Will PCP-fuelled used vehicle over-supply force used prices down?

By Paul Smith, Director, Traka Automotive

Speculation stirred by remarks about a possible fall in US used car prices, not only served to remind dealerships of the economic ties between the new and used vehicle markets; reaction also raised questions over whether the long-term consequences of sales-boosting financing models such as Personal Contract Purchase (PCP) and excess pre-registrations may be forcing a state of reversed polarity, in which the new offers a perception of consistently better value than the used.

Interviewed on CNBC's Trading Nation, Jonathan Banks, an executive analyst from the influential NADA Used Car Guide, said that US used car prices will fall by 5-6 per cent over the next 7 months to the end of 2016. The fall will not be due to an under-supply of buyers for used cars, Banks explained, but to an over-supply of used cars entering the market. According to Banks, over 800,000 more used cars are entering the market in 2016, compared to last year.

The impending glut is largely the result of the surge of new car sales driven by PCP financing take-up and manufacturer discounts that have been increasing substantially for over three years now. This sustained pump-priming of new car sales is starting to come home to roost as larger volumes of PCP lease plans reach maturity this year and next. Such is the nature of these deals that the majority of PCP leaseholders are opting to trade up into the next new car rather than pay a final 'balloon payment' to own the 3-4 year old car they’ve leased up to that point. The returned, now approved used cars, are reaching the market in larger numbers on both sides of the Atlantic.

The additional 800,000 used cars in the US this year is linked to PCP sales from 2013 but there is evidence that PCP sales were even higher in 2014, so this trend looks to be accelerating. These cars will of course be joining the thousands of other vehicles entering the used markets; but being only 3-4 years old, they should attract top approved used car prices, especially as PCP vehicles have to be in great condition, with moderate to low mileage, to hold their value for the point of exchange. The problem is exacerbated by the fact that greater numbers of buyers who have been purchasing used cars for the last decade or so, having been turning towards new car purchases – seduced by cheap financing and manufacturer discounting which is now skewing the market in this direction.

So we think there's an emerging dilemma for dealerships with both new and approved used models displayed on their forecourts if it's true that PCP and OEM discounting is over-boosting new car sales, simultaneously eroding the cost differential between new cars and used cars to the point where a significant percentage of traditional buyers of used cars are now swapping out to new cars, even for second or third car purchases in larger households.

But this hypothesis has yet to be borne out by actual used car values in the UK. Indeed the used car market has been doing well since the start of this decade as the recession receded. According to the latest edition of the Used Car Market Report, published by British Car Auctions (in association with the Centre for Automotive Management, University of Buckingham), the value of used car sales in 2014 reached £45.1 billion – a year-on-year increase of 5.6 per cent, and an all-time high for the sector. Dealers account for £34.3 billion (78.3 per cent) of all used car sales, and 4.1 million sales (equivalent to 57 per cent of all sales).

However, the promotion and uptake of PCP schemes, which according to some observers coincided with a partial return of consumer confidence in 2012, has definitely moved the market in a different direction. PCP options have found appeal for multiple reasons. They were new and well marketed, and their selling points easily understood. They had commonalities with instalment-based contract hire and hire purchase financing that many business car owners had already adopted. Warranty periods on new cars have also being lengthening to further stimulate the new car market.

PCPs’ multi-option exit plans seem equitable to all parties, and calmed any uncertainty a car buyer might have about their future ability to keep-up monthly payments. The option to trade-up in a relatively hassle-free way to the latest model after three years, holds appeal for Generation X buyers who are less hung up on the importance of owning all the products they use. And the popularity of PCP meant more new car sales. The latest figures from the Society of Motor Manufacturers and Traders (SMMT) shows continued gains in the UK's number of new car registrations, accompanied by mainly positive fluctuations in the number of new monthly new registrations (private and fleet).

April, for instance, saw a two per cent increase on the previous month, with 189,505 cars being registered in the month – the most in an April since 2003. SMMT chief executive Mike Hawes described the sector's first quarter as “robust”, as UK consumers “continue to demonstrate their appetite for new cars”. It feels like we have been on the top of a new car buying bell curve for some time now.

However, if the scenario that NADA envisages becomes a reality, and used car prices do start to show signs of falling, then dealerships with both new and used stock may find themselves with some stark choices. For example, the precepts of PCP itself might come under scrutiny if prevailing market conditions mean that a new car will be worth significantly less after 36 months than was estimated at contract purchase. Getting buyers into the next new car may suddenly look more difficult if the top up payments start to look prohibitive.

If dealerships want to maintain an interest in the used market, then an inventory realignment toward premium vehicles, rather than volume models, may be one of the few viable approaches to retain margins. For example, offering PCPs on approved used prestige models could well encourage determined used buyers to 'trade-up' to higher performance, more profitable models that they would not otherwise have considered if they were looking at the next new car.

Another option is to target the used route for second and third family-unit vehicle purchasers. This is already very often the case, but where the 'Bank of Mum and Dad' funds car purchases for ‘live-at-home’ millennials, then better value maintenance and warranty options may well win the argument in favour of used. Again, the marketing message targeting such categories of potential purchasers needs to be precise. However, with unsold used cars hogging valuable showroom real estate, the time for innovative financing options and selling techniques, combined with more dynamic repricing to clear used stock faster, may well be close at hand.