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Canadian consumers expect their higher Canadian dollar to automatically translate into lower prices for new vehicles, as low as the prices they see advertised in the United States. Yet when they compare Canadian prices against American prices, they often see a huge gap and start planning to purchase in the U.S. instead of at home.
Well, the rising dollar that has put downward pressure on new-car prices is also lowering used-car prices in this "borderless" world. Cheaper used cars imported from the U.S. are having the effect of lowering the market for used cars generally. Lower used-car prices are a major reason why Canadian manufacturers are desperately holding out against dropping their new-car prices.
It works like this: when a consumer returns a car at the end of the lease period, generally three years, it comes back with a residual value. The residual is what the car was calculated to be worth at this point in its life; it is the purchase price less depreciation.
But remember, this residual was calculated three years ago and now the market says that vehicle is worth a lot less. A vicious circle has been created; the manufacturers need windfall profits on new cars to cover their residual losses on the used ones.
Tino Rossini started at an early age in the automotive business handing tools to his father who was a mechanic. He has since worked at both the manufacturer level and the dealer level and until fairly recently he owned a new-car dealership in Durham. Today, he owns the Strada Auto Store in Newmarket, Ont., which imports and sells exotic cars (www.stradaautostore.com).
Vaughan: Are you telling me the reason the manufacturers won't lower Canadian prices on new cars to U.S. levels is because of cars coming off lease?
Rossini: It's an important reason, yes.
In most instances, the residual of the leased vehicle that is coming back to the manufacturers these days is higher than what the vehicle is worth in today's market. The manufacturer is going to lose money when they sell that used car. They have to try to make it up elsewhere.
Somebody has this big loss on their books; is it the dealer or the manufacturer?
The manufacturer.
New-vehicle leases offered by dealers to customers are "walk away." This means the lessee is not responsible for the residual value of the vehicle at the end of the lease; the lessee is only responsible for the condition and kilometres travelled.
The manufacturer, through its captive finance company, assumes the loss if the market value does not match the residual value.
These losses are a moving target depending on the used-vehicle prices at the time the lease return is converted to cash — i.e. sold. If the residual value is not recaptured, it generates a loss, which must be covered by the manufacturer's captive finance companies.
The bulk of a manufacturer's profits come from the sale of new vehicles to its dealers. A portion of the new-vehicle profit is used to cover residual losses.
If they have all these used cars that are worth a lot less than they expected they would be, what can they do about it?
This is why you see so many manufacturer-supported CPO (Certified Pre-Owned) programs. They're designed to enhance the value of lease returns and diminish residual-value losses.
Where do you see this situation going? You wouldn't believe the number of e-mails I get from people who think they're being taken advantage of by Canadian dealers and swear they're going to the United States for their next car.
We will not see price parity with the U.S. on new vehicles and I don't think Canadians expect price parity.
Canadians want to see a "fair Canadian price" for a vehicle; the current prices are not perceived as being fair or good value and the explanations given by the manufacturers are not perceived as credible.
So more and more people will go to the United States for their next car.
The savings, for people who do buy a vehicle in the U.S., require a good amount of due diligence, the funds to pay cash, a co-operative U.S. dealer, a co-operative manufacturer, and having several days to personally finalize a transaction and drive the vehicle back to Canada.
Not everyone is in a position to go buy a vehicle in the U.S., but everyone is in a position to quickly make price comparisons with U.S. prices. In most instances, the initial price differences are dramatic.
When the Canadian dollar crossed the 90-cent (U.S.) level, manufacturers should have considered a few outcomes; when the dollar reached parity that was a watershed moment for Canadians, which required pro-active and not reactive actions.
Canadian consumers showed their power by withholding, and delaying, vehicle purchases, or going to the U.S. If a manufacturer cannot justify in simple terms the pricing value proposition, why should a consumer do business with that manufacturer?
This is all about the world losing confidence in the American dollar. Some day that confidence will return and the loonie will drop like a stone and things will return to normal.
Warren Buffett expects the U.S. dollar to remain low for the mid-term; I respect his opinion.
Manufacturers believe that the Canadian consumers are comparing apple and oranges by comparing Canadian and U.S. MSRPs (manufacturer's suggested retail prices) and concluding that manufacturers are taking advantage of them.
The purpose of any business is to create a customer and potential customers are not buying into the existing Canadian pricing. Manufacturers have to price their vehicles with a fair Canadian MSRP and realistic residual values. That means increased transparency for the consumer.
Most folks get their information and price comparisons online and information must be transparent on a computer.
Michael Vaughan is co-host with Jeremy Cato of Car/Business, which appears Fridays at 8 p.m. on Business News Network and Saturdays at 2 p.m. on CTV.
