Cars Are About to Get a Lot More Expensive Thanks to Inflation, Other Costs

Cars Are About to Get a Lot More Expensive Thanks to Inflation, Other Costs

Cars are about to get a lot more expensive. Manufacturers and drivers should brace themselves.

The price of everything that goes into a vehicle is going up. Raw materials — from the steel used for bodies, gear parts and frames to the plastic that winds up in bumpers and doors trims — account for a big portion of manufacturing costs. These are only growing. Add to that labor, logistics, the pressure to invest in new technologies and creeping inflation, and carmakers are seeing a very different landscape from the relatively profit-friendly market they have enjoyed over the past few months.

Part of what has been helping the auto industry is its scaled-back production. Despite all the complaining about shortages of various parts, including chips, carmakers have kept their shareholders happy. They’ve been smart and uncharacteristically nimble about leveraging broader economic imbalances. Despite plant shutdowns, manufacturers across the globe posted blowout results in the first quarter. They’ve made fewer, arguably better, vehicles and have pushed margins higher.

But when carmakers start consistently talking about lower production, it should be a worrying sign. In the latest set of results, auto giants including the world’s largest, Toyota Motor Corp. and Ford Motor Co., said they will produce far fewer vehicles this year because of a worsening chip shortage. The shortfall alone is expected to result in almost 4 million fewer units, or 5{09c3c849cf64d23af04bfef51e68a1f749678453f0f72e4bb3c75fcb14e04d49} of estimated annual sales this year.

For automakers, this dynamic — of rising expenses and falling volumes — can become problematic all too quickly. That’s because the car industry has high fixed costs to begin with. Firms need to make a certain amount to break even. If production starts dropping quickly, then the cost pressure builds even faster and affects earnings disproportionately.

Consider a car manufacturer with $100 billion in sales. A 10{09c3c849cf64d23af04bfef51e68a1f749678453f0f72e4bb3c75fcb14e04d49} decline in sales volume would push earnings before interest and tax down by 40{09c3c849cf64d23af04bfef51e68a1f749678453f0f72e4bb3c75fcb14e04d49}, the Boston Consulting Group has estimated. That’s an optimistic scenario — and this analysis assumed the company could eliminate all variable costs such as raw materials and labor. In the current situation, that’s not quite possible.

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