Top Factors Driving 2011 Auto Sales

By Lacey Plache May 31, 2011

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U.S. automotive sales are finally gathering speed on the road to recovery from the Great Recession as several factors, including a strengthening labor market, support their growth. Demand is likely to remain strong through the rest of 2011, given the continuing economic recovery and the sizable amount of pent-up demand set to be released. However, various headwinds are blowing that could exert considerable drag on the auto sales recovery. The level of auto sales will be influenced primarily by demand momentum driven by pent-up demand, supply shortages from the Japanese earthquake's effect on production, and higher prices resulting from both rising demand and shrinking supply. Other factors, such as rising gas prices and consumer beliefs about vehicle availability, are more likely to change the mix of vehicles sold.

At this point, expects demand to remain strong enough to overcome higher prices and other demand-lowering factors. The effects of supply shortages are expected to resolve in time for sufficient delayed sales to support the auto sales recovery in 2011. As a result, is maintaining its beginning of the year forecast of 12.9 million units for 2011, with the upside potential for sales of more than 13 million if supply issues resolve quickly enough.

Demand In Driver's Seat
Following the recent recession, auto sales recovery was quite sluggish, with sales more than 20 percent below pre-recession levels at the beginning of this year. The key question for industry followers was when sales growth would accelerate and pent-up demand would release. Fortunately, sales began to gain momentum in Q4 2010, with the seasonally adjusted annual rate (“SAAR”) rising above 12 million in October 2010, and remaining there in the following months. During 2011 to date, we have seen continued growth in auto sales, with the SAAR topping 13 million in February, March, and April.

AO052011 US Monthly Auto Sales.jpgThe strength in auto sales in the first four months of 2011 is particularly noteworthy since it occurred amidst a series of events (including rising gas prices, war with Libya, and the Japanese triple threat of earthquake, tsunami, and nuclear disaster) that had the potential to adversely affect the recovery, thereby creating uncertainty for consumers. Several factors contributed to this sales strength, including continuing economic recovery and, especially, improving employment numbers.

January and February also featured a favorable pricing environment with General Motors in particular offering strong incentives. As a result, consumer confidence, which had begun to trend upward in early fall 2010 due in large part to a booming stock market, increased further still, and consumers were more motivated to make large purchases of durable goods such as autos. Indeed, 2011 year-to-date sales appear to have been bolstered by some release of pent-up demand.

Demand is likely to remain strong during the rest of 2011, given the continuing economic recovery and the sizable amount of pent-up demand from the recession and early recovery periods that has yet to be released. During 2008-2010, auto sales fell far short of the 16 to 17 million unit level seen during much of the 2000s, with a resulting 13 million or so units potentially not purchased. Some of those lost sales were diverted to used cars. Others have likely been eliminated as households scale back on the number of vehicles owned. Even so, there are still potentially millions of units of pent-up demand to be released.

Supply Keeping Pace
Growing momentum in demand for auto sales in the first four months of 2011 was the dominant factor affecting auto sales until the Japanese earthquake and ensuing parts shortages caused production disruptions. At this point, Japanese automakers are operating with reduced production, often half time or less, in many plants in Japan and abroad. Recent announcements indicate progress toward resolving the production disruptions. For example, Nissan’s key engine plant returned to full production in May and Toyota has planned an accelerated return to full production in June for some models made in North America, including top-selling Camry and Corolla. Honda’s North American production is slated to return to normal for all but one model in August. However, both Toyota and Honda have stated that they do not expect production for all models to return to normal levels until the end of the year. Nissan projects a return to full global production by October.

As a result of reduced production, inventories of Japanese vehicles have started to shrink. Given the lag between when a vehicle is produced and when it is available for purchase, inventories are expected to tighten further in the coming months, even after production returns to normal levels. Although there have been no significant production constraints to date on non-Japanese automakers supplying the U.S. market, nearly all automakers are still at risk to some extent due to the global nature of production and the continued uncertainty surrounding parts availability from at least some Japanese parts manufacturers.

Combining growing demand with weakening supply, for the first time since at least World War II, the auto industry finds itself in the position where demand could outpace supply. The first effect of such a situation is that fewer sales will be made. In addition, tight supply, coupled with strengthening demand, is likely to result in pressure on prices to rise and incentives to fall. Additional pressure on prices will result as the Japanese automakers are hindered in their ability to offer incentives by the cost of reconstruction and by the revenue impact of lower sales. Accordingly, their non-Japanese counterparts may also lower incentives due to weaker pricing pressure.

The small car and hybrids segments are at the greatest risk for higher prices due to greater supply impact from the higher shares of Japanese cars in these segments and greater relative demand for these vehicles from higher gas prices. Indeed, we are already seeing price increases in these segments but also throughout the industry as automakers anticipate supply shortages. We expect more price increases in the months to come as supply becomes tighter and demand remains strong. Both shortages and changes in incentives will lead to a shift in mix to available vehicles for individual makes, as well as a shift in share to makes with greater availability and relatively better pricing. Finally, to the extent that consumers choose fewer options when faced with higher prices, automakers also may see decreased profitability on those vehicles, especially on the lower-priced vehicles with more budget-constrained purchasers.

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Demand Drivers
A key driver of demand for autos is consumer motivation to make such a large durable goods purchase. Consumer motivation to buy is based on confidence in their current and future financial situations and in the economy overall. Not surprisingly, such confidence plummeted during the recession and has yet to recover to pre-recession levels. Lowered confidence resulted in pent-up demand as consumers delayed auto purchases. Employment and income might be expected to be the primary factors for consumers in their assessment of personal and aggregate economic conditions.

However, another important factor is the performance of the stock market. When consumer confidence began trending upward in the early fall of 2010, employment had yet to show strong improvement. In contrast, the stock market began its own ascent at that time and appears to have carried confidence, and, shortly thereafter, auto sales, along with it. However, as shown by the dip in confidence in March amidst rising gas prices, war in the Middle East, and disaster in Japan, confidence is driven not only by economic fundamentals, but also by the degree of uncertainty surrounding these factors and their future paths. Confidence resumed its upward trend in April without derailing auto sales momentum. Maintaining this trend is crucial for maintaining auto sales recovery and the continued release of pent-up demand in particular.

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In addition to being motivated to purchase autos, consumers also must be able to fund such purchases. This ability was diminished by economic conditions during the recession. For consumer spending on autos, the key component of the recovery that must show improvement is employment, namely job availability, and to a lesser extent, income growth.

The first four months of 2011 saw growing momentum in private sector employment recovery but this momentum faces headwinds from inflation, uncertain economic situations abroad, and ending government stimulus programs that funded jobs. Supporting the momentum is moderate forward momentum in GDP growth, including export growth from a weak dollar and growth in inventories. If employment recovery does continue, as we expect, auto sales will increase. In addition, improving employment conditions will result in increased consumer confidence, and thus further growth in auto sales.

Greater availability of jobs also will likely result in stagnant or slightly rising unemployment rates as discouraged workers return to the labor market, but this temporary reversal is a natural part of economic recovery and should not substantially affect auto sales since it does not reflect weakening economic fundamentals. Similarly, the fact that the government is still shedding jobs is to be expected as stimulus winds down and there is a shift back to the private sector as the engine of job growth.

AO052011 Private Sector Jobs Added.jpgMix Shifters
While the above factors primarily affect the level of supply and demand for autos, other factors will primarily affect the types of vehicles that are purchased. The price of gas is one such factor. Gas prices near or above the $4 per gallon mark have become a reality in the much of the U.S. in recent weeks, and, despite a fall in the price of oil following the death of terrorist leader Osama Bin Laden, the Energy Information Administration (“EIA”) projects oil markets to tighten through 2012 and gas prices to remain elevated as a result.

Rising gas prices generally do not affect total auto sales, but rather the types of vehicles that are purchased, as consumers shift to smaller, more fuel efficient choices. Of course, such shifts are naturally limited because not all consumers feel the “pain at the pump” equally given differences in driving habits and income and because some consumers have limited flexibility in the vehicle they drive, such as consumers who require a truck for their job. Moreover, in the current market, the shift in sales mix could be further constrained by supply issues for notably fuel efficient Japanese cars. Finally, the expected duration of these higher gas prices is unprecedented in recent years, raising the question of whether consumers will adjust to these prices and thereby minimize the extent of the shift in mix.

An increase in demand for smaller and/or more fuel efficient vehicles will result in higher overall prices for such vehicles, in both the new and used car markets. In addition, there will be less pricing pressure and/or higher incentives for larger and less fuel efficient vehicles as well as lower trade-in values for these vehicles.

AO052011 Gas Price and Small Car also expects consumer purchases to be driven by what they believe they can get and by their beliefs about prices. With a high degree of uncertainty about economic conditions, consumers are forced to make decisions based, to a greater extent, on their beliefs about various factors. In this case, beliefs about vehicle availability and pricing are likely to influence what, when, and whether consumers make auto purchases this year. Beliefs can turn into self-fulfilling prophecies if enough consumers hold them and act accordingly. In this case, we would expect to see 1) decreased sales of “affected” models, 2) less pricing pressure on those models, and 3) shifts in share to competitors.

Beliefs about the limited availability of Japanese vehicles already have led to reduced sales of certain models, such as the Toyota Prius whose consideration on has fallen substantially since the earthquake and whose daily sales rate fell 18% from February to April 2011, based on the daily selling rate, despite rising gas prices. Beliefs about availability also have led to a slower rate of inventory reduction, as measured by declines in Days to Turn, for Japanese vehicles relative to non-Japanese vehicles, despite strong demand for fuel efficient vehicles.

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Delayed Responses
While gas prices and consumer beliefs about availability may change what cars consumers buy, two other factors, consumer brand loyalty and the availability of new models, may change whether consumers buy now or delay purchases until supply availability changes. Data on which cars consumers trade in when they make a new car purchase show that consumers are more likely to purchase another vehicle by the same make than by another make. Consumers are also more likely to purchase another vehicle by a manufacturer of the same geographic region (e.g., American, Japanese, etc.) than from a manufacturer of a different geographic region. For Japanese manufacturers, loyalty as measured by sales with trade-ins of the same make or region is particularly high. While there are certainly some consumers on the margin who will switch if vehicle availability of Japanese cars declines and/or if prices rise, there are certainly others who will wait until the vehicle they most want is available at an acceptable price.

AO052011 Purchase v Japanese trade.jpgNon-Japanese automakers could see short-run gains in market share from sales to consumers willing to switch; however, it is likely that such market share gains will be eroded when shortages abate and consumers shift back to Japanese vehicles. In addition, we expect Japanese automakers to launch programs to retain their customers, such as working with lenders to offer lease extensions. Since we expect that nearly all loyal consumers who delay purchases due to availability or price will eventually make a purchase, overall auto sales should not be significantly affected by these delays. The exception would be consumers who choose to buy used Japanese cars rather than new non-Japanese cars. Whether yearly sales for 2011 decrease substantially from delayed purchases depends on how long shortages and elevated prices remain.

In addition to loyalty, consumer may be less inclined to purchase new vehicles to the extent that new model launches are delayed due to the production disruptions. Research has found that all-new and updated models typically spur sales and shift share toward those models. With the current amount of pent-up demand, new models this year especially have the potential to spur sales. However, parts shortages threaten to delay new models or at least constrain their supply. For example, Honda has announced a delay of at least one month for the planned fall 2011 launch of its 2012 CR-V crossover. Honda has further said that production slowdowns have slowed the roll-out of its new 2012 Civic, which was launched in April 2011 and whose production will not reach normal levels until sometime in the fall. In addition, the late summer 2011 launch of the Scion iQ microcar has been delayed indefinitely due to parts shortages. To the extent that significant delays or shortages occur for new models, sales may fall in 2011 as the release of pent-up demand is delayed further. In addition, decreased availability of new models means less competition for the previous year’s models and thus higher prices on these models, potentially further dampening sales growth.

The “X” Factor
The extensive array of factors affecting auto sales in 2011 adds substantial uncertainty to the outlook for auto sales in 2011. Indeed, given the unexpected events of the year to date and the large amount of uncertainty facing the auto market, the possibility of another market-shaking event cannot be ruled out. At this point, however, expects demand to remain strong enough to overcome higher prices and other demand-lowering factors. The forecast also expects the effects of supply shortages to resolve in time for sufficient delayed sales to support the auto sales recovery in 2011. As a result, is maintaining its beginning of the year forecast of 12.9 million units for 2011.

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