The used-car market has witnessed significant upheaval in recent years. From 2014 to 2024, prices witnessed an average annual increase of 3 percent. The onset of the COVID-19 crisis and the subsequent supply shock sent used-car prices soaring, rising by approximately 50 percent between the second quarter of 2020 and the third quarter of 2022. However, since late 2022, used-car prices have dropped by 20 percent in several European countries, leaving much uncertainty about their future trajectory (Exhibit 1). This is particularly evident in the electric vehicle (EV) segment, where the price index fell by up to 34 percent, twice the price drop in the European market across all fuel types during this period.

Unraveling the Dynamics of the Used-Car Market and Its Implications

The Impact on Car Dealers

Car dealers are currently facing challenges in getting rid of their stock. The prolonged holding times and significant price reductions are taking a toll on their business. With the used-car market in a state of flux, dealers need to find innovative ways to manage their inventory and adapt to the changing market conditions.

For instance, dealers may need to explore new marketing strategies to attract customers and offer more competitive pricing. They also need to be vigilant in monitoring market trends and adjusting their strategies accordingly. Failure to do so could lead to increased inventory costs and reduced profitability.

The Role of OEMs

Original Equipment Manufacturers (OEMs) play a crucial role in the used-car market. They must adjust new-car prices to reflect changes in residual value and used-car prices. For example, Tesla's decision to cut car prices by 10 to 13 percent in the United Kingdom in January 2023 had a direct impact on used-car prices.

OEMs also need to invest in research and development to improve the quality and performance of their vehicles. This will not only enhance the resale value of their new cars but also help to stabilize the used-car market. In addition, OEMs need to work closely with leasing companies to develop strategies that address the challenges posed by the used-car market.

The Effect on Individual Consumers

Individual consumers are also feeling the effects of the used-car market fluctuations. The price changes have made it more difficult for them to make informed purchasing decisions. Consumers need to be aware of the market trends and factors that affect used-car prices.

For example, consumers may need to consider the age and mileage of the vehicle, as well as the supply and demand dynamics in the market. They also need to be cautious when purchasing an EV, as the price decline in this segment has been significant. By doing their research and being informed, consumers can make better decisions and avoid potential financial losses.

Leasing Companies' Opportunities and Risks

Leasing companies have a real opportunity to protect and even boost their profit margins in this challenging environment. However, they also face significant risks, particularly in the EV segment.

To mitigate these risks, leasing companies need to quantify their residual-value risk per fleet segment and develop potential future scenarios. They also need to implement relevant risk mitigations, such as professionalizing used-car leasing and pushing contract extensions, developing an optimized remarketing strategy, and transferring the risk. By taking these steps, leasing companies can reduce their exposure to pricing shifts and protect their bottom line.

For Live Fleets: Addressing High-Risk Segments

Leasing companies can take several actions to address the high-risk segments in their live fleets. One option is to offer used-car leasing and contract extensions. This allows them to capitalize on larger in-life profits while reducing the final residual value and associated risk exposure.

For example, an extended contract could reduce the vehicle residual-value exposure by 8 to 12 percent. Another option is to develop an optimized remarketing strategy by diversifying used-car sales channels and proactively recalling vehicles ahead of schedule. This can help to reduce the residual-value exposure loss by 5 to 15 percent.

For New Business: Anticipating Market Trends and Reinventing the End-of-Contract Process

In the longer term, leasing players can consider several additional actions to mitigate residual-value risk for new business. One option is to harness AI for dynamic residual-value estimates. By incorporating sophisticated data models and predictive algorithms, leasing players can forecast residual values with greater accuracy and reduce the risk of setting overly optimistic residual values.

Another option is to diversify the leasing portfolio by spreading exposure across different vehicle types, brands, and market segments. This can help to mitigate concentration risk and minimize the impact of declining prices in any single market segment. Finally, leasing companies can negotiate buyback agreements with dealers or OEMs to transfer risk and protect their bottom line.

In conclusion, the used-car market is in a state of flux, and leasing companies need to adapt and innovate to survive and thrive in this challenging environment. By taking proactive measures and implementing relevant strategies, leasing companies can reduce their exposure to pricing shifts and protect their profit margins.