This is getting truly ridiculous. On Friday, the world's largest automaker, General Motors (NYSE: GM), upped incentives on many of its 2004 model year SUVs to the record level of $6,000. Heck, I'm not that old of a guy, but I still remember the days when you could buy a brand new vehicle for less than $6,000.
On the one hand, the strategy seems to be working for GM. September sales, when incentives were a bit lower than the recently announced offers, defied analyst projections by jumping 20% over last year's numbers. Now that's impressive -- and it stands in marked contrast to the poor results posted by Ford (NYSE: F) for the month, despite that company's offering similar levels of sales incentives.
Still, this doesn't necessarily mean that GM's incentives are a good idea. After all, $6,000 cash back on vehicles ranging in price from $30,000 to $50,000 translates into discounts of 12% to 20%. That kind of percentage discount would be fine for a company selling Microsoft (Nasdaq: MSFT) software or Cisco (Nasdaq: CSCO) routers -- products with 80% and 70% gross margins, respectively. But cars? No way. Just take a look at GM's margins, and you'll see that GM cannot possibly afford to keep this stuff up. From 2001 to 2003, GM's gross profit margin has dropped from 18.8% to 18.0%. Over the trailing 12 months, it has averaged just 17.8%.
Granted, SUV sales are among GM's most profitable ones. They probably make a bit more than 18% gross profit on those sales. But clearly, regardless of what profits are built into the sticker price, if you remove 20% of those profits and rebate them to the buyer, you're going to eviscerate your net margin.
And that's precisely the catch-22 GM has forced itself into here. In order to improve on its profit margin -- which is just one-third the size of the margins sported by rivals Toyota (NYSE: TM) and Nissan (Nasdaq: NSANY), and just half of Honda's (NYSE: HMC) -- GM must pare back its incentives. But over the past several years, GM has simultaneously (a) trained its customers to expect generous incentives and (b) sold enormous amounts of new vehicles. Put another way, GM has created a situation in which any reduction in incentives will guarantee that customers: (a) think twice about buying and (b) can do so comfortably, as they probably own a new car, bought just one, two, or three years ago.
For more on the great auto incentive wars, read:
Fool contributor
Rich Smith
owns no shares in any company mentioned in this article.
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