House of Commons - Trade and Industry

Select Committee on Trade and Industry First Report

III PRICE DIFFERENTIALS

Fluctuations 1993-98

11. The European Commission's figures are based on the recommended retail prices submitted by European and Japanese car manufacturers of their best selling models. Prices are adjusted for equipment differences and are given in both local currency and in ECU. In May 1993, after the UK had left the ERM and sterling had depreciated, the UK was one of the lowest-priced car markets;[32] by May 1994 the UK was one of the highest priced markets;[33] by May 1996 after sterling had fallen once more, the UK had the lowest prices for 16 of the 78 models surveyed, second only to Portugal.[34] As sterling strengthened between 1995 and 1997, the relative UK prices of many of the cars in the survey increased. By November 1996 the UK was the most expensive for 15 of 75 models,[35] by May 1997 the UK had the highest car prices for 54 of the 75 models examined,[36] and by May 1998 that figure had risen to 60 out of 74.[37]

12. The Commission determined that, to be tolerable, net price differences between Member States (expressed in ECU) should not exceed 12%, or over a period of less than one year, 18%. This was expressed in the Commission's Notice concerning the original regulation and continues to apply under the new regulation.[38] As CA told us "we have seen sustained differences between the United Kingdom and certain other European countries of 30, 40 and 50%".[39] The current price differentials between the UK and other EU countries are far beyond those formally regarded by the EC as acceptable.

Reasons

General

13. There are factors that can influence the validity of such price comparisons as well as factors that can account for any inherent differences. The two main factors that not only influence comparisons but also are put forward to account for the price differentials are exchange rates and taxation levels. Other reasons which may account for the high prices UK consumers currently pay compared to other EU countries include: manufacturers' policies, competition and discounts, fleet cars and car specifications, the second hand car market, and the existence of the Voluntary Export Restraint.

Exchange rates

14. Exchange rates and relative currency strengths have an obvious impact on price comparisons and differentials. In the November 1996 report, the European Commission stated that the new position of the UK as one of the most expensive places to buy a car was "not only due to price increases by manufacturers but primarily to the strong revaluation of the British pound".[40] The SMMT told the Committee that the "prime reason that the prices in the UK appear high compared to Europe is that of currency movement" and that actual car prices had risen by only 2.5% in two years. [41] However, CA stated that "50 % difference in the price of a car here and Ireland, both right-hand drive markets, cannot simply be a matter of exchange rates".[42] They also told us they have been looking at car issues for a considerable time and that " fifteen years ago [we] railed against the high prices that the United Kingdom were paying for their cars. Unfortunately, we have seen very little change since then".[43] Exchange rates have varied considerably during that time.

15. In the November 1997 report the Commission stated that "the price of some models has been lowered in the United Kingdom....this is an appropriate response to the continuing strength of sterling. However, most manufacturers have either not adjusted their prices, or have, in fact, raised them for some models, thus continuing to realise 'windfall' profits".[44] In May 1998 those cars with lowered prices on the British market were the Peugeot 106 (by 7%), the Ford Escort/Orion (by 11%) and the Renault Mégane (by 16%).[45] The argument that the UK's position as the most expensive place to buy cars is primarily due to the strong pound is not substantiated by the actions of the car manufacturers. The Chairman of Vauxhall was recently reported to have admitted that manufacturers "had not cut their prices as fast they could after they had gained from increases in sterling".[46] Elementary economics suggests that in a competitive market a strong currency means cheaper imports. Despite the fact that the UK imports over 60% of its new cars,[47] there does not seem to have been any substantial drop in prices. Either the market is not competitive or the strong pound is not the main reason for the price differentials. As early as 1984, the European Communities Committee during its consideration of the draft block exemption regulation noted that "the suppliers of [] imports take advantage of the higher prices ruling in the United Kingdom. They do this by following the prices set by the market leader rather than using their cost advantage to charge lower sterling prices".[48] Whilst we would not expect car prices to rise and fall directly in line with exchange rates, the fact that consumers are not benefiting from lower prices for imported cars indicates that relative currency strengths do not account for underlying price differentials.

Taxation

16. It is important to take into account the differing levels of taxation on new car purchases in different EU countries when making price comparisons. The Commission's figures specifically exclude those countries (Denmark, Greece and Finland) where particularly high taxation is applied. As the NFDA pointed out "a high tax tends to amplify differences in prices quite dramatically".[49] Taxes levied at 57.6% in Ireland as opposed to 17.5% in the UK do alter the Commission's figures.[50] The SMMT list taxation, along with exchange rate fluctuations, as one of the underlying causes of price differences stating that "in low volume markets where taxes are high manufacturers set local prices to support sales and dealer viability in the short term".[51] As the NFDA put it "Consumers in countries with high car taxes are being subsidised by consumers in countries with low car taxes".[52] In countries where high taxes are in place, list prices for cars are lower than in the UK because consumers in those countries would not buy a car priced at UK pre-tax levels. The SMMT, along with ACFO, suggest that tax harmonisation is a remedy for the problems of high price differentials. The ramifications of such a move would, of course, stretch well beyond car price differentials. We are disturbed to have discovered that consumers in lower tax countries such as the UK are, as a result of manufacturers' policies, paying higher prices for new cars than their neighbours so that the national treasuries of those higher taxed countries can be assured of more revenue.

Manufacturers' policies

17. There have been some suggestions that the higher prices faced by UK consumers are simply due to the manufacturers themselves. As CA put it, "the primary bodies responsible for the situation are the manufacturers, that is fairly clear" due to their ability to "restrict the market".[53] The Commission stated in its first price comparison of May 1993 that "it is not possible to distinguish between the purely mechanical effects of the devaluations on the prices in ecus and the consequence of manufacturers' commercial policies".[54] ACFO differentiate between factors which affect list prices and those which affect transaction or invoice price levels. They state that, in their view, "the largest single factor leading to price differentials at list price levels is the manufacturers' aspirations for its model range across different markets".[55] During oral evidence the NFDA told us "we are, we believe ... subsidising other export markets" and "you will find products produced in this country, landed in that country at a price well below that which is in place in this country. This is because the manufacturer has chosen to subsidise that market to obtain market share... In turn, they look at this market and, over a number of years, have succeeded in keeping prices high."[56] As they stated in written evidence, " we have a perfect scenario for higher than average prices, as manufacturers seek to balance volume and profit opportunities across the whole of the EC".[57] Whilst manufacturers will, of course, price goods according to a range of variants such as market share and customer demand, we are concerned that UK car buyers appear to be suffering as a result both of car manufacturers wishing to increase their market share elsewhere, and of manufacturers' confidence, well-founded or not, that UK new car buyers will be willing to go on paying over the odds.

Competition and discounts

18. The motor vehicle industry is characterised by over-supply. It is suggested that there is potential manufacturing over-capacity of 5 million units per year worldwide and a "constant tendency to produce rather more than is truly required to satisfy customer demand".[58] Nonetheless, it is still claimed by both car dealers and manufacturers that it is an "ultra competitive environment".[59] The opposite view is held by CA who stated "you do not see enormous price competition in this market".[60] To understand the divergence of opinion on the issue of competitiveness, it is important to distinguish between inter-brand and intra-brand competition. Whilst the number and variety of models available points to the existence of inter-brand competition (ie between manufacturers of different brands), the tendency towards consolidation creating fewer, but larger, dealer territories has led to a reduction in intra-brand competition (ie between different retailers of the same brand).

19. The car dealers maintain that there "are more brands represented in the United Kingdom than any other market" with around 55 brands and well over 1,500 variants in the price list.[61] They also argue that new products coming on to the market are generally "being brought in by manufacturers at very competitive prices, probably with more specification, no increase and maybe in some cases a decrease".[62] However, the operation of the current arrangements means that the manufacturers set the wholesale and list prices leaving very little margin for car dealers. Over the years, dealers' margins have been systematically squeezed, leaving them with "arguably the lowest margins in Europe".[63] The NFDA state the benefit from this is "consistent national pricing";[64] CA's view is more critical stating that retailers are not free to sell cars at the prices they wish as "undue pressure [is] put on them to sell cars at the price that the manufacturer wants them to".[65]

20. ACFO assert that " a single retail customer can normally negotiate substantial discounts for a single transaction-provided he has no trade in".[66] However, CA describe "a culture of discounting" that is actually an "illusion".[67] The dealers find it difficult to offer discounts because they are being "squeezed" and this "creates a structure which stops consumers being able to negotiate a good deal".[68] Any discounts that are offered to consumers will be constrained by the margin of the car dealer, normally around 10%.[69] The control exercised by manufacturers over dealers' margins has taken the possibility for varying the invoice price out of the dealers' hands. The nature of the relationship between manufacturers and dealers means that the manufacturers have dominant power over retail prices.

Fleet cars

21. Fleet cars account for a substantial percentage of the new car market in the UK. One of the MMC's principal findings in 1992 was that the company car was "far more significant" in the UK than in the rest of Europe.[70] The NFDA argue that the fleet buying power means fleet operators are able to attract discounts of "20% and 40%"[71] and that "the retail customer was subsidising the discounts to the fleet and corporate market...this fact continues to be the principal reason behind the current price differentials".[72] They reiterated in oral evidence "we suggest most strongly that retail customers who have to pay closer to high list prices have been subsidising the large corporate fleet buyer".[73] However, ACFO stated in their evidence that a 30% to 35% discount from a list price would be considered "exceptional" even for a very large fleet and the "majority of fleet operators buy the majority of their vehicles at discounts ranging from between 5% and 11%".[74] They deny that most fleet buyers are regularly receiving large discounts, while conceding that "a small number of very large fleets, buying several thousand vehicles from a single source each year, command significant discounts".[75]

22. Large buyers are also increasingly dealing directly with manufacturers, thus reducing the role of the car dealer to that of facilitating the distribution and delivery of the vehicles. ACFO state "there are occasional very exceptional deals, normally associated with wholesale clearances of manufacturers' surplus inventory".[76] The overcapacity in the market means that if manufacturers acquire a large stock of unsold cars then these are "distressed marketed". A fleet operator who is willing to accept large number of these cars "thereby relieving the manufacturer of an inventory problem, would expect to be rewarded for this through discounts".[77] ACFO also state that other production-surplus vehicles are registered to the dealer or manufacturer, thus appearing to be fleet purchases, and then are sold as 'used' or 'delivery mileage only' cars. This puts the UK consumer "at no disadvantage to the typical UK fleet operator".[78] In a market characterised by over-supply, such sales are to be expected.

23. The MMC report found that the size of the company car market has "created a class of professional buyers who are able to secure greater discounts than are generally available". The report went on to say "The higher prices paid by the private consumer finance the discounts given to company car buyers".[79] Given the size of the fleet market, it would seem inevitable that fleet buyers will be in a position to negotiate substantial discounts: that the manufacturers seek to recover from other sales some of the profit foregone: and that as a result consumers find themselves paying considerably higher prices.

Car specifications

24. Both the SMMT[80] and ACFO state that UK customers show a consistent preference for high specification vehicles. ACFO refer to a "powerful body of evidence" that Japanese marques made great inroads in the UK market because they were "fitted with all the bells and whistles".[81] Common sense would dictate that if Japanese cars had all the 'extras', were reliable and competitively priced, they would do well in any market-price and reliability are likely to be key determining factors despite the assertion that on mainland Europe cars tend to be regarded as more utilitarian.[82] The NFDA believe that the manufacturers' desire to gain a greater share of the fleet market was behind car upgrades, forcing greater competition within specifications. As they put it "the first manufacturer to include sun roofs within in their standard specification gained market share over those without. Over a period of years we saw the addition of sun roofs, alloy wheels, metallic paint, fog lights and now air conditioning, added in an attempt to entice more custom from 'user choosers'".[83] These items were extended across the manufacturers whole range and list prices were increased. It is suggested that "fleets paid no more" and the final cost burden fell on the domestic consumer. "It is very clear that the retail customer was confronted with a higher list price with little or no scope for negotiation".[84] In 1992 the MMC concluded that the power of the company car buyer was such that it had a distorting effect on the market in that it encouraged high specifications and was one of the main reasons why United Kingdom cars were so much more richly specified than their continental equivalents.[85]

Second-hand Cars

25. In their evidence to us, both car dealers and car manufacturers cited residual values as a key concern, arguing that lower list prices for new cars in the UK would have an adverse effect on the used car market. The SMMT state that part exchange prices have traditionally been higher in the UK than elsewhere and that "manufacturers are keen to protect residual values, to maintain and improve their market competitiveness and promote affordability by reducing the cost to change to a new car".[86] In oral evidence they told us that part of their pricing policy was to "protect" second-hand car prices and that they are "responsible for all the customers who buy our products in terms of giving them service throughout the ownership experience. That includes making sure we, as manufacturers, do not do anything to undermine the fundamental value of their vehicles".[87] Whilst residual values are important, particularly for those who wish to trade in their existing car for a new one, and whilst lower new car prices might indeed lead to lower second-hand car values, this in itself is not a justification for high car prices. Consumers are not the ultimate beneficiaries of high prices in the second-hand car market.

26. The current structure of the market means that whilst the car dealers may lose out on large sales between the manufacturer and the fleet operator, they may gain through the second-hand market when fleet cars are auctioned. The NFDA told us that "the fleet operator wishes to dispose of those vehicles in very large quantities in a way a member of the public could not do" and that "our aim is to buy those vehicles in large quantities and distribute them round our dealerships for onward sale at very competitive prices".[88]

Voluntary Export Restraints

27. In order to protect UK manufacturers, Japanese exports of cars to the UK have been the subject of Voluntary Export Restraints since the end of 1975. The intention was to limit Japanese new car imports to about the share of the UK market that they held in 1975, ie around 11%.[89] The agreement, negotiated between the SMMT and Japanese Automobile Manufacturers Association (JAMA) (and with the support of the Government)[90] meant that over the years 1976 to 1990 the Japanese penetration of the UK new car market has fluctuated between 9.3 and 11.9% .[91] The restriction fell to around 7.3% in 1998,[92] to allow for Japanese cars manufactured in the UK. Subaru stated in their Memorandum to the Committee that they "continue to be severely hampered by continuing and tightening restrictions on the import of Japanese vehicles". The restriction is due to be lifted at the end of 1999 although Subaru are sceptical: "Official statements that the quota system will end in 1999 are treated with considerable scepticism. We have heard this all before."[93]

28. Four other European Member States have national restrictions on new car imports from Japan. In France the Japanese share of the market is limited to 3%, in Italy a quota agreement means that overall, Japanese penetration is less than 1%, in Spain the quota amounts to less than 1% of the market and there is a small quota in Portugal.[94] The MMC looked at the situation in its 1992 report and concluded that "VERs on imports of Japanese cars are the principal restriction of competition in new car sales in the United Kingdom, and the main factor in prices being higher than they otherwise should be, through reduced competition and because there is less incentive for Japanese suppliers to cut prices or sell cheaper models as the number of cars they can export is restricted".[95] We noted with surprise during evidence from the Secretary of State for Trade and Industry on 4 November 1998 that the question of the expiry of the Vertical Export Restraint had not been addressed by him.[96] However, we welcome the statement in the Pre-Budget Report of 3 November 1998 that the expiry of the VER was "fully supported by the Government",[97] and the subsequent confirmation of the Secretary of State's support in a note to the Committee and in a written answer.