The Hidden Economics Behind Rental Car Industry Pricing

Nobody has ever enjoyed renting a car. You land, drag your luggage onto a bus, and then stand in a line that hasn't moved in 30 minutes, while a single agent tries to upsell every customer for insurance they already have. When you finally get to the counter, the car you booked weeks ago is mysteriously unavailable, but there's nicer ones they'd love to upgrade you to for a fee. You sign a stack of papers that no one has time to read, decline 20 different add-ons, and get handed the keys to a car with crumbs and scratches that no worker will admit is there. Then after your trip, the real bill lands and it's

somehow double of what they quoted online with upcharges and penalties for dings that you never saw. Even though you took hundreds of photos of the car before and after, you now spend weeks trading emails to contest the bogus charges, only for both sides to eventually discover that the damage was caused by a different renter or that accounting simply build the wrong person. It's tempting to blame it all on greed, but the experience has been like this for decades. And the truth is that it's baked into the economics. The reality is that rental cars have always been a bad business with margins as low as airlines in good years and as thin as grocery stores in bad years. And in their best years, they make more selling

cars than they do renting them. The cost cutting, barebone service, predatory billing, and inconsistency of modern car rentals all stem from the same rotten unit economics. The industry has never had a golden age where consumers can look back on with nostalgia. And for all the talk about technology and disruption, that's never worked either. Startups like Turo, which dropped the crushing debt, extreme overhead, and crippling liabilities of rental fleets in exchange for asset light, peer-to-peer sharing, all net the same tiny margins. Through history, car rental companies have always been treated as strategic assets rather than healthy standalone businesses. In the 50s, the fast-growing industry was seen as a high- growth critical

infrastructure for modern Americans, just like how movie theaters and airlines were perceived at the time. With fleets of tens of thousands of vehicles, their assets and scale were valuable to anyone who wanted a stake in post-war travel. Herz was passed around through generations and by the 80s had gone through the hands of NBC, United Airlines, and Volvo. Avis bounced from an investment bank into Sherin Hotels, Hunts Ketchup, and the parent of Tropicana and Orville Reinbacher. National ping-ponged between Boeing and HSBC. Regardless of if it was telecom, food, defense, finance, or airline, none of these conglomerates could make the numbers work and offloaded these rental

companies within years of their acquisition. By the '90s, the big rental giants had landed with the one group remaining that would want them, the big three American automakers. Ford took Hertz. General Motors took National and Avis. Chrysler took Dollar and Thrifty. Only Enterprise and Alamo stayed out of the automakers hands as private independent operators. Because these brands had been bought and sold across so many industries over much of the 20th century, there was little for antitrust regulators to object to. But not even the automakers could stomach the rotten unit economics. One by one, they divested, having learned firsthand that the rental business was far worse than

assumed, and that the rental companies needed automakers far more than the automakers needed them. With no conglomerates willing to shoulder their overhead as private subsidiaries inside larger empires, the rental giants had no choice but to find their future alone with public investors. Much like the movie theater chains before them, Chrysler had been the first to exit, combining Dollar and Thrifty in a single IPO back in 97. Ford offloaded Hertz in the early 2000s to private equity, the only buyer still willing to touch such a perennially distressed asset. The PE firm loaded Herz with even more debt and flipped the company onto the public markets in less than a year. In the same

period, Avis was cut loose with its own IPO. By the time the dust finally settled in the mid200s, the world got to see just how unattractive the car rental business really was. Since then, the industry has only fallen further for investors and consumers alike. The business is so structurally flawed that the only way to ring out margins is to squeeze it out of customers by nickel and dimming every add-on and fee to generate profit that the model itself can never deliver. In this episode, we break down the horrifying business of car rentals from Avis and Herz to Turo and explain why no one has ever managed to disrupt this industry and why no amount of technology can save a business

model this broken. From the outside, car rental shouldn't be this hard. The business is absurdly simple. You buy or lease cars, park them in a lot, and then rent them out daily for as much as you can get. The underlying asset is commoditized, and service is non-critical. Anyone with enough money can do it. Most industries build moes on expertise, brand, or technology. But in car rental, the only real barrier is capital. You're only as competitive as the cars you have, and no amount of five-star customer service or slick marketing will win you a booking if you don't have the cars people want at the price and availability that they want them. The cars are the entire business. And while capital gets you in, it buys

you no edge at all. Because the money gets you the same cars as everyone else. The deeper problem is that cars are depreciating assets that lose value the moment you buy them, and they continue to bleed value, whether they're earning on the road or sitting idle. Renting it out is the only way to claw back the money you paid for the car in the first place. But renting also accelerates the depreciation that it's meant to offset. The more you rent out a car, the more you earn, but the more miles it logs, the harder its value falls. Conversely, if you rent it out less to protect that value, you leave money on the table while time eats the car anyways. A

natural question at this point is why sell at all? Why not run the cars into the ground the same way that taxis, truckers, couriers, and bus drivers do and ring every last mile out of them? A car rental company can't do it for two reasons. First, the best margins will always be renting out the newest models with the lowest mileage. These are the cars that consumers want and they'll willingly pay that premium for their business trip or vacation. The people willing to risk their time and money rattling around on the cheapest, most beat up, high mileage clunkers are too few and too low margin to sustain the business. As a result, a car rental must constantly refresh its fleet with the

latest and greatest models to stay relevant and hold on to its most valuable customers. At the same time, as cars rack up in mileage or age, they fall out of warranty and lose their reliability. like depreciation. Car reliability is an exponential curve. The older the car gets, the more expensive repairs will cost and the more likely it will break down. A car stuck in the shop is one that isn't earning and bleeds cash and value even faster. As a result, it's far more efficient to buy new cars than it is to fix old ones. And the only way to afford new cars is to sell the old ones and roll whatever they can get into new ones over and over again. In contrast, if the cars were run all the way into scrap, the company would still

have to find the cash to front the full price of a new fleet every single year. Under this lens, car rentals from the inside are like hedge funds that happen to specialize in cars. They hold billions of dollars of cars as assets, fund purchases with debt, earn as much rent as it can over the next 2 years, and then sell them all before their residual value and reliability plummet. And then repeat this annually. Everything rides on two numbers, utilization and residual value. Utilization is efficiency. How many of these cars are being rented out at any given day and at what rate. Residual value is how much the same cars are worth in the used market when it's time

to sell. And the challenge is to time that sale as close to the peak as possible. If you nail both, then the rental income, used car sales, insurance upcharges, and add-ons will cover the next fleet, and any money left over is your profit. But if you have too many cars idling and miss on utilization or sell too late when the used car market is soft and fetch low residual value, then you'll lose money. And if you run the cars to scrap, then both sides of the business collapse. Thus, it's not only about price, but also liquidity. The older and more worn out a car gets, the harder it is to sell. Anything beyond that 1 to threeyear window, and the pool of buyers disappears. As a

result, holding on to cars for too long costs you twice. you lose not just residual value but also the liquidity necessary to fund replacements that will objectively earn more and cost less to run. Another natural question at this point is then why not optimize for the most reliable cars like Toyotas or Hondas? If your fleet is reliable and is cheap to fix with mechanics and parts on every corner, then surely the economics will improve. But it doesn't work that way. Japanese cars hold their value far better than American or European ones. But that's exactly why they cost more to buy in the first place. The strong resale value is already priced into the sticker. You pay more upfront to get

more back later and the difference washes out. The cars with the best residual values are the ones you can't get cheap and the cheapest cars to put in a fleet are the least desirable ones, not the most. This equation of residual value and utilization is why the industry's bet on electric vehicles became such a disaster. In the early 2020s, Herz ordered hundreds of thousands of Teslas, committed to buying even more from GM, and poured money into charging infrastructure. Avis played it more cautiously and got burned just as bad. Utilization was inherently poor because the cars were so hard to fix. Teslas are so vertically integrated that ordinary mechanics couldn't service them. Parts were scarce and available

only through the manufacturer, and the battery, the most critical component, could be easily damaged in a minor collision. repairs cost twice as much and took twice as long as gas cars, which resulted in more cars sitting in the shop instead of out earning. Yet, it was residual value that was the bigger disaster. The rental industry had been swept up in the optimism of the early 2020s and believed in the widespread Wall Street narrative that EVs would get cheaper, go further, and hold their value better than gas cars. Yet, the opposite happened. EVs ended up depreciating twice as fast as gas cars, and the widespread concerns and documentation of battery degradation and range loss crushed demand in what

everyone had expected to be a booming used market. At the same time, Tesla and other EV makers slashed the prices of their new cars repeatedly to prop up demand as interest rates spiked, Chinese rivals surged, and the US government imposed price caps for tax credits. Every markdown to a new Tesla tanked the value of every used one and hurt the tens of thousands sitting in Hertz and AVA slots. The theoretical depreciation curve that they'd been trying to stay ahead of was ripped apart by the automakers above them. With plummeting utilization and residual value, Hertz lost $200 million, while Avis lost half a billion on EVs alone. But even if there was a perfect car, one that was

incredibly cheap, reliable, easy to fix, and carried high residual values, it still wouldn't matter. Every rental company would pack its lot with that same car and that product advantage would vanish instantly. You would fall right back to renting the same cars as everyone else at the same thin margins. The type or performance of a car is really only an edge for the automaker and not for the rental company that provides a commodity service. Thus, residual value and even utilization to some extent is in the hands of automakers rather than rental companies. What's worse is that all purchases are forward-looking bets on demand. Avis and Herz can't walk into an automaker and

order a thousand of a specific model for delivery next month. They must forecast demand a year in advance and commit to that order long before customers show up. Ultimately, every input that decides their fate is set somewhere else. The price rental companies pay for new cars is set by automakers. The price they recover on used ones lives in an entirely separate market set by consumers, wholesalers, and automakers all at once. The cost of debt for new car purchases is set by the credit market and interest rates. And the end consumer demand rises and falls with the broader economy as air travel, employment, wages, inflation, and auto loans all influence the need for rental cars in the first place. Every rental

agency is at the mercy of these four separate markets. To complicate matters even further, each of these four markets are cyclical. They fluctuate based on timelines and real world events that no one can predict. New car supply floods one quarter and then dries up the next. Used car prices can rocket to highs one year and collapse the next. Borrowing can go from cheap to expensive overnight with Fed hikes. Travel can dry up in one season and surge in the next. These markets are inherently unstable because the events that move them like a pandemic, a chip shortage, a travel restriction, a mass recall, or a rate hike can never be timed. Thus, rental companies are placing leverage bets every year in advance across four

markets and need to hit every single one to make profit. The depreciation curves that they use to decide when to buy and when to sell is ultimately just theoretical. This is why car rental has always been such a brutal business. The other problem beyond the macro level is that the actual day-to-day market that rental companies compete in is just as broken. Airlines, movie theaters, and hotels all defend their pricing power by locking down territory and holding the real estate, locations, and routes that keep competition out. Rental car companies have no such play. Their product is equally as perishable. An unrened car is like an empty airline seat or unsold hotel room where the cost of ownership is already sunk and the

marginal cost of an additional customer is near zero. Every player from Avis to Enterprise is under constant pressure to cut prices. A booking at almost any price beats an empty car that earns nothing. And across a fleet of tens of thousands, that revenue can meaningfully offset that day's depreciation. The distinction here is that this pressure arises from the business model rather than from the competition. Pricing is really the only lever that rental agencies control. And so every player, even when left on their own, must resist the temptation to discount in order to maximize utilization. And whenever one giant cuts, the others match within hours. which means the big three operate

exclusively between two states. An all-out price war at one end or tacic collusion at the other at the same time. While airlines can at least fly their planes to wherever demand is strongest, and movie theaters can flex showings and staff to match demand, a rental car can do neither. To cover the weekday peak, those same cars sit dead on the lot all weekend. This is why airports remain the strongest, highest margin, and most coveted venues in the entire industry as the one place where these dynamics don't apply. With corporate travelers paying out of expense accounts and walk-up travelers deplaning in a hurry, the audience is uniquely captive and price blind. Entry is restricted by the

airport itself as a rental company must bid to get a spot, squeeze into the shared facility with its rivals, and hand the airport a tenth of its revenue along with minimum annual guarantees. These barriers keep new entrance out and hold an implicit price truce in place between Avis, Enterprise, and Hertz. But outside of the airport, it's open season. Customers shop on price and the big three tear each other apart. This kind of mode only exists at airports because of their regulation and every attempt to recreate this elsewhere has failed. Zipar in the late 2000s was hyped as a disruptor that would pull the legacy daily rental business away from

mature contested airports and into mass market urban neighborhoods. With an app, self-service, and a membership model, the startup promised a better business built on deeper utilization and greater consumption frequency where cars would be rented by the hour rather than by the day. Avis acquired it in 2013 for $500 million, adding fuel to the narrative that urban car rentals were an untapped market and that Zipcar would be a billiondoll brand as a modern digital hedge against the legacy airport rental business. Now, over a decade later, none of it came to pass. Zipar's unit economics turned out to be far worse than the traditional model. Hourly rentals made high utilization nearly

impossible, and because members needed to return the car to the exact spot they took it from, Zip Car could only ever serve the people that lived right there. The service was a luxury rather than a utility and viable only in a handful of dense, affluent urban neighborhoods. The acquisition has been a catastrophe as Avis today barely mentions Zipcar has shut down the service in the UK and has quietly scaled back its domestic operations. We talk a lot on modern MBA about market leaders and the modes that protect them. Right now it's said that every day your business is late to AI.

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getting to the next level. Once modern MBA scales to that sevenf figureure milestone, we plan to adopt Netswuite next ourselves. For the first time ever, you can try Netswuite next for free. If your revenues are at least in the seven figures, go to netswuite.ai/modern MBA. That's netsweet.ai/modern MBA. Built for every industry, ready for every boardroom. Thank you to Netswuite for supporting Modern MBA and making this episode possible. With all these structural problems, the only remaining question is how did any of these companies survive? How did the industry make it through the 20th century even when propped up by various parent companies if the economics were this broken from the start? The reality

is that for most of that history, they weren't following the equation we've described. The impossible balancing act of utilization and residual value across the new car market, the used car market, the capital markets, and the rental market all at once is a relatively modern development. In the decades prior, a rental company only needed to optimize for utilization. Residual value was someone else's problem, and that someone was Detroit. No rental company buys cars with its own cash. A nationwide fleet of tens of thousands of vehicles costs hundreds of millions, and for Herz and Avis, it's billions. No company on the planet has that kind of cash lying around to sink into depreciating assets. As a result, the

legacy giants finance purchases with debt secured against the cars themselves, borrowing 70 to 80% of the cost upfront and putting up the remainder with their own money. Multiply that by hundreds of thousands of cars, and you get a rolling mountain of debt that's collateralized by the fleet itself. If the rental agencies stop paying what they owe or default, then the creditors can seize the fleet and sell off all the cars to get their money back. But financing is the simple part. The harder question is, who's responsible for depreciation? As we covered, a rental company only wants to use a car for its first two to three years and then be rid of it. A conventional auto loan doesn't work because it's designed to end in

ownership. Consumers pay down the cost of the car every month over years until the title is theirs, which is exactly what rental companies are trying to avoid. A lease is designed for people who want to drive a new car for a few years and then walk away. It shifts residual risk onto the automaker. The manufacturer commits upfront to a number it thinks the car will be worth in 3 years and then eats the loss if the car fetches less than that at auction. Automakers do leases carefully because they can spread risk across hundreds of thousands of individuals, models, regions, and end dates. But it doesn't work if one buyer wants to lease thousands of the same car, same model,

and same year and will eventually return all of them at once in a single afternoon. Ultimately, all the rental companies wanted was the timelines and protection of leasing where the problem of depreciation and residual values could be offloaded to someone else at scale. That way, they could focus exclusively on utilization. Detroit solved this problem by building an instrument exclusively for the rental industry called program cars. Herz and Avis got to buy vehicles in huge volume straight from GM, Ford, and Chrysler. They still exchanged cash for title, but inside every sale, the big three automakers bundled a special contract where they promised to buy back those same cars at a fixed price on a future date, so long as each vehicle was

returned in good condition and under a certain mileage. Sometimes the automaker took the car back as obligated. Other times, it had the rental company sell the car itself and wrote a check for the difference between what the used market paid and the price it had guaranteed. Either way, the outcome was the same. The automaker set the residual value and absorbed the loss if the car turned out to be worth less than it had promised years earlier. By buying back the cars themselves in the future, the automaker believed they could control the used market. If the rental companies were allowed to dump hundreds of thousands of cars whenever they wanted, then they would destroy the value of their used

cars and new cars entirely. On paper, it was meant to be a win-win where rental companies got to buy thousands of cars below sticker price and carry zero depreciation. They knew their costs the day of delivery and set rates against that exact figure. And whenever demand softened, they could hand back the cars early and shrink fleets without swallowing a loss. The other half of the modern business in predicting residual value, timing the sale, forecasting depreciation, and staying on top of the used car market simply didn't exist for the rental giants. This worked for decades as through the 80s, 90s, and 2000s, Hertz, Avis, National, and Alamo fleets were overwhelmingly programmed

cars, and their businesses looked stable. But in reality, these companies were being subsidized by Detroit. The real question is, why would America's biggest, most powerful car manufacturers agree to a losing arrangement where they held all the downside? The answer, as usual, was Wall Street and unions. Detroit in this era was addicted to volume. GM, Ford, and Chrysler measured themselves on units sold, and so did their investors, who treated raw sales volume as a scoreboard of popularity. The only metric that mattered was growth. Rental fleets were the easiest way to inflate volume. An automaker could book hundreds of thousands of cars to Avis or Hertz as sales in a single

quarter and then defer the residual loss for years. It was growth by accounting where volume got pulled forward and costs got pushed out. The second reason was labor. Workers at the big three were fighting factory automation that would improve efficiency but also eliminate jobs over time. To appease the unions, the automakers created Jobs Bank, a program where workers who got laid off would still be paid 95% of their wages plus full health benefits. This single-handedly turned labor overnight from a variable cost to a sunk cost. An idle factory suddenly cost the same as a running one because workers got paid whether or not they were sitting at home or working in the factory. This

completely wrecked all common sense. Instead of cutting production to meet demand, the only rational move for automakers was to keep the lines running all the time because stopping saved nothing. As a result, Detroit kept building cars that nobody had ordered. It couldn't push its surplus to dealerships as the over supply would tank new car prices and margins. Rental companies became that private outlet where the big three automakers could dump their over production and book it as sales. This was all a uniquely American problem. Toyota, Honda, Mercedes, and Volkswagen experienced nothing as ridiculous or self-destructive. They built to demand and never signed union deals where workers got paid to do nothing. This is why Japanese and German cars have held

their value so well over generations, as they never got branded as cheap rental fodder, the same way American cars did. The fundamental problem was that every wave of program cars coming back flooded the used market with hundreds of thousands of identical vehicles. This over supply destroyed the normal depreciation curve. With so many used cars of the exact same model and year, their residual values collapsed, which only made the next buybacks progressively more expensive than the last. It also punished GM, Ford, and Chrysler's most loyal customers. Someone who had paid full price for the same car watched their investment lose value far faster than a comparable Honda or Toyota for reasons they couldn't see or

understand. The big three were effectively cheapening their own brands and products. And the idea that they could slowly drip feed these cars back into the used market to protect residual values was naive. There were simply too many cars. By the mid200s, American automakers began feeling the long-term consequences of their short-term tactics. The terms that had been so generous to the rental companies dramatically changed. Investors started to prioritize profit over volume. And the automakers started pulling back, lowering the guaranteed payments, raising the depreciation rates on program cars, and tying rental companies to minimum purchase amounts to clawback margin. Then in 2008, the entire house of cards collapsed. A spike in fuel

prices sent the resale values of trucks and SUVs into freefall. Ford lost more than a billion dollars on leases and Chrysler shut down their leasing division entirely as its cars were worth so little that leasing was just no longer viable. Then the following year, GM and Chrysler both went bankrupt. In the midst of a complete industry meltdown, the union surrendered. With every automaker on the brink, the choice was simple. Give up Jobs Bank and keep some jobs or lose every paycheck and pension. With the repeal of Jobs Bank, Detroit could now finally lay off workers and shut idle plants. With labor restored as a variable cost, overp production no longer made sense. Surplus

stopped being built and the automakers no longer needed a channel to dump excess. At the same time, they were in no financial position to guarantee residual values, subsidize rental companies, and keep up the buybacks. So, they all walked away. For the first time in generations, Hertz, Avis, Dollar, Thrifty, and Enterprise were on their own. But just because Detroit stopped guaranteeing residual values didn't make depreciation disappear. It just changed who had to eat it. That risk had to land somewhere and it landed squarely on the rental companies where it stayed ever since. Today, virtually every Herz, Avis, or Enterprise carries no manufacturer guarantees. For most of the

industry's history, Detroit had told these companies exactly what their cars would be worth and handed them a fixed artificial depreciation curve. Now, nothing is handed out. Rental car companies have to forecast residual value all by themselves years in advance for hundreds of thousands of vehicles across four different markets and eat the loss whenever they get it wrong. To understand why getting the residual value wrong is so financially crippling, we have to look at the debt structure. Fleets are bought with borrowed money and the cars themselves are collateral, but it's not a one-time loan. The lenders give out a cash advance based on a fixed percentage of the fleet's value,

which typically hovers between 70 to 90% and the rental company puts up the rest. But the value is not set once and left alone. Instead, the lenders continuously track the value of the fleet as it ages against the present-day used car market to make sure that the cars never fall below the money they advanced in the first place. As long as the cars hold their value, the loan stays covered and the rental company pays its interest and principal on time. Everyone sleeps fine. But the moment the fleet's value falls in the used car market, the math breaks. The cars are suddenly worth less than the lenders assumed, which means the loan is undersc. The lenders are no longer protected. Because if the rental

company defaults and they repossess the fleet, selling those cars would no longer bring back the money they lent out in the first place. Thus, whenever the cars depreciate faster than estimated, the rental company must put up more collateral by adding more cars or more cash just to keep the debt in place and the cars under their ownership. It's identical to a margin call where you buy stocks on leverage, but then your position moves against you. Your brokerage demands more collateral to cover the shortfall, or else they liquidate you, and until you settle, they won't let you buy any more stock. The rental companies operate in the same exact arrangement, except their leverage is a parking lot full of the

cars they need to make money. Yet, when the used car market swings up, they thrive. During the 2021 chip shortage, used car prices skyrocketed. The cars that Avis and Herz had been depreciating were suddenly worth far more than estimated. Instead of losing money on sale as expected, they made money. Avis's monthly percar depreciation fell by a third and it sold its fleet into a supply starved used car market for record profits. Herz earned more than a billion dollars in free cash flow doing the same. And for those few years, the rental business looked like a slam dunk. Whenever the used car market beats the depreciation that a rental company has booked, the difference is pure profit.

But the market moves the other way just as easily. The most extreme cases were in the great recession and co. Under this lens, the fleet is a trap and anyone who doesn't own the cars should have a better business. But the irony is that the asset light peer-to-peer car sharing tech startups like Turo are actually worse businesses than the legacy rentals. Their pitches are all the same. You offload the depreciation, residual risk, liability, and capital requirements to individual car owners and then make money taking a cut of every booking as a software middleman. On paper, this should be the perfect antidote where there's no fleet, no debt, and zero exposure to the used car,

new car, and capital markets. Yet, the public markets have rejected these companies three times in a row. Getaround went public in 2022 and was kicked off the New York Stock Exchange in less than 2 years. The company has since shut down its entire US business and operates in only a handful of European cities. Zoomcar was booted off the NASDAQ within 18 months of its listing and exists today as a penny stock. and Turo, after seeing both its rivals fall apart, quietly withdrew its own IPO. The problem is that the model just swaps one liability for another. Legacy car rental is a leveraged bet on used car values. The peer-to-peer model is a leveraged bet on insurance and liability, which gets extremely

expensive when you put strangers behind the wheels of cars owned by other strangers. Every single trip is a potential claim with exposure on both sides of the transaction. Under this lens, Turo is closer to an insurer than a rental company and its insurance costs don't scale because every additional trip is another claim to pay. Thus, as Turo grew, its unit economics ran the other way as claims outrun fees. Getaround proved the same point from the other end. By owning no fleet, it was vulnerable to the insurance pricing set by carriers and regulators it didn't control, and cities legislated the company out of the dense, high liability

urban markets where it was supposed to thrive. The asset light model is ironically most fragile where the asset heavy model is the strongest. At the end of the day, the one thing that everyone treats as a weakness for the legacy giants is the exact thing that keeps them alive. A fleet is a liquid, financable, material asset. You can borrow billions against it and when everything goes wrong, you can still sell it into an actual market to raise cash. The assetike platforms have nothing of value and so when the VC money runs out, there's nothing on the balance sheet except insurance liability. When you own nothing, you control nothing. And you can never guarantee the supply, quality, reliability, and pricing needed to bring

a customer back.