Over the last century Detroit has touted durability, tailfins and apple pie to persuade Americans to buy new cars. But now the automakers are enjoying their first surge in sales after three bleak years, thanks in part to a fresh approach: persuading Americans not to buy at all.
Instead of buying, the companies argue, their customers should lease-paying for the value of the car they use up over two to three years, then returning it to lease a new one. For the consumer, they say, leasing means no fat cash payments in lean times and no aging hulks depreciating-without warranty-in the driveway.
For manufacturers and dealers, it means brisk business at last, as Americans in growing numbers seize the offer.
“I checked into it, and I think it’s the only way to go,” said Robert L. Ewart, a retired farmer in Spink County, S.D., who leased a cherry-red Buick LeSabre in June, after a lifetime of buying. “There’s absolutely no risk.”
No risk, perhaps, for Ewart. But the automakers, in the view of some Wall Street analysts, are taking a colossal gamble.
“It’s easy to say that the auto companies have a handle on the situation, but I think that’s the $64,000 question,” said Jack V. Kirnan, an auto analyst with Salomon Brothers. “A lot of people in the industry think they don’t.”
Last month, Kirnan downgraded his rating of Ford Motor Co. largely because of Ford’s growing reliance on leasing. While leasing is helping manufacturers move cars today, he said, it could cut into their profits later if they guess wrong about their values as used cars.
If the gamble pays off, however, the car companies will have molded their customers’ behavior to guarantee a steady market for new cars to lease, potentially flattening out the industry’s boom-and-bust cycles.
In the first four months of the year, the most recent period for which data are available, leases accounted for 26 percent of all retail car sales by the domestic manufacturers, or about 300,000 cars, up from 22 percent a year earlier, according to CNW Marketing/Research, a Bandon, Ore., company that tracks leasing.
A lease counts as a sale because the dealer sells the car to a finance company, usually owned by one of the automakers.
Ford is widely credited with having the most aggressive lease program. From January through June, dealers sold 199,400 more Fords, Lincolns and Mercurys than they did in the first half of last year. More than half of those vehicles-107,200-were sold back to Ford’s finance arm, and leased.
Though other factors, from low interest rates to the rising prices of foreign cars, are contributing to the pickup in sales, analysts, dealers and manufacturers cited leasing as a leading element.
“There’s no question,” said George T. Reganis, head of lease programs offered by the financing arm of General Motors Corp.
Leasing, he said, is “a market that is really accelerating at a very rapid rate.” He expects total retail leasing to climb by more than 60 percent this year to 2 million cars and light trucks, up from 1.2 million last year. “All of a sudden there’s this major change, and it’s a cultural change,” he said.
Leasing draws in people who would not have considered a new car. According to CNW surveys, 63 percent of people who lease probably or definitely would not have ventured into a showroom if leases had not been available.
Some predict leases will eventually account for half of sales. “By the end of this decade, you’re going to see 50 percent of the retail deliveries annually,” said Art Spinella, vice president and general manager of CNW. “If it weren’t for leasing, the auto industry would be in the dumps.”
Weighing the risks
For Detroit, the risks are that when a lease expires, the customer may jump to a different company. More critical, though, is whether the lease payments sufficiently cover the value the car loses in the lease.
To determine those payments, GM, Ford and Chrysler Corp. must accurately guess the “residual value,” what the new car will bring on the used-car market in a few years.
But if they guessed high on the residual value to offer a lower monthly lease payment-as they have done-they could lose hundreds of millions of dollars.
“I worry about that,” said Joseph S. Phillippi, a Lehman Brothers analyst. “They’re conning themselves that they can control this thing, because by making what you think are accurate, albeit optimistic, estimates on residuals, it’s a way to cost-justify the aggressive lease payment.”
The automakers reject such fears. “We are unswervingly confident that it is the right way to go,” said Ross H. Roberts, a vice president of Ford and general manager of the Ford division.
For manufacturers and dealers, leasing has several advantages. As quality improves and the life span of cars lengthens, leasing forces consumers to return to the dealer to get a new car as soon as every two years, preventing them from deferring new purchases when times get tough.
In the past, the companies could hope to lure them back only through frequent, flashy design changes.
“We could sell three cars or four cars every 10 years, instead of only one or two,” Reganis of GM said.
In addition, dealers know precisely when customers who lease need a new car. As the lease expiration date approaches, they begin barraging them with offers. Because leases generally force consumers to return their cars to the dealership where they leased them, the dealer is guaranteed a crack at another sale.
Eighty percent of the consumers who lease get a new vehicle from the same dealer. By contrast, only a third of car buyers buy again from the same dealership, according to CNW surveys.
Profit motive
Because the down payments and monthly payments tend to be lower than in purchasing, leasing also allows dealers to sell more expensive-and hence more profitable-cars than customers could otherwise afford.
Ewart, the retired farmer, said the deal seemed so good he was suspicious. But he could find no wicked fine print when his dealer offered him the LeSabre at only $220 month-without a down payment, because he traded in his ’92 LeSabre, valued at $16,000.
The lease runs two years, so the car will be under warranty while Ewart drives it. And can buy it for only $1 at the end of that period (again, thanks to the trade-in) or lease a new one.
“That way you get a new car every two years,” he said. “I’m 66 years old, retired-you don’t come up with $22,000 real easy.”
Given all those considerations, the fact that he doesn’t own the car doesn’t bother him. “I can’t say it affects me,” he said.
For some customers, it can be hard to give up on the idea of owning, said James K. Lust, the dealer whose company leased Ewart his car.
“We’ve ingrained that in the public for years and years and years,” Lust said. “There is a leap of faith to go from ownership to usership.”
But rising car prices, shrinking budgets and tantalizing lease offers are helping consumers set aside the bias. Howard Castleman, president of Crystal Ford Isuzu near Silver Spring, Md., said: “It’s a win-win for the consumer, it’s a win-win for the dealer.” Less certain, he said, is whether it’s a win for the manufacturer.
“They’re gambling that their product is going to be worth what they say it’s going to be worth in 24 months, and if it isn’t, who eats it?” he said.
In some cases, dealers said, the car has no chance to be worth what the manufacturer predicts. “They say in two years the vehicle is going to be worth $8,000 or $8,500, and we know, and they know, it’s only going to be worth $6,000,” said W. John Daub, president of a Chrysler and a Ford dealership in Pennsylvania.
Wait and see
The future value, he said, is often impossible to predict. For example, a spike in gasoline prices could send the residual value of usually expensive guzzlers such as Cadillacs and Lincolns through the floor, forcing Detroit’s financing subsidiaries to absorb the loss. “It’s a crapshoot,” Daub said.
Another unknown is the effect of a rush of 2- to 3-year-old vehicles into the used-car market. If that causes used-car prices to fall below predictions, the manufacturers could be caught with overly valued used cars. The automakers say, however, that the used-car market is large enough to absorb the leased cars.
Used-car prices also could climb. Furthermore, even if prices fall, the manufacturer may lose less through leasing than through the steep rebates-of as much as $2,000-offered to new-car buyers. “That’s money you know you’ve lost,” Spinella of CNW said.
The manufacturers insist that they are not highballing their estimates-that if anything they are too low.
“There’s no reason for us to play with residuals-that would be the dumbest thing in the world,” said Ford’s Roberts.
Outside experts agree that the companies aren’t playing games. Randall R. McCathren, executive vice president and general counsel of Bank Lease Consultants in Nashville, which advises banks and automakers, said manufacturers learned to be cautious about residuals in the late 1980s, when used-car prices stalled.
The banks and auto finance companies lost an average of $1,300 on the sale of each car returned in 1990, he said.
“We could be headed for a fall, or we may do very well,” McCathren said. “It’s unlikely it’s going to go back as bad as it was in ’86 to ’90, but who knows?”
