Pricing – a blunt instrument to influence demand?

Before Christmas we saw headlines from around the world as Tesla cut prices dramatically in order to stimulate sales before the year end.  This achieved the desired result for Tesla of getting close to their previously declared shipment target for the quarter, but also attracted negative headlines from customers who had recently purchased at the original price and from those in the motor trade who had used Teslas in inventory which now had to be written down in value.  More recently, following the transition to agency by Mercedes-Benz UK, they have also attracted negative comments as they have launched high profile promotions on specific models such as £3000 off an A-class.  This does not seem to be consistent with the claim on their website in describing the benefits of agency as ensuring that customers “can rest easy knowing you're getting the best price, regardless of where you buy from.”

Discounting is obviously not new to the industry and current circumstances aside, customers have been trained over decades that they should negotiate a price when you buy a car.  Under the traditional franchise model, the discounts have been provided using a range of different levers including discounts funded from the dealer margin, additional discounts funded indirectly through specific manufacturer campaigns and over-age stock incentives and support for low interest finance and deposit contributions.  Manufacturers also make tactical use of low margin channels including daily rentals, brokers and pre-registrations.  As an average across the total sales volume, these various can easily add up to 15% to 20% of the retail price, but applied selectively.

Regardless of whether a manufacturer is remaining with a franchise model or in particular if they are moving to agency, then clearly pricing is an important tool to influence demand and allow this to be balanced as closely as possible with supply.  This is basic economics, but how it is applied is fundamental to how a brand is perceived and consequently residual values maintained.  If there is a perception that the new car price is regularly and heavily discounted, then residual values will reflect this in turn influencing the assumptions built into lease payments and affordability of that product.

In an effort to shine a light on this area, we held a webinar last week for members of the ICDP Research Programme where we looked at the practises of other industry sectors to determine how they might apply in automotive.  In particular we returned to the topic of dynamic pricing, something that we first flagged in reports over 20 years ago, but have more recently suggested should be a cornerstone of any switch to agency.  Dynamic pricing is a tool which most of us will be familiar with from experiences of buying airline tickets or booking hotel rooms.  Everybody understands that there is not a single price for a particular flight, nor for a night in a particular hotel – both change on a case by case basis depending on the expectations of the provider for what the demand will be on the day.  They continually track the fill rate against an expectation of how it should develop in order to ideally achieve 100% utilisation of the seats or rooms by the time the day actually arrives.

From an automotive perspective a series of flights or the capacity of a hotel over a period of time can be compared to the production slots available in a factory.  Having 180 seats on each plane operating a particular route four times a day over the course of the year, or 500 rooms available each night in a hotel are comparable to a plan to assemble 2000 cars per day over the coming months.  In each case there is finite capacity, and from a business perspective you want to maximise the revenue, which is not only about using every slot but also about optimising the mix so that high value slots help to balance out those that have been discounted in order to stimulate demand.  For airlines and hotels, that equates to differentiating prices between early and late bookers, premium and economy customers and free tickets available from rewards programmes.  In automotive we need to differentiate in a similar way.  If a customer is prepared to order for delivery in a period which is seasonally slow then the price should be lower than for someone who wants delivery at a seasonal peak.  A customer who is interested in a car with some high margin options might get a higher discount than a customer who wants the plain vanilla variant which has a lower margin in order to meet a price point.  In monitoring the order fill as we approach the sales month, the pricing policies being applied need to reflect the actual order fill against an expectation off what was anticipated so the rate of fill can be either stimulated or constrained in order to achieve 100% by the end of the sales month.

However if we look deeper into the airline or hotel model, then there is another level of refinement where a customer who has expressed interest or committed to a purchase will then be offered additional services, for example full board or spa treatments in a hotel, or incentivised to upgrade their purchase such as paying a discounted rate for a suite because the hotel operator knows that the order fill for suites is lagging behind the rate that they require.  Having secured the customer, there may also be mechanisms to help build the brand and loyalty through complementary offers and reward schemes.  All of these form a full dynamic pricing model which will yield the maximum profit from the available capacity.

Even as the industry rushes towards widespread adoption of the agency model, it seems that one of the most fundamental building blocks for success is not being leveraged.  I know that in some cases manufacturers have investigated this sort of best practise but I fear that in others there is a naive belief that just by saying prices are fixed, then customers will continue to flow in the numbers required to optimise the supply chain as a whole.  Tesla was in an exceptional position when it was able to maintain stable visual pricing over long periods of time but they have now demonstrated that period has come to an end, even for them.  Other manufacturers are coming from a legacy of regular deep discounting and will really need to be on the game in terms of dynamic pricing if they are to have any chance of success with agency.