Sky-high car prices have only one direction to go from here

For much of the past three years, car prices knew one direction: upward.

This was simple economics: There was far more demand for new vehicles than manufacturers could meet due to pandemic-related disruptions. As chips, wire harnesses and other components in short supply flow more freely again, a slow but inevitable march to normalization has begun.

Tesla and Ford were among the manufacturers making noteworthy cuts the past couple of months, with the latter predicting new vehicle pricing will fall 5% in the U.S. this year. Elon Musk embellished a bit Wednesday when he suggested Tesla had made minor adjustments to the cost of its models – the company charged 20% less overnight for its top-selling Model Y before bumping prices back up – and described affordability as a limiting factor for the company.

In Europe, Volvo and Mercedes-Benz remain bullish on pricing, citing healthy order books. Still, analysts expect that easier access to parts and stretched wallets will eventually bring auto prices back down. With energy, food and borrowing costs on the rise, consumers will think twice about splurging on a new set of wheels.

Net pricing for Volkswagen, BMW and Stellantis may drop 6.1%, 5.6% and 1.4% respectively this year, according to RBC Capital Markets. Mercedes may be the exception, with analyst Tom Narayan expecting the company to eke out 0.5% growth, he wrote in a report last month.

The German luxury carmaker has reaped huge benefits from focusing on its most expensive models even more so than its peers. The average price of a Mercedes climbed to around $77,485, last year, up 43% from 2019. That chimes with Ola Källenius’s push upmarket with top-end models like the S-class sedan and the G-Wagon sport utility vehicle.

Mercedes posted a 14.6% profit margin with its cars division last year and $15.7 billion of total net income. The automaker is among several “putting value over volume,” Bernstein analyst Daniel Roeska said last month.

It remains to be seen how further Mercedes can take this push. Success has partly been due to the company introducing several pricier electric models like the $147,500 Mercedes-AMG EQS – a sedan Bloomberg Pursuits reviewer Hannah Elliott recently took for a spin. While it’s relatively easy to command steep prices in the upper-luxury bracket, commanding more for the revamped E-Class rolling out in the coming months will be a tougher ask. The workhorse sedan has been a staple among taxi drivers and is one of the carmaker’s highest-volume models.

Downward pressure in the mass market looks clearer cut. In Germany, several Volkswagen dealers have been rebelling against a new agency franchise system that Europe’s biggest carmaker is introducing for its EVs. While dealers have no balance sheet risks because they’re selling cars belonging to VW, they also get less flexibility to offer the rebates customers have been used to and are worried about losing them if prices won’t come down.

Talk of an imminent full-blown price war is probably overblown. Tesla turned heads with its radical reductions in January, but it’s long taken a unique approach to pricing, often changing them multiple times a year. Musk has teased potential for a smaller Tesla costing around $25,000 as part of his push to bring EVs to the masses, but he let down those hoping for a glimpse of next-generation models at last night’s investor day.

While executives including General Motors CEO Mary Barra have sworn against going back to inventory levels they used to reach, don’t discount the likelihood that manufacturers eventually will return to chasing volume and market share. Old habits die hard.