Inflation has been on consumers’ minds for months now, and there are few industry sectors in which its effects are as evident as in automotive. From 2021 to 2023, core inflation experienced a significant rise: 3.6% in 2021, 6.2% in 2022 and around 5% in 2023. In that same period, Manufacturer’s Suggested Retail Prices (MSRPs) for vehicles increased at an even faster pace.
But that is only part of the story. The actual prices consumers pay – the transaction prices – have soared at a far higher rate than both. That is almost certain to have consequences as the rest of the decade unfolds.
Before the pandemic, MSRP increases were typically around 2%, aligning closely with inflation. However, post-2020, both inflation and MSRPs have escalated, with industry average MSRPs now increasing roughly in line with or slightly higher than inflation: 4% in 2021, 6.7% in 2022 and nearly 5% in 2023.
The bigger concern isn’t the MSRP hike; rather, it’s the net transaction prices that consumers face. In the “normal” pre-pandemic market, dealers typically reduced their margins, and manufacturers matched competitors by offering incentives to lower prices, essentially meeting consumers halfway.
But in supply-constrained years 2021 and 2022, dealers typically did not lower their margins, leaving minimal negotiation room for shoppers. At the same time, manufacturers also drastically reduced incentives from around 10% of MSRP pre-pandemic to just 2% in 2022.
As a result, the actual prices buyers paid shot through the roof. In 2022, industry-weighted average transaction prices spiked by 13% from 2021 on top of a similar increase from 2020. While increased MSRPs are part of the equation, the dramatic rise in what buyers are paying is driven by the absence of support mechanisms – dealer discounts and manufacturer incentives – that are used to mitigate the effect of annual MSRP hikes.
Before the pandemic began in 2018, transaction prices typically stood at around 85% of MSRP. During the pandemic in 2022, the average transaction price escalated to 100% of MSRP. Although in 2023, this has slightly decreased to 95% of MSRP, it remains notably higher than pre-pandemic levels.
The surge in transaction prices has significantly enhanced dealer profits. While in pre-pandemic times, dealers had operated on slim front-end margins of less than 1%, during the pandemic margins reached 5%-7%.
As supply gradually returns, dealer margins are decreasing but still remain higher than pre-pandemic levels.
Continued inflation compounds the situation. Before 2022, carmakers typically raised prices only during model-year changeovers. But in light of the supply constraints felt in 2022, automakers began increasing MSRPs between model year transitions, aiming to capture additional margin. Some manufacturers have raised MSRPs to match the current higher dealer margins, a move that seems logical at first glance but could create challenges when readjusting in the future.
One complicating factor is “competitive asymmetry.” Not all manufacturers recovered uniformly from the supply chain disruptions post-pandemic. Some had supply but refrained from increasing prices, while others, despite having vehicles, prioritized higher-priced models or limited production of lower-end vehicles, focusing on more expensive SUVs or pickups. Consequently, consumers currently face a market where MSRPs are rising for available vehicles, especially on high-end models, while lower-priced or more affordable trims remain relatively scarce.
This strategy makes sense for manufacturers striving to maximize profits when faced with limited resources like materials and semiconductors. The transition out of this scenario isn’t smooth, as rolling back prices in the two-tier auto distribution chain is difficult.
Traditionally, manufacturers countered consumer price resistance by offering incentives rather than lowering MSRPs. Now, the significant year-over-year increase in MSRPs poses a dilemma for manufacturers. Reverting to pre-pandemic pricing levels through incentives would demand astronomical incentives due to the escalated MSRPs.
While dealers are currently experiencing lower grosses compared with the peak pandemic years, they are still operating with margins significantly higher than pre-pandemic levels. Manufacturer inventories are below pre-pandemic levels but show a significant disparity in their recoveries. Some still struggle with supply, while others are regaining stability. This results in an imbalanced inventory, with customer demand not fully met.
For many potential new-vehicle buyers, current prices are simply too high. Median transaction prices for vehicles were around $30,000 in 2019 (i.e., half of the industry new-vehicle retail sales were below $30,000). However, in 2023, the median has shifted to $40,000, $5,000 above the inflation-adjusted price of $35,000. To ward off the effects of inflation and increasing interest rates, adjustments in production – favoring lower-priced trims and vehicles – and increased manufacturer incentives are necessary. This disparity and the readjustment efforts needed to remedy it define the current industry challenge.
Normalization involves various approaches. Manufacturers with constrained supply need to ramp up production to meet demand, while those with oversupply seek strategies to balance their inventory. This rebalancing act is crucial for the industry to regain equilibrium.
Forecasts indicate a potential return to balance in late 2024, as manufacturers align production with demand, potentially stabilizing prices. Post-2025, while prices might remain elevated, the focus will shift from pricing to other factors such as interest rates and market dynamics. Achieving this rebalance and stabilization is the industry’s primary goal moving forward.
Srini Rajagopalan (pictured left) is managing director of Data & Analytics at, J.D. Power.
