease vehicles out of auctions. Similarly, in March, another manufacturer started allocating off-lease cars to dealers.
The explanation for the policy given by Automotive News is that 'a flood of discounted off-lease vehicles depresses used-car prices and makes it difficult to establish strong lease-end values on new units.'
I'm afraid that interpretation is too simplistic, and the actions by the manufacturers to deal with that phenomenon are not only short-sighted and ill-advised, but they could actually upset a system that is working extremely efficiently.
Following are some of the facts that are being ignored because of false assumptions:
1. The weakening of used-car prices is neither dramatic nor unexpected.
Used-car prices have been at record levels since 1994. It was inevitable that they drop. That is the cyclical nature of our business.
As of mid-June, retail used-car prices had dropped approximately 2 percent compared with this time last year, according to the Bureau of Labor Statistics' Consumer Price Index for Used Cars. That decline certainly does not justify such extreme reactions from the manufacturers, nor does it warrant a superficial analysis by the press.
2. There is not a 'flood' or 'glut' of used cars.
As has been reported, some 2.9 million off-lease cars are returning to the market this year. That does not mean there are 2.9 million more used vehicles than there otherwise would have been. In fact, probably only 1 million of those vehicles are in excess of the normal return to market of vehicles that formerly were purchased on normal two- or three-year installment loans.
In a market with 40 million used-car transactions annually, 1 million more vehicles is not enough, by itself, to destabilize the market.
3. Off-lease vehicles sold at auction are not 'discounted,' as the article suggests.
Rather, their prices reflect true market values. In fact the only true market price is the price established by a willing seller offering his product to many willing buyers in open bidding. All other means of pricing are compared to that true market price attained at competitive auction.
4. New-car incentives are a big contributor to the decline in used-car prices.
Policy decisions should be based on 'value,' not 'price.' Price is the actual dollar amount charged for a used vehicle. Value is that price relative to the price of a corresponding new car that has been adjusted for incentives.
As Fortune magazine reported June 23, 'Automakers are piling on incentive money: General Motors boosted its spending 44 percent in the first quarter.'
And that is just one example. The recent decline in used-car prices corresponds to that increase in new-car incentives. There has been little or no decline in the 'value' of used cars.
If the manufacturers want to establish policies to protect used-car residual values, they would do well to look first at their new-car incentive policies and worry more about value than they do about price.
When manufacturers pay dealers cash incentives to buy used cars - after paying customers cash incentives to buy those same cars when they were new - they remove all stability from the pricing equation and make it impossible to determine true value.
One of the great virtues of the auto auction system is that the marketplace is allowed to establish the true price of a vehicle based on supply and demand. Sooner or later, the manufacturers must allow those principles to function freely. That means allowing auctions to continue to provide a marketplace in which values can be set.
The manufacturers have attempted to bypass the auctions in the past, and always with disastrous results. Our hope is that they will avoid that mistake again and will let the free market perform freely.