Cloudy Outlook: Market Insiders Offer Their Prediction for 2011

Randy Martin, an Internet manager at Columbia, S.C.’s Dick Dyer Toyota, says that May started out with a practically empty incentive sheet. But by the middle of the month, Toyota began offering subvented rates and special leases on several models. It’s not dealer cash like he wanted, but it’s something.

“We were informed in April that we’d see a lot less incentives and inventory,” Martin says. “We were told it would be that way for the next three months.”

Martin’s initial concern was that a cut in incentives might drive customers to other brands, which was an encouraging prospect for Bill Pearson’s single-point Ford store in Peoria, Ill. But it’s Pearson’s used-vehicle department that has him excited. “National statistics show that there are four used customers to one new, so there’s high demand for used vehicles,” he says. “Some of that has to do with the economy, some of it has to do with fuel economy and some of it has to do with what happened in Japan.”

Paul Taylor, the NADA’s chief economist, says the industry was facing a post-World War II situation following the March 11 earthquake and ensuing tsunami that struck Japan. The year was 1945, and vehicle production facilities were either wiped out or needed to be reconverted from wartime-goods makers to car producers.

“That was the last time we faced a situation where the supply side of the market was restrictive,” Taylor says. “Of course, the pressure was higher then, because the capacity for vehicle production in Europe and Japan had largely been destroyed.”

Market watchers like Taylor see a rough summer ahead. Come September, however, it’s anyone’s guess what the market will look like for the rest of the year and beyond.

A New Paradigm

Analysts estimate that the disaster in Japan will result in the loss of 300,000 to 400,000 new vehicles. But U.S. dealers are now selling three used for every new vehicle sold, according to TrueCar.com, so most analysts believe the used market will feel the pressure the most.

“I think July and August is when that pipeline is really going to dry up,” says Black Book Managing Editor Ricky Beggs. “The speculation will be, ‘Do I go ahead and buy used cars now, hold onto them for 30, 60, 90 days so when I don’t have new, I’ll at least have used product to sell?’”

Complicating matters are gas prices, which increased by 37 percent from January to April. The concern is that rising prices will cause dealers to unload gas guzzlers in a panic like they did in July 2008, when the U.S. average price for regular gasoline hit an all-time high of $4.11 per gallon and wholesale prices on used trucks and SUVs plummeted by about $12,000 virtually overnight.

May data from AuctionNet, a wholesale auction database, showed that supplies of SUVs, large pickups and intermediate compacts at auction were down 17, 40 and 26 percent, respectively. Jonathan Banks, who manages the NADA Used Car Guide’s data and editorial services, says that’s an indication that dealers aren’t dumping vehicles in a panic.

That could change if gas prices hit $4.50 a gallon. Taylor, however, says recent evidence shows that prices could fall to $3.80 a gallon, which would allow manufacturers to sell their full range of vehicles, including higher-valued vehicles like SUVs and trucks.

Also encouraging is the credit situation. As of March, average loan amounts generated through auto finance companies were up 88 percent over 2009, according to Equifax. “What we’re seeing is a number of loans across different segments increasing,” notes Michael Koukounas, a senior executive with Equifax. “They’re not increasing to pre-recession levels, but they’re increasing in general, and automotive is one of the industries leading the way.”

Koukounas attributes the increase to automakers being able to get more for their products, a belief supported by recent incentive data from Edmunds.com. In April, average incentive spending per new vehicle sold fell to its lowest point since October 2005. The NADA’s Banks attributes that to the industry’s new reality.

“I call it a new paradigm, because we had real strong diligence on the new-car side in terms of production and sales, which kind of lowered incentives and kept supply and demand in check,” he says. “And everyone was able to be profitable at these lower sales levels because we’re selling more vehicles on a pull-type basis.”

But this new reality also has made the market more sensitive to shocks to the system, as was seen following the Japan disaster. Wholesale prices for intermediate compacts increased 10 percent in March and should have, at most, remained flat for April. Instead, prices increased another 6 percent after Toyota and Honda announced that dealer allocations would be at about 50 percent for May and June.[PAGEBREAK]

Dealers Better Prepared

The good news is that dealers are getting more for their vehicles at retail. Black Book’s Beggs says retail prices for three-year-old used vehicles in May were up 22 percent, or about $3,700. Prices on entry-level vehicles and compact SUVs were up almost 29 and 7.5 percent, respectively. “The consumer is saying, ‘I don’t want to be tied up with a $25,000 to $26,000 loan for five or six years, but I’ve got to have good transportation,’” he says. “So the thinking is, ‘I’ll tie up half of that much money for half that period, and maybe I’ll be able to get the car I want three years from now.’”

Data from AutoTrader and J.D. Power and Associates confirms that dealers are now able to pass on the higher prices they’re paying for vehicles to consumers, but many believe that’s because of tools like vAuto’s inventory management software.

Pearson’s Finish Line Ford is a vAuto user. He says the software has kept all five of his used-vehicle buyers dialed in. “Most dealers don’t calculate days supply, and that’s one of the things vAuto does real well,” says Pearson. “Right now, the software is showing me that there’s only a 35-day supply of SUVs. Now, I’m not looking to pick up 20 or 30 of them, but if I see a 30-day-supply vehicle and no one else is bidding, well …”

Pearson is looking to move 3,000 used vehicles this year, which he’s done in each of the last two years. He’s even tinkering with the idea of his Internet department adopting an out-the-door pricing strategy, which he knows doesn’t lend itself to F&I production.

“If we’re really selling value, and we have good F&I products that are backed by good providers, then what are we afraid of?” he asks. “Hey, people thought I was crazy when I began lowering prices on my used cars based on market demand, and that resulted in a 300 percent increase in business.”

Worse Projected, Not Expected

What’s encouraging to Taylor is that brands poised to capture market share are striking a chord with consumers,  but he says their ability to produce cars consumers want while keeping quality high will be tested over the next four months.

“Supply is a constraint, but if the ability to stock cars is low, it’s the improvement in the flow of new production to the marketplace that’s encouraging,” says Taylor. “We have stock models and floor models and this is a tight stock, but a flow that was retrained is starting to pick up.”

News out of Japan also began to improve at the end of May. Toyota officials hope to reach 90 percent production by the end of June, and Honda announced it will be at 100 percent by August. Meanwhile, Justin Leech, a spokesperson for Toyota Financial Services, says the company is using its response to last year’s recalls as a template for helping dealers through the expected product shortages.

In April, the company rolled an offer to extend leases for up to a year in six-month increments. That will give dealers the opportunity to keep returning customers on the line until the new car they want becomes available. The company also announced that it would increase residual values by two points on all 2011 model-year Toyota and Lexus vehicles, an offer that runs through August.

“What we’re going through now is not unlike what we went through during the recalls,” Leech says. “We created a program specifically to help our dealers manage through that period and I think we were the first captive to announce support programs this time around. So we were pretty quick to respond then and we were pretty quick to respond now.”

Ford stopped making some vehicles for one week after the crisis in Japan. A resulting shortage in parts was partially responsible, but Todd Nissen, a Ford spokesperson, says the company also was responding to slowing demand for its F-Series trucks. Ford also faced a potential shortage of certain colors produced in Japan, a problem that was quickly rectified when the OEM located replacement colors.

 “There were several layers of supply chain that were affected by what happened in ways I think people never even imagined,” Nissen says. “It was a bit of a learning experience, but, at the same time, it was an opportunity to put contingency plans into use.”

Although the picture was beginning to clear up, the NADA’s Taylor admits his vision of the future is clouded. “We’re hopeful that manufacturers headquartered in Japan can not only get back to near peak levels of products, but can sustain those levels through the end of the year,” he says. “But we simply don’t know what the outlook is from August through the end of the year.”