New-vehicle production issues and steady demand fueled by continued population growth have created unprecedented profit margins on historically low volumes. The past 18 months have raised many pressing issues about the sector’s ability to sustain this high-octane dynamic.

Intuitively, most leaders understand that the current trends are not indefinitely sustainable. The question is: When will market conditions shift in a new direction?

According to the ALG natural demand metric, a potential inflection point for the relationship between supply and demand to flip could come as soon as 2024, barring any other major disruptions in the market. While manufacturers and dealers can leverage ongoing supply and natural demand imbalances to support higher transaction prices, it will be necessary for the industry to be prepared for swift adjustments when natural demand is eventually met.

Natural demand addresses pent-up demand from deferred sales during economic disruptions by measuring the need for vehicles by eligible drivers in the U.S. and comparing that number against annual scrappage rates.

A slowdown in new-vehicle production and sales will result in higher transaction prices, lower incentives and potentially fewer vehicles sent to the scrapyard — which increases the average age of cars in the U.S. An oversupply yields the inverse: lower prices and higher incentives as automakers force vehicles into the marketplace. The transition from one condition to another can often occur suddenly, catching key players by surprise. In these circumstances, the key is to keep from getting seduced by prevailing market conditions.

Avoiding this temptation is easier said than done. The industry, collectively, trends toward bad habits regarding sales and production discipline. Ebbs in demand are not always met with appropriate prompt production adjustments, resulting in overcrowded dealerships that ignite a downward spiral in profitability across the industry.

This is where data-driven decision-making comes into play. Automotive executives who properly manage data and predictive metrics can significantly reduce the risk of missing a critical turn in production requirements and inventory.

ALG’s natural demand equation predicts that supply will exceed demand by the middle of the decade, at which point incentive spending will rise in response. The formula has created three potential scenarios for how automakers will approach the current supply imbalance and consumer behavior:

  • The first scenario assumes lower scrappage rates and fewer cars per driver. Lower scrappage rates minimize the vehicles flowing out of the market, requiring fewer vehicles to backfill demand. It suggests that record-high prices today will result in consumers being more willing to maintain or fix aging cars for extended periods before purchasing new ones.
  • A second scenario assumes fewer drivers and owners. Fewer consumers would be getting their driver’s license or owning a vehicle because of a heavier reliance on ride-share and car-share services. In this scenario, reliance on these services and public transportation result in a surge in the number of miles traveled per vehicle, causing a subsequent increase in the scrappage rate. However, the second scenario seems unlikely because of continuing hesitation in the safety of public transportation and sharing services.
  • The third scenario assumes a continued overall increase in automotive production. If automakers could, they would already be producing more.

As shortage issues remain unresolved, automotive manufacturers will have a strong desire to satisfy demand.

This scenario is the most logical outcome, but it will take time to ramp up the required production to reach parity with demand.

The earliest expectations of achieving that goal are 2024, assuming sales rebound in 2022 and 2023.