Record levels of incentives are eroding sales margins of car manufacturers

19 September 2018 4 min. read

Automotive companies have lean and well managed operations, focused on reducing production and operations costs. However, many are being stung by increasingly expensive incentives, which can account for 10% to 20% of revenue. A new report sheds light on the causes of incentive cost creep in the automotive industry.

The automotive industry has in recent decades seen considerable ups and downs – from bailouts in the late 2000s, to more stable conditions as global demand for new light vehicles approached 100 million units. The industry has been a stickler for agile processes, focused on reducing waste and costs out of its supply chains – much of which has been relatively effective.

However, a new report from McKinsey & Company considers how far automakers have been able to control a key part of their cost structure – incentives. The firm finds that the relative eye on the ball seen in other parts of the business, may be missing – creating unnecessary costs.

Incentive costs as % of revenues

Incentives represent around 10% to 20% of total revenues, with, as the firm argues – little current management. Tight and sophisticated management on the OEM level represents around 70-80%, largely on the cost of procurement and production for the good sold. General and administrative costs represent less than 5% of the total cost – and have seen increased attention in recent years. This leaves net profit margins of around 4%-10%.

The stakes are relatively high, with automakers tending to be relatively big and expansive companies – thus on a $50 billion revenue company, around $5 to $10 billion is spent on incentives. Costs in other parts of the business tend to be under tighter control, argue McKinsey’s consultants.

Automotive incentives reach all-time high

The finding comes on the back of the revelation that automotive industry incentives have in recent years seen their levels hit all-time highs. In Germany, the index has spiked 54% since 2010 and were in 2017 more than 60 basis points (bps) above 2009 levels. Meanwhile in the US the relative incentive spend per unit across all brands has increased 8 percentage points on 2010 levels, from 15% to 23%.

The reason for the increase in incentive costs are multifaceted. Product lifecycles have decreased from 130 months to 91 between 2000 and 2017, incentivising producers to clear out end-of-life-cycle vehicles. Changes in channel, with increased fleet and rental businesses pushing bigger fleet discounts while online channels increase price transparency and competition. Finally, competition is a major trend, with low-cost car-makers likely to see price pressures rise in coming years – with incentives needed for core market players to retain market share.

The increased need to create incentives, as well as the wide range of OEMs, has seen a considerable rise in complexity – particularly for dealerships. In some instances, dealers are spending so much more time managing the wide array of incentives on a broad arrange of makes and models, that sales are suffering.

Incentive programmes

Overall sales prices are heavily affected by both tactical incentives and dealer margins. On the tactical side, there are promotional costs, including finance support, volume boosters, delayed delivery, buy back and other costs – totalling between 10-20 categories. Variable dealer margins, which can be tied to tactical incentives, also need to be factored in – before fixed dealer margins are considered.

The consulting firm further notes that current incentive practices come with a number of different risks. The authors – Thomas Furcher (a Partner in McKinsey’s Vienna office0, Michael Viertler (a Senior Partner in the Munich office) and Philipp Landauer (a partner in the Stuttgart office) – write; “When mistakes happen or circumstances change – and they often do – companies typically attempt short-term fixes using tactical incentive spending to close critical gaps and to ensure sales while machines continue to run. This spending often lacks transparency and even the basic management techniques.”

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