Deep Discounts a Risky Bet for Auto Industry

Published July 11, 2005

| Associated Press

General Motors Corp.'s (GM) "Employee Discount for Everyone" program sent the automaker's sales soaring last month to the highest monthly total in two decades and allowed it to unload huge amounts of inventory.

Now, Ford Motor Co. (F) and DaimlerChrysler AG's (DCX) Chrysler Group are launching pricing schemes of their own.

These are busy times for U.S. automakers, and GM's recent success is the first bit of good news to emerge from the world's largest automaker in a long while. Whether that can be sustained may hinge on how all the automakers play the promotional game going forward. Big discounts can often be a blessing for bolstering sales, but they can also become a curse for profits.

Automakers might want to look at the retail industry to see how discounting can help as well as hurt business. Merchants, especially department stores, have become increasingly reliant on promotions to lure consumers into their stores.

But shoppers have become somewhat numb to the constant discounting. They often wait until they know it is the absolute lowest price before they buy (just think of the success of the post-Christmas sales). While that might clear out inventory, it doesn't do much for profits.

The auto industry isn't in such a predicament yet, but it has come to rely on promotions to drive customer traffic. That push largely started after the Sept. 11 terrorist attacks, when automakers launched zero-percent financing deals to revive sales, and they have rolled out other promotions since.

But the current scheme extends beyond what has been done before — which is exactly what has some industry-watchers worried.

On June 1, GM began offering its vehicles to the public for the same price that GM's employees pay. That allowed customers to buy vehicles for an average of $400 to $500 less than they spent in May, before major cash rebates. GM spent an average of $4,458 per vehicle on incentives in June, up $449 from May.

Those discounts, which took the haggling out of car buying, hit a positive note with car buyers. GM tallied a 41 percent jump in its sales in June compared with a year ago, the highest monthly total in nearly 19 years and a big gain from the single-digit growth it has seen so far this year.

In addition, GM inventory declined 26 percent to 980,000 units, an important reduction before 2006 models arrive later this year.

Given the robust response, GM is extending the program through Aug. 1. But now it will face competition, with Ford and Chrysler both announcing that they would offer similar deals starting this month.

Automakers say that these deals are only for the short term, but whether that holds true is unclear. For one, should sales slow dramatically after the employee-discount programs end, they might be forced to consider cutting prices again.

There also are particular concerns over what happens when the 2006 models are launched later this year. Consumers may balk if they perceive the prices are significantly higher than what's in the showrooms now. Analysts say that could mean that the automakers are left with no choice but to implement another round of promotions.

"Now we are at employee-level discounts. Is there a level below that, like $500 more off that price, that they will have to go to next because that is what consumers expect?" asked B. Craig Hutson, a senior bond analyst at Gimme Credit (search), a research company specializing in corporate bonds.

Should Detroit's Big Three automakers continue the promotions, some analysts worry that will cause the sales effect to fizzle over time. Morgan Stanley auto analyst Stephen Girsky said in a note to clients this week that "the longer these programs last, the less successful they will be" and suggests that is exactly what happened with GM's "Keep America Rolling (search)" zero-rate financing campaign in 2001, which was an initial success.

There is also the issue of what the heavy discounting does to a brand over time. It's possible that a brand's value diminishes if consumers associate an automaker with its promotional programs.

Even with all those concerns, GM should get credit where credit is due. It set off major car buying with this promotion, even for its SUVs that it had been struggling to move out in recent months. In addition, GM managed to win over customers who have not bought its cars before. Its market share climbed above 30 percent last month, well above the 25.7 percent realized year-to-date, Hutson said.

It's rare to see a such a successful discount program, which is why all U.S. automakers need to plan their next move carefully.

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