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Discounts are a dangerous road to redemption
By Jochen Siebert |
October 24, 2012, Wednesday
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Print Edition
Print Edition
CHINA'S car dealers have been following the upward path of the market easily in the past few years, and they don't want to go into reverse. That's why they have introduced purchase incentives this year to meet sales targets amid cooling demand.
At the end of June, the average dealer inventory level in China stood at 59 days, which was way above the danger zone that starts at 45 days. The excessive inventory exerts enormous financial pressure on dealers, forcing them to use discounts in order to keep cash flow up. The average discount is around 7 percent in the market now, with some dealers offering 25 percent or more.
A Mercedes S-Class, for example, now goes with a discount of 30 percent in China. Compare that with the booming sales years of 2010 and 2011, when Mercedes could charge more than the list price within less than three months of launch.
Starting from the high end of the market, the incentives are producing a domino effect on pricing in other segments.
If a Mercedes C-Class is selling at a 20 percent discount, its price of 300,000 yuan (US$47,000) drops to 240,000 yuan, which might tempt a potential client for a Toyota Reiz to switch to the Mercedes C-Class. The Toyota dealer then might offer a 15 percent discount on the Reiz, which takes its pricing down to level of a Camry.
This chaotic situation has already disturbed the launch of new vehicles.
For example, the Chevrolet Malibu was introduced earlier this year at a sticker price of 170,000 yuan, while the price for a Buick LaCrosse was 240,000 yuan. But when some dealers gave a 20 percent discount on the LaCrosse, they forced Malibu to offer a more competitive price as well, which led to a 20 percent discount only three months after the launch.
Taking the brunt of this price war will be the low-end car producers because their margins are already very slim.
The Chery QQ3, for example, sells for only 25,000 yuan, after a 15 percent discount. By our reckoning, the company is breaking even or losing money at that price.
Many domestic brands are facing the same problem, and it will be hard for them to survive this market downturn for long. Using incentives has been a normal practice in the US and Europe, but it is a relatively new concept for China.
Unlike price reductions that change the offer more or less permanently, incentives sound time-limited and are more likely to cause impulsive shopping. That means incentives may have an immediate effect on retail sales, but at the same time, they risk disturbing the pricing system of the whole market.
Seeing the extent to which incentives are being used to drive up demand this year, we raised our forecast for China car sales this year and lowered it for 2013. At some point, consumers will get used to discounts and perceive them as permanent. And after that phase, incentives will not be capable of increasing overall demand, but merely creating a zero-sum game.
Once car brands use incentives to drive sales, it is hard for them to stop, especially in China, where competition is more intense than elsewhere.
Highly unstable prices and demand make it more difficult for automakers to do volume planning, especially for those with a big number of models that are priced within 15 percent of one another.
In this sense, Toyota and Honda may have a bigger competitive advantage, compared with General Motors and Volkswagen, because the average list prices of their models are significantly higher, with more space for discounts, and they have a significantly lower number of models with less danger of cannibalizing.
At the end of June, the average dealer inventory level in China stood at 59 days, which was way above the danger zone that starts at 45 days. The excessive inventory exerts enormous financial pressure on dealers, forcing them to use discounts in order to keep cash flow up. The average discount is around 7 percent in the market now, with some dealers offering 25 percent or more.
A Mercedes S-Class, for example, now goes with a discount of 30 percent in China. Compare that with the booming sales years of 2010 and 2011, when Mercedes could charge more than the list price within less than three months of launch.
Starting from the high end of the market, the incentives are producing a domino effect on pricing in other segments.
If a Mercedes C-Class is selling at a 20 percent discount, its price of 300,000 yuan (US$47,000) drops to 240,000 yuan, which might tempt a potential client for a Toyota Reiz to switch to the Mercedes C-Class. The Toyota dealer then might offer a 15 percent discount on the Reiz, which takes its pricing down to level of a Camry.
This chaotic situation has already disturbed the launch of new vehicles.
For example, the Chevrolet Malibu was introduced earlier this year at a sticker price of 170,000 yuan, while the price for a Buick LaCrosse was 240,000 yuan. But when some dealers gave a 20 percent discount on the LaCrosse, they forced Malibu to offer a more competitive price as well, which led to a 20 percent discount only three months after the launch.
Taking the brunt of this price war will be the low-end car producers because their margins are already very slim.
The Chery QQ3, for example, sells for only 25,000 yuan, after a 15 percent discount. By our reckoning, the company is breaking even or losing money at that price.
Many domestic brands are facing the same problem, and it will be hard for them to survive this market downturn for long. Using incentives has been a normal practice in the US and Europe, but it is a relatively new concept for China.
Unlike price reductions that change the offer more or less permanently, incentives sound time-limited and are more likely to cause impulsive shopping. That means incentives may have an immediate effect on retail sales, but at the same time, they risk disturbing the pricing system of the whole market.
Seeing the extent to which incentives are being used to drive up demand this year, we raised our forecast for China car sales this year and lowered it for 2013. At some point, consumers will get used to discounts and perceive them as permanent. And after that phase, incentives will not be capable of increasing overall demand, but merely creating a zero-sum game.
Once car brands use incentives to drive sales, it is hard for them to stop, especially in China, where competition is more intense than elsewhere.
Highly unstable prices and demand make it more difficult for automakers to do volume planning, especially for those with a big number of models that are priced within 15 percent of one another.
In this sense, Toyota and Honda may have a bigger competitive advantage, compared with General Motors and Volkswagen, because the average list prices of their models are significantly higher, with more space for discounts, and they have a significantly lower number of models with less danger of cannibalizing.
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