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The Automotive Industry and the Dynamics of Consumer Demand: The case of automobile leasing Fred Mannering
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The sad state of US automakers: Declining market share Non-competitive products Retirement /health care liabilities The supply-chain squeeze Undesirable product mix Reliance on high profit SUV/Trucks
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Market Shares (cars):
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Market Shares (cars and trucks):
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Car/Truck sales 2000 to 2005:
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Techniques for moving inventory: Interest-rate incentives Cash-back incentives Employee-pricing incentives Leasing incentives Value pricing
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Outline: Background on leasing growth Structure of the leasing-demand model Data Leasing-model estimation results Profit maximizing industry model Implications of findings
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Why has leasing grown? Leasing is the correct economic decision Manufacturers prefer and have promoted leasing New vehicles have become too expensive to buy Consumers do not want to hassle with vehicle disposal Leasing allows consumers to upgrade their vehicles Leasing offers protection against reliability risks
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Recent car add promoting leasing: Drive new every 3 years Never have negative equity Never have a trade-in hassle Always in warranty Guaranteed purchase price Gap protection (many leases cover difference between amount owed and vehicle value in case of total loss)
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Historical Trends in Leasing Shares
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Leasing growth – Study Approach: Based on Mannering/Winston/Starkey Survey consumers’ vehicle ownership history and acquisition methods (cash, finance, or lease) Estimate a disaggregate econometric model of acquisition method and vehicle type choice Develop a profit-maximizing model of manufacturer behavior and forecast future trends in vehicle leasing
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Data: 654 households buying new cars and light trucks in 1993, 1994, 1995 National household panel (National Family Opinion, Inc.) Vehicle attribute data from various sources
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Disaggregate Vehicle-Choice Modeling Utility maximizing model of the types of vehicles to own Numerous applications since the late 1970s addressing a variety of vehicle related issues Most often multinomial logit or nested logit to take advantage of consistent parameter estimates when sub-sampling alternatives
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Indirect Utility Function ( for consumer i ) V m|am = Indirect utility of vehicle m conditioned on acquisition method am BL m = Brand Loyalty to m BP m = Brand Preference to m X m = Vector of attributes of m Z = Vector of consumer attributes
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Advantages of Disaggregate Modeling: Can account for high level of detail in vehicle attributes and consumer characteristics Can draw inferences from marginal rates of substitution and elasticities Can compute changes in consumer welfare (Small/Rosen 1981 Econometrica)
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Potential modeling problems: IIA violations if a logit model is used – can be tested and resolved with nesting Accounting for Brand Loyalty – Lagged variables give issues of state dependence vs. unobserved heterogeneity Price elasticities can be problematic in the presence of unobserved heterogeneity
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Past brand loyalty measures: Accumulated mileage on same-make vehicle (Mannering/Winston, 1985 Rand paper) Number of consecutive same-make purchases (Mannering/Winston, 1991 Brookings microeconomics paper) Previous same-make purchase
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Model Structure
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Nested Logit Formulation: Conditional type-choice models
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Nested Logit Formulation: Finance/Lease Model (conditioned on choice of non-cash)
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Nested Logit Formulation: Unconditional Cash/Non-Cash Model
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Conditional Type-Choice Models: Variables Common to lease, finance and cash models: Horsepower, turning radius, consumer reports’ repair index, expected operating costs, vehicle class indicators, brand preference variables, price, passenger airbag
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Conditional Type-Choice Model - Lease: Expected residual value after 3 years (+) Loyalty (number of previous repeat purchases of the same brand) (+) Loyalty (number of previous repeat leases of the same brand) (+)
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Conditional Type-Choice Model – Finance: Expected residual value after 3 years (+) Loyalty (number of previous repeat purchases of the same brand) (+) Loyalty (number of previous repeat leases of the same brand) (-)
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Conditional Type-Choice Model - Cash: Expected residual value after 3 years (+) Loyalty (number of previous repeat purchases of the same brand) (+)
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Findings suggesting upgrading: Willingness to pay for luxury items higher in lease model than finance model (determined from MRSs) – more on this later Negative lease loyalty in finance model
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Conditional Acquisition Model - Lease/Finance: Higher income, higher debt, higher education all increase propensity to lease Expected miles driven over 12,000 decreases propensity to lease
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Acquisition Model – Cash/Non-Cash: Higher education and owning a home increase propensity to pay cash Higher debt and annual miles driven decrease propensity to pay cash
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Elasticities and Willingness to Pay Income elasticity of leasing increases with income (0.82 at $75K, 1.43 at $125K) People who lease have higher willingness to pay for luxury items (horsepower, vehicle size, passenger- side airbags)
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What has driven growth in leasing? Vehicle upgrading behavior and large real income growth in upper income groups Close-end leases and other improvements in leasing contracts (model year indicators) Habitual behavior/familiarity
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What has driven growth in leasing? Income of top 5% of households grew 17% from 1990-95 (compared to median income stagnation)
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Alternate explanations: Changes in new vehicle prices – negligible in real dollars Changes in vehicle quality – improving quality so leasing not likely being used to minimize uncertainty Dealer’s behavior – no evidence Tax advantages – none to speak of Vehicle usage – increasing, so mileage limits remained a leasing barrier
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Profit maximizing industry model: Manufacturers set differential leasing and purchase prices to maximize profits Profits maximized on a 3-year discounted time horizon (current prices affect future profits through brand loyalty and acquisition method)
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Profit maximizing industry model (continued): Manufacturers behave in a Cournot- Nash fashion (other manufacturers’ prices given) Forecasts made from 1996 to 2004
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Forecasting results: Manufacturers should have raised their real lease prices an average of 17% by 2005 (assuming real cash/finance prices remain constant) Average percent increase: GM 16%, Ford 21%, Chrysler 14%, Honda 16%, Nissan 21%, Toyota 14%, European 23%
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Total Actual vs. Predicted Lease Shares
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Summary: Acquisition method and vehicle type choice can not be viewed separately Growth in leasing has been fueled combination of factors - models suggest upgrading and income growth Market dynamics indicate that leasing will not grow significantly in the future
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Short-term strategies for US manufacturers moving product: Leasing incentives? Downside risk on residual values Rebates/incentives? Risk consumer burnout Value pricing? Cold consumer response so far Hope for favorable macroeconomics? Cheap fuel, low interest rates
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