Why electric vehicles are changing how we evaluate residual values

Electric vehicle (EV) usage is rising but manufacturers should consciously measure the residual values to help users determine the total cost of ownership. 

In brief

• Measuring the residual value of EVs has several considerations, including market demand, technology, and policy. 
• EV residual value impacts the larger automotive industry in reporting product and business financial performance. 

Why electric vehicles are changing how we evaluate residual values  

Electric vehicles (EVs) don’t function like their fossil fuel cousins, and because of it, the way we measure their value needs to be reworked. Residual values are essential when determining the total cost of ownership (TCO), which affects buying, financing, and leasing decisions for both consumers and fleets. For EVs, it’s becoming a prevalent issue for their wide-scale adoption. 

It’s estimated that by 2035, more than 83.3 million EVs will hit the roads in the United States and Canada.¹ This is a seismic change in the way we think about mobility. One of the changes that will need to happen is the method in which residual value is calculated. EVs operate differently, so they also age differently. Consider that a typical internal combustion engine (ICE) vehicle drivetrain has roughly 2,000 moving parts. An EV typically has only 20.² How will EVs impact the near-term and long-term value of ICE vehicles? How does the lifespan of EVs compare to ICE vehicles of the future? How quickly will battery technology advance to boost the performance of both modes of transportation? Several factors will impact EV residual values, such as how fast battery technologies are changing and how quickly these packs will reach the end of life. In-vehicle technologies can open up additional monetization opportunities for operators. Think of vehicle to grid, for example, or car sharing, infrastructure maturity in different markets, government incentives, and most definitely model choices. 

This is a pivotal moment for those who work in the automotive sector, as each of these variables will help shape the new model for residual value calculation. The market knows how to evaluate an ICE vehicle. How does the process change for an EV? If the market can’t reliably predict depreciation schedules, the ripple effect across the industry will be significant. Original equipment manufacturers (OEMs) must think strategically about how to shift their product mix over time while maintaining their production in the present day to fund future investments. On the consumer front, some are eager to ride the wave and quickly jump into an EV. Others need more time, and will wait until the next iteration, hoping it will provide even more value upon purchase. Financiers should begin identifying concepts that address a larger portfolio concentration of EVs and determine system capabilities to handle the segmentation. Automotive OEMs and suppliers alike have foreseen the significant impact of future car architecture and invested heavily into new growth areas. Some players have already started to streamline their ICE-related portfolios, while others have disconnected them and are now managing the business separately. Various capital allocation choices are emerging, including investment in captive capacity, acquisitions, spin-offs and joint ventures (JVs), among others.³ Everyone is watching with anticipation, eager to learn how this new market will take shape and how it will transform the automotive industry for the next 5 years, 10 years and beyond. 

Don’t assume permanence

The two most immediate concerns for automotive industry leaders as they pertain to residual value modeling are: 

• Core supply and demand – How many EVs are going to be on the market? What is the true demand for EVs? How strong will it be? How quickly will the market be able to ramp up supply to meet demand? What will that mean for the ICE vehicle market? 
• Technology advancement – How quickly will alternative technologies increase battery range? What battery chemistries will prove to be more sustainable and/or more durable? How does the concentration of value in the battery of an EV compare to that of an ICE-powered vehicle? 

As analysts try to predict how quickly EVs will take market share, some will reflect on what happened with sport-utility vehicles (SUVs) in the wake of the Great Recession. What had been a growing trend collapsed as consumers turned to vehicles with better gas mileage. But as the market emerged from the recession and the price of gas came back down, consumers quickly went back to buying SUVs. Companies need to consider all the levers that can impact residual value, and they cannot afford to assume permanence. There will be unexpected developments and innovations that no one saw coming with EVs. It’s up to each player in the space to keep up with what’s happening and be ready to respond when those surprises occur. 

Even within the EV space itself, rapid advancements in battery range, density and/or durability could render existing batteries unwanted and obsolete. How can technologies be leveraged to capture data points around battery health, the number of charges, charge cycles, high-speed charge capability and other factors that dictate the value of a battery, as well as the EV itself? 

The modularity of batteries in the future might be a significant differentiator in the value of EVs. Vehicles that have space for additional battery packs to support a longer trip for the owner may have a better secondary market opportunity, which demonstrates the influence the battery economy could have on residual value. There is also an uncertain propulsion component, which remains the highest-cost component of the EV itself. All this leads to another question: How difficult is it to project value when the foundation of the EV is still undetermined? A big component of total cost ownership (TCO) is residual value. It’s challenging to come up with a true TCO if it’s unclear what the asset will be worth at the end of its life or how long that life will be.

Anticipating the rise of EVs

Analysts believe the most innovative financial engineering ideas for EVs will come on the fleet side of the market rather than the consumer side. Combined with improved TCO, this could push fleets to be early adopters of EVs. To capture this shift, OEMs and their captives see an opportunity to extend their customer connectivity by taking on such roles as EV fleet orchestrators and introducing new financial products through insurance plans. Fleet sales are still big business, though volume has dropped in recent years. Total US sales of vehicles to fleets dropped from 3.3 million units in 2019 to 1.9 million units in 2021, according to the 2022 Cox Automotive Market Insights & Outlook report. Cox Automotive expects the decline to continue in 2022, dropping to 1.8 million units sold into fleets.⁴ Industry leaders will be studying these and other data points as they consider the impact on residual values.  

Here are some additional questions about the EV transition that need answers: 

• When will there be enough EVs in the market to truly assess EV residual value? Today there are just over 2.1 million battery electric vehicles (BEVs) in the US car parc (0.73%), and 17.7 million BEVs in the global car parc (~2%).⁵ Some believe between 10 million and 20 million vehicles will be enough to start finding good correlation in terms of residual values for EVs in a single region (e.g., the United States or the European Union). Others who closely follow the automotive industry may see it differently.  
• Is mileage the right metric to think about when setting the term of a lease? Mileage is a convenient way to look at engine health and thus is a primary data source in appraising the value of ICE vehicles. It may not be the best way to look at battery health. Will future leases be based on miles driven or on some kind of metric around battery health or number of charges? An argument could be made that a three-year lease is no longer workable because the time horizon is too unpredictable right now. 
• What happens to ICE vehicles? As we have seen with technology innovation in other segments, there is an entire segment of vehicles that is likely to quickly fall out of favor — not because they don’t perform, but because nobody is going to want them in three to four years when the consumer is looking to sell. How will this play out in residual value calculations? 

Lobbying, regulatory policy will shape EV market

The tipping point into mass EV adoption coincides with enhanced regulation and government-led initiatives to encourage acceptance. In the US, the federal government aims for 50% EV sales and 500,000 public chargers by 2030.⁶  

However, a group representing major automakers said EV tax credit requirements passed in the federal Inflation Reduction Act (IRA) will jeopardize those goals. To be eligible for the credit, vehicles must be assembled in North America, which made some current EVs ineligible as soon as the bill took effect, according to a story published by Reuters and posted to the National Automobile Dealers Association website. The newly approved IRA also imposes other restrictions to deter automakers from using Chinese-made materials by phasing in required percentages of North American-sourced battery components.⁷  

The EV adoption targets are underpinned by existing incentives and new funding packages of $7.5 billion to build charging infrastructure and $3 billion for advanced battery supply chains, as set out in the federal Infrastructure Investment and Jobs Act (IIJA), and explained in the EY EV Acceleration Report, June 2022.⁸ The belief across the auto industry is that as cities, states and countries leverage experience where regulatory and tax policies have been enacted, they can boost acceptance and build momentum for more EV purchases in those respective regions.  

Lobbying and influencing will play a critical role in developing a workable structure for automotive financing in this new environment. These actions can obviously have significant balance sheet implications for companies. Key to making this effort work is getting all concerned parties engaged in the process. On the surface, tax credits give consumers another reason to consider making a purchase. But it’s not always that simple. Lobbying and involvement in shaping policy, when done responsibly, informs policy and enables everyone to come out of the process with something to gain.  

There is a need to evaluate residual value calculations, but the best strategy may be to proceed with patience and an open mind. As the market continues to evolve, those in the automotive industry should consult with their legal and financial advisors and be willing to get creative. There may be lucrative opportunities that haven’t even been considered. 

Shannon Clarke and Branson Smith contributed to this article.