Car prices: Is there any method to the madness?

Toyota just raised prices of its cars, and the other two car makers are expected to follow. That seems almost counterintuitive to the aims of profit maximization because any rosy projections of demand recovery should have been comfortably busted by the new world order under the coronavirus. Even if Toyota operates on a low-volume, high-margin strategy; it seems the company will have to start getting creative with their business model.

Let’s look at demand. Volumes have so far only plummeted (cumulatively down 47% in 9MFY20). In fact, automakers have witnessed some of the worst declines in production among large scale manufacturing (LSM) singlehandedly bringing down the overall average. Now, we already know that car consumers in this country tend to be less sensitive to price changes (also called elasticity) and more sensitive to income changes (this is based on the study conducted by Dr Hafiz Pasha in 2012). Which is why, car makers in the country, especially Toyota and Honda managed to sell cars over the past two years despite raising prices up to 50 percent (citing currency depreciation).

But when incomes decline, demand does get affected which is what we have seen in the past few months as economic slump hit Pakistan. Volumes dropped so much that all automakers have had to shut down plants for days because of piling inventories and no customers to sell them.

High cost of borrowing also dissuaded potential car buyers as leasing costs rose and auto financing also dropped. The Pakistan car market is small—only those customers buy cars who really need it—which is why auto makers make the volumes they want and set the prices they wish. However, demand is not entirely inelastic—(to illustrate the concept, take cigarettes. Demand for cigarette is highly inelastic because users are addicted and cannot stop buying just because of a price hike. Demand for cars, in comparison, is not as inelastic but still pretty insensitive to price changes because of the lack of options).

This will likely evolve as market expands substantially. Automakers will not be able to increase prices as often as they desire. This phenomenon can be already seen in the motorcycle segment. Because volumes are so high and there are several players into production, motorcycle players just cannot keep raising prices without fearing of a substantial loss in market share.

With that, what happens now? Corolla volumes have declined 51 percent while Fortuner’s sales have dropped by 47 percent in 9M. This is all pre-corona. With prices further up, and no sign of COVID-19 disappearing or countries around the world with a firm strategy on how to address it, we are in record unparalleled times. Maybe incomes of Toyota and Honda buyers will not suffer, but the world is too uncertain to spend a substantial chunk of money on vehicles, even for those who can afford the incremental price. Folks will be keeping cash close to the chest; closer still as lockdowns continue. If interest rates are really low which could very well be possible (yesterday, the monetary policy committee slashed policy rate by 200bps down to 9%), maybe that would bring back some demand. But who will want to take on a loan is an important question up for discussion.

One thing is certain: it seems car makers are working on the assumption that car buying behaviors will not change. They should know that coronavirus is not going away and everything we know, all our projection models must be reviewed because there is a new variable in town. A deadly one in more ways than one.