Greg Standing looks at the different factors contributing to growth in UK car sales, the impact of PCP products on the industry and both the challenges and opportunities facing the industry in the future.
UK car sales are buoyant. In October last year the Society of Motor Manufacturers (SMMT) reported a 9.5% year-on-year increase in new registrations. At the close of 2014 a total of 2.48 million cars had been sold in the UK; an increase of 10% which far exceeds the growth of the UK economy as a whole.
The sales figures are supported by strong underlying manufacturing performance as more than 1.5 million vehicles were produced in the UK last year - the highest number since 2007. That equates to one car being made in the UK every 20 seconds.
Understanding the growth
A number of background factors contribute to this surge in sales. Some of these relate to the general economic upturn with interest rates remaining at a historic low of 0.5%, freeing up money for motoring which would otherwise have been applied to mortgage repayments. Falling oil prices, meaning less money spent on fuel, and historically low inflation will continue to drive consumer spending through 2015.
However the most significant contribution to booming car sales is arguably the explosive growth in vehicle finance and leasing, not only in terms of the amount of cars being bought on finance but also the value of advances made.
Since car sales were last at their peak in 2006-7 the amount of cars being purchased with the assistance of finance packages had increased by 29% by the close of 2013, according to data released by the Finance and Leasing Association (FLA). Over three quarters of new car sales in the private sector are now made with the assistance of finance from FLA members. That means 880,108 new cars were bought with finance in the 12 months to September 2014 - up 13% on the previous 12 months.
The picture doesn't just show that more people are buying their cars on finance packages. The value of advances has also increased. Members of the National Association of Commercial Finance Brokers reported a 106% increase in total sums advanced to £834 million in the year to October 2014, whereas the value of advances written by FLA members was up 18% year-on-year. In short, people are buying more cars on finance and the cars being bought are more expensive models than before.
Personal Contract Purchase
This increased appetite for motor finance owes much to a recent invention of the industry: the Personal Contract Purchase (PCP). Industry expert Professor David Bailey describes PCP as the "engine" behind the car sales boom.
The product provides for lower monthly repayments than more traditional finance products such as hire-purchase. This is due to payments being calculated not on the entire value of the vehicle but only on the amount its value deteriorates in the contract period (typically three years). Essentially customers only pay for the value the car loses during their period of ownership. This sum is set at a fixed level at the start of the contract as the Guaranteed Minimum Purchase Value (GMVP) the dealer will ascribe to the car after three years.
At the end of the contract period customers then have three options:
- Making a "balloon payment" (based on a percentage of the GMVP) to retain full ownership of the car; or
- Handing the car back to the dealer; or
- Taking out a new PCP (using any positive equity accumulated in the car to part-fund the deposit).
The appeal of this model is obvious to manufacturers and dealers: lower monthly payments drive more sales and the prospect of repeat business is good as customers nearing the end of their contract period require a new car. In fact the preference of consumers is predominantly to take out a new PCP at the end of their previous contract, rather than making the balloon payment to retain the original car.
For consumers the attraction lies in driving off the forecourt in a nicer car than they could afford to buy outright or through higher monthly payments in a hire-purchase agreement. And because payments are based on the deterioration in value of the car, cars with a higher list price can actually be cheaper than cars priced below them because their resale value will be higher at the end of the contract period. These factors mean that PCP now accounts for a staggering 77% of the vehicle finance market as a whole.
Ensuring future growth
In the short term sales are likely to continue to rise. The SMMT expects over 2.5 million new registrations in 2015 with a year-on-year increase of 1-2%. As the engine of increased sales, the finance industry will invariably grow in tandem to this; particularly as PCP has struck a chord with both dealers and customers. But the industry should be alive to challenges facing PCP and other finance products in the longer-term.
One of the biggest developments in the industry is the advent of driverless cars as rapid advances are being made in the underlying technology. The impact of driverless cars on the market is as yet unquantified.
It could drive further sales as the customer pool expands, licenses now no longer being a pre-requisite to ownership. But equally, it could lead to fewer cars in the long run by facilitating car-pooling and sharing. If you're going on holiday, why not programme the car to drive to a friend or relative who needs it for the week, rather than paying for airport parking?
Jaguar Land Rover and Ford are due to trial driverless models on the roads early next year as part of the UK Autodrive initiative; a consortium made up of the UK's leading technology and automotive businesses and universities. As the only law firm involved in the scheme, Wragge Lawrence Graham & Co will be reviewing the legal and ethical roadmap necessary to allow driverless cars on the mass market.
The consumers of tomorrow
Another challenge is generational: will young people ascribe the same value to car ownership as previous generations? Those of "Generation Y" (people born between 1977 and 1994) have grown up surrounded by the dual detractors of high oil prices and concern about emissions created by fossil fuelled cars - challenging our reliance on cars on both economic and ethical grounds.
At the same time they are native users of modern communication technology - instant messaging, video-calls and social media, and so they may have less need for transport for face-to-face meetings. By way of illustration, a recent survey commissioned by Deloitte shows that 25% of young adults in Generation Y don't plan on purchasing a car within the next five years.
Sustainability of PCP financing
Finally, dealers and manufacturers should examine closely the sustainability of the PCP model itself; will it continue to provide value for both the industry and consumers in the future?
Professor Bailey strikes a note of caution by describing the effect PCP sales may have on the used car sales market. If customers continue the trend of exchanging their cars for a PCP on another new car at the end of their contract period, the second-hand market will be flooded with used cars.
As supply goes up the value of the used cars will fall. Initially this will leave dealers short as they are obliged to exchange the cars on the basis of the GMVP when the actual re-sale value will be lower. In the longer term as GMVPs are adjusted the cost will be shifted onto customers in the form of higher monthly payments. On the other hand the PCP model of ownership may help bridge the appeal of cars to younger generations.
In an article in the Telegraph, Nick Gibbs suggests that young people have been conditioned into comparing products by their monthly payments rather than their lump sum cost - through smartphone contracts. They are used to comparing the value of phones not by its up-front hardware cost but by the level of monthly payments and the extra services included in that fee (texts, minutes and data).
Some car manufacturers, such as Peugeot with their "Just Add Fuel" deals, are already starting to draw on this similarity by bundling free insurance and servicing into their PCP deals. Perhaps the PCP model of ownership might therefore help address the generational challenge and ensure the enduring appeal of car ownership?