Incentives: They Aren’t What They Used To Be

Incentives: They Aren’t What They Used To Be

By Dale Buss

TV advertising is spiced with year-end incentives for auto buyers. Mercedes-Benz shows Santa’s elves tinkering in his workshop on E- and C-class sedans for its Winter Event program. It’s Happy Honda Days! General Motors is revisiting its now-annual Red Tag clearance sale for 2007 models.

Lexus has renewed its iconic incentive program that tries to lure consumers into putting big red Christmas bows on new vehicles and parking them in the driveway for their loved ones. And Lincoln is running a copycat campaign.

But don’t be fooled by airwaves full of incentive advertisements: as enticing as they seem, these offers only amount to a holiday treat. That’s because money-back and cut-rate-interest programs aren’t what they used to be in the auto industry.

While there’s still plenty of year-end window dressing in these limited initiatives, consumers no longer can count on big-money, marquee incentive programs to come along periodically and rescue their purchase intentions.

The Detroit Three, especially, have pledged to wean U.S. car buyers away from the blowout incentive programs that defined the marketplace – and corroded profits – for several years, until as recently as 2005. Production cuts, better vehicles, healthier brands and reductions in fleet sales have paved the way. And while they’re not yet executing the strategy to perfection, the automakers clearly are moving the needle in the right direction.

“This is the best position we’ve been in in several years” in regard to the lack of a need to make a splash with big incentives, Brett Wheatley, Ford’s retail marketing manager, told AutoObserver. “We used to have big spikes, only to give back those sales in later months. We’re planning things now to make [pricing] more stable.”

Outside observers agreed. “They’re pursuing a value-pricing strategy where they sell the car now, not the deal – whereas, we used to see pretty much blanket incentives on everything they sold,” said Jesse Toprak, executive director of industry analysis for Edmunds.com.

Actually, GM, Ford and Chrysler have demonstrated such new overall discipline that their total share of industry spending on incentives has been coming down for about a year and a half, while Japanese makes’ share has been rising.

To be sure, there’s no call yet for a celebration of victory over incentive addiction. Hefty givebacks have slid right into a major role in the current donnybrook in the crucial pickup-truck segment. GM, especially, has let its guard down a bit in regard to overall incentive levels in the second half of 2007, largely due to the fact that Toyota introduced the Tundra and has, throughout the year, slapped heavy incentives on it.

And incentives will remain a tactic in a competitive marketplace where individual models and segments, and gasoline prices and other economic vicissitudes, continually create new dynamics.

“It’s still a work in progress,” said George Pipas, U.S. sales analysis manager for Ford. “The focus on the deal was built up over several years’ time, and you can’t unwind that overnight.”

Incentives Roll After 9/11

Of course, cash-back rebates and even low-rate loans have been a staple of factory and dealer arsenals for at least a generation. But the modern era of incentive primacy began in October 2001, when GM essentially picked the U.S. economy out of its post-9/11 doldrums by offering humongous, $3,000 rebates combined with zero-percent financing in a program that it grandly – and prophetically – called “Keep America Rolling.” Both consumers and the industry were hooked on incentives more than ever.

Over the next few years, Detroit Three incentives reached as high as $8,000 on some vehicles. When various automakers tried occasionally to pare back or withdraw major deals, consumers stayed home. In 2002, the Weighted Average Total Cost of Incentives (TCI) industrywide, a proprietary measure calculated by Edmunds.com, was $1,926. That number rose to $2,521 in 2003 and peaked at $2,655 in 2004.

For GM, which had led the industry into this incentive no-man’s land, the numbers were far worse: $2,723 in 2002, $3,595 in 2003, topping out at $3,872 in 2004. But that was also the year that the industry’s sea change on incentive spending began to brew.

“We had trained people like laboratory animals to wait for us to give them the next big incentive; they became addicted to them,” recalled Mike DiGiovanni, GM’s executive director of global market and industry analysis. “You put out bigger and bigger dollars to keep the volume going, and you erode your brand health more and more – so it bites you in the rear end."

GM and the industry would lurch into incentive hell one last time in 2005, this time with programs that offered rank-and-file American consumers the same discounts as automakers’ employees received. The factories lessened their own pain in that program, Toprak explained, by requiring dealership financial participation in the incentives. Partly as a result, the industry’s Weighted Average TCI, according to Edmunds.com, actually declined in 2005, to $2,012 per vehicle from $2,655 in 2004. And GM’s number ebbed to $3,603 for 2005 from $3,872 in 2004.

“White-Knuckle Time”

But Detroit Three executives knew that something – something bigger – had to change, and soon. “We had built up such inventory by the end of 2004 that we had to look into the mirror and just finally align production with reality,” DiGiovanni said. “That was white-knuckle time.”

So in the fall of 2005, GM announced wide-ranging cuts in its U.S. and Canadian production, initiating the shutdown of nine assembly plants and the elimination of 30,000 jobs. It also began an effort to pare output, in particular, of lower-priced vehicles that were popular in daily-rental fleets but which ended up hurting the value of its brands in poor residuals.

“That’s what finally allowed us to wean people off of incentives,” DiGiovanni said. “That was a difficult financial decision. But we got it behind us and it enabled us to move on.”

But GM and its Detroit Three counterparts couldn’t simply rely on addition by continual subtraction. They chose their timing in part because GM, in particular, and Ford were ready to come forth with an array of well-conceived and well-designed new products that would finally support their ambitious goal of backing away from big-money incentives for good. DiGiovanni said that GM was tempted as late as 2006 to go back to the marquee-incentive well one more time but resisted.

“The key to this whole thing, in terms of their attempts to lower their dependency on high incentive spending, has been new-product introductions, either redesigned or brand-new vehicles, “ said Toprak of Edmunds.com. “The only time you can legitimately pull down incentive spending without a big consumer backlash is when you introduce a dramatically redesigned or a new vehicle in the marketplace. Any other time, if you have the same car and simply lower your incentive spending, it’s going to backfire.”

For GM, an additional factor has been just about every one of its new offerings over the last few years has been a verifiable winner. The new Cadillac Escalade. The Saturn Sky and Pontiac Solstice roadsters. New large SUVs and pickups that have shown strong despite higher gas prices. Last summer’s introduction of the Lambda-platform crossover vehicles: Buick Enclave, GMC Acadia and Saturn Outlook. Last fall, the new Cadillac CTS. And, currently, the all-new Chevrolet Malibu. Nearly every new vehicle has struck a chord with an important part of GM’s consumer base and with some non-GM buyers as well.

“At the end of the day, our brand health is improving,” DiGiovanni said. “That’s reflected in the fact that not only are our products better, but the image of our products is improving.”

By 2006, in fact, “exterior styling” had surged to first place in GM customers’ reasons for purchase, according to the automaker’s own data, and it has kept first place this year. By contrast, “rebate /  incentives” faded to fifth place in 2006 and has dropped off the top-five chart completely this year.

Optimizing Selective Incentives

Obviously, none of this means that incentives simply have disappeared: The year-end programs, for example, have been institutionalized. As the general industry environment has toughened over the last several months, and as GM has tried to protect its tiny recent increases in market share, incentives have become a more tempting tool. In fact, GM’s Weighted Average TCI actually has increased in 2007, to $2,975 for the year to date, compared with $2,896 for all of 2006.

Meanwhile, Ford’s Weighted Average TCI this year to date is $3,105, according to Edmunds.com analysis, or about $130 more than GM’s. However, Ford’s average spending actually is down by more than $300 from its 2006 number, $3,410. At $3,812 for 2007 to date, Chrysler’s Weighted Average TCI is flat, at $16 more than the $3,796 number of 2006.

“The last couple of years of the incentive wars enabled domestic automakers to learn quite a few valuable lessons about how to optimize their incentive spending,” said Toprak. “So now, although their [incentive-spending] averages aren’t dramatically lower, they’re being a lot more selective about where they’re spending their money. That means if they see a weakness in a specific category, they’ll spend proportionally higher amounts there versus a well-performing category.”

One way that Ford has revised its strategy and, as a result, reduced overall incentive spending has been to devote more resources to regional programs. “We’re making different year-end offers, for example, depending on what our dealers and regional managers tell us they need, such as a lease payment, or a cash message versus an APR message,” Wheatley said. Big cash rebates on pickup trucks right now are de rigueur in Texas, for example.

Actually, the Detroit Three now treat incentive spending more like their Japanese counterparts whose market-share advances and leaner cost bases have enabled them to avoid most of the rebate and low-interest-loan bloodbaths over the last couple of decades.

“Honda does not use direct consumer incentives like rebates to move inventory,” noted Honda spokesman Chris Martin. While it has offered special finance and lease rates “for getting slower products moving,” he added, “we’ve never gone to the extreme of 0% financing.”

Nissan “basically use incentives strategically,” said Bill Bosley, vice president and general manager of the company’s Nissan division. “We haven’t gone down the road of some of the big programs” as the Detroit Three have.

Big Trucks, Big Incentives

But as the Japanese Three have more avidly pursued segments of the U.S. market that long have remained the purview of the Detroit Three, they have had to get their hands dirtier with incentives. The fierce battle of incentive programs in the pickup truck market is Exhibit No. 1. And Page 1 of Exhibit No. 1 is the fact that Toyota has had to offer huge rebates -- $3,000 cash -- on its brand-new, full-size Tundra pickup just to begin to scratch out a foothold for it.

“Everyone understands that truck buyers have grown accustomed to incentives,” explained Xavier Dominicis, a Toyota spokesman. “That’s the price of admission: It’s a more incentive-driven segment than any other. And we want to stay competitive in that segment. But our incentives are still well below those of our competitors.”

Well, maybe by a bit. “Toyota’s incentives weren’t the highest in the category,” Toprak observed, “but for a freshly designed Toyota, they’re pretty generous.”

Added Ford’s Wheatley: “That was not something that people anticipated.”

Automakers Resolve Incentive Restraint in ‘08

Overall, Toprak said that 2007 was a good test of the Detroit Three’s new resolve to avoid massive incentive programs and that, for the most part, they passed the test. “Particularly last summer, everyone was waiting for one of the Big Three to come out with something new and dramatic,” he said. “But no one really pulled the trigger.”

And Ford’s Pipas offered a caution for the near future.  “We’re not in this freefall in terms of pricing anymore,” he said. “The industry has exercised some restraint; it starts with discipline in the production system and aligning it with real consumer demand for each and every product. As soon as you stray from that approach and have excess inventories, you can be right back into [heavy incentives] in the blink of an eye.”

Notwithstanding some sort of global or national economic calamity or unforeseen malaise, however, Toprak projects that the auto industry should be able to extend its new resolve against huge incentive programs for the foreseeable future, even as they and their foreign rivals continue to try to rationalize worldwide overcapacity. “I see carbon copies of, say, 16-million-unit years each of the next few years,” he said. “So I don’t expect big changes in incentive spending during that time.”

Michelle Krebs:  is Editor-in-Chief of AutoObserver.com. Follow @AutoObserver on Twitter.