Rafi Mohammed

Memo to the Big Three Automakers: Don't Abandon Leasing, Just Focus on Setting the Right Prices

Posted on July 30th, 2008 (0 Comments)

Last Friday Chrysler LLC announced it would stop offering leases through its lending arm, Chrysler Financial. Today the Wall Street Journal reports that both GM and Ford are scaling back their leasing efforts. Once considered a key driver of growth, leasing is now on the endangered species list at the Big 3 U.S. automakers.

Leasing is the pricing concept of renting a vehicle for a fixed time period (e.g., 36 months). At the end of the lease period, you simply turn in your vehicle or purchase it at a pre-negotiated price. Leasing companies forecast what the value of the car will be at the end of the lease, and your payments cover this depreciation cost. This is what’s so interesting about leases…payments have little to do with a vehicle’s selling price. Instead, they are based on how much a vehicle depreciates over the lease term. This is why Honda can lease a $25K CR-V for $199 a month while Ford has to charge roughly double that amount for a similarly priced Taurus. Since you aren’t buying a car, leasing payments are usually lower than loan payments (one web site claims 30% - 60% lower).

The crinkle to leasing, of course, is forecasting a vehicle’s residual value – there’s a great deal of uncertainty. I mean, who could have imagined that gas would be $4 a gallon when a SUV lease was signed three years ago? The Power Information Network reports that last year, higher gas prices depressed the resale value of pick up trucks and large SUVs by 12% and 11% respectively. In part due to these lower residual values, Ford just announced that its financing division had to write down $2.1 billion in Q2/08.

If I were a U.S. automaker, I wouldn’t be so quick to abandon leasing (note: no foreign car makers are scaling back their lease programs). A large segment of customers prefer to lease cars (20% of Ford and Chrysler vehicles are leased while 40% of GM’s retail sales are leased). Who amongst us is willing to risk losing 20% - 40% of our customer base?

So what’s a Detroit automaker to do? They need to hire econometric specialists to improve their vehicle forecasting models. Economists use sophisticated statistical tools to forecast our economy, insurance liabilities, and Wall Street futures prices…I bet they can handle residual car values.

Lease prices will inevitably go up. Ok…so instead of being 30% - 60% lower than monthly payments, perhaps they are now 20% - 40% cheaper. And yes, because of these price increases, some customers will switch to foreign car leases. But if the alternative is losing a significant chunk of current customers, if I were the Big 3…I’d brush up on my vehicle depreciation forecasting skills.

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