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GM Goes for Help with its Used Cars

Recently General Motors decided to provide a bumper-to-bumper full warranty for one year or 12,000 miles on its used vehicles going back to the 2003 model year. The warranty applies to GM Certified Vehicles. You might ask yourself, why would GM bother to add a warranty to cars that they have already sold? The answer is that the company wants to improve the residual values that the market puts on its used cars, and for very good reason.

The original purchaser of a car rarely holds it to the end of its life. Rather, the majority seem to sell their cars, or trade them, after about five years. The residual value of the car after five years is the value that the original owner uses to reduce the purchase price of his or her next new car. Here is where GM, and Ford and Chrysler for that matter, has a severe problem.

The residual values for foreign auto marques, especially Toyota and Honda, are far higher as a percentage of the original purchase price than are the domestic makes’ residual values. These differences in residual values are an undeniable criticism of the GM products. Any purchaser of a new car who does his homework will factor this higher residual value into his evaluation of the “cost of ownership.” The foreign makes’ higher residual values are equivalent to a deferred discount on the next car he purchases.

Here’s how this works. Assume that both GM and Toyota are selling today an automobile with a $30,000 price tag. Further assume that after five years the Toyota is worth 50% of its original purchase price while the GM make is worth 35%. These are reasonable estimates for the current market. At the end of five years the Toyota automobile is worth $15,000, while the General Motors automobile is worth $10,500. The difference of $3,000 gives the owner of the Toyota automobile $4,500 more to purchase his next car than the General Motors purchaser has. Over the course of five years, the Toyota owner spends $4,500 in total, or $900 per year, less to drive his car. That’s a savings of 6 cents per mile on a car driven 15,000 miles per year.

General Motors is hoping that its warranty on its used cars will increase their residual values by enough to offset the advantages that the foreign makes have. GM is creating a Reliability innovation that puts the company’s promise in writing that the used car will operate for 12,000 miles or one year with no problems. (See the Perspective, “Reliability: The Hard Road to Sustainable Advantage” in StrategyStreet.com.) Will that be enough to offset the significant differences in residual values at the end of five years? Probably not, but it is a start in the right direction.

Posted 9/2/08

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