General Motors Company (GM): Why Does It Care About Used Car Prices?

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Last year, Volkswagen AG (ADR) (PINK:VLKAY) was the most profitable automaker in the world, reporting a huge $15 billion in operating profit.

That blew away the totals from Toyota Motor Corporation (ADR) (NYSE:TM) and General Motors Company (NYSE:GM), the two automakers that sold more cars than VW.

General Motors (NYSE:GM)

But while Toyota’s $11.1 billion operating profit was at least in VW’s ballpark, GM’s $7.9 billion total wasn’t close.

General Motors Company (NYSE:GM) CEO Dan Akerson is doing everything he can to close that gap – including something that might not seem to make any sense at first glance: trying to raise the used prices of GM cars and trucks.

GM’s used car prices: improving, but not yet great
What General Motors Company (NYSE:GM) actually cares about is “residual values”, the term for how much a vehicle is worth at the end of a lease. If you lease a new car for three years, and the car is worth $20,000 at the end of the lease, that’s the residual value. But it’s often expressed as a percentage: If your car’s sticker price when new was $50,000, we would say that its residual value was 40%.

For a long time, GM’s cars had terrible resale values, a legacy of the automaker’s reputation for cheapness and unreliability. As recently as 2009, in the wake of GM’s high-speed bankruptcy reorganization, General Motors Company (NYSE:GM)’s overall residual values were just 36.5%.

That number has already come a long way, thanks to the improved quality of GM’s cars and trucks. According to a recent Bloomberg report, GM’s average residual value in 2012 was a respectable 44%.

Respectable, but not great. That’s still below the industry average of 46.5%, and well behind the 51.5% posted by Honda (NYSE:HMC) , the leader among mass-market brands.

But why does GM care about the prices of its used cars?

Why GM cares about its used car prices
As Chuck Stevens, CFO of General Motors Company (NYSE:GM)’s North America division, told analysts last week, GM cares because those lower residual values cost the company more money when it comes to leasing. Automakers like GM set lease terms based in part on what the car is likely to be worth at the end of the lease.

If its residual values are higher, that makes it easier for GM to offer lower, more attractive lease terms on new cars. Stevens said last week that GM spends between $150 million and $200 million a year to make its lease offers more competitive with rivals whose cars have higher residual values.



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