Behind GM's Big Push On Incentives

Behind GM's Big Push On Incentives

By Jeremy Anwyl March 3, 2011

As they did in January, the incentives from General Motors Co. led the industry in February. The company’s sales shot up – so was its increase a good move? And why, when the story from GM all last year was managing production, inventories and costs has GM taken this preemptive move? It’s a complex picture, but also one worth studying more deeply. For one thing, this kind of aggressive pricing -- and how the rest of the industry responds -- can materially change the overall sales landscape for the year.

Let’s start with the why. GM chief executive officer Dan Akerson (above) has talked publicly about being a bit unpredictable as a way to keep the competition off balance. So far, this aggressive posture vis-à-vis pricing would seem a good example. But there is more to this than unpredictability. GM inventory on dealer lots plummeted during bankruptcy. Since then, inventory has been gradually climbing – and, as it’s important to note, generally at a rate that exceeds retail sales.

This has been a shot in the arm for profitability, as GM books the revenue when the dealer buys the vehicle, not when the vehicle is retailed to the consumer. But it also means that retail inventory is ballooning. It is still at a relatively comfortable 65 days, but the trend has to have caught GM’s attention. Netting this out, GM needed to goose the increase in retail sales above the recent trend.
 
A second aspect to note: so far, these incentives are largely offensive. By that, I mean they are designed to expand sales. And as long as key competitors hold back, the gains achieved by GM will outweigh the increased costs.  In other words, these high incentives are likely to result in a net increase in profitability – in the short term. This is important to think through. Incentives – mostly – are temporary pricing actions. Reducing prices can make vehicles more affordable, bring more consumers into the market and make a new vehicle more competitive versus a used vehicle.

GM remains a formidable player and there are many past examples of its incentive programs igniting sales across the industry. Incentives on even a single vehicle can stir up cross-shopping as well as direct shopping, resulting in a spillover that also can benefit competitors. From this perspective, incentives look like a pretty good idea. But it’s is not that simple.

The first issue is that incentives loose their impact over time.  By this I mean that 0% (for example) may work well the first month, less well the second month, etc.  This forces manufacturers to keep searching for the next offer, or worse, keep increasing the offer for the same impact. Incentives dropped during the recession and bankruptcies.  Any trend showing increases raises concerns.

But the big issue is that if GM continues to succeed with its incentive strategy, competitors will have to react. This results in spending that is defensive in nature and no longer is about growing sales and/or share but about defending. Overall sales can increase (a simple price/demand result), but cost increases overwhelm the benefits of any increase in sales. Worse, though, a large percentage of the sales won through incentives would have occurred anyway over subsequent months.  (The dreaded "pull-ahead" effect.)

As long as GM is unmatched in its aggressive use of incentives, the company will enjoy a net gain. But this is not a situation I would expect to continue. GM has signaled its incentives in March will drop. Looking at the programs they have announced, which are largely continuations of February programs, you could assume this was a disinformation campaign designed to catch the competition off guard. But looking more deeply, there is one change in GM’s incentive strategy that I would view as significant. That's a subject for my next column.

Jeremy Anwyl:  Chief Executive Officer of Edmunds.com. Follow @JeremyAnwyl on Twitter.