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Business and Management

Cash for Clunkers: A Mixture of Promise and Pitfalls

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By Matt Scruggs, Research Analyst, Frost & Sullivan’s Automotive Practice

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The Consumer Assistance to Recycle and Save Act, otherwise known as "Cash for Clunkers," is expected to be signed into law, after being voted in by the House and Senate earlier this month. While programs of this sort have been successful in Europe, boosting new vehicle sales in spite of a slumping global economy, a program of this nature faces unique challenges in the United States.

The "cash for clunkers" bill provides a cash incentive to dealerships to be applied to a consumer’s purchase of a new vehicle. The vehicle to be traded in and scrapped must get less than 18 mpg combined, be manufactured since 1984, be in drivable condition, and have been insured for the past year. Consumers must then purchase a vehicle that gets 4 more miles per gallon than their old vehicle for a $3500 incentive, or 10 more miles per gallon for $4500. For light trucks, a 5 mpg gain nets a $4500 incentive, while a 2 mpg gain is worth $3500. This incentive will be, for all intents and purposes, exclusive to vehicles with a resale value that is lower than the incentive value, meaning the greatest concentration of eligible vehicles will be large cars, pickup trucks, and SUVs that are more than 8 years old.

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Replacement incentive programs are available in Germany, France, Italy, Spain, and the UK, with Austria, Portugal, Romania, and Greece expected to follow suit. Success has varied, from marginal YOY gains in Italy for March 2009, to a roaring 40% YOY sales increase in Germany for the same month. While there is no doubt that even a marginal increase in new vehicle sales in the United States would be beneficial to the economy, the nature of the US aftermarket and the restrictions of the bill pose potential detriments to success.

One aspect that bears consideration is that of scale: In Europe, enough funds were allocated to provide incentives for 600 thousand (Germany) to 300 thousand (UK) new vehicles. The United States has allocated $1 billion, which is expected to fund the replacement of approximately 250 thousand vehicles. It is important to consider that the total number of vehicles in use is only approximately 30.2 million in the UK, of which 7.36 million are eligible for incentives. In the United States, there are approximately 244.8 million vehicles in use, of which approximately 30.3 million are eligible.

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Currently, 2009 US vehicle sales are expected to drop by 37% YOY, which translates to a decline of almost 5 million vehicle sales. By factoring in sales derived from the cash-for-clunkers bill, that drop is reduced to 35%. Clearly, this is not enough to re-vitalize the staggering automotive industry. However, if month-to-month sales show a significant rebound that can be attributed to the bill, more funding is likely to be allocated during the review scheduled in November 2009.

The difference in scale suggests that the United States simply will not experience results as powerful as those seen in Europe unless government officials are willing to allocate a much larger amount after a review of the effects, or they find another method to fund the incentives. In the UK, for example, the government contributes half of the €2,000 incentive, and the OEM contributes the other half. However, in light of the financial situation of American automakers, this solution may not be applicable. Whatever the funding, the benefit of these effects is also balanced by the potential for harm in the aftermarket in the United States.

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The Effect on the Aftermarket

The aftermarket in Europe and the UK is heavily concentrated in the OES supply channel, meaning that a reduction in the older vehicle population has a minimal effect overall; a lack of revenue in the repair sector is made up for by an increase in vehicle sales. In the US, the situation is not as simple. The independent automotive aftermarket generally handles repair and maintenance work required on vehicles after they migrate away from the OES channel at around four years of age. This important sector of the economy thrives on the business generated by the same vehicle population that this bill is designed to scrap.

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Approximately 176 million vehicles are serviced primarily through independent aftermarket channels. The 250 thousand vehicles which are to be replaced through the cash-for-clunkers program is a small percentage of the overall industry; however, they draw directly from the 8-12 year old vehicle population that provides the greatest amount of revenue for the aftermarket. If funding for this bill is expanded enough to cover the 30 million vehicles believed to be eligible for replacement incentives (a big if), the net effect would be an overall increase in scrappage rates for the duration of the bill. The resulting drop in revenues for the independent aftermarket would be devastating.

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Critics may point out that scrappage rates will return to normal after funding for the bill is cut, but with the detrimental impact to the aftermarket, the overall economic benefit of the cash for clunkers act will be marginal at best, disastrous for a large sector of the automotive industry at worst. This highly vulnerable market segment represents 39% of the vehicle population, but generates almost 50% of the aftermarket spending on repairs and maintenance.

Fuel Economy Increase: Incentive or Market Dynamics?

Also worth examination are the fuel efficiency goals of the bill. The upper mileage goals offer significant benefits in individual fuel consumption, though again the scale of the incentives needs to be considered when looking for the total beneficial effect. However, because of the discrepancy between CAFÉ standards (rated by the NHTSA) and actual vehicle fuel economy (rated by the EPA), measuring the increase of fuel economy on a per-vehicle basis has the potential to yield greater nationwide fuel-economy benefits than new CAFÉ standards, which leave significant loopholes for manufacturers.

However, the lower limits present questionable benefits. In the expected vehicle demographic of 8+ year old SUVs, large cars, and pickup trucks, manufacturers are aggressively pursuing fuel economy gains while retaining similar performance capabilities. For the smaller incentives based on modest fuel economy gains (a 4 mpg improvement in cars and only 2 mpg in light trucks), consumers will, for the most part, have a hard time not purchasing a vehicle that offers the minimal qualifying fuel economy improvement. In this case, while an incentive is likely to boost vehicle sales, it is likely to create a negligible effect on nationwide fuel economy; market dynamics is providing a much larger push.

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While an incentive program can be made to work well, as it has in Europe, the scale must be adjusted to account for the larger US vehicle population. To prevent economic backlash, the effect on the aftermarket must be taken into account and provided for, perhaps with additional measures tailored to boost aftermarket service early in the vehicle’s life. Focusing on fuel economy can provide benefits, but for the maximum effect, both the scale and the minimum standards should be addressed. “Cash for Clunkers” is a small step in the right direction, but to really benefit the industry, a giant leap, one fraught with many dangers, is required.

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