GM’s Balancing Act With Fleet Sales Can Help Boost Profits In The Long Term
General Motors (NYSE:GM) recently reported that its rental car sales are down by 11% in 2015 on a year-to-date basis. [1] Sales to car rental businesses are part of GM’s fleet business, which also includes sales to commercial and Government buyers. The demand from this market is steady and can be an important source of profit to auto companies. However, the Detroit based auto maker is trying to phase out its sales to rental buyers in a planned manner. There are two main reasons behind this. The first is that these sales are less profitable than sales to commercial or Government buyers. But the second is more interesting and needs to be discussed in detail, as follows.
How Sales To Rental Buyers Affect Used Car Prices
The rental channel of fleet sales, while being profitable in itself, also doubles as useful advertising for the company, as it exposes potential buyers to the company’s products. But the amount of vehicles sold to fleet buyers also affects the prices GM can get for its leasing business. The price of a leased vehicle depends on its residual value after the lease term expires. The residual value is the price that the car can command in the used car market after its lease term expires. Typically, this figure is expressed as a percentage of its price at the time of sale.
GM’s cars have had lower than industry average residual prices for a number of years. While top mass market auto makers tend to command residual prices of around 50% of the price of their cars when new, GM’s price level has hovered in the low 40 percents. There are two main reasons for this: 1) the poor quality of GM’s cars; and, 2) the high volume of GM’s cars in the residual car market. The volume of these cars in the used car market in turn depends on the number of rental car sales, since rental buyers tend to sell off their cars in bulk after a couple of years of use.
As far as the leasing business is concerned, it is good to have higher residual prices. This means that since the car can command a high price at the end of the leasing period, the car company can charge a lower price on the lease itself, thus allowing it to offer more competitive lease terms while still retaining profitability. By restricting the sale of cars to rental buyers, GM can reduce the volume of its cars that end up on the used car market in a few years, thus improving the competitiveness of its leasing business.
Leasing Business Is Crucial To the Sale of Luxury Cars
Leasing has always been a big part of the luxury car business but its importance has increased in recent years as the transaction prices of mainstream luxury vehicles have increased. For example, the average price of a luxury vehicle from General Motors reached $38,500 in November this year. Leases with longer terms and generous monthly payment plans help to get more buyers into purchasing luxury cars. Moreover, customers who otherwise cannot afford to spend six to seven years paying off their car loans are helped a great deal by leasing plans. Improved car quality, higher residual prices and competitive lease terms will help GM compete for these customers better going forward.
All of this is extremely important as luxury vehicles form the bulk of the profits of the car industry. While only commanding 10% of the volume share they command 20% of the revenue share and 50% of the industry’s profit share. Therefore, increasing the percentage of vehicles sold in the luxury segment is perhaps the most effective way of boosting profits for an auto maker. This is why GM’s reduction of sales to rental buyers makes perfect sense.
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Notes:- GM, Ford cut back on rental sales; Asians pick up the slack, Automotive News, December 2015 [↩]