By Kaloyan Zhelev
If we go to the website of the National Statistics Institute to take a look at the average annual consumer price index for the previous 12 months, for the month of June we will come across a growth of only 3.1% for cars. A similar check at Eurostat would show more than five times the harmonized index for the EU, and the pace since the start of the year has been increasing.
Today, however, we will turn our backs on doubts about the representativeness of inflation statistics and face a fact that is obvious to all: car prices have soared into the stratosphere.
And if, according to various data from Europe and the USA, the growth in the average transaction prices of new cars is between 15 and 25, and in some cases up to 40% in the last year, then those of used cars have risen between 30 and 50%.
Costs To understand why, we’ll first look at costs in the automotive industry, deliberately simplifying an otherwise extremely complex process like manufacturing a car.
And since the infinite variables and complex interrelationships make it impossible to boil things down to one final number, let’s start by saying that the production of the most complex product for mass individual consumption depends on the type of car, its content, the cost of energy, raw materials and components as well as that of labor and research and development (R&D). And if the cost components themselves are much more and more complex, then they fall into two main categories – fixed and variable.
But before that, let’s clarify the concept of profit. In a large and multinational business, profit is reported at different levels, some of which may be profitable, some of which may not. Automakers typically define profit at three levels: gross, operating, and net, so it’s first and foremost important to be clear about which “level” of profit is being assessed.
The first level in the published accounts is “gross profit” – the difference between sales revenue and production costs. Level 2 is “operating profit,” which is gross profit minus normal operating expenses (overhead, rent, lease payments, and depreciation). The final level is “net profit”, which is operating profit minus finance charges, tax payments, debt repayments and extraordinary items such as proceeds from the sale of assets. In most analyses, different businesses are compared by gross and operating profit, and because of differences in financial structure and taxation, net profit is primarily used for time comparisons within a business.
Thus, the gross profit of car manufacturers in recent years has been moving in a corridor between 10 and 20% (average historical indicators are lower), with luxury brands being at the highest part of the scale, and mass brands occupying its base. Exceptions to the rule, of course they exist.
Automotive manufacturing is a series of many interrelated processes, but at the beginning of all of them is research and development. Every time a new model is to be made, a series of research and development (R&D) and extensive tests are carried out. The implementation of these activities, as a rule, takes years and is associated with mandatory costs.
When calculating the cost of building a car, you must consider the costs of maintaining facilities, creating and testing prototypes, finding suppliers, retraining workers, and adding new tools and technology. These costs do not change depending on the number of cars produced.
Unlike fixed costs, variable costs depend on production volumes. In automotive manufacturing, the costs of raw materials, labor, and distribution can be classified as variable because they are directly related to production and change with its volume. If a car company wants to produce more cars, it will need to hire more labor; if he wants to reduce the volume, he will buy less raw materials.
Besides production volume, other factors also affect variable costs. Among them are the prices of energy carriers, so relevant to explain the trends at the moment.
Variable costs are the most significant component that automakers consider in their pricing; they are also most relevant in making economic decisions.
The major cost components in automotive manufacturing are research and development (R&D), raw materials, labor, and advertising. Raw materials account for about 47% of production, with steel accounting for almost 22% of the company’s operating costs. The cost of materials and components depends on the region in which they are produced, the markets in which they are purchased and the volume of production.
Labor is the second largest source of cost for automakers. According to Statista, for example, direct labor accounts for 21% of the total cost of manufacturing a car. Labor input also varies across car manufacturers, meaning different marginal costs.
It is usually paid on an hourly basis. In general, the time to make one car is about 17 – 18 hours. This, to be clear, is the time required to assemble the components, not the overall manufacturing process. Smaller cars can be assembled within 11 to 12 hours, while the manual processes of specialty cars such as Rolls-Royce can take months.
Research and development (R&D) is another major cost component in automotive manufacturing and accounts for about 6% of total manufacturing costs. Automakers also have to factor in administrative costs, which take up an additional 10%. Other costs, such as depreciation, logistics and advertising, accumulate to a total of about 16%.
How They Price When determining the price of a car, car manufacturers weigh a variety of factors, far more than just production costs. They necessarily do market analysis, taking into account similar patterns, consumer interests and buying trends, and a host of other factors, such as generational characteristics.
However, this is all just basic economics. Roughly speaking, companies set their price so that it is not too high to discourage sales and not too low to balance their profit and operating costs. Among the exceptions are the ultra-expensive limited editions of premium manufacturers, where the demand mechanisms are set backwards.
Car emblems produce different models every year. They update their model range both to compete with their old models and because of their rivalry with other brands. If, for example, Volkswagen lowers the price of one of their models, say the Golf, there may be a negative shift in the demand curve for their other models, as some of the demand would prefer the Golf to other products.
Larger and more luxurious cars command higher prices due to their size and special features. As a model gets older, you will surely notice that its price starts to decrease. This reduction is the result of a decline in manufacturing costs with lower tooling and engineering costs over time. Subsequently, the price is reduced and to make the product more attractive, increasing/maintaining its sales volumes in line with the plans.
An increase in the production rate for a given period can also lead to a decrease in the cost of production. This can mean buying large quantities of raw materials and components at reduced prices, using automated machinery and using labor more efficiently. This reduction in unit production costs can lead to reductions in unit car prices.
More Factors Among the most significant pricing factors, as discussed, are the dynamics of supply and demand, as well as the action of contingencies such as climatic anomalies, epidemics and geopolitics.
It is their fortuitous combination in recent years that has caused the automotive industry to experience acute logistics and component shortages, starting with semiconductors, and with the superimposition of other factors (example: container imbalances, the emblem of which became the Ever Given stuck in the Suez Canal) were also added those of other primary raw materials and components, such as lithium, cobalt, plastics (the cold Texas February of 2021), structural wiring (Ukraine after February 24 this year), and many others.
Covid-19 social distancing measures have both held back demand and created a new wave of interest in individual transportation. The component deficit, on the other hand, caused a significant drop in capacity, which in 2021 drastically diverged between supply and recovering post-pandemic demand.
Lyrical digression: one often-overlooked factor driving up car prices is the unharmonized regional regulatory mish-mash. In Europe alone, car manufacturers comply with over 100 EU regulations and 80 directives covering the industry’s activities. The example of the 77 regulations concerning the security of the United Nations Economic Commission for Europe, of which there are 50 in the European Union and another 40 in the Gulf Cooperation Council, suggests to what extent the end product of the automobile industry is made more expensive by the lack of regulatory harmonisation. As you notice, we haven’t even brought up the subject of EU-mandated “green” electrification, which is forcing the entire industry to re-adjust its value-added and supply chain to adapt, and that means only one thing – a drastic increase in the price of the final product. To the extent that the executive director of Stellantis, Carlos Tavares, warned earlier this year that one of the main functions of the automotive industry, namely the provision of rights under Art. 13 of the Universal Declaration of Human Rights concerning freedom of movement.
All these processes forced a considerable part of consumption to reorient to the secondary market, the stocks of which also quickly began to melt. To the point where new and slightly used car prices have leveled off and their new levels have delivered record profits despite falling production volumes and rising upstream and energy costs.
When The big question, of course, is when the situation will return to normal. The answer is by no means easy, mainly because of the simultaneous action of disparate factors moving in different directions.
Even if the supplies of some components and raw materials are normalized, nothing guarantees the effect of similar factors on others; at this time, geopolitics is a constant source of instability, directly affecting energy and commodity prices, not to mention the supply chain.
And even if we assume that everything suddenly normalizes, it will take time to catch up with the accumulated demand and balance it with the supply. All kinds of deadlines are heard – from the end of 2023 to never, so the forecast of normalization is impossible due to the complex interaction of the listed factors, and today we did not even count them all.–
Yes, cars are very expensive. And to the question of when the situation will normalize, I would rather bet on an answer in the spirit of: to look at the present as a new “normality”, hoping for a certain mid-term decline, and to accept any other, more optimistic scenario as very pleasant and an unlikely surprise.
IN SUMMARY The growth in the average prices of new cars is between 15% and 25%, and in some cases up to 40%, and of used cars – between 30 and 50%.