Record High Automotive Incentives Could Harm Sustained Profitability

Matt Posky
by Matt Posky
record high automotive incentives could harm sustained profitability

Every industry analyst is beginning to sing the same tune. Despite things looking good now, the worm is about to turn. Global sales look poised to remain strong this year but the market has peaked and sales should persist on a graph as a flat line. Next year could be a different story, however, and there’s much apprehension surrounding lengthening loan terms and the upsurge of subprime lessees.

Rising incentives are also causing alarm; J.D. Power and Associates expects the average incentive per new unit to top $4,000 in 2017. While that tactic may get people into dealerships now, it might also harm long-term profitability as the automotive industry swings toward leaner times.

“Looking at the top line, it looks great. We should be giving each other high-fives,” Thomas King, vice president Power Information Network, media, and marketing for J.D. Power, said at New York’s NADA Forum.

Current transaction prices and automaker profit margins are high enough now for a $4,000 incentive average to not be a big deal. But that won’t always be the case and automakers cannot suddenly half their incentive spending when they realize they’re bottom line is shrinking.

“Incentives at industry level only ever rise, they basically never come back down … because everybody is chasing that short-term fix,” King said. “Inevitably, with each escalation [in incentives], you’re going to see some margin pressure on manufacturers [and retailers].”

Although, while King may see this as short sighted, he has yet to announce that the sky is falling. While many analysts anticipate a full-scale disaster, he thinks the industry can come out somewhat unscathed thanks to logistical flexibility and a greater profitability margin. Automotive companies are much better prepared for hard times now than they were in the years leading up to the recession.

Interest rates, while creeping ever upward, are also still relatively low. Chief economist for IHS Markit Nariman Behravesh also spoke at NADA, saying “Short-term and long-term rates are exceptionally low … Even after raising for a couple of years, they will still be exceptionally low by historical standards.” It would seem that, while darker days are definitely coming, just how bleak they will actually be is up for debate.

[Image: Faris/ Flickr ( CC BY 2.0)] [Source: Automotive News]

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  • Barndoors4life Barndoors4life on Apr 14, 2017

    Are they really incentives? The manufacture is setting the MSRP for the vehicle and then offering money off of it. It's all a mental game we're playing. If you take a average midsize sedan and price it at 50 thousand and offer 25 thousand in incentives it's no different than pricing it at 30 thousand and offering 5 grand off. The manufacture has realized the profit curve for the amount of cars they need to sell, at what price they have to sell them, and what the market will actually pay. The whole MSRP-incentive game is a joke. Automakers won't need to half there incentives because they can always just raise the MSRP and keep the same incentive and the purchase price will still rise. The consumer won't know the difference and will still think they're getting a great deal. It's possible I'm missing the point of this article, but a manufacturer can decide to sell a lot of cars at a small profit margin or a small amount of cars at a large profit. The incentive game is how they swing back and forth between the two to max profits. I wouldn't take rising or falling incentives as a sign of anything, especially when their based on an arbitrary MSRP.

    • Stuki Stuki on Apr 14, 2017

      Touche! ALG 3 year residuals times 2 is a much better representation of "new price" than whatever stream of arbitrariness many auto marketers are operating with. The saddest thing is that those makers who do focus on keeping residuals reasonable by keeping MSRP at realistic levels; over time become the chosen brands of those consumers with decent enough credit to be fairly unproblematic even in tougher times. While those who do not, get to fight for the business of the "0 down, 100 year term, friends of Repo Man," crowd.

  • Sector 5 Sector 5 on Apr 15, 2017

    Crystal ball meth.. say analysts we all know the market's cyclical. Rates are low, monies cheap. Folks are taking on debt.

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