Residual Values are on the Minds of Volvo Brass

SANTA BARBARA, CA — Before Volvo's first-ever SUV hits the U.S. market, company executives are focusing on what it will be worth in a few years as a used vehicle.

The launch of an all-new vehicle may seem premature to discuss future residual values. But it reflects how important those are to manufacturers, especially premium car companies such as Volvo that depend heavily on residual-driven leasing.

Volvo expects to move nearly 40,000 units of its new XC 90 car-based SUV, mostly through leases, when production ramps up. It goes on sale next month. Retail pricing ranges from about $33,350 to $44,000.

“We want to make sure we get everything right with the XC's value now and in the future,” says Vic Doolan, CEO of Volvo Cars of North America. “The resale value is an intrinsic factor. We have the responsibility to maintain good resale value because we lease so many cars.”

Volvo leased about 60% of the 134,937 vehicles it sold in North America last year. Volvo Finance of North America, truly a “captive” arm of a manufacturer, handles about 99% of those leases, says Angelo Nyars, its vice president of sales.

Much of a premium brand's success, new-car and otherwise, depends on its vehicles retaining high resale values. BMW is a good example of that. It keeps current buyers and attracts new because of strong BMW resale value.

On the other hand, anemic resale values can wreak havoc. For the lessor, the wheels can come off a lease deal (its monthly payments based largely on its projected off-lease value) if the actual value turns out to be far less than the predicted value.

Residual values have been inflated for years, allowing unrealistically low monthly lease payments to drive sales. That's changing. Residual setters are becoming more conservative. That creates lease market challenges this year and next, as the great lease deals of yesteryear become more extinct.

Low-residual vehicles can haunt a model's demand, tarnish the overall brand and hurt new-car sales.

Doolan says that Volvo, like all premium car companies, has long paid attention to residual values. Many leasing firms and captive finance companies, including Volvo Financial, get burned when forecasts are way off — as they have been in recent years.

Industry-wide residual loss levels are declining but the money involved is still staggering. Residual losses totaled $11 billion in 2000 and $10 billion in 2001. The not-so-great good news is they are expected at only $8 billion this year, says Nyars.

“Our focus on resale values is a continuation, but also an intensification,” says Doolan. “It's fundamental in this business. Resale value is the ultimate mirror that reflects true strength of a premium brand.”

The Ford-owned Swedish auto maker has struggled with residuals in the past. Volvo finished dead last in a Consumer Reports' ranking of premium car brands' residual values.

Says Nyars, “Resale value goes to the heart of our business… No one in the organization is comfortable with where residuals are. They need to get better.”

Towards that end, Volvo is getting more involved in used-car marketing. The auto maker is trying to do that through a certified pre-owned program, considered a good way for manufacturers to remarket cars coming off lease. Volvo hopes to sell 37,000 certified used vehicles this year.

Says Doolan, “We want to build a strong pre-owned business with our dealers. They appreciate it and profit from it.”

Nyars says the goal is to sell as many XC 90s “as we can.” But that can be a balancing act for premium car companies. They must move the metal, but not dilute the exclusivity of the luxury brand. One way to do the latter — and mess up residual values at the same time — is to glut the market.

Volvo vows to keep demand “slightly ahead of supply” to bolster those resale values because they're “a reflection of the brand,” says Walt Langley, vice president of product marketing for Volvo Cars of North America.

Residual setters and experts are watching with interest as Volvo addresses resale value issues for a vehicle that isn't even out yet.

“There's a big push by Ford Motor Co. top executives on down to concentrate on residuals,” says Joshua Wilson, editor of Automobile Red Book, which tracks used-car prices. “They're saying, ‘Don't shoot yourself in the foot.’ Fundamentally, it's making sure supply doesn't exceed demand.”

Mark Perleberg of the NADA Appraisal Guides warns that vehicles take residual hits when manufacturers focus heavily on fleet and rental lease sales.

He says, “Often, in such circumstances, you get back cars in tacky shape and they come back en masse. It's hard to remarket all of them at once and it hurts residuals if Enterprise dumps 400 cars on a place like Orange County, CA, which only has three Volvo dealers.

“Manufacturers are realizing residuals are not a free-for-all, and what you do now affects your future.”

Adds Tom Shaver, a senior auto analyst for J. D. Power & Associates, “You can say what you want to do. But then, the market forces take over. The XC 90 should sell well. If it does or doesn't, the market will dictate what it will be worth in two or three years.”

Volvo is trying to convince the residual-setting community that the XC 90's resale value shouldn't be a projection of Volvo's history of rather weak residuals, says Charlie Vogelheim, executive editor of Kelley Blue Book, a tracker of used-car values.

He explains, “Volvo is saying this is an all-new vehicle in a new class for them, so its residuals should be set accordingly. They can present a rosy viewpoint going in. But, in the end, John Q. Public decides residual values. It's really about the desirability of a product.”