Automotive loyalty in the wake of the COVID-19 recession

With auto sales forecast to decline as a result of the nationwide shutdown due to the coronavirus disease 2019 (COVID-19) outbreak, the automotive industry is set to be impacted at levels unseen since the 2008 recession. Examining the events surrounding the 2008 recession may provide valuable insights about how the upcoming downturn will develop. By identifying the length and essential factors of the recovery, we can better determine what awaits the automotive industry and why this recovery could face more challenges than in 2008.

In the two years leading up to the 2008 financial crisis, new vehicle retail registrations peaked at 3.6 million in the third quarter of 2006. Following that peak, a rapid decline emerged as the industry entered the early stages of the recession in the first quarter of 2008, eventually falling about 50% to its lowest point in the first quarter of 2009.In the two years leading up to the 2008 financial crisis, new vehicle retail registrations peaked at 3.6 million in the third quarter of 2006. Following that peak, a rapid decline emerged as the industry entered the early stages of the recession in the first quarter of 2008, eventually falling about 50% to its lowest point in the first quarter of 2009.

The impact to registrations was felt among both sectors of the automotive industry, with the luxury sector down 51% and mainstream brands down 44%.  However, luxury accounted for only 13% of total registrations during that period, yielding the bulk of the contribution to the non-luxury sector.

As registrations declined, so too did customer return-to-market (RTM) activity, a key indicator of economic health.  RTM volume followed a pattern similar to that of registrations, peaking at 1.8 million in the third quarter of 2007 before falling to a low of 1 million in the fourth quarter of 2008, one quarter prior to the registration low point. Although the peaks and troughs of registration and RTM activity vary, the correlation coefficient between the two metrics is a robust .95, signaling a strong direct relationship between them.  

Once the lowest point of the recession was reached in late 2008/early 2009, the next question was, how long the recovery would take, and what steps were needed to assist in recovery. 

To identify when the initial signs of recovery, we need to look at the last period of healthy sustainability in the industry. Using each quarter of 2006 as a base period to compare retail registration volume, there were 27 consecutive quarters where registration volume was lower than the corresponding quarter of 2006. From the first quarter of 2009, where registration volume bottomed out, it took 19 quarters (until the fourth quarter of 2013) to see the first period when registration volume outpaced 2006 levels.

The luxury sector was quicker to recover from its low point (19 quarters) than the non-luxury sector (21 quarters).

Looking at the manufacturers, European manufacturers were the first to see a consistent pattern of growth versus 2006, starting in the fourth quarter 2011, while Asian manufacturers started growing a year later in the fourth quarter of 2012. In contrast, the domestic manufacturers never fully recovered post-recession, taking 26 quarters to reach a new peak of 1.6 million in the third quarter of 2015. However, this peak was still 6% lower than their prerecession peak.

Tracking RTM volume to the corresponding quarter in 2006 indicates that the first two quarters of the recession showed moderate gains versus 2006, signaling a slight variance with registration movement. This positive year-on-year (y/y) change in RTM volume, compared with a decline in registration volume during the same time period, could potentially be attributed to a loss of first-time buyers, which the RTM metric does not account for. Starting in the third quarter of 2008, it took 18 consecutive quarters before RTM volume approached 2006 levels. The most significant drops in RTM volume correspond with the quarters where retail registrations showed the sharpest decline in volume, again highlighting the strong correlation between the two.

Examining RTM activity at the manufacturer level suggests which brands may have been responsible for the automotive industry’s recovery. While Asian and domestic brands reached their lowest levels in the fourth quarter of 2008, Asian manufacturer RTM volumes grew 47% through the fourth quarter of 2011 while domestic volume grew by only 19% in the same period (European manufacturers also saw growth of 36%). However, from the first quarter of 2012 to the fourth quarter of 2019, Asian and domestic RTM volume grew at a rate of 48% and 45%, respectively, while European manufacturers’ RTM volume climbed 65%.

Overall, industry make and manufacturer loyalty levels continued to grow, relatively unaffected by the recession.  While the first quarter of 2009 was the worst quarter for retail registrations, make and manufacturer loyalties peaked above prerecession levels. The notable drop in loyalty during the third quarter of 2009 can be attributed to the “Car Allowance Rebate System” often referred to as “Cash for Clunkers.” This lack of decline can be attributed to the nature of consumer purchasing habits and consumers’ reluctance to move away from the familiar when given little flexibility to do so. During economic slowdown and industry stagnation, returning customers are more likely to remain with their previous brand than defect to something new. The “Cash for Clunkers” program stands out as an outlier because of the robust incentive tied to it, allowing the buyer more flexibility to venture away from what they were familiar with.

In comparing each quarter with the corresponding timeframe in 2006, there were only three quarters when make loyalty declined compared with the base periods. The first two quarters showing decline were in the second and third quarters of 2008, which led to the worst periods of registration and RTM volume. With loyalty movement contrasting with RTM and registration trends, it is important to understand the factors that contributed to the recovery from the recession and how they influenced each metric.

As fuel prices were reaching all-time highs and the effects of the economic downturn were limiting buyer activity, the Car Allowance Rebate System ("Cash for Clunkers") program was instituted to incentivize consumers to return to the market. By trading in gas-guzzling vehicles, consumers were rewarded with a substantial cash incentive to purchase a new, more fuel-efficient vehicle. The program was an immediate success, spurring a surge in sales activity through the mid-to-latter part of 2009. While retail activity improved industry-wide, the results varied across manufacturers, with loyalty revealing the winners and losers. 

Domestic manufacturer loyalty was hit hardest by the "Cash for Clunkers" incentive. From the second to third quarter of 2009, loyalty dropped 8 percentage points while import manufacturer loyalty declined only 3 percentage points. When looking at the recovery time of manufacturer loyalty throughout the recession, domestic manufacturers took much longer—nearly five quarters—compared with just one quarter for imports. Loaded with high fuel-consumption vehicles, the domestic brands faced an uphill battle trying to retain customers and minimize defection to the more fuel-conscious import brands. For example, according to the US Department of Transportation, during this time period the most common trade-in was the Ford Explorer AWD, while the most frequently acquired vehicle was the Toyota Corolla.

Although all three major US automakers were impacted by "Cash for Clunkers", Chrysler suffered the most. From the second to the third quarter of 2009, Chrysler’s manufacturer loyalty dropped 16 percentage points. while General Motors and Ford’s loyalty rates only fell 5 percentage points. At this time Chrysler’s lineup leaned heavily on gas-guzzlers, limiting the brand’s appeal to consumers searching for more fuel-efficient options; as a result, Chrysler needed 15 quarters to recover to precession levels, compared with just one quarter for Ford and General Motors.  

The bankruptcies of General Motors and Chrysler and their subsequent government-bailout funds led to a negative consumer sentiment surrounding most domestic vehicles, hurting their sales performance for years to come and hindering their portfolio overhaul. Ford was the only domestic brand to see any positive buzz surrounding its brand, betting the future on rebuilding the brand on its own in lieu of a government bailout. 

The drop in sales during the recession, in addition to the institution of "Cash for Clunkers," revealed untapped potential via leasing. A combination of a rapidly dwindling used vehicle supply due to "Cash for Clunkers" and the recession, along with more disciplined go-to-market strategies among all OEMs, yielded a surge in resale values, strengthening residual values and making leasing less expensive for OEMs and their lenders. At the start of the recession, industry retail lease penetration was 23%, eventually dropping 13 percentage points to a low of 10% in the third quarter of 2009. It took six quarters for lease rates to recover to prerecession levels; however, lease rates continued to grow along with registration volumes. By the second quarter of 2016, the industry lease penetration was three times what it was when it was at its lowest in the third quarter of 2009.

The rapidly growing popularity in leasing is clearly reflected when looking at its impact on loyalty. While leasing has consistently shown higher loyalty levels than purchase, the loyalty lift from leasing has grown steadily since the end of the financial crisis. In a 10-year period from the fourth quarter of 2009 to the fourth quarter of 2019, lease loyalty increased by 7 percentage points, while purchase loyalty improved by 5 percentage points.

By observing the length of the 2008 recession, it can be assumed that the expected fallout resulting from the COVID-19 shutdown could potentially be as damaging. The many factors that influenced the automotive industry's recovery phase in 2008 have undergone drastic changes in the last few years, thus the path to recovery in 2020 may be entirely different.

•    "Cash for Clunkers": As Corporate Average Fuel Economy (CAFE) standards continued to rise, fuel-economy levels among the industry improved, resulting in a market that has clearly adapted to current trends. Unless the government is willing to institute a used-to-new trade-in incentive program, regardless of mpg and age limits, the automotive industry will be missing a key stimulus program to boost vehicle sales as it heads into the economic downturn. 

•    Room for growth: Auto sales were already forecast to decline during a time when the economy was stable. Now with production slowing down due to shutdowns, and the economy headed toward a recession, the retail sales potential will only diminish. Automakers will need aggressive sales and incentive strategies to maintain market share, which could lead to a trickle-down effect that may further weaken the market.

•    Demand for crossovers: As a primary driver for sales growth during the last few years, the industry has placed a heavy emphasis on producing more crossovers, overtaking sedans as the majority body type in the market. With industry sales expected to decline even further than the previously forecast level of under 17 million units, it may be difficult to rely on this pipeline in the future, owing to their high MSRPs and a consumer base that is more price-sensitive entering a period of financial uncertainty.

•    Leasing and the growing used supply: As lease penetration continues to remain at an all-time high, the used supply will continue to grow, hurting resale values and lowering residual values, making it difficult to offer a competitive lease payment. In addition to the challenges facing lease payments, the rise in used supply, and subsequent decline in resale values, could shift demand away from the new market as consumers become more price conscious.

Understanding the past and recognizing the limitations of the present and the future will play a significant role in whether an OEM can minimize loss during economic uncertainty. While a large portion of their consumer base will potentially remain loyal when returning to market, the ability to limit defections and capture as much of the returning consumer base as possible will be integral to maintaining market share and accelerating recovery.