Used cars and aftermarket segments, new services categories to experience sustained demand
Saudi Arabia’s automotive market is bracing for a tripling in value-added tax (VAT) rates. Effective July 1, 2020, Saudi Arabia hiked its VAT from 5% to 15% as part of measures to address the fiscal imbalance between public revenues and expenditures and counter the financial and economic burden imposed by COVID-19. What does this mean for the automotive market, which has already been battered by dampened consumer spending in the aftermath of pandemic-related lockdowns?
Between March to May 2020, new car sales dropped sharply by 65%-70%, as footfalls in showrooms declined by a steep 75% due to the complete lockdown during May and June. In the aftermarket, consumers delayed vehicle maintenance, resulting in a 70%-75% drop in revenues related to periodic maintenance and spare parts purchase. This, in turn, caused job losses in the entire automotive sector of close to 20%-30%.
With new vehicle sales already reeling, the increase in VAT now looks set to further flatten demand. The dual impact of COVID-19 and VAT increase is projected to trigger a 30%-35% decrease in new car sales in 2020, compared to the previous year. However, the prognosis is not all gloomy. The effects of the pandemic are likely to wane gradually, and the impact of VAT is expected to stabilize by the end of the year.
Spike in New Car Sales during Pre-Implementation Phase
A VAT increase typically advances the buying decisions of consumers during the pre-implementation phase as they seek to beat the inevitable price increase. Accordingly, the automotive market has seen significant demand in June 2020, marking the first month of positive growth since March 2020. While this has placed a fair amount of strain on dealers in terms of managing their supply chain and resources, it nevertheless represents a silver lining for new car sales in 2020 amidst the general pessimism caused by the pandemic and economic slowdown.
Many consumers have postponed their new car purchases as a result of ongoing uncertainties. However, as commercial activity resumes, consumers will adjust to the new pricing realities. July and August may see a significant drop in new car sales. Nonetheless, from September onward, consumers will exhibit greater interest in economical trims and cost-effective versions of small sedans and compact SUVs. Moreover, given the price elasticity of demand, auto dealers will explore ways to reduce the VAT burden on consumers. For instance, some dealers might partially absorb VAT costs in their margins, while others might entice customers with an array of promotional offerings, including on insurance, registration, and fuel cards. Frost & Sullivan believes that dealers will be less likely to replicate their strategy of absorbing VAT costs in their margins as they did when the tax was first introduced in 2018. This is because the severe drop in sales caused by the pandemic has already placed their margins under tremendous pressure.
Surging Used Car Sales to Result in More Organized Financing Options
The pre-implementation VAT phase has seen a glut of second-hand cars entering the market as a result of consumers trading in their existing cars in anticipation of buying new cars before price increases kick in. Job losses among expatriates and restricted domestic and international travel since March 2020 have also contributed to the massive supply of used cars in the market from rental companies. Such trends will drive down the prices of used cars. At the same time, we are confident that the VAT increase is likely to have a minimal impact on used car purchases, given that nearly 60%-70% of used car transactions are C2C. With the expected surge in used car transactions, used car financing—which is currently not offered by many financial institutions—is poised to become more organized and affordable in the coming years.
Deferments in Vehicle Servicing and Spare Parts Purchase in the Short Term
To avoid the immediate impact of the VAT increase, consumers are likely to postpone periodic maintenance by one to two months in the short term and only undertake the bare minimum in terms of vehicle maintenance. But in the long term, we expect the average age of vehicles to increase by almost a year as Saudi consumers retain their cars for longer periods and avoid new car purchases. This will result in higher long-term spending on vehicle maintenance and accessories. Simultaneously, we anticipate consumer preferences to shift slightly toward aftermarket brands in the short to medium terms. The inevitable rise in spare parts prices is expected to boost the online sales of both OEM-franchised dealers and independent aftermarket brands like Bosch, Denso, and NGK in the independent aftermarket channel.
At the same time, we expect the spare parts market to become more organized and structured as companies are pushed to compete on service and product delivery and not just on price. Factors like convenience of booking, ease of purchasing, scheduling repair, pick up and drop off, and overall aspects of enhancing the customer journey are likely to become competitive differentiators. Additionally, we believe that the share of Do-It-Yourself (DIY)—although currently limited at about 3%—might also expand, further boosting online sales.
Even though the tripling of VAT is expected to impact most buying and vehicle servicing decisions in the initial months of implementation, we anticipate that consumers will be more accepting of the new normal by the fourth quarter of 2020. OEMs and dealers are expected to come up with aggressive offers on new and certified pre-owned cars. Meanwhile, although new car sales have declined since 2015, used car sales have proven resilient amidst economic uncertainties. Buoyed by the dominance of C2C transactions, this segment has been relatively insulated from the impact of the VAT increase. Moreover, growth in the used car segment is poised to create considerable opportunities for pre- and post-purchase vehicle inspection, vehicle certification and other value-added services. These will drastically change traditional paradigms in used car sales.
Saudi Arabia has among the highest number of car enthusiasts in the GCC, albeit with limited options to personalize their vehicles. With the expected increase in used car sales, consumers might look for options to personalize their vehicles, enabling growth opportunities for vehicle accessories. The drop in new car sales over the short term is expected to create opportunities in other areas as consumers begin to explore long-term auto loans and long-term car leases and switch to mobility solutions in the medium to long terms.
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