The automotive market is currently experiencing a period of unprecedented volatility, presenting both opportunities and challenges. For car dealerships, it’s a seller’s market. However, for consumers eager to purchase a vehicle, the landscape is proving to be significantly more complex and expensive, as recently experienced by Richie Iglar.
In the fall, Iglar and his wife embarked on the search for a new SUV, scheduling an appointment at a Mercedes-Benz dealership in New Jersey. Initially, the interaction with the salesman was positive, until the discussion turned to pricing. The dealership presented a price tag a staggering $20,000 above the manufacturer’s suggested retail price (MSRP).
“We were both shocked and politely declined, saying while we would like to have the car, we can’t justify over-spending for it,” Iglar recounted. Seeking to understand if this was an isolated incident, Iglar contacted another dealer. Within a week, they responded with their own markup of $15,000. Faced with these inflated prices, Iglar decided to postpone his purchase. “I can’t justify spending that much over sticker,” he stated, echoing the sentiment of many consumers in today’s market.
Iglar’s experience is not unique. While markups of tens of thousands of dollars are extreme cases, significant dealer premiums are becoming increasingly common across the nation. This phenomenon is driven by a combination of supply chain disruptions and robust consumer demand, tilting the power balance firmly in favor of new car dealers who are leveraging this advantage.
Ivan Drury, a senior manager of insights at Edmunds, a consumer research company, explains this dynamic: “At the end of the day, it’s saying, ‘Look, if you don’t buy this, the guy right behind you or the gal three people behind you is going to, and they’re going to pay me $1,000, $2,000 more than you’re willing to, so I have to go with them.’ It’s one of the first times in history where the dealer has so much demand that they can actually do that.” In essence, with multiple buyers competing for limited inventory, dealerships are effectively conducting auctions, prioritizing the highest bidder.
According to Kelley Blue Book, the average price for a new car in the United States reached $46,085 in February, marking a $5,000 increase compared to the previous year. The Consumer Price Index further highlights this trend, indicating a 12.4 percent surge in new vehicle prices over the past year. While used car prices have also escalated dramatically, the focus here remains on the factors driving up the cost of new vehicles and their broader economic implications.
Dealer markups are undeniably contributing to this overall price inflation, although they are not the sole cause. As Iglar observed, “It comes down to if someone’s willing to pay it, and they can sell it and keep selling it, I think they’re going to ride that train as long as they can.” This reflects a fundamental aspect of market dynamics, where pricing is often determined by what consumers are willing to bear.
The current inflationary pressures have sparked a debate regarding the underlying causes of rising prices. Some economists and political figures suggest that corporate profiteering is a significant factor. This argument posits that companies are capitalizing on the current economic climate to inflate profits, thereby exacerbating inflation. However, other economists dismiss this notion, pointing to supply chain bottlenecks, increased consumer demand, and rising commodity prices as more substantial drivers of inflation. It’s undeniable that the pandemic has created a unique economic environment, but whether “corporate greed” is a primary driver remains a contentious issue.
Regardless of the specific causes, the reality is that businesses are operating within a capitalist system where profit maximization is a core objective. In a landscape characterized by scarcity and inflation expectations, it’s almost predictable that some businesses will seek to increase prices. As Drury aptly puts it regarding dealerships, “Are they taking advantage of the situation? Yeah. I think they’re doing exactly what anyone else would if they were selling something too.” This behavior, while perhaps opportunistic, is arguably inherent to the current economic framework.
This environment of scarcity allows intermediaries to elevate prices and capture additional revenue. Compounding this is the prevailing inflationary climate, where consumers anticipate price increases, creating a degree of acceptance for higher costs and potentially allowing for some level of “padding” in pricing strategies.
Even amidst rising inflation, companies are fundamentally driven by profit generation. Numerous executives have openly acknowledged their ability to pass price increases onto consumers while sustaining or even improving profit margins. Procter & Gamble, for instance, has implemented price hikes across a range of consumer goods, which has bolstered revenue alongside mitigating rising costs.
The question remains whether these incremental price increases are contributing to a broader, economy-wide inflation. While many economists might argue against a singular cause, it’s evident that when businesses, both large and small, possess market leverage, they tend to utilize it. This dynamic, inarguably, does not alleviate inflationary pressures.
Mark Paul, an assistant professor of economics and environmental studies at New College of Florida, emphasizes the complexity of price changes, stating, “We need to be honest that price changes are complex, and I don’t think it’s fair to boil it down to a single cause. Saying that profiteering is playing a role and profiteering is driving inflation are two different arguments.” He concedes that the significant price increases observed in the automotive sector align with a scenario where companies are charging premiums beyond reasonable markups due to market disruptions.
Looking ahead, there is an expectation that the current supply-demand imbalance in the automotive industry will eventually correct itself. The semiconductor shortage is anticipated to ease, supply chain disruptions will likely diminish, and new car production should increase. This normalization should subsequently moderate used car prices and, in turn, contribute to cooling down overall inflation, as new and used vehicles are significant components of inflation metrics.
In the interim, consumers like Iglar face a choice: either wait for market conditions to stabilize or accept the current inflated prices to purchase a new vehicle.
If You Need a New Car Now, Prepare to Pay a Premium
Historically, paying above the sticker price for a new car was uncommon. However, this has become the new norm.
Edmunds data reveals that in January of this year, 82 percent of new car buyers paid above the MSRP. This is a stark contrast to January 2021, when only 2.8 percent paid above sticker, and a mere 0.3 percent in 2020. On average, new car transaction prices in January exceeded the MSRP by $728. In the same month in both 2021 and 2020, transaction prices were over $2,000 below sticker price. For luxury vehicles, like the Mercedes SUV Iglar sought, dealerships are reportedly charging tens of thousands of dollars above the manufacturer’s suggested price.
In typical market conditions, dealerships often compete by undercutting each other’s prices to attract customers. Currently, with severely limited inventory, consumers are now competing against each other for available vehicles.
Bill Brunner, vice president and general manager at Paramus Chevrolet in New Jersey, illustrates this inventory scarcity, noting that his lot currently holds around 80 vehicles, a significant reduction from the typical 300 to 600 cars in the past. This situation has created a “balancing act” in pricing. “Our prices have definitely adjusted based on availability,” Brunner stated. “Having said that, we still need to be conscious of our customer base.” Dealerships must balance maximizing profit in the short term with maintaining customer relationships for future business.
Brunner indicates a gradual increase in vehicle volume, which should enable dealerships to become more price-competitive. However, pricing remains heavily dependent on available stock. “There were some vehicles that we made better gross profits on than we would have if we had 100 of them in stock. It’s just supply and demand. If we had two of a particular model instead of 100, our pricing structure is different. It’s just the way it is,” he explained. Brunner also acknowledged the pandemic’s adverse impact on dealerships, mirroring the challenges faced by numerous businesses.
Interestingly, some auto manufacturers are expressing concern over excessive dealer markups, fearing potential damage to brand reputation. Companies like Ford and GM have reportedly cautioned dealers against egregious price gouging. It’s crucial to recognize that dealers, not manufacturers, ultimately determine the final price. Traditional automakers also face competition from direct-to-consumer models like Tesla. Furthermore, the push towards electric vehicles, often with extended wait times, adds another layer of complexity.
Drury highlights the brand relationship risk, particularly with new EV customers: “You figure somebody’s trying out your brand for the first time and it’s an EV product, you don’t want to ruin that relationship by saying, one, you’re going to wait, and two, you might pay more than you expected.”
Ford CEO Jim Farley, during a February earnings call, revealed that Ford estimates 10 percent of its dealers have charged above-MSRP prices in the past year. Ford has warned that “future allocation” of vehicles could be affected for dealers engaging in this practice, potentially limiting access to popular models. The Wall Street Journal reported that GM also communicated similar concerns to dealers, threatening action against “a small minority of bad actors” selling and leasing vehicles at excessively inflated prices.
The Wall Street Journal also noted that Toyota and Honda have engaged in discussions with individual dealers regarding above-MSRP pricing. Jack Hollis, Toyota Motor North America’s senior vice president of auto operations, believes that prioritizing short-term profits over customer experience is a mistake. He emphasized the long-term value of positive customer interactions, stating, “If that customer experience is great during this time, they’ll be with you.” The Journal further reported that many dealers themselves are concerned about the potential reputational damage to the entire industry.
Dealer markups are just one piece of a larger puzzle contributing to rising car prices. Stephanie Brinley, principal automotive analyst at IHS Markit, emphasizes the confluence of factors, stating “A whole slew of things” are making cars more expensive. The pandemic has significantly disrupted the automotive industry, causing chaos across supply chains and production. Semiconductor shortages and broader supply chain issues have hampered production, while manufacturing and transportation costs have also increased. Brinley also points to consumer preferences for more expensive features as another factor driving up average prices. “It’s a combination of trying to maintain margin and keep profitability up, but it can’t be done if consumers don’t want it,” she concludes.
Vehicles experiencing the highest markups are often already in the higher price brackets. Drury observes, “If you have $50,000 to spend on a car, how bad can someone feel for you when they can’t afford a $15,000 used car? I don’t feel bad for certain people when they can bid up the price.” This perspective highlights the disparity in the market, where affordability issues are more acutely felt at lower price points.
Brinley advises consumers to leverage readily available online resources to determine the manufacturer’s suggested retail price. She recommends that buyers research MSRP and then be prepared to “move on” if a dealership is charging beyond their willingness to pay. While this approach might require patience and persistence, it empowers consumers to make informed decisions in the current complex market.
In the current automotive landscape, adopting a “move on” strategy may be necessary for an extended period as the market seeks to rebalance.
