Will a focus on residuals succeed in stalling rising new car costs?

As the values of cars rise, car manufacturers look to old methods to control costs

Volkswagen dealership

Lotus is one manufacturer switching to an agency model

Nissan dealership

Car makers are putting new faith in an old and often neglected price-control method to clamp down on the rising costs of electric cars: residuals. Residuals is automotive industry jargon for the value of your car when you come to sell and, as you might have noticed recently, that’s a lot more than it has been.

This has created two effects. One: used cars become more expensive. And two: car companies earn a lot of money, particularly on the finance side of their business. VW Financial Services, for example, saw profit more than double to just under €6 billion (£5bn) in a record year, citing higher residuals. Morgan Stanley, a bank, called its performance “EXTRAORDINARY” in an analyst note. (Analysts aren’t known for their prolific use of capital letters.)

In 2021, the value of a three-year-old car rose an unprecedented 28% from the start of the year to the end of the year, according to price experts CAP hpi. The reason for the rise in values was simple: supply of new cars was hit by semi-conductor shortages, meaning buyers turned to the used market to find a car, increasing demand.

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The shortage of semi-conductors has had another side effect: car makers focused on higher-price models and slashed discounts. VW’s average selling price last year rose from €24,000 to almost €30,000 (roughly from £20,000 to £25,000), Morgan Stanley noted. “It’s hard to see how this is sustainable for a beleaguered consumer,” the bank wrote.

But there is one upside. “It’s not necessarily bad news that you’re not getting a big discount as long as that’s also reflected at the back end in the residual,” said Steve Young, managing director of retailer analyst firm ICDP. Or to put it another way, if your car is worth more when you, the bank or the car maker sells it on again, that increased value is reflected in lower monthly payments.

That could be crucial when it comes to selling higher-cost electric cars. “No one is speaking about cars costing £45,000 or £50,000. You speak about monthly payments,” said Guillaume Cartier, head of the Nissan region that includes Europe. “Residual values are higher on EVs so the cost to finance is less than the increase of the price.”

But there’s a huge responsibility on the part of the car maker, or OEM, not to damage those residuals. “You need to make sure that the behaviour of the OEM is proper on the new car,” Cartier said. “Because if the new car is discounted, then the value is impacted. And you need to make sure that you don’t overproduce by more than your demand.”

That has not always been the case and Nissan, along with a whole slew of mainstream and premium brands, has been guilty in the past of destroying residual values, rather than shoring them up.

“Before, they were more focused on increasing market share, and that meant they sold cars through more distressful routes,” said Chris Plumb, senior valuations editor at CAP. A distressful sales route is trade jargon meaning anything involving heavy discounting, including short-term rental, pre-reg sales (dealers registering new cars to themselves to hit targets and sell as nearly new) and sales via brokers. “With the pandemic, we are seeing a lot less of that. Pre-registration is nearly a thing of the past,” Plumb said.

Car makers such as BMW and Mercedes in particular have said they’re not going back to those bad old days and instead promised to actively restrict supply. Not quite as restricted as now (although many are booking record profits as a result) but still lower. Quality of sales rather than quantity is the new mantra. “It’s what we have learned with the semiconductor crisis,” Cartier said.

Car makers also have a range of shiny new levers to pull to help them protect residual values. For example, over-the-air updates can bring the latest digital services, apps and even features to a second-hand car. With a click of a button, a used car can be better specced than when it was delivered to the first customer.

Car makers are looking to the chip makers to supply the most sophisticated digital brain possible to ensure the car is upgradeable for the second/third/fouth owner. “The reason why we are changing this architecture is… to increase the residual value of the car,” said Thierry Cammal, the head of Renault Group’s Software Factor, during an announcement earlier this year that it will collaborate with chip maker Qualcomm on future digital platforms.

With a simple update of the software to boost power and features and perhaps even the addition of an ‘S’ badge, it’s easy to imagine car makers upgrading used electric cars to a price bracket not far off that of a basic new version. And even if the car itself is approaching the end-game, the battery inside is likely to still have value for static energy storage.

The move by car makers to grab more of the sales process from their dealers in a shift to the so-called ‘agency’ retail model will also give them more of a say what happens to used cars. Used car refurbing to an ‘approved used’ condition has long been a way to bump up residuals, but because more car makers will now own used cars when they come back off leases or subscriptions, they can better control prices. Renault, for example, plans to convert its plant in Flins near Paris to ‘remanufacture’ used cars.

Lotus is switching to an agency retail model, meaning any trade-ins of new models such as the £100,000 Eletre SUV will belong to Lotus. “They will control the second-hand car market for five years,” Nima Khandan-Nia, owner of Lotus Silverstone, said. “It’s a clever mechanism to control the brand and keep track of residuals. They’re not going to be rock-bottom like, for example, a BMW 7 Series might be three years later.” Customers who paid cash or via straight hire purchase could sell privately but few do. “If you’ve got an £80,000 car, very rarely do you sell. It goes to a dealer as a trade-in,” Khandan-Nia said.

While residuals for EVs may stay strong, car makers are worried that those of internal-combustion-engine vehicles could collapse as used buyers worry about legislation making them more expensive to use. “It’s important we shouldn’t be doing anything to destroy them. We should be cautious about how we transition [to electric],” Lisa Brankin, the head of Ford of Britain, told the audience of a recent conference hosted by car maker lobby group the SMMT.

All eyes, meanwhile, are on how car makers react as supply issues ease and volumes return. Not everyone is convinced by their promises not to destroy residual values by balancing supply with demand. “We think the narrative about structurally higher car maker pricing discipline will fall apart as soon as the market is no longer undersupplied,” Patrick Hummel, head of European autos research for the bank UBS, wrote in a December analyst note. “Old bad habits will likely be back soon.” 

Electric laggingThe promise that EVs will have better residuals than internal-combustion-engine cars is believable as more people are incentivised to change, but right now that’s not the case based on values of three-year-old/60,000-mile cars monitored across last year by CAP. EV values rose by the least among fuel types, with full hybrids out in front.

Price rise between start of 2021 and end of year

With thanks to CAP hpi for the use of its data

Keyword: Will a focus on residuals succeed in stalling rising new car costs?