To many, Detroit is the center of the automotive universe, the home of the industry's big dogs. But a small company in the laid-back beach hamlet of Santa Barbara, Calif., increasingly is becoming the tail that wags the dogs.
The firm, Automotive Lease Guide, is the most widely used benchmark for determining the residual value of vehicles - what they will be worth up to five years down the road. In a nondescript one-story office on a sleepy residential street just a stone's throw from the beach, 30 mathematicians, statisticians and data analysts pore over every vehicle on the market to determine their worth when used.
Their decisions can rattle corporate boardrooms from Tokyo to Turin.
Every two months, the guide's ratings are recalculated. Every two months, the finance guys at automakers, banks and used-car auctions feel their hearts quicken in anticipation of a jump or drop in the numbers.
Normally, Automotive Lease Guide residuals flicker by a percentage point or less, usually by season. But it set the industry on its ear in January when it slashed 36-month residual values by an average of 3.7 percentage points across the board, and by as much as 6.8 percentage points on supposedly red-hot products such as full-sized and compact sport-utilities.
The 36-month residual value forecast for the industry, on average, dropped to 46.8 percent of sticker price, from 50.5 percent. That meant a vehicle with a $25,000 sticker suddenly was worth $925 less at lease-end than previously calculated.
A $40,000 full-sized sport-utility suddenly was worth $2,720 less.
The forecast hit the industry like a bomb. In a pen stroke, the assessed value of hundreds of thousands of lease vehicles on the books of automakers and lenders had been reduced by several billion dollars.
Joe Poi, manager for residual risk for Ford Motor Credit Co., said Ford had anticipated a correction by Automotive Lease Guide, but was surprised by its severity.
'It was difficult to see ALG come down that dramatically,' he said. 'Now it's a matter of waiting to see whether they've overcorrected or if they are right.'
Kjell Bergh, a multifranchise dealer in Florida and Minnesota, said he has seen a dramatic slowdown in leases and sales as a result of the guide's recalculations.
'It's very damaging short-term, but the captives and independents were leading us down the path of exuberant subvention,' he said.
'You can't buy (sales) and then have the manufacturer die when the lease returns come back.'
Raj Sandaram, Automotive Lease Guide's vice president and lead man for mathematics, analysis and data structures, argues that his numbers merely underscore an obvious, if painful, fact: The auto industry has been living way above natural demand because of incentives.
'Some call it incentives; we call it inventory. Because once they build it, they have to sell it,' he said.
'Incentives are merely the result of the supply situation. If incentives were market-correct, the natural demand would be at 15.8 million units. I'm all for a 16.5 million market, but not with discounts.'
In leasing, the customer finances the difference between a vehicle's transaction price and its stated residual value, so a higher residual means lower monthly payments for the consumer. That has meant higher sales for the industry.
But the practice can result in a loss for lenders if the actual market value of a car at the end of its lease is less than the residual value that has been set.
Good track record
Automakers' captive lenders, as well as banks, investment bankers and auction houses, typically use Automotive Lease Guide as a benchmark, and deviate from it at their peril. That's because the guide has an impeccable track record for being right.
Sandaram knows that a good chunk of his day will be taken up with automakers' brand managers arguing that Automotive Lease Guide has set its residuals too low. Conversely, Sandaram also gets plenty of calls from finance reps and auction firms making sure he doesn't give a product too strong a residual and leave them hanging with an overvalued portfolio. It's a never-ending tug-of-war.
Indeed, courting Automotive Lease Guide has become a full-time job. Guide staffers now are routinely invited to automakers' P.R.-intensive product introductions that normally are restricted to the press.
'They may not all agree with us, but that allows us to keep our integrity,' said Sandaram, who worked in the controller's office at Ford Motor Co. and with product strategist Jack Collins at Nissan North America Inc. before coming to Automotive Lease Guide.
'We listen to everyone, but there is no subjective talk,' Sandaram said.
The guide's history
For a company that holds the industry in such sway, Automotive Lease Guide doesn't look the part.
The company was founded in 1964 by Jim Aiken, who owned an Oldsmobile dealership in Santa Monica, Calif., and who believed that leasing a high-priced depreciating asset such as a luxury car was a good idea. But not many lending institutions followed the trend, so Aiken ended up calculating the residuals himself.
After several years, Security Pacific Bank came on as a client, while Automotive Lease Guide still did all the bookkeeping. The 1970s were a time of change, as son Doug bought the business and General Motors and Ford signed on to have their lease portfolios watched. That was the beginning of a tidal wave that now has every automotive captive and scores of third party lenders having their portfolios tracked by the guide.
In 1997, Doug Aiken handed the day-to-day business over to a duo of Young Turks - technical guru John Blair and mathematics whiz Sandaram. To be sure, Aiken still analyzes strategic trends from afar. But in showing his distance from daily operations, Aiken politely declined to be interviewed for this story, preferring the 34-year-old Sandaram to be the point man.
Short on ambience
Automotive Lease Guide moved from Santa Monica to Santa Barbara in 1986. With an exterior that could be mistaken for a dentist's office, the digs are a far cry from the glass-and-steel monolith that its reputation would suggest. Inside, about 30 casually dressed number crunchers with uniformly firm handshakes reside in a warren of cubicles.
While the company is made up almost entirely of math wonks and data trackers, most are serious car enthusiasts. Nearly every cubicle has a picture or die-cast model of some high-end sports car perched above the desk.
Automotive Lease Guide takes its lean-and-mean work ethic seriously. There are no secretaries, and just one administrative assistant. New hires must cut their teeth doing data entry for six months before they are allowed to enter any opinion into the guide's reports.
Automotive Lease Guide takes all the different vehicle valuations already on the market and crunches them into one formula, tosses in data from hundreds of recent used car auctions, and then takes its own perspective of the future. That accounts for nearly 50 different databases and data structures compiled into formulas and hashed through by the guide's squad of statisticians.
Automotive Lease Guide does this for 1,100 vehicle trim levels offered in America, but structures it for a five-year history. That's 5,500 calculations every two months. And then there's Canada, which has an entirely different residual value structure.
Goodies not so good
Automotive Lease Guide also targets add-ons in its calculations of residual values.
Sandaram says automakers tend to value add-ons and the base vehicle the same. But add-ons depreciate much faster and deeper than the base vehicle, he points out, because they have little real value to a used-vehicle buyer.
'The gold package is worth zero ... the ultra-luxury items are worn out, and none of that stuff brings any value,' Sandaram said. 'This doesn't happen so much with Civics and Camrys, but it does with those loaded Suburbans, Expeditions, Silverados and F series.'
As a result, the guide has created a new rating category, called 'maximum residualized MSRP,' which places a ceiling on vehicle pricing for each trim level.
It includes only those dealer-added options that the guide thinks will hold their value at resale. If the sticker price is above the guide's ceiling, it warns leasing companies that a vehicle's residual value can no longer be determined by multiplying sticker price by the percentage residual.
Sandaram points out that the guide's recalculations are for lease vehicles coming due in three years. However, he agrees with forecasts that industrywide lease losses could hit $10 billion in 2001.
'The losses are going to be big. And right now we're just hearing about the banks, not the captives,' he said.
'Some thought that we overdialed in January and February. We don't sit around enjoying forecasting doom and gloom, because it hurts business. But if you haven't pissed everyone off, you haven't done your job.'
Mark Rechtin is a staff reporter in Los Angeles