Mystery solved: Why the car companies are gouging us

Why does a Lexus cost $20,000 more in Canada than it does in the U.S., even now that the Canadian dollar has reached parity with the U.S. dollar? Why do products made in Canada often cost less outside Canada than they do domestically?

A free trade agreement should ensure that, adjusted for transportation costs, goods sell at much the same price in member states. But at present we are witnessing border differentials of 20 per cent in car prices.

Callers to phone-in shows think Canadians are being gouged, and they’re probably right: Segmented markets leave themselves open to price discrimination.

Different demand conditions mean that a supplier will maximize profit by choosing a different price in each market. In other words, nice unquestioning Canadian buyers are not likely to shop around for better prices. Suppliers who recognize this can price-discriminate.

At the same time, competition is supposed to eliminate such price disparities. Monopolists can price-discriminate because they have no close competing products, and warranty conditions may limit resale opportunities. But a Toyota is not so different from a Mazda; a Mercedes is not so different from an Audi. Yet Canadian car dealers are not aggressively cutting their prices to U.S. levels in an effort to increase their sales.

Canadian buyers are beginning to look at purchasing in the U.S., but are frequently prevented: Dealers refuse to sell to buyers who do not have an American address. Some manufacturers are telling their American distributors not to sell to Canadians at all. What’s going on here?

The answer has to do with leasing: Lower prices might boost new-car sales in Canada, but that is not, right now, in the interest of the manufacturers which own big chunks of the leasing corporations.

Each year in Canada more than half of all new vehicles going through dealers are leased, rather than sold. If, on average, cars lose half their value over a three-year leasing period, then the value of a $40,000 car, after a three-year lease, will be $20,000. This $20,000 is an asset on the books of the leasing company.

Now, if the $40,000 new-car price were reduced in Canada to the U.S. level of $33,300, then the buy-back value after three years would be only $16,650.

Between 2004 and 2006, Statistics Canada data say 1.5 million light vehicles were sold in Canada each year: 800,000 cars, 200,000 SUVs and 500,000 light trucks. If half of these are on lease, there might be 2.25 million outstanding leases. If each of these leases/assets were to take a $2,000 hit (assuming the average retail overpricing is only $4,000) then parity in pricing would be almost a $5 billion loss on the balance sheets of leasing companies. Obviously, lease owners have an interest in continued high prices.

How will this market evolve in the coming months? First, some cracks are showing in price maintenance. Suppliers with a small market share in Canada (Subaru for instance) and a growing market (i.e. contented dealerships) seem to place no barriers to Canadians buying in the U.S.

Second, there is a real possibility of a major slowdown in Canadian sales. Once a critical number of Canadians purchase in the U.S., reputation and network effects will become important, and the Canadian retail car market could slide disastrously.

Our prediction is that competitive pressures will bring Canadian prices down to U.S. levels in the not-too-distant future. If not, it seems to us that the Competition Bureau should step up to the plate and bat for the Canadian consumer without delay. That is why the Bureau exists.

Marcel Boyer est vice-président et économiste en chef de l’IEDM, Ian Irvine est professeur à Concordia.