High interest rates and rising consumer debt levels are impacting the outlook for dealership success.
Let me start by saying that generally we are still a year away from possibly experiencing significant upward shifts in our retail automotive businesses in Canada.
Some months back I wrote an article entitled stay alive until 2025. There are many factors that still must align, and I believe that 2024 will be the continuation of the alignment that started at the tail end of 2023. There is still, however, a long way to go.
Canadian new vehicle sales peaked in 2017, almost repeated in 2018 when new vehicle sales topped 2.0 million units in both years.
According to DesRosiers Automotive Consultants (DAC) January 3, 2024, report, 2023 new vehicle sales galloped their way to a year-over-year increase of 11.8 per cent to 1.664 million units.
Even with new vehicle sales significant increase for 2023, the market only performed at 80.0 per cent of its 2017 peak.
Since 2018 much has changed. The industry challenges have been well documented and I will spare you by not repeating them here. Rather I want to focus on a few macroeconomic challenges and opportunities and the microeconomic impact of consumers and automobile dealerships.
According to the World Bank, macroeconomics focuses on the performance of economies — changes in economic output, inflation, interest and foreign exchange rates, and the balance of payments.
Poverty reduction, social equity, and sustainable growth are only possible with sound monetary and fiscal policies, whereas microeconomics is based on models of consumers or firms (which economists call agents) that make decisions about what to buy, sell, or produce — with the assumption that those decisions result in perfect market clearing (demand equals supply) and other ideal conditions. The two are interrelated.
Over that period 2019 to 2023, Canadian annual new vehicle sales decreased significantly. By the end of 2023 new vehicle sales registration were still 20 per cent below the 2017 peak. One could conclude that this alone creates a significant new vehicle sales backlog of several hundred thousand units heading into 2024.
On top of this, the population of Canada, over the period 2019 to 2023 increased from 37.3 million to 40.6 million, a cumulative increase of 8.9 per cent.
It’s a well-known fact that overall, all Canadians need a vehicle to facilitate employment. In 2019, 19.2 million were employed in Canada. By October 2023 that number had increased to 20.3 million, an increase of 1.1 million workers.
Although workers choose between new vehicle and used vehicle purchases, the increase of 1.1 million workers creates demand for vehicles in general. When combined with lackluster pandemic driven new vehicle sales, the population growth along with increased number of workers in the workforce create a realistic reason for optimism in 2024/2025.
All is not rosy, however. Consumers are facing stiff headwinds on many fronts. In recent weeks, the Bank of Canada, and the U.S. Federal Reserve (late December) hinted that interest rate hikes may have peaked or are at close to peak, creating a glimmer of hope that interest rates could start their downward movement sometime in 2024.
Elevating interest rates have had a significant impact on the cost of consumer and business debt. As part of this, monthly vehicle payments have materially increased for most Canadian households seeking a new ride.
When combined with elevated mortgage payments, significant financial pressure is being felt by most Canadians. The housing market is shifting from the seller’s market of just a year to 18 months ago to a buyer’s market.
Also, as vehicle production begins to ramp up, the automotive market is beginning to show signs of weakness with some brands offering large discounts and low interest financing with the goal of stimulating new vehicle sales for their brand.
The automotive market is shifting away from the “take it or someone else will” market of the past couple of years. As vehicle inventories build, dealers are incurring significant floor plan interest and other floating financing costs. Gross margins on vehicle sales are beginning to decline as vehicle affordability issues are addressed. This exerts downward pressure on dealership profitability.
Inflation has increased consumer household budget and business operating costs, significantly causing all to tighten their belts and try to reduce costs.
Consumers are having to make critical spending decisions between paying higher mortgage payments, higher vehicle payments, higher home and vehicle fuel payments, increased insurance payments and higher food costs, etc.
For many Canadians there is not enough cash coming in to meet their monthly expense levels. According to the Financial Consumer Agency of Canada (FCAC), more Canadians are facing financial challenges with the rate almost doubling in 2023 from August 2020.
From my vantage point, 2024 will still be a tough year for most Canadian households even though some have increased compensation packages.
Consumers are far from feeling comfortable and that does not bode well for required and discretionary spending.
For automobile dealerships, inflationary operating costs pressures will continue, along with gross margin suppression resulting in downward pressure on profitability.
OEMs will still require additional investment from their dealers that will contribute to overall increasing operating costs. Many of these investments surround electric vehicles as OEMs attempt to achieve aggressive federal and provincial environmental targets.
The OEM challenges here are enormous with many drivers living in multi-urban residential dwellings like condominiums and apartment buildings.
The retrofitting costs are enormous and out of the industry’s control. With the industry up against a race against the clock, pressures on consumers and dealers will continue to increase. With 10 per cent of consumers contributing over 30 per cent of all kilometers driven, consumer acceptance is critical to achieving the government’s desired results. There is still a lot of work required here.
As we move into 2024, there is reason for cautious optimism.
Dealerships however must keep a watchful eye on the macro and micro issues affecting their customers, their community, their brand, and their dealership.
We are in the midst of auto retail shifting from a new vehicle sales focus to greater dependence on fixed operations and used vehicle penetration in an environment of ICE and EV powered vehicles. This will be no small challenge.
