Vehicle "scrappage rate" drops
By Marc Stengel
NOVEMBER 16, 1998: You don't have to be a full-time financial analyst to understand some of the interesting trends shaping today's automotive marketplace. You just have to be curious about the way seemingly unrelated circumstances may actually influence each other in powerful ways.
Consider, for instance, the fact that the median age of all vehicles on the road skyrocketed to 7.9 years in '96 from a mere 4.9 years in 1970. What's known as the scrappage rate--the percentage of vehicles headed for the dumpster--is down to 6 percent so far this decade, compared with 8 percent in the '60s. The obvious conclusion is that used cars are lasting longer--significantly longer. So what?
Well, on the flip side is the fact that new-vehicle sales have been fairly flat for the last 18 months or so. As of October '98, total sales of all new cars and trucks have grown just 1.74 percent compared to the first 10 months of '97, while car sales by themselves have actually dipped 2.8 percent for the same period. Clearly, new cars have reached--or are approaching--a saturation point.
"Pre-owned" vehicles, by contrast, are the objects of all kinds of new sales and marketing schemes. That's one reason why used-car superstores are popping up nationwide, with two slated for Middle Tennessee in the very near future. But potentially more meaningful to individual used-car buyers is what the industry bible Automotive News calls the "sales surge" of used-car service contracts. These extended warranties for used cars represent an exciting new source of big profits for dealers; for buyers, however, it's more profitable to beware.
Everyone knows about extended warranties, right? You can't even buy a boom-box without being asked to gamble whether the cost of future bad luck will outweigh the immediate price of an extra little insurance premium tacked on to the bill of sale. It works basically the same way for new and used cars--except with a used car, the risk that something might go wrong is deemed to be greater. Accordingly, the premium is priced a little higher. But here's an interesting little secret: According to Automotive News, that premium includes a profit of 50 cents on the dollar!
Marketing these used-car contracts is subtle and sophisticated. Because of the used-car glut, manufacturers are stumbling all over themselves to create and promote "vehicle certification" programs intended to reassure buyers that "used" is actually synonymous with "like new." A certified vehicle is typically 2 to 4 years old with low mileage and a good report card following a thorough inspection of 100-plus service and wear "points."
Once the vehicle is certified, the manufacturer instructs its dealers to honor a basic used-car warranty that can range from one month/1,000 miles to three years/36,000 miles. But--and this is the important part--an extended service contract is also available...just in case. The sales psyche usually goes something like this: "The manufacturer has certified the car, so it must be OK; but it is used, after all. Why not buy a little extra insurance just to be safe?" It's a persuasive pitch. Reports show that half the buyers of used vehicles certified by GM and Toyota, for example, elect to purchase extended coverage.
Intrinsically, there is absolutely nothing wrong with the extended-service concept; and in many cases, it can be the safest, best option for the buyer. Toyota's contract, for example, specifies six-year/100,000-mile warranty protection for almost anything that might go wrong with a certified used vehicle. But before reflexively signing an extended service contract that may add as much as $2,000 to the price of a $12,000-to-$14,000 used car, it pays to ask a few questions and do a little analysis:
1. Who actually backs the extended-warranty policy?The best answer is "the manufacturer," which doubtless will remain in business well beyond the term of the policy. Unfortunately, the same cannot be assumed about all third-party insurers. If your contract issuer goes belly-up, the service agreement won't even make a good swab for your dipstick. A little research and phone-calling can tell you a lot about who's going to hit the road with you for the next three years/36,000 miles.
2. Is the warranty transferable and/or renewable?Even if you're lucky enough never to have to make a claim against your service contract, it can still add significantly to the value of your vehicle should you decide to sell it during the coverage term--but only if the contract is transferable to any new buyer without qualification. By the same token, a set renewal clause at a fixed price will afford you the valuable option of holding onto a car longer than you had originally planned without increasing your maintenance risks. These are crucial--and typical--"fine-print" items that you usually have to ask about, or, better yet, discover for yourself by carefully reading the entire service agreement.
3. How long will you keep the car?There's no sense in paying up-front to over-insure a vehicle that you know you'll be selling before the service contract expires. Of course, a transferable contract may allow you to recoup some of your premium; but if you're not sure how long you'll keep the car or you know you'll be reselling soon, just make do with the basic warranty that comes with most certified used cars. Find out the deadline for purchasing a service contract on this car at a later date; then, if your plans change and you decide to hold on to the vehicle a bit longer, you can buy extended protection before the basic warranty expires. But be sure to ask first!
4. What will a dealer take for a service contract--regardless of what he's asking?Let's face it: A 50-percent profit on any product or service is an invitation to haggle. And shame on you if you don't. Extended service is one of the highest-margin products a car dealer has to sell. Don't make the mistake of negotiating hard-ball for your used car only to give the dealer a winning home-run in the form of a full-price service contract. A rule of thumb is to offer two-thirds of what the dealer's asking for an extended warranty, then settle for somewhere between three-quarters and seven-eighths. Even if he whines about it, that's still a spread of from 12 to 31 percent profit for the dealer no matter what; and now he knows you're paying attention.
Extended service agreements can be a great boon for the used-car buyer, but a blanket warranty against bad mechanical luck in the future is no substitute for good ol' common sense right now. Ask questions and crunch the numbers to determine whether a service contract might extend your leverage the next time you negotiate for a used car. Otherwise, you may find yourself outwitted and overextended in the bargain.
To comment, recommend, or blow off steam, your e-mail is welcome at Autosuggestive@compuserve.com or by fax at (615) 385-2930. Dealer news and other views are also invited.
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