Grabbing the headlines

Over the last few months, price cuts seem to have been a consistent theme in the headlines.  Arguably kicked off by Tesla in the last quarter of 2022, other manufacturers jumped in (or were dragged), leading to an extended period where headline prices have been adjusted by 10% or more on a regular basis.  This is very different to the discounts that have always been a feature of automotive distribution, where the headline price is stable or rising, and discounts have been applied in different forms at different levels, but always with a degree of opacity.

The situation is most intense in China where the demand for BEVs is strongest, and multiple international and local players are slugging it out.  In the last couple weeks alone, VW cut the price of its ID models by between 8% and 27%, just a few weeks after Ralf Brandstaetter, their China CEO, said that they would not “join the discount battle at any price”, and Cadillac dropped the price of its Lyriq BEV model by 14%.  Nio, one of the leading Chinese newcomers, was drawn into the price war, with the pressure contributing to the need for new investment, which came from an Abu Dhabi government owned investment fund with over US$700 million of new funding, giving it a 7% stake in the company. In an effort to prevent some sort of death spiral, the China Association of Automotive Manufacturers brokered a deal between 15 domestic manufacturers and Tesla to avoid ‘abnormal pricing’, but subsequently withdrew it after anti-trust complaints.

Looking to Europe, it is Tesla that has led the way with price cuts, creating turmoil in the residual values of all used BEVs, but supporting the company’s overall goal for 2023 of 37% volume growth year-on-year, slightly lower than their long term 50% annual growth target.  The numbers seem incredible to anyone more used to the single figure ambitions of traditional players, but the effect of that sort of volume increase on purchasing and manufacturing costs is highly likely to protect Tesla profitability as long as the two go in lockstep.  If volume retreats, then the situation becomes very different, and there is some indication of this with lay-offs reported in their battery production facility in Shanghai.  In Europe, VW and others have resisted cutting prices to align with Tesla, but consequently face demand challenges, leading to some downtime being taken at the Emden plant that produces the ID range in Germany.  The head of the Works Council there claimed that production was 30% below plan, a variance as influential on the downside in terms of production costs as the 37% gain for Tesla.

So where does this leave all the various stakeholders – other than confused?  For the traditional manufacturers, they have no option under European emissions regulations but to push the volume out, and at the moment, retail demand seems generally weak for BEVs, aggravated by the uncertainty around residual values caused by the Tesla price cuts.  To the extent that achieving the volume requires price support – through finance subvention, diverting volume through low margin channels or different forms of self-registration – the profitability assumptions that lay behind the original investment case will be in tatters.  For the Chinese manufacturers, they are likely to split into two camps.  They all appear to have a cost advantage over the established manufacturers on BEV, allowing them to offer products in Europe at competitive prices, so that offers them the opportunity to accelerate their growth ambitions.  However, if their financial resources are being limited by the domestic price war – as seems to be the case for some – then the pace of international expansion may be slowed, a decision taken by Nio for example.

Leasing companies, including the captives and subscription providers, who have BEVs on their balance sheets face significant uncertainty over the carrying cost of BEVs.  Under normal accounting principles, the values need to be adjusted to market value, which can weaken the balance sheet and result in a breach of banking covenants.  This is a problem currently being faced by Onto, a BEV only subscription service that has performed well in the UK and has European ambitions, but now needs to find new funding as the main previous funder has been scared off by the new uncertainties.  For the manufacturer captives, we may see write-offs of hundreds of millions on their balance sheets in their next reporting cycle unless the situation stabilises – something we last saw a decade ago after the financial crisis.

Dealers on a smaller scale are exposed to similar losses on their used BEV stock.  One dealer I spoke to recently had to knock 25% off the price of some units in order to clear them through, resulting in deep losses.  However, the franchised dealers remain under pressure to move the new BEVs, in some cases having specific mix targets from their manufacturers.  They have the job of convincing retail consumers that they will not face any financial losses from the current uncertainty – helped by the high penetration of leasing on BEVs, but each sale adds to the underwriting risk for the finance company, and if list prices are unchanged whilst residual values are falling, the monthly cost to the consumer will go up without matching support from the manufacturer.

Consumers do not understand all these intricacies and interdependencies.  What they see are car prices that seem out of reach, headlines about big price reductions that somehow infer they were being taken advantage of in the past, and – possibly – a monthly payment that still seems affordable.  However, it does create an atmosphere of uncertainty and doubt, in which case, the easiest response is delay and defer.  That will only add to the demand slowdown, creating a vicious circle that adds fuel to the fire.