For many, buying a car is the second-largest purchase they will make in their lives, after their home. The number of first-time homebuyers in the UK rose to a 12-year high in August 2019, thanks in part to government initiatives such as Help to Buy. Meanwhile, the rate of car ownership by UK households has held more or less steady at around 78 per cent, largely due to the growing availability of different financing options.
Since the recession, the popularity of personal contract purchase (PCP) has boomed, allowing buyers to spread the cost of their car and keep the option to trade it in, while helping retailers and manufacturers increase customer retention. However, in recent years, the rise of personal contract hire (PCH) and, later, subscription services such as Zipcar have threatened to undermine the very idea of car ownership. But what do the emerging trends in motor financing tell us about the future of the sector? And what does the rise of 'mobility-as-a-service' offerings mean for the auto retailers?
PCP began in the 1990s with Ford Options, allowing customers access to a new car for a monthly fee based on their expected mileage, deposit amount and the length of their agreement. However, it didn’t emerge as the most popular way to buy until after the financial crisis, when it allowed customers access to vehicles they may have struggled to buy outright, while retaining an option to change that was lacking from more traditional hire-purchase (HP) agreements.
PCP is now the largest source of motor finance in the UK, and data from the Finance & Leasing Association show that its popularity is still growing, although long-term leasing, or PCH arrangements, are gaining ground rapidly.
How does PCP work?
Under a PCP arrangement, a customer is offered the car for a deposit plus a monthly fee, which varies based on the length of the agreement, the expected mileage and the size of the deposit. During the agreement, they have the option to trade in their car for a different one, and at the end they can pay a “balloon” payment to own it outright.
As the customer is not buying the car outright, their payments can be set lower than they would be on a hire purchase agreement – where they pay off the car’s entire value – said Adrian Dally, head of motor finance at the FLA. “What you’re really funding is the depreciation, you’re borrowing less so you’re paying less”.
However, some argue that, besides being a question of price, the rise in PCP is reflective of a wider societal shift towards usage, rather than ownership, of assets.
“It’s a bit like when you have a phone you use or rent,” said Steve Oliver, founder at consultancy Oliver and Twist, “you don’t ever really think about it as whether you own it or you rent, it’s just your phone… to an everyday life point of view it’s irrelevant, really”.
Taken in isolation, customers simply opting for a cheaper way to access a vehicle is unremarkable. However, the way the sector changes in the future could have a profound impact on the companies that operate within it. PCP has allowed manufacturers and retailers to deepen the relationship they have with their customers, but if the subsequent rise in hire arrangements and mobility-as-a-service offerings signal a shift away from consumer ownership of these assets, there could be dire effects for the companies that make their money selling them.
One advantage of PCP arrangements from a retailer’s perspective is that they drive far higher retention of customers. The option to renew after the initial period means there is an additional opportunity to sell to the customer, having built up a better understanding of their tastes, needs and usage patterns.
“The loyalty rate of a customer who buys on PCP both for repeat purchase of another car and for aftersales is literally twice that of customers who don’t buy on PCP,” said Ian Plummer, commercial director at Autotrader (AUTO).
The average price of a used car has risen
For this reason, it has created an advantage for the retailers that have a strong position with popular car brands. Marshall Motor (MMH) recently became Volkswagen’s largest partner in the UK in terms of locations, with the acquisition of seven franchises. These relationships allow retailers to command higher prices on used vehicles.
“The most expensive place you will buy a used car from is a franchise retailer,” said Daksh Gupta, chief executive of Marshall Motor Holdings. “When you’re making what will be your second largest purchase outside of your house, you want that peace of mind for that investment… you’re going to have the warranty that the manufacturer wants that comes with it, manufacturer parts, manufacturer service.”
There has been some controversy over PCP arrangements, with the FCA publishing a report on the sector in March 2019, citing concerns over the potential for misaligned incentives. It announced plans to change how retailers receive commission in October. It is currently carrying out an investigation into legacy sales processes at Lookers (LOOK), after an independent review commissioned by the group found some issues with its sales process.
Mike Allen, analyst at Zeus Capital, also warned that sterling weakness since the EU referendum could also pose a threat to PCPs, by removing some of the currency benefit EU-based manufacturers enjoyed.
“When sterling was strong there was added margin you could use for stimulation, when it goes the other way you have less margin to play with.”
He added these concerns would largely disappear if the UK left with an attractive deal, but if there was no deal, “those cars become unaffordable”.
Hire, don't buy
PCH is a leasing agreement that allows the customer to rent their car over a set period of time, often a number of years. Leasing allows people access to cars at what is often a lower price than a PCP or hire purchase agreement would allow, but they do not have the option to purchase the vehicle and may face charges if they want to exit the agreement early.
“I think that people look at everything increasingly as it’s all about usage” said Mr Oliver. “It is much more geared towards how I use that product or service.”
The risk for retailers is if the rise of PCH is part of a wider shift towards a usage-based view of the economy. Already companies such as Zipcar and Uber (NYSE:UBER) offer what has become known as ‘mobility-as-a-service’, allowing people to cheaply rent cars or bicycles for a short period of time. Already manufacturers have begun to enter the market. Volkswagen has formed a partnership with Zipcar, and BMW and Daimler last year formed a joint venture to work in urban mobility services, encompassing everything from ride-hailing and electric car charging points, to parking services.
“I think this is what manufacturers will be working on,” Mr Oliver said. “...We’ll see manufacturers looking to provide more and more of those services.”
However, Mark Lavery, chief executive of Cambria Automobiles (CAMB), was sceptical that most customers would be comfortable with sharing their car.
“People like to drive what they consider to be their car,” he said.”In the customer’s mind whether it’s PCH, PCP or HP, it’s their car. It’s not rented and its not shared.
Expert view
In terms of new car market stimulation, the PCP boom is certainly easing, but the bubble has far from burst. There has been increasing speculation that the ubiquity of car finance could have negative consequences for the economy. Some commentators are concerned that to hit high volumes, lenders have made credit acceptance easier, thus making PCPs more readily available to those with less than perfect credit records – and unable to fulfil their commitments, like the sub-prime housing market in the US.
Other concerns include the impact of the massive increase in end-of-contract cars hitting the second-hand market, placing too much pressure on what is already a delicate eco-system, the effect of which will dramatically decrease the price of used cars. However, as per our Retail Price Index, there is absolutely no evidence of this on our marketplace.
Manufacturers and industry bodies have been keen to point out that drawing comparisons with the housing market, along with other forms of consumer credit, is incorrect. Unlike housing, where prices can go in any direction, the value of cars can generally only go down, and in a relatively predictable way. As a result, manufacturers assess the risk very carefully and are conservative in their outlook, offering PCPs with a buffer to safeguard against a fall in car prices.
PCP arrangements in the UK differ to those in the US as they are often taken over shorter time periods, but importantly they aren’t associated with a sub-prime consumer lending base and therefore aren’t associated with the same level of risk as other lending facilities. What’s more, PCPs are backed by assets, the cars themselves, unlike many forms of consumer lending. The suggestion that retailers have built a false economy for themselves is an inaccurate one.
Excerpted from Has the finance bubble burst?, a report from AutoTrader
