The Federal Reserve’s 50 basis point rate cut in September was the first since March 2020 — and prior to the onset of the coronavirus pandemic, a half-point easing had not occurred since the global financial crisis in 2008. The Fed’s November meeting brought another 25 basis point reduction, lowering the target federal funds rate to 4.75% at the upper bound as inflationary pressures ease. The microeconomic logic is that less expensive money will spur the consumer to spend on goods and services — including new and used automobiles. The next earnings cycle for franchised dealers hinges on much more than a soft landing motivating consumers back into the showroom. The dealership base — which is smaller by 9,483 franchises since the beginning of 2008 — needs its OEM partners to rationalize their own U.S. production capacity and better align new-vehicle supply with demand.
Historically low interest rates beginning in 2008 had a more profound impact than simply influencing consumers to buy new vehicles. Investments in new capacity and technologies after the global financial crisis positioned U.S. automakers as growth companies in search of tech firm valuation multiples. The long cycle of cheap and easy money drove the U.S. manufacturing base to bloat in pursuit of scale and technology gains. But while U.S. vehicle sales rebounded to a new annual record by 2016, demand hasn’t kept pace with the production capacity installed by automakers, leaving them with underutilized and costly plants. Tentative consumer demand has reflected inflation fears as well as trepidation to pay a premium for unconventional and unproven autonomous driving and electric drivetrain systems.
As automakers showed off their high-tech capabilities to investors, they also realigned product portfolios to expensive pickups and SUVs to cover inflating fixed costs. Light-truck mix in the U.S. represents 80.9% of new vehicle sales so far in 2024, up from 51.2% in 2013. The heavier truck mix has helped increase the average transaction price of a new vehicle by 52.4% during that period to $47,602. The transition up market — underpinned by a richer truck mix — is on pace to increase the total U.S. automotive retail revenue pool by $144.1 billion in 2024 compared with 2016 even though 2 million fewer vehicles are likely to be sold this year. This mix shift to more pickups and SUVs has been the industry’s key earnings catalyst since 2013 — not the transition to electrification and not higher volume. With automakers’ pursuit of revenue and profit contribution over scale and unit sales, the average transaction price in the U.S. has reached historic highs that constrain the market’s ability to return to the sales pace of the 2015 to 2019 period when 17.2 million new vehicles on average were sold annually. This is the critical structural pain point for automakers, as the domestic manufacturing footprint is still scaled for new-vehicle volume that is unobtainable without devastating price points and margin integrity.
Data from the Federal Reserve indicates that automobile and light-duty motor vehicle factories have run below 75% capacity utilization in 19 of the last 20 quarters, 16 of them consecutively. This is the second-worst stretch for capacity utilization since 1972 and better only than 2006-11 when 22 of 23 quarters fell below that mark, 18 of them consecutively. That period produced its own reckoning, with General Motors, Chrysler and 27 suppliers filing for bankruptcy by the end of 2010.
Overcapacity in the U.S. auto industry has been a direct line to oversupply for decades — creating a manufacturer ‘push’ model where the priority of the production target is to cover costs rather than align with the organic demand level. In a push model, the gap between supply and demand is closed using factory incentives and dealer discounts. During the peak U.S. new-vehicle volume period of 2016 through 2019, retail transaction prices averaged 6.6%, or $2,359, below MSRP before manufacturer incentives, low-rate financing or aggressive lease residuals. Those types ofmanufacturer assistance accounted for 8% of the average transaction price in 2016 and reached into double-digit percentages for some brands. During the pandemic and microchip supply shortage, that chronic discounting reversed. From November 2021 through October 2022, with inventory levels below 2 million, consumers paid an average of $435 over sticker price in an undersupplied market.
The move to lower interest rates in the current climate will ease floorplan expense for dealers now that supply levels are returning to historical norms. And inventory oversupply will get consumers more incentives from the factory and price flexibility in the showroom. Greasing the wheels with discounting creates a more favorable retail environment for the consumer and releases pressure on the entire automotive value chain. But those dynamics also create stress on automaker and dealership profits. That’s clear when comparing publicly traded dealership group earnings in the high-volume 2016-19 period — an average of $1.7 million in pretax profit per store — with results in supply-constrained 2022 — an average of $5 million per store.
The current challenge is whether lower interest rates could be enough of a financial lubricant to create more robust demand and enable manufacturers to increase their capacity utilization and generate additional profitable unit sales. With unsold inventory in the U.S. topping 3.1 million units on November 1, supply sits at 67 days, just above the top of the range that is considered manageable. Another turn of the output screw that is not met with a comparable bump in profitable transactions would reinforce the demand ceiling near 16 million units and damage automaker and dealer margins. The dealer base is in a slightly better position as it has already contracted, but dealers should remain vigilant on costs. Automakers are likely to consider more severe cuts to address structural costs and footprint reductions as soon as 2025.
