Cars as Differentiated Durable Consumer Goods

Mike Smitka
Retired Economist
GERPISA Steering Committee
Automotive News PACE Judge

The investor site SeekingAlpha just posted my most recent article, Tesla's Thin Model Pipeline. That article is an application of the economics of differentiated durable goods to the auto industry.

First, autos are highly differentiated consumer good. Car company strategies reflect that, since Alfred Sloan organized General Motors to offer A car for every purpose..." (the ad is downloaded from the digital archives at The Henry Ford). More generally, use cases differ tremendously, from utilitarian transport to vehicles meant to display wealth. Work vehicles are even more differentiated, with up-fitters adding bodies to frame/drivetrain/cab sets for a multiplicity of businesses. We have small commuter cars, family-oriented SUVs, performance cars, and full-sized pickups with towing packages for farmers and others – I go past the Virginia Horse Center every time I head to town, lots of fifth-wheeler duallies.

Empirically, that suggests lots of models and a fragmented market. I use model-level data for Europe and for China (the world's largest vehicle market) to show just that. In Europe, no single model (or model series, e.g. the BMW 3-series) holds even 2% of the market, while over 400 models were available. In China, only 3 vehicles (barely) cleared 2%, while over 540 models were available. And these are just passenger vehicles. I don't have comparable data for the US, so I did a "deep dive" into the market-leading F-150 to show that it in fact consists of a family of models, suggesting that the upper limit for market share is likewise 2%.

The second piece is that vehicles are durable, with the average car on the road over 12 years old, and light trucks even older (from memory, 14 years). Used car sales are roughly 3x those of new. Hence new cars compete with used, and the more years a new car model is on the market, the greater the cannibalization from used cars. Henry Ford discovered that the hard way in the mid-1920s, as sales of the Model T fell despite repeatedly lowering the price. Ultimately Ford shut down production.

The economics literature on durable goods pricing is thin, and I know of only one set of studies that directly address that issue, from Adam Copeland of the NY Fed, solo and with various co-authors. Transaction data are hard to come by, the datasets compiled by various consulting companies are expensive and need to be cleaned up to handle rebates to consumers and dealers. That most new car purchases are accompanied by trade-ins further muddies the data. Their findings include an annual price drop of nearly 9%, and a shift down the income scale as a model ages. US consumers are well aware of these trends, and those on a tight budget time their purchases accordingly. Such consumers are also more likely to compare new and used cars. My son just bought a Subaru Legacy, and he shopped both. Given the current (August 2022) distortions in the market, he found that if he could wait, he could purchase a new car at MSRP, sticker price. If he wanted one immediately, he had to purchase used and pay above sticker. He could and did wait.

...to grow, Tesla has to develop a portfolio of new products and regularly renew existing ones...

Combine both of the above and the result is that car companies offer a portfolio of products that they renew on a regular basis. On SeekingAlpha I detail that as well, looking at the release cadence of new and refreshed models by the luxury car companies with which Tesla competes. As to Tesla, they have only one concrete future product, the Cybertruck set to launch in the summer of 2023. This year they've also refreshed the interior of the Model S. However, they've not updated the sheet metal on any of their existing vehicles – the Model 3 is overdue for that – nor have they announced any future product, only vague promises to come out with a limited-volume Roadster. Furthermore, I detail the limited market for pickups in China and Europe. The Cybertruck may do well in the US, but it's not a global vehicle. The stock market values Tesla as a high-growth company. However, they have revealed no strategy to develop a portfolio of products or to regularly renew existing products. My analysis indicates they can't grow without doing both.

Tesla appears likely to launch the Semi in 2023, but that is not a passenger vehicle and again is aimed at the US market.

China's NEV Market: Rising Segments, Falling Segments will generate winners and losers

Mike Smitka
Prof Emeritus of Economics
Automotive News PACE Awards Judge

I've been tracking Chinese sales data for a couple years, and pulled together thoughts in a brief article, China NEV Segment Analysis, on the finance website Seeking Alpha. The midsized segments, both sedans and SUVs, are stagnant. That's where Tesla's Model 3 and Model Y compete. In contrast, the compact "A" segments are expanding. Players there include one one startup, XPeng, but has BYD, VW and Geely as major players. To my surprise, I also find SOEs with decent shares, particularly GAC's Aion [GAC is owned by the Guangzhou Municipal government]. Most of the SOEs have lived quite well off of profits earned by their joint venture partners, such as Toyota and Honda for GAC. Are these proper commercial ventures, drawing upon the experience of SOEs in designing vehicles and running factories? Historically the SOEs were poor at design and at marketing. Some of that is the home boy effect – you won't find many Aion vehicles on the streets of Shanghai or Beijing. I don't know the produzct, I'm not a "car guy," so maybe these are real ventures properly run with earning money as a goal. But they could also be the result of party hacks pushing management to follow the EV trend, using their joint venture profits to make up for a lack of business acumen (and a very crowded market).

I also argue that the car market faces many headwinds. China has worked through the demographic dividend generated by falling birth rates, but now the working age population is shrinking, and probably the overall population as well. It's easy among the monthly NEV sales hype to overlook that the overall Chinese car market peaked in 2017. Then there's the end of the real estate bubble, evidenced by the failure of Evergrande, and the prospect of continuing lockdowns, an ironic side effect of China's initial success in using a combination of testing, contact tracing and quarantines to suppress the pandemic. There's no concrete left to pour after the huge infrastructure expansion that kept China from suffering the worst effects of the US real estate meltdown. That ammo has been depleted, and while Beijing talks about boosting car sales to offset the slowdown, consumers can't sell the condo that represents the biggest part of their life savings, and on top of that are worried that their bank may be the next one to shut its doors.

In any case, it will be interesting to see who does well in the NEV market, which just (barely) set a new sales record in July of 560,000 units. I think it's the bigger players who will fare well. VW's R&D spend is $3.6 billion a quarter; that's more than the combined revenue of XPeng and Nio, two of the current "pure play" EV favorites. Cars are in the end a consumer product, and having a broad, regularly refreshed portfolio of models on offer is of the essence. So my belief is that in the end the global OEMs will do well, and one or more of the private Chinese car companies: BYD, Geely and Great Wall. BYD is already in 6 of the 9 segments I tracked, as is Geely. VW, despite its late start, is already in 7. They cover most of the bases already. In contrast, Tesla can't seem to get new product out the door, and is stuck with but two models, and those in the stagnant mid-sized segment. They aren't heading towards failure, but they do risk being left in the dust as an also-ran.