In May 2018, President Donald Trump directed the U.S. Department of Commerce under Section 232 of the Trade Expansion Act of 1962, to review whether imported vehicles posed a threat to national security. Related to this, President Trump proposed imposing 25 percent tariffs on imported automobiles and automotive parts. The estimated effects of such tariffs would be widespread in the automotive industry as even “American-made” vehicles contain imported parts. Here is what individual dealers can expect if such tariffs are implemented.
Customer Price Sensitivity
The Alliance of Automobile Manufacturers estimates the tariffs will increase the average cost to dealers of imported and American-made vehicles by $6,000 and $2,000, respectively. The National Automobile Dealers Association (NADA) estimates that the increase in cost will result in an increase of $4,400 in the average retail price of vehicles.
Cost sensitive subprime buyers would be forced out of the new car market by such price increases. These customers tend to be low income buyers with low credit scores. According to Cox Automotive, subprime buyers pay 16 percent interest on average for new vehicles. As such, any increase in price would significantly impact the customer’s monthly payment, a key driver in such sales. The only remedy available to reduce the monthly payment in these cases would be to increase the loan term. Based on recent data, car buyers are already stretching loan terms out as far as 96 months. Will we soon see loans for 120 months? Will lenders even allow such terms? Statistics show that longer loan terms correlate with higher rates of default. As auto lenders have been tightening standards on loans to such borrowers and particularly those with credit scores of less than 620, it is at least reasonably possible that lenders may not finance more expensive vehicles over longer terms, for subprime buyers.
If subprime buyers are pushed out of the new car market, what brands will suffer most? As of June 30, 2018, Cox Automotive reports that the Nissan Sentra, Kia Forte, and Hyundai Elantra – all models imported from Mexico and South Korea — are the most popular amongst subprime buyers. Prices on these models are expected to increase 10% with the proposed tariffs, potentially making such models unaffordable to those buyers.
Overall, the American Automotive Policy Council estimates that these vehicle price increases will result in a drop of 1 to 2 million in annual new vehicle unit sales.
Used Vehicle Sales
The market for used vehicles is already strong with 40 million used vehicles sold in the U.S. every year. However, if proposed tariffs go into effect and new vehicle sales drop, used vehicle demand and average prices are expected to increase further as customers look for more affordable alternatives.
With the strongest lease year ever in 2015, many units are coming off lease into used vehicle inventory. These vehicles with minimal age and mileage will likely become viable options for customers seeking lower cost vehicles. However, once these units are sold, how will dealers continue to source used inventory? Fewer new vehicle sales correlate with fewer trade-ins and lease returns. Additionally, auctions will likely become more competitive and expensive in response to increased customer demand. As such, dealers already suffering lower new car sales may not be able to source the used inventory needed to meet demand.
New Vehicle Supply
Manufacturers have been evaluating the possible effects of tariffs on their business due to the volume of imported vehicles sold in the U.S. For example, these European car manufacturers imported the following percentages in 2017:
|Manufacturer||Percentage of vehicles sold in the U.S. in 2017 imported from Europe|
*Percentage of imported Volvo vehicles is expected to decrease as the company is opening its first U.S. plant in South Carolina later this year.
Toyota imported half of its 2.4 million units sold in the U.S. last year. All units of the RAV4, Toyota’s top model, shipped from Canada and Japan. Likewise, 95 percent of RX crossovers sold in the U.S. were shipped from Canada. As a result, like all manufacturers, Toyota is considering raising its prices, if the tariffs are implemented. The company’s other potential option is to halt imports. However, this strategy raises several questions, most importantly: if imports are halted, will dealers have the new inventory needed to meet customer demand? Both the RAV4 and RX are popular models. If Toyota halts imports on either model, will (1) those models then be manufactured in the U.S. or (2) will dealers be without inventory on those models for an undetermined period of time? These are questions that must be resolved over time, with the results having a significant impact on individual dealers.
The U.S. Department of Commerce has been investigating the economic impact of the tariffs as a potential threat to national security. No date has been announced regarding when the results of the investigation will be available. Hearings have already been held with many representatives from different companies and organizations vocalizing the potential negative effects on the automotive industry and U.S. economy of the resulting tariffs. Time will tell whether the investigation deems such imports a threat to national security and if the proposed tariffs are implemented.
In the meantime, here is some analysis and suggestions of what you could be doing now to prepare for any downturn that could occur, should the tariffs be imposed.
As you know, the seasonally adjusted annual rate (SAAR) for unit sales has exceeded 17 million units for 3 straight years for the first time in history. However, sales are plateauing and it is not expected that such levels can be maintained. As a result, outside of the potential tariffs, volume is already expected to decrease. Therefore, dealerships need to prepare for the possible downturn and tariffs as this will directly affect the value of their businesses.
They can do so by:
- Starting the process of forecasting/budgeting at lower volume levels to identify potential areas to grow (i.e., used cars, service)
- Reviewing expenses for opportunities to become more lean, particularly related to larger variable expenses (payroll, advertising, interest)
At MBAF we will be watching this issue very closely, and will be sure to keep you up to date on the latest developments.