Why are car prices high and when will they drop?

It’s a wild time out there in the car market. Wild in a good way if you’re a car dealer trying to sell a car. Wild in a less good way if you’re a consumer looking to buy, which is the spot Richie Iglar recently found himself in.

In the fall, he and his wife were in the market for an SUV and made an appointment at a Mercedes dealer in New Jersey. The salesman was “super nice” throughout most of the process, Iglar explained … until it came to the price. The dealership wanted to charge them $20,000 over the manufacturer’s suggested retail price (or MSRP).

“We were both shocked and politely declined, saying while we would like to have the car, we can’t justify over-spending for it,” he said. Iglar emailed another dealer trying to get a sense of what their markups were, and a week later they responded they were adding on $15,000. He decided to put a pause on buying. “I can’t justify spending that much over sticker.”

Iglar is hardly alone. Tens of thousands of dollars over the sticker is something of an outlier, but across the country, people on the hunt for a new vehicle are being met with significant dealer markups, thanks to supply shortages and high consumer demand. New car dealers have the upper hand at the moment, and some of them are willing to use it.

“At the end of the day, it’s saying, ‘Look, if you don’t buy this, the guy right behind you or the gal three people behind you is going to, and they’re going to pay me $1,000, $2,000 more than you’re willing to, so I have to go with them.’ It’s one of the first times in history where the dealer has so much demand that they can actually do that,” said Ivan Drury, senior manager of insights at Edmunds, a consumer research company. “If there are five people raising their hand to buy the exact same product, you just go with whoever is bidding the highest.”

According to Kelley Blue Book, the average new car price in the United States was $46,085 in February, $5,000 more than it was a year ago. Going by the Consumer Price Index, which measures what consumers pay for goods and services, new vehicle prices are up 12.4 percent over the past year. (Used car prices are up a ton, too, but for this story, we’re focusing on new ones.)

How much are dealer markups contributing to this average price increase? The answer is certainly not all of it, or maybe even most of it. But they’re not helping, either. “It comes down to if someone’s willing to pay it, and they can sell it and keep selling it, I think they’re going to ride that train as long as they can,” Iglar said.

Amid the current inflationary environment, there’s a broader debate going on about what’s causing prices to rise. Some Democrats and economists argue that corporate greed is playing a role, basically saying that companies are taking advantage of the moment to boost their profits even when it’s not necessary, and contributing to higher inflation overall. Other economists have dismissed this, saying it’s a flimsy excuse, and that other factors, among them supply chain problems, increased demand, and commodity prices, have much more of an impact. After all, corporate greed wasn’t invented in the pandemic.

I am not going to litigate whether profiteering — which is generally legal in the US — is driving up inflation. But it’s hard not to recognize that in some corners, businesses and CEOs and salespeople are likely looking at the current economic landscape and thinking, “Eh, why not bump that price tag up a little more?” And who can blame them? That’s capitalism.

“Are they taking advantage of the situation? Yeah,” Drury said with regard to dealers. “I think they’re doing exactly what anyone else would if they were selling something too.”

This is capitalism. Welcome.

In an environment where goods are scarce, intermediaries can push up the prices to pocket the money. We are in an environment where goods are scarce, and where, because of inflation, people sort of expect prices to go up anyway, and so in some corners, there’s a little bit of padding going on.

Even in a moment like this, with inflation on the rise, the point of companies is to make money. Many executives have been pretty open that they’re able to pass on price increases to consumers and keep their margins up, or do a little bit better. Procter & Gamble, for example, has hiked prices on a variety of items over the past year, including diapers, razors, and feminine care products. It has helped them deal with rising costs but also has helped them increase revenue.

Are these price increases along the margins creating broad-based inflation across the economy? Many economists say probably not. But in the system we live in, when businesses big and small are in a position of power, they use it, and that’s certainly not helping.

“We need to be honest that price changes are complex, and I don’t think it’s fair to boil it down to a single cause. Saying that profiteering is playing a role and profiteering is driving inflation are two different arguments,” said Mark Paul, an assistant professor of economics and environmental studies at New College of Florida. “The degree of price increases we’ve seen today are absolutely in line with a story where car companies are charging consumers above and beyond what should be considered a reasonable markup due to these market disruptions.”

Eventually — and hopefully — the current supply/demand mismatch the automotive industry is seeing will sort itself out. The semiconductor shortage will subside, other production and supply chain bottlenecks will settle, there will be more new cars available, which should also help the used car market settle down. And that, again eventually and hopefully, will help cool inflation down. (New and used cars are a pretty significant factor in current inflation numbers.)

In the meantime, consumers like Iglar can bide their time and wait for things to settle back down. Or they can bite the bullet and pay much more than they’d like to for a new car.

If you want a new car right now, you have to really ($$$) want it

Previously, it’s been pretty rare for shoppers to pay above sticker price for new cars. Now, it’s pretty common.

According to Edmunds, 82 percent of customers paid above sticker price for a new car in January of this year. For some perspective, that figure was 2.8 percent in January 2021 and 0.3 percent in 2020. On average, transaction prices for a new car in January were $728 above the sticker price. In the same month in 2021 and 2020, they were more than $2,000 below it. For some higher-end vehicles, like the one Iglar was in the market for, dealers are charging tens of thousands of dollars above what manufacturers suggest.

In more normal times, it’s car dealers that are often trying to undercut one another on prices to attract customers and compete. Now, with inventories so low, it’s customers who are competing with each other for vehicles.

Bill Brunner, vice president and general manager at Paramus Chevrolet in New Jersey, told me that right now he has about 80 cars on his lot compared to what used to be 300, 400, or even 600 vehicles available. The scenario has created what he describes as a “balancing act” on pricing. “Our prices have definitely adjusted based on availability,” he said. “Having said that, we still need to be conscious of our customer base.” He knows some people have a budget. He also wants customers to come back next time their lease is up or they want to buy a new car.

Brunner said he’s starting to see some vehicles come through with more volume now, which will allow his dealership to be more competitive with the pricing. But it all really just depends on what they have. “There were some vehicles that we made better gross profits on than we would have if we had 100 of them in stock. It’s just supply and demand. If we had two of a particular model instead of 100, our pricing structure is different. It’s just the way it is,” he said. Brunner also noted the pandemic has been tough on dealerships, as it has been on a lot of businesses.

Still, some auto manufacturers aren’t loving the situation and have told dealers to knock it off on some egregious price hikes out of concern it will hurt their brands. (A lot of people don’t realize it’s the dealer that ultimately sets the price, not, say, GM or Ford.) Traditional auto manufacturers are also dealing with competition from companies such as Tesla, which sell direct to consumers. Plus, a number of car companies are launching electric vehicle products that they hope will expand their customer base, and many of those vehicles already come with long wait times.

“You figure somebody’s trying out your brand for the first time and it’s an EV product, you don’t want to ruin that relationship by saying, one, you’re going to wait, and two, you might pay more than you expected,” Drury said.

In a February earnings call, Ford CEO Jim Farley said that the automaker believes 10 percent of its dealers over the last year had charged above-MSRP prices and warned that “future allocation” of their models would be impacted by those policies, meaning the dealers in question might not be getting their most popular cars. The Wall Street Journal reported that GM also told dealers in a letter it might take action against a “small minority of bad actors” selling and leasing far above sticker price.

The Wall Street Journal has also reported that Toyota and Honda have talked to individual dealers about charging above MSRP, too. Jack Hollis, Toyota Motor North America’s senior vice president of auto operations, told the publication he thinks dealers thinking only about the short term are making a mistake. “If that customer experience is great during this time, they’ll be with you,” he said. The Journal noted that many dealers aren’t happy with the practice, either, because they worry it could damage the entire sector’s reputation.

To be sure, dealer markups are not the only thing contributing to price increases. “A whole slew of things” are making cars more expensive, said Stephanie Brinley, principal automotive analyst at IHS Markit. The pandemic has tossed the car industry into chaos over the past couple of years. Semiconductor shortages and supply chain woes have caused major setbacks in production, and the costs of making and moving the cars have gone up as well. Brinley pointed out that many consumers also want more, costlier features, which drives prices, too. “It’s a combination of trying to maintain margin and keep profitability up, but it can’t be done if consumers don’t want it,” she said.

Many of the vehicles with the highest markups are ones that are already pricey to begin with. “If you have $50,000 to spend on a car, how bad can someone feel for you when they can’t afford a $15,000 used car?” Drury said. “I don’t feel bad for certain people when they can bid up the price.”

Brinley pointed out it’s pretty easy to figure out what manufacturers suggest the price should be on a new car — the information is readily available on the internet. If you’re in the market for one, she suggests looking it up and then going from there. “Figure out what you’re willing to pay, and if you’ve got a dealership that is charging more than you might be willing to pay, you might not get a car in the next two hours, it might be a bit more complicated, but move on,” she said.

In the current landscape, you might have to be in “move on” mode for a while.

We live in a world that’s constantly trying to sucker us and trick us, where we’re always surrounded by scams big and small. It can feel impossible to navigate. Every two weeks, join Emily Stewart to look at all the little ways our economic systems control and manipulate the average person. Welcome to The Big Squeeze.

Have ideas for a future column? Email [email protected].

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