Dealership troubles

In January, the Wall Street Journal ran a page one story about the troubles facing two dealerships in southeastern Kentucky.  One of them, Johnny Watkins, had filed for bankruptcy.

At the time, we predicted that there would be a lot more dealership closures in 2009, especially in smaller towns. 

MaysvilleFordAuctionThen, a couple of weeks ago, we received an auction notice to liquidate the assets of Maysville Ford.
Why is this happening to dealers in small towns?  There are a few key reasons:

  • There really isn't enough critical mass of car sales to support a dealership in a small town.  So dealers have to draw customers from nearby cities, usually with discounts that squeeze their profitability.
  • The most profitable part of the dealerships come from service to vehicles after the sale.  When out-of-town customers purchase from a small-town dealer, they tend to have their cars serviced somewhere else, as the dealer is too inconvenient for frequent maintenance.  So small-town dealers lack the service customers that larger dealers have.
  • The heavy reliance on car sales (and the lack of substantial service sales) means that small-town dealers are much more sensitive to economic downturns.  As car sales plummet, the service business is what has sustained many big-city dealers.  The smaller dealers just don't have that cushion.

The economic realities of being a dealer in a small town mean that a lot of them won't survive over the next couple of years.

[where: 41056]

Dealership Economics: Wall Street Journal Edition

Here at Under the Hood, we've spent a lot of time analyzing the automotive industry.  You might remember the three-part series about the economics of dealerships (Click here for Part I: Car sales, Part II: Service, and Part III: Toyota) or the entries about the problems of the Big 3

Today, The Wall Street Journal has Page 1 profiles of two car dealerships in London, Kentucky (about 75 miles away from us here at Lowell's).  The profiles echo a lot of the themes you've heard here:

  • How the financial fundamentals of dealerships have been deteriorating.
  • How the Big 3 have too many dealerships (look closely at the WSJ "Dealership Decline" chart).
  • The relative strength of Toyota and the Japanese carmakers versus those from Detroit.

My guess: In 2009, we're going to hear a lot more Johnny Watkins-type stories of dealerships going out of business, especially in smaller towns.

[where: London, KY 40507]

The Big 3: Saving the industry

As the Big 3 executives have returned to Washington asking for emergency funds with gestures that are both symbolic (driving in hybrids and taking $1 salaries) and substantive (slashing the numbers of dealers and brands), the question remains: Should we bail out (or invest in) the auto industry?

In my last Big 3 post, I said that I couldn't support a bailout.  But that was before the execs got flamed for their corporate jets and came back to congress in hybrids with business plans…  What do I think now?

I'm really disappointed. 

While many of the figures in the business plans are truly staggering (GM plans to fire up to 35,000 employees), my reaction to the plans is this:  Not enough. Not nearly enough.  My criticism flows along three lines of thought: 

  1. There appeared to be no cooperation among the Detroit automakers in drafting their plans, especially with regard to an inspiring "moonshot" style project to create a new generation of vehicles.
  2. There was little to address the huge overhang of retiree obligations which created much of Detroit's disadvantage to begin with.  The labor concessions the UAW appears prepared to accept are minuscule by comparison to the ongoing burden the retirees pose.
  3. The measures outlined in the plans — while aggressive on the surface — offered little in terms of real, structural changes to the way the Big 3 operate.

The current proposals still smack of "life support" rather than a true plan for vibrant growth.

But rather than sit back and take easy potshots at the executives, I thought it might be more productive to outline what I had in mind.  So (using my beloved GM as an example), here is my not-so-modest proposal:

Scale Back the Brands.
GM has proposed scaling back or selling their Hummer, Saab, Saturn and (maybe) Pontiac brands — leaving them with Chevrolet, Buick, GMC, and Cadillac.  That is still 2 brands too many.

They should pour all mainstream car and truck efforts into the Chevy brand and clearly distinguish luxury vehicles with the Cadillac brand.  Just drop the rest.  To paraphrase John Moore, if Pontiac went out of business tomorrow, would any of us really care?  Buick?  GMC?

I can hear the objections: But Pontiac produces iconic performance vehicles like the Firebird and Grand Prix and GTO, right?  Oh, they don't anymore?  I think the nation will be OK without the G6 or the Torrent, as well-made as they might be…  The Buick brand is surprisingly strong in China, but the appropriate Chevy or Cadillac models should be rebadged as appropriate for that market.

Concentrating on two brands would rid GM of the ridiculous 8x duplication they have today in product development and marketing.

(Ford should drop the Mercury brand, and Chrysler should just become "Dodge" and focus exclusively on trucks and minivans.)

Revamp the Dealer Model.
GM's dealer network is broken — too many dealers chasing too few car sales, and doing so in the wrong way.  They've proposed cutting nearly a quarter of their dealers, but they should cut closer to half of them. 

One way to speed the process?  Get rid of dealers who won't accept the following: All dealers must accept a flat pricing model with no typical dealer shell games.  By adopting the major innovation that Saturn offered to the market (and which GM is currently offering through their "Red Tag Event"), GM might be able to offer a competitive difference in the notoriously awful purchase experience.  Doing so may draw buyers back to the showroom.

They'd also begin to align the dealer's interest with that of the customer.  The dealers that still want to use smoke and mirrors to drive their profit?  Get rid of 'em.

Establish a semi-public National Automotive Technology Institute (or some such entity) with the explicit objective of crafting an inspirational next generation of smarter, more desirable, more fuel-efficient vehicles within the next 3 years. 

Force the Big 3 to contribute their energy and talent to the venture.  Connect the Institute to the best private- and public-sector initiatives on energy, artificial intelligence, and vehicle design. 

Motivate the best and the brightest individuals to develop a true national energy program in which we 1) drastically curtail petroleum use, and thereby 2) stop funding despotic regimes who dislike (or terrorize) America the most: Russia, Venezuela, Iran, and Saudi Arabia.

How to fund this?  Any dollars used to fund continuing operations at the Big 3 must be matched dollar-for-dollar with funds for the Institute.

Scale Down Retirees.
The one problem that there is no real solution for is the retiree obligations.  Both the UAW and Big 3 management colluded for years to create monstrous future pension and health obligations for retirees that both sides knew was untenable. 

They are both to blame.  So they both must pay. 

First, the retirees must accept significant reduction in their benefits.  As painful as that might be, it is better than the alternative of no benefits if the Big 3 go belly up.

Second, the company must meet what remains of its obligations to the retirees.  But everyone knows that they can't afford even a reduced set of obligations.  So, in exchange for a federalization of the retirement programs (as well as in exchange for a cash infusion), the companies must give up a significant chunk of their equity to taxpayers, to ensure that they are an ongoing concern.

As long as they abide by the other elements of this not-so-modest proposal, a public investment in the Big 3 should turn profitable within the decade as Americans (and the rest of the world) come back to attractive, affordable, and fuel-efficient American cars.

Have I been over the top?  Perhaps… But really saving the auto industry will not be accomplished through bland half-measures.

[where: Washington, DC]

Dealership Economics, Part III: Toyota

Toyota-logoIn the first two installments of Dealership Economics, we talked about why the car sales process is so vague and about the importance of the service department to the dealership's business.  In this post, we'll look at what the dealership company's financial statements say about Toyota's position in the auto industry.  

With the financial crisis at GM, Ford, and Chrysler (more on this in an upcoming post) making front-page news every day, you might wonder about the implications for Toyota in this economic downturn.  Toyota has definitely been hurt by the recent slump (see here and here), although it is not in the disastrous financial shape that Detroit's automakers are in.

So how will Toyota fare relative to the industry?  We can learn a lot when we go back to the dealership company we looked at in our other posts.

When we look at the numbers, two things jump out right away.  The first is that the Big 3 automakers' share — in both number of cars and dollar amounts — has eroded dramatically in just one year.  In just one year, the Big 3 has shrunk from over 35% of this company's car sales to under 30%.  Even if the economy were stable (which it obviously is not), such loss in share indicates that Detroit isn't making cars that people want.

The second number which jumps out is Toyota's share.  Even as the economy is deteriorating and car sales are slumping, Toyota grew its share of sales to 21%.  So, while the industry is getting weaker in a weak economy, Toyota's position within the industry is getting stronger…

So, what does this mean for the long term?  When the economy recovers, Toyota is in the best position to lead the automotive industry.  In addition, the long-term bets that Toyota made years ago (hybrids, flexible manufacturing, etc.) have helped sustain it through these difficult times.  In the end, Toyota will emerge as the dominant player in the auto industry.

Dealership Economics, Part II: Service

In Part I of Dealership Economics, we looked at the financial reasons the car sales process is so perplexing.  In this (shorter) post, we'll look at where the service department fits in to the business.

ServiceWhen someone buys a new car, there is a widely-held myth that they are required to return to the dealer for service to keep their warranty valid.  In fact, you can service your car elsewhere, and the warranty still holds — and there is a section of your owner's manual which should state this fact.  But the superstition persists, and is often reinforced (or, at least, not refuted) during the sales process…. Why is this?

I think it goes back to the economics of the dealership.  As I looked over the financial statements of the dealership company, I saw one set of statistics which really jumped out at me:

  • 85% of a dealer's sales is generated from car sales (58% from new cars, 24% used cars, and the rest from finance, insurance, and "other").
  • The remaining 15% of sales comes from the service department.

That might not be so surprising… But here's where it gets interesting:

  • The service department generates almost half (45%) of the dealer's profit

The cars are expensive, but contribute relatively little profit to the business.  The service department is relatively small, but generates huge profits for the dealer…

It is to the dealer's benefit to maintain the warranty myth, and keep as much of that service business to themselves as possible. 

If you have a relatively new Toyota, Lexus, or Scion, and would like to service it at Lowell's, you shouldn't let concerns about the warranty hold you back. 

Dealership Economics, Part I: Car sales

I hate going to the dealership to buy a car.  I don't like the haggling over the price, and I don't like the games they play (like "I'll have to run that by my manager…").  While there are a few dealers who are "up-front" on prices (for example, I shopped at CarMax for my last vehicle), most are less-than-forthright when it comes to pricing.  Why can't they just tell you what the price is? 

For fun, I like to look over financial statements for different kinds of companies (I know… I need to get a new hobby).  This weekend, I was looking over a the earnings for a company that owns several dealerships, and I learned some really surprising things about the economics of dealerships which helps me understand why the purchase process is so convoluted.

This particular company sold new cars for an average of about $30,000.  Out of that $30,000, it paid the car manufacturer (Toyota, GM, Ford, etc.) an average of $28,000.  Out of the $2,000 that was left, about $1,500 per vehicle goes to things like rent, salaries and commissions, and advertising. 

That means that when this company sells a new car, it will make only $500 in profit for its owners.  I say "only" because they have to buy a car for $28,000 and keep it on the lot and hope that it does eventually sell…  That's a pretty big risk to get less than 2% in return.

This helps me better understand three distinct behaviors I've noticed at dealerships:

  1. Vague Pricing: The dealer can take advantage of a customer's lack of knowledge about pricing to generate much higher profits.  If, for instance, they could convince an uninformed customer to pay $1,000 over what other customers would pay — $31,000 — then most of that extra $1,000 is profit and the dealer stands to make about $1,500.  So, by getting the customer to pay just 3% more, the dealer can triple its profit.  Being vague pays off.
  2. Needless Add-ons: I remember shopping for a new Accord in Lexington many years ago (this was before I met Lowell), and not being able to find one without pin-striping.  There were usually a host of other add-ons — special floor mats, trunk liners, wheel locks, etc. — as well.  I knew I didn't want to pay $150 for $5 worth of colored tape, but a "plain" Accord didn't seem to be an option.  But if the dealer gets customers to pay a few hundred dollars for some cheap "special" options, then they significantly boost their profit.
  3. Pushing Insurance: When the deal was closing, I always wondered why the dealers would push insurance so hard — openly questioning the quality of their product by telling us all of the things that could go wrong with the car.  Well, it turns out that the company I looked at made nearly as much by selling financing and insurance for the car as they did from selling the car itself.  Much like the add-ons, this is where the dealers can really grow their profits. 

So, the next time you are looking to purchase a car, don't be surprised if you see these strange, infuriating tactics. 

In Part II of Dealership Economics, we'll look at how the service department fits into the business.