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.