Back to the Barracks on IncentivesBy Dale Buss February 14, 2011
Relax. As you were...
Hyundai Motor America CEO John Krafcik got competitive juices flowing in the industry last week because he complained that General Motors had set off a price war with its remarkably aggressive and unseasonable incentive activity in January. But what GM did was more like executing a sortie than starting a war, or even a skirmish. It takes at least two sides to battle, and besides a reluctant Toyota, no other major automaker has joined GMs unseasonably proactive incentivizing. With a recovery gradually building in the U.S. market, they dont see a need to.
It piqued interest in consumers, Ivan Drury, Edmunds.coms supervisor of pricing and industry analysis, said of GMs January gambit. People went to dealerships. If you look at every other OEM, what GM did was well-planned and [well-]targeted. It was a one-time, really effective technique.
David Cole, chairman emeritus of the Center for Automotive Research, agreed that GMs ploy was the equivalent of a tactical flourish rather than the opening salvo of a broadening incentive war in a delicately recovering industry. Ive heard every single OEM including GM commit to a pull market that is driven by consumer demand rather than pushed by incentives, Cole said. And theres a downward trend in incentives generally. Youre just always going to have some moves here and there.
Even GM was trying to calm interpretations rather than stoke speculation. I wouldnt read too much into it, said Don Johnson, GMs vice president of U.S. sales, on the day that GM announced its January sales had leapt a robust 22 percent on the back of its generous incentives. We are not going to return to the days of driving production with incentives. We know that is not going to be a recipe for success for us.
So why all the buzz? Heres what happened: In January, GM busted open its incentive cache, reaching $3,733 in its True Cost of Incentives (TCI) paid on average for each vehicle, according to Edmunds.coms proprietary calculation. That was a whopping 22-percent increase over GMs December TCI of $3,065.No other leading automaker came close to that level of increase.
Each of the Big Three Japanese players boosted incentives as well, but Nissan was the leader, and its percentage increase in TCI in January was less than half of GMs. Even Toyota which arguably faces the biggest market-share challenge of any major automaker this year boosted its TCI by only less than 2 percent. And by sharp contrast, Ford actually reduced its January TCI by nearly 7 percent, to an average of $2,504 per vehicle. Chrysler, meanwhile, eased its TCI by about 2 percent as well, and still turned in the best year-over-year sales gain in January of any major automaker, with a 23-percent boost.
Not only did GMs generous incentives stand out from its competition on an isolated monthly basis, but the fact that the company opened the spigot so widely in January was remarkable as well. Historically, January sales are the lowest of any month in the U.S. market, and automakers typically use the month as a breather between feverish Christmas-holiday promotions and the spring selling season that often begins with Presidents Day initiatives in February.
From 2002 through 2010, said Edmunds.coms Drury, each December-to-January transition has resulted in a lower TCI in January versus December except the last one an average drop of 4.5 percent. But this year, GMs boost nearly alone pulled up the overall industry TCI to an increase of 0.9 percent.
GMs Johnson actually wasnt of much help in explaining why GM did what it did. After noting that GM had spent a lot of time getting very disciplined around our inventory management [and] our incentive discipline over the previous year, he um, elucidated by adding this:
The one side effect of that was a lot of noise out there in the system about sources of data, competitors saying this, competitors saying that. We are just trying to take the noise out of the system. We do think fundamentally that our sales results and our financial results are going to tell the story for us, and right now those are I would say results that really dont need any explanation. [Huh?]
So not all that surprisingly, competitors began fretting. Some major positives had emerged from the industrys restructuring amid the Great Recession: It enabled auto companies to strip a lot of excess capacity, begin a tighter balance between the inventories of assembled vehicles and consumer demand, pare manufacturing costs significantly, reduce incentive spending, and allow them to focus more on building brands and promoting the attributes of their products.
If GMs move represented some sort of effort to upset the apple cart, other automakers would have to react. Thats what Krafcik did on the sidelines of the Chicago Auto Show last week. I think we can officially say that a price war broke out in the industry, Krafcik said. There is apparently a lot of pressure to deliver sales results. Stories quoted Krafcik as saying that this is a step backward for the industry. This is short-term thinking in a long-term process that hurts manufacturers and consumers.
Battle Cry or Blow Over?
So is Krafcik right? The consensus of industry insiders and outside observers is that the concern he expressed is overblown. Heres the case for the notion that a full-blown price war could be forming:
GM does face some unique pressures. Regardless of whether it is trying to lure competitors into matching its generous incentive levels, GM must cope with unique factors that presumably prompted Januarys action and could cause company decision-makers to prolong their reliance on deeper incentives (the company declined to offer an executive for an interview with AutoObserver.com).
Theres certainly a tremendous amount of pressure on them to continue to grow market share, said Rebecca Lindland, an analyst for IHS Automotive, in Lexington, Mass. In year-to-year comparisons, for instance, GM cant talk any more about qualifications from before such as having four brands now versus eight before.
Specifically, GM also sees an imperative to increase its leasing penetration after entirely dropping out of the leasing market for a while during the recession, so it boosted leasing incentives. Especially as lenders are loosening consumer credit standards more every week, even including some subprime borrowers, GM presumably wants to make sure that it can grab a significant share of a re-accelerating lease market.
And sure enough, in January, 19 percent of all GM transactions were leases, according to Edmunds.com data, the highest for any month since March 2008. During January, GMs lease TCI was the highest of any Big Six automaker and its highest lease TCI since July 2008. Whats more, a newly restructured and recapitalized GM with remaining significant ownership by U.S. taxpayers and a new collection of public shareholders after its IPO in November now faces unprecedented pressure to perform in the marketplace and to justify its continued existence. GM has to answer to the market again, so now theyre more conscious of keeping up sales and hitting their targets, said Lacey Plache, Edmunds.coms chief economist.
Added an industry insider: GM is wanting to show some really positive results to get off to a very fast start in 2011 regardless of whether they make money. Indeed, already GM has indicated a sort of follow-up in kind to what it did in January. On Friday, the company announced that it is waiving the last three payments on existing leases if holders buy a new car.
Toyota seems to be joining the fray. Toyota Division General Manager Bob Carter sounded the brands own alarm by announcing loudly that Toyota was getting more aggressive about incentive spending in February as it attempts to regain market share it lost last year over its safety recalls and a lack of significant new products. Our plan is to get off to a very good start in the first quarter, Carter said, mentioning a new Toyota advertising campaign as well as a very aggressive incentive program for February that includes zero-percent financing and cash rebates. Our incentives were competitive, but now our incentives will be leading the market, Carter vowed.
Lindland said that Toyota is likely to continue to follow a more aggressive incentive plan regardless of what competitors do. Maybe if they have heavy incentive levels they can get people back into their showrooms and say that theyre fully healed and back to 2008 levels, she said. Toyota declined to offer an executive for an interview by AutoObserver.com for this story.
The More Convincing Case
But most in the industry believe that GMs gambit will remain a relatively isolated and short-term phenomenon, for the following reasons:
GM has no fundamental rationale for long-term aggressiveness. Pretty much in line with the rest of the U.S. industry, GMs inventories are at comfortable levels a 64-day supply in the retail network, about average for OEMs, and 41 days to turn, according to Edmunds.com calculations up a bit from December, but fully in line with its rivals.
Moreover, GM has no imbalance between 2010 and 2011 model-year vehicles to address with, say, generous incentives on the old models. Fully 93 percent of GMs sales in January were 2011 models, according to Edmunds.com, most of any of the Big Six automakers. GM is only being opportunistic. While GM is being aggressive, it may be because the company sees short-term opportunity in aggressive incentives that could yield long-term gains.
They could be seeing what people in the industry have been saying for a long time was coming: a period of pent-up demand coming into play, said Edmunds.coms Plache. They may be thinking that consumer spirits are up now, and there are signs of credit loosening so lets see if they can pull some people out of the woodwork who might be hiding and may be ripe for buying.
In particular, one competing executive said, GM incentives in January seemed to be targeting existing GM owners, including those who are GM credit-card holders and who got a special offer that expired January 31. This is evidenced by the fact that GMs strongest gain in retail-market share in January, compared with a year earlier, came in the Great Lakes region where the company is headquartered and where, traditionally, its market share is largest of anywhere in the country.
GM gained 1.7 percentage points of retail market share in that region during January compared with a 0.4-percentage-point gain in the East region, GMs second-best-performing region in January, and versus a gain of only 0.2 percentage points nationally. GM also has reasons to pause. For example, GM executives must continually be mindful of their need to perform on metrics other than immediate market-share gains. With their shiny new shareholders, they also have the responsibility to protect their balance sheet, Lindland said. Theres a fine line between increasing market share and not hurting profitability.
Most rivals have no reason to follow. The Great Recession beat down cost structures, especially among the U.S. Big Three, meaning that they have more room to play with incentives. There also is a remarkable market-share donnybrook going on now in which previously marginal players such as Nissan and Hyundai are asserting themselves effectively. And as the year goes on, beginning with the onset of spring selling season, some analysts foresee overall levels of incentives nudging upward again.
Nevertheless, most big players in the American market arent likely to abandon their hard-won discipline of tighter inventories, firmer pricing and more attention to brand-building in order to chase expensive and probably ephemeral upticks in market share with expensive incentives and just as the recovery is getting underway in earnest.
Citi analyst Itay Michaeli concluded that, while GMs large share gain [in January] may prompt competitors to respond, lean industry inventory and genuine intentions to avoid repeating past mistakes suggest it is too early to worry about an all-out incentive war. The 2010 pricing environment was quite firm. Once you got past Toyotas situation, there was no stupid, crazy game with incentives. So at the very least, Krafciks remark is premature.