The Substitution Effect: New and Premium Cars Lose ShareBy Karl Brauer September 8, 2010
The recession may not have changed everything about the auto business - but it's changed just about everything. And here's the one that currently is hurting automakers at the most fundamental level: buyers who in normal times would have been snapping up new vehicles now are shopping the used-car market. And those who were cracking open the wallet for a premium badge are shifting to less-indulgent, less high-falutin brands.
This "substitution effect" is what many analysts expected as a plausible outcome of extensive unemployment, under-employment and a drastic downshifting of household consumption. What largely wasn't expected is how extensively the substitution effect is manifesting across multiple metrics, as Edmunds.com has identified.
New-Car Smell Versus Used-Car Value
Car buyers clearly are delaying new vehicle purchases, as the evaporation of millions of units in annual new-car sales over the past three years confirms. But there always are those who cannot delay; their vehicle is simply worn out (or perhaps damaged beyond repair in an accident) and must be replaced.
Replacement shoppers currently are driving a healthy portion of new-vehicle sales. But a growing number of these former new-car shoppers are replacing their worn-out vehicles with - a less-worn-out used model.
This is reflected in at least two definitive and telling measures: Edmunds.com's used-car page views compared with new-car page views, as well as in the upward trajectory of used-car sales as a percentage of all vehicle sales over the past four years.
For a two-year span from June, 2006, through July, 2008, there were just three months when used-car page views at Edmunds.com outnumbered new-car page views. Those months were February, March and April of 2007; during those three months, used-car page views beat new by an average of 7.1 percent. But in August, 2008, used-car page views outpaced new page views by 40 percent and have outpaced them ever since by an average of 36 percent.
Furthermore, in 2006, when credit was still readily available and the national unemployment rate was less than 7 percent, used-car transactions made up almost exactly half (49.7 percent) of all vehicle sales transactions. The number dropped to 47.9 percent in 2007, then grew to 51.3 in 2008 and 53.2 percent last year.
The shift to used-car sales outpacing new-vehicle transactions isn't overwhelming, but it represents several hundred thousand used-car transactions that previously were new-car purchases. This confirms an increased willingness for new-car buyers to go used when it's time to replace a vehicle. A significant number of today's recession-weary vehicle shoppers are willing to substitute new-car smell for used-car value.
Sometimes Used is Cheaper than New
Increased demand for used cars is driving up their value. Data from Edmunds.com at the end of June indicated that the average used-vehicle price was at a peak not seen since 2004. And the average price of a three-year-old used vehicle has spiked 11.1 in the past year.
Last summer's Cash for Clunkers program scrapped thousands of used vehicles that would have ended up on dealer lots and the drop in vehicle turnover (because people are keeping their cars longer) is reducing the total supply of used cars.
Both factors are working to push the price of used vehicles higher, reducing the amount of money saved when buying used instead of new, and in more than a few cases, making new cars cheaper than used.
Not Paying the Premium for Premium
Another example of the substitution effect is seen in the growing number of non-premium vehicles purchased by those who formerly bought luxury nameplates. Edmunds.com has spotted this trend in more than one market segment, but let's start by taking a look at what currently is being traded in for Hyundai/Kia products.
One might assume the trade-in brands for Hyundai/Kia are more Mazda than Mercedes-Benz. A good assumption, as Mazda made up 2.12 percent of Hyundai/Kia trade-in vehicles on 2010 models while Mercedes-Benz made up only 0.53 percent.
But the combined Hyundai/Kia trade-ins coming from 10 premium brands (Acura, Audi, BMW, Cadillac, Infiniti, Jaguar, Lexus, Lincoln, Mercedes-Benz and Volvo) made up 3.48 percent for 2006 models. The number stayed relatively stable for 2007 Hyundai/Kia models (3.52 percent) and 2008 (3.30 percent) before spiking to 5.86 percent for 2009 models. It dropped slightly to 4.77 percent for 2010-model Hyundais and Kias - but currently sits at 6.15 percent (nearly double the rate of 2008) for 2011 model purchases.
Is this an indication of premium buyers looking to save money in tough economic times, or simply a reflection of the growing appeal of Hyundai/Kia products like the near-luxury Hyundai Genesis sedan? Likely both, but when the rate of premium-badged vehicles being traded-in nearly doubles in a three-year period, there's more going on than just the introduction of one aggressively-priced upscale model.
New Taurus Clearly No Bull
The recently redesigned Ford Taurus presents more support for the "trading down" substitution effect.
From 2006 to 2009, the ratio of luxury vehicles traded in for a Ford Taurus averaged 4.6 percent - and given the previous-generation Taurus' status as a rental-fleet staple in those years. even that number is surprising. But with the 2010 redesign - coinciding with the depth of the recession - the number of luxury-brand trades for the Taurus nearly tripled to 12.6 percent.
And so far this year, luxury-brand trades account for 9.4 percent of 2011-model Taurus trade-ins. Ford's effort to move the Taurus upmarket with the 2010 redesign was clearly successful, and it's obvious many luxury buyers are accepting the new-generation Taurus is a suitable replacement for their premium-brand vehicles and likely at a lower purchase price than a premium replacement.
The Silver Lining
Yes, economic concerns have former new and premium-car buyers "substituting" used vehicles and non-premium brands. And both behaviors are hammering automakers' bottom lines.
But some of the profit from lost new-vehicle sales is being recovered in the largely effective "certified pre-owned," or CPO programs, most full-line makers have in place. And upwardly ambitious brands like Hyundai/Kia and newly-repositioned, quasi-upscale models like the redesigned Taurus are making the transition easier for buyers trying to redirect their dollars in a more value-driven way.
The recession has created a "new normal" in the auto market that may be in effect for years. Today's more-than-acceptable options to buying new - or buying premium - mean the good old days of 16 million annual new-vehicle sales might be a long time in returning.
Graphics created by Mark Holthoff, Edmunds.com manager of Customer Support.