3 July 2020
Residual value market analyst Patrick Herget from Autovista Group’s car to market team in Germany considers the influencing factors on vehicle lifecycle management and highlights best practices for OEMs to manage them successfully.
The residual value (RV) of a vehicle is the ultimate measurement to compare makes and models. A high RV can be the result of an OEM’s strategic, technological, engineering and design capabilities. Additionally, RVs are a key component when it comes to offering competitive leasing rates. The rate of depreciation over the first few years of a vehicle’s life is a critical consideration as it determines the monthly payments and the overall cost of leasing or financing packages (e.g. three-way financing, subscription model). To put it simply, the rate a customer is paying should balance the vehicle’s loss in value over an agreed period. Even a slight deterioration in a model’s rate of depreciation can make both leasing and financing rates less competitive and put pressure on profits of OEMs, leasing companies and financial institutions (e.g. captive banks, non-captive banks).
Thus, managing a vehicle’s lifecycle successfully, i.e. ensuring a stable depreciation rate, comes with great benefits for OEMs, leasing companies and financial institutions. Stable depreciation rates lead to more predictable RVs, which help leasing companies and financial institutions assess risk and give more certainty in their offerings. Additionally, it limits the amount of subsidies which have to be made to keep leasing and financing rates competitive with a model’s increasing age. Simultaneously, OEMs benefit from higher sales as models with less exposure to unexpected surges in the depreciation rate are more attractive in the new-car market. Consequently, after establishing a decent level of RV, it should be the ultimate goal, to retain this value over the longest possible time.
To manage a model’s lifecycle successfully and optimise its rate of depreciation, it is important to understand some of the influencing factors. The length of a model’s lifecycle, the announcement of a facelift or new generation and shifting customer demand can all greatly affect a model’s depreciation rate.
What can affect a model’s depreciation rate?
One factor that influences a vehicle’s depreciation rate is the length of its lifecycle. On average, a model lasts around three to four years in the market until it receives a facelift and around six to eight years until a new generation replaces it entirely. After such a long period, new generations usually come with a bigger exterior, interior and technological changes. Consequently, a model’s current version will look outdated and less attractive which then results in a steep rise of the depreciation rate.
Towards the end of any model’s lifecycle, the question arises of when to announce and present the new generation to the public. Unveiling a new model too early can undermine the sales of the current version; companies and individuals looking to buy a new car delay their purchase until the new generation is released. This could increase the temptation to offer the current generation with promotions and other incentives to stimulate sales. Additionally, missing private and corporate sales will allure OEMs to increasingly target the rental sector. Both actions will have a detrimental effect on the depreciation rate of the current generation.
Finally, yet importantly, a model’s depreciation rate is influenced by changing market behaviour and customer demand, which can be affected by influencing factors like government regulations and advanced technological innovations in turn. In most western European countries, for instance, the diesel crisis resulted in stricter emission regulations and the announcement of diesel bans. This led to declining demand for diesel cars in countries like Germany, France, Spain and others. Consequently, customers are seeking for future-proof diesel alternatives that have the same benefits. To meet this demand, OEMs are increasingly offering internal combustions engine (ICE) models as mild-hybrids (MHEV), hybrids (HEV) or plug-in-hybrids (PHEV). Thus, keeping up with technological trends and changing customer demand could help maintain a stable RVs and save profits.
What can OEMs do to keep the depreciation rate at a low level?
After an OEM successfully launches a model with a highly forecast RV which meets customer demand, it is crucial to retain this value over the longest period possible.
Keeping lifecycles short and offering smaller but more frequent updates is one approach to limit the risk of putting the current model under big pressure and ensuring a steady depreciation rate.
’Over the air’ software updates, for example, enables the vehicle to keep up-to-date on quickly advancing technological innovation, but is also very convenient for customers and can be a unique selling point. at the beginning of May 2020, BMW started a software-update for around 500,000 vehicles. The update included a ’Drive Recorder’, which records the vehicle’s surrounding with an integrated camera for 40 seconds. Customers can download the update via the smartphoneapp or directly through the vehicle’s sim-card.Daimler, Volkswagen and BMW are also working on a new operating platform that will allow customers to add further functionalities to their car (e.g. satellite maps, EV range, etc.) without buying a new model.
Additionally, launching facelifts with minor exterior changes and small, but noticeable interior changes (e.g. bigger multimedia screens) can help to keep the model fresh, without impairing the current generation’s performance too much.
Shortly after a new generation has been presented, the current generation is put under pressure, and its RV, as well as its sales volume, are at risk of a steep decline. Therefore, OEMs should choose the timing of a new generation’s announcement wisely. To balance the pressure of the new generation, special trim lines with greater standard equipment can be introduced to increase the current model’s attractiveness and reduce the temptation to offer cash discounts.
Announcing a new generation around six months before the launch should give OEMs enough time to produce, introduce, promote and sell special trim lines. Prior to the launch of SEAT Leon’s new generation in April 2020, SEAT introduced a ’Fast Edition’ of its flagship model in Spain in November 2019. The special edition came with morestandard equipment and only a minor list price difference. Moreover, instead of pushing cars into the market through the rental channel, OEMs should focus more on fleet customers by offering a business trim line.
Meeting changing customer demand by following current technological trends and government regulation will reduce a model’s depreciation rate. Even though total registrations of MHEVs, PHEV and battery electric vehicles (BEV) are still low in Europe, we see a strong trend towards alternative engine technologies. Market observations show that demand is increasing at an exponential rate.
According to Deloitte’s 2020 Automotive Consumer study, 51% of Germans are considering an alternative powertrain as their next vehicle. This number increased by 27% compared to 2019. Therefore, OEMs should offer current ICE models with a variety of alternative powertrains (such as MHEV, HEV, PHEV, BEV) to increase fuel efficiency, reach CO2 emission goals, meet upcoming demand and remain attractive in the future. Audi set a great example by offering more than 70% of their ICE models as MHEV or PHEV versions to follow up the electrification trend.
In summary, to limit the rate of depreciation and risk of quickly dropping RVs, OEMs can make smart strategic decisions throughout a model’s lifecycle. Keeping lifecycles short, offering special trims to rise attractiveness towards the end of a lifecycle and following up with the latest technological trends are major actions that can ensure long-term profitability.
What are the financial benefits of successfully managing a model’s lifecycle?
It is beyond question that balancing a model’s depreciation rate requires a lot of research and investment, but it also comes with great monetary benefits. With 150,000 models sold in Europe and a reduction of the compound monthly depreciation rate from -0.3% to -0.2%, an OEM could save around €130 million. Finally, models with lower depreciation rates are more attractive to fleet, leasing and private buyers, which will lead to higher sales and profit margins.