Maryann Keller Speech to the NADA/JD Power Conference, NYC, MArch 2013

For the over four decades I’ve been involved with the auto industry, first as an investment analyst and now as a consultant and director serving on the boards of both automotive companies and auto dealers. Over those four decades, I’ve heard many arguments made against the franchise dealer system…which dealers never fail to disprove time and time again.

One myth promulgated in the 1990s - and now resurfaced by Tesla - is that factory stores save money by reducing distribution expenses wrongly estimated at 30% of total expense. Let’s put aside for the moment that the percentage itself is nonsense, Ford’s ill-fated Auto Collection experiment proved conclusively (as told to me by a former Ford executive last week) that corporate guys are not risk takers and lack the entrepreneurial spirit to manage dealerships. Big corporations control from the top but selling cars requires street smarts and adapting to local market and competition. Ford ended its experiment after a couple of years of market share losses amid mounting evidence that factory stores do not deliver a better customer experience nor reduce costs, in fact they proved to be bad at both. GM, perhaps after watching Ford’s travails, and despite repeating the same nonsense about reduced costs through factory ownership, canceled its plans to buy 10% of its dealers, plus the Saturn stores, and operate them in through what it called GM Retail Holdings. Ford’s failed experiment demonstrated that, franchise laws notwithstanding, dealers are essential partners in the long process of a car’s journey from the factory to a customer’s garage. Franchise laws protect dealers from arbitrary actions by automakers and given the financial commitments they continue to make in response to factory demands in image programs, equipment, training and even vendor selection, the laws are entirely reasonable. Given the intense competition in auto retailing, it’s hard to understand how anyone could suggest that franchise laws hurt consumers.

Franchise dealers’ cumulative investment in land, equipment and facilities easily exceeds $100 billion. Dealers fund 60 days of inventory and another month of inventory in transit that would otherwise fall to the car maker. The inventory buffer allows automakers to adjust future production levels. For a company like Ford US inventory funding equals about $15 billion at any point in time.

Tesla may be the first start up to launch a car and change the retail process as well but it is definitely not the only company that saw dealerships as a costly impediment to customer bliss. A few years ago I was involved with one such company funded by venture capitalists, and led by a non-automotive executive, that invested in a small car promising to build to order sold though mall-based stores. The car never made it to production and the company folded after consuming the investors’ capital. . Despite evidence to the contrary and lacking any real world understanding to the business, a journalist writing on Yahoo Autos last year stated “Instead of building cars and selling them to dealers who hawk them to shoppers, Tesla wants to build only cars to customers orders, eliminating part of the auto industry’s massive overhead costs in inventory. By selling cars directly Tesla’s executives believe they can make their customer happy, and eventually sell more cars for less money.” Well we will see if it is fact is more economical for the factory to pay the rent, salaries, delivery and service or have someone else do it using his or her own capital. And build to order works only as long as there is an order bank…what happens when the orders dry up…do you send the assembly workers home, tell your suppliers to send to stop producing until you call?…..unfortunately auto assembly really doesn’t lend itself to build to order. It is capital and labor intensive even when work is farmed out to suppliers.

Every dealer knows that the vast majority of customers want their car that day not a date convenient to a manufacturer. The dealer has always been the buffer with the automaker facilitating inventory management through various incentives and production adjustments. It is the dealer who finds the market-clearing price for a vehicle even at the sacrifice of his or her profits. Others have tried experiments in selling away from the traditional retail dealer location on the notion that a big box retailer or mall would mitigate advertising expenses by placing cars where the customers are.

Early in the 2000s, Asbury struck a deal with Walmart to sell used cars in the parking lots of Walmart stores. Asbury would take the cars to where the retail customers were at America’s busiest retailer. A few dealers have experimented (as Tesla is now doing) renting inline space in large shopping malls as storefronts to sell cars. So far, the history of non-dealership settings to sell cars – with perhaps the exception of the infrequent offsite tent sale – hasn’t worked. The Asbury/Walmart experiment ended in less than two years when both parties discovered there were too few car buyers among the static population of regular customers who shopped for food and other necessities at their local Walmart each week.

I suspect that once the novelty associated with Tesla wears off, it too will also discover that mall locations aren’t ideal places to market or sell cars. The enclosed shopping mall typically has several large anchor stores – Nordstrom, Macy’s, Neiman Marcus, etc. – and perhaps eighty to one hundred or so “in line” shops like GAP, the Limited, Zale’s, Sunglass Hut, Apple, etc. A large successful mall might have more than a million or more visitors a year – and that’s about 3,000 folks per day. Those big numbers can dazzle but they aren't what they seem. Much of this traffic represents repeat visitors, as it did at Walmart, coming each week or so to see the changing merchandise at her favorite stores – new fashion and seasonal clothing, makeup, shoes or the latest Apple gadget. Everything can be purchased on a credit card. I used the pronoun “her” deliberately because the vast majority of mall stores are dedicated to women and children not the men who would be the targets for an expensive, high tech performance car.

Furthermore, new car models are only really new only every four to six years. The merchandise doesn’t change very often – so on the second or third visit to the mall, the car store looks exactly as it did last month or even the month before. What was fresh once is now stale with the passage of time…so visitors to the mall just skip past that new car display.

What the uninformed forget – or figure out after an attempt or three – is that automotive retailing is very different from traditional retailing. The product car dealers sell is expensive, generally requires financing, and often involves a trade. It often includes helping shoppers match their budget to a car that might not be their first choice but rather one they can afford. The process is slowed by required disclosures and regulations resulting in a pile of documents that have to be signed even for the most straightforward transaction.

A car weighs 4,000 pounds and takes up 50 square feet of space. It can’t be delivered overnight to one’s front door by FedEx. And most folks don’t have a big enough credit limit on their Visa card to pay for it. And what do they do with their trade? Or get it serviced?

While we are talking about myths, how about the still repeated one that people hate dealers so, if given the chance, they will buy a car online. I almost don't know where to start in taking this one apart…..In the early days of the Internet, Silicon Valley funded and lost hundreds of millions, maybe even a billion dollars, on ill-fated ventures that promised to do just that. CarOrder.com, Greenlight.com, and CarsDirect.com (in its original configuration), among others, all promised to avoid the dealership experience. A few actually did that by buying cars from dealers and then reselling them at lower prices to customers until they blew through their capital. Build to Order.com proposed that you would place your order for a fully customized car while lounging in a company-owned showroom entertainment center. Again here the premise was to build these cars using an automaker’s parts and technology but avoiding high labor costs and dealerships and give the customer the exact car they wanted. Build-to-order.com never built anything for anyone. In 1999 and 2000, I ran PriceLine.com’s experiment with selling cars online, which like most others of the era no longer exists. The essential elements of the PriceLine model were replicated by TrueCar.com and of course they too ran afoul of franchise laws for the same reasons as PriceLine. What I learned then – and this is still true today – we could connect buyers with dealers and that the price of a vehicle was the easiest part of a deal. The other elements are harder to control and often the cause of frustration for the customer and the dealer. People don’t like to hear that their trade isn’t worth the value they saw online or that their poor credit doesn’t qualify them for the no down payment, zero percent loan. There are few people who would think about buying a house online from a few photos taken make rooms seem larger than they are or the neighbors Beware of dog sign. Buying a car is comparable to buying a house, why should we think it should be as easy as buying a pair of shoes from Zappos with a return receipt in the box in case they don’t fit.

Although many automotive websites claim to have “sold” millions cars, even today twelve years after PriceLine decided to concentrate exclusively on travel, automotive websites link a buyer to a dealer who actually sells the car. The Internet has mostly replaced the newspaper as a source of information about cars and dealers but it has not reduced advertising expense per vehicle or made buying a car as easy as buying a book.

Add up all the monthly traffic to all automotive sites, including automakers, dealers and independent sites – and you’d get more than 100 million possibly close to 200 million unique visitors using the web to get information about buying or selling a new or used car. Except there’s one problem if this traffic is somehow suppose to represent potential sales…the total number of new and used cars sold by dealers at retail and excluding fleet each month is only about two million units, and that is probably generous given that not all retail customers go online..some might just release the same brand of the leased car they are returning to the dealer. So the real shoppers – however you want to define that number – are only a small fraction of the total visitors. So just like newspaper, radio, or TV advertising, dealer spend on the internet is likely no better targeted – once again dispelling the notion that the internet would solve the age-old problem of knowing which 50% of a dealer’s advertising works.

And what was once promised as to the beauty of the Internet for used cars…listings of available cars with pictures, even videos, and stated pricing would make it easy for shoppers to find the best car at the best price. But what has happened is that for any given vehicle, within a similar bandwidth of age, mileage, trim, the price range for specific models is usually within a few hundred dollars, not enough to make price the deciding purchase factor. The Internet hasn’t created a pricing advantage for any seller and customers simply have confirmation that similar cars within a market are priced the same. With the exception of hard to find cars, the differentiating factors are having the car the customer wants, proximity of the dealership and the dealer’s reputation in providing a good customer experience.

In summary, technology is a wonderful thing…and dealers have adopted it nearly full tilt. Sophisticated software to manage every aspect of the business is now de riguer…BDC’s to support internet sales…and eDocuments will eventually become the norm. But the point is that the system of franchised dealers – using their own risk capital to fund their businesses and guarantee millions of dollars of inventory, promote their own brand and that of their OEM, provide the expensive tools needed in their service departments, and manage the endless headache of a workforce – will not be superseded by technology or factory owned mall stores. Factories have learned that they cannot do a better job than independent businessmen at the retail level. And new start ups – many of whom will come and go – with new systems of selling and servicing retail automobiles will all reach the same conclusion: the dealer network is the best way. Thank you for listening today.

“Moral Motors” vs the Traditional Franchise New Car Dealer.

First, some ground rules.  This is not to imply that the “traditional” franchised new vehicle dealers aren’t “moral.”  But there is a perception among many consumers and certain consumer watch dog groups that certain “traditional” dealer practices are “unsavory,” at best.

It is a given that a new car dealer needs about a 10% gross profit on each transaction, front and rear combined, about $3000 in today’s market based on an average new vehicle sale for the Dealer to break even and provide a small measure of ROI.  Most consumers and advocacy groups don’t disagree with this, when asked in a survey.  Where these groups differ with the “Traditional Dealer” is when all buyers aren’t charged the same 10% margin.  The idea that one consumer could get away with paying a $1000. gross profit while another pays $5000. to maintain the $3000. average seems outrageous to them.  
Of course, 10% doesn’t seem like much to a consumer until they figure out that that is about $3000. on a $30,000. vehicle.  Consumers tend to have no understanding of the difference between gross profit and net profit.  Perhaps they think the factory absorbs facility overhead, taxes, utilities, staff, etc.  Many consumers also tend to think that new inventory is provided on consignment by the manufacturer.

So let’s do some arithmetic while making the assumption that all other factors are equal.  Let’s assume that two dealers have equal overhead expense, and that their sales staffs are equally adept at product knowledge and “building value.”   The “Moral Motors” dealer never asks for full gross profit and hence, never receives it on any car deal.  After all, they want everyone to pay the same margin.  In addition, the “Moral Motors” dealer passes on the “cheap deals” out of principle, when efforts to justify the price fail in the face of a better price from competitive “Traditional Dealers.”  The “Traditional Dealer” gains extra volume via the “cheap deals” he/she can accept, and gains the additional trade ins, F&I income, and warranty and repair opportunities.  He/she also gains in Units in Operation, which can be leveraged down the road into repeat business.  Plus, there is the additional gross profit that comes with at least making an effort to make full price or additional gross profit and giving everyone the opportunity to pay it.  So add in this extra gross profit to the extra profit from being able to take the “cheap deals,” and the math is easy.  The “Traditional Dealer” sells more cars and makes more money.

Advocates of the Moral Motors business model try to make the case that word of a “no hassle” buying experience will bring additional buyers to their store to make up for the loss of gross profit from the deals and gross profit they turn down.  Great experiments in the past to prove this concept have failed miserably, despite the fact that advocates can always come up with the occasional anecdote.

The comparison gets even more interesting when the two dealers want to buy another dealership.  The additional “cheap deals” of the “Traditional Dealer” translates into additional market share.  Auto manufacturers look at 3 primary factors when considering the approval of a buy/sell agreement.  First, does the purchasing dealer have a record of consistent profitability and the money available to properly fund and operate the additional dealership?  Second, does the purchasing dealer maintain a satisfactory CSI score?  And third, how does the purchasing dealer penetrate his/her current market?  Any dealer who has ever tried to get factory approval for a buy/sell knows how important market share is to an auto manufacturer.  Despite this fact of life in the auto industry, we weren’t able to get any specific comment from any of the OEMs we contacted, other than in very general terms.

Consumer advocacy groups would like us to think that the “Moral Motors” dealer carries higher CSI. but they are unable to cite more than anecdotes.  There are MANY “Traditional Dealers” who maintain more than satisfactory CSI scores.  Without satisfactory market share, the “Moral Motors” dealers will be found wanting, all other things being equal, and will not likely be approved for expansion even if the other two critical items are without issue.

“Moral Motors” can make money if his or her overhead is controllable, especially if his/her dealership is in a market with other less aggressive dealers.  But it also means the dealer has to take a strong stand with his OEM regarding “factory image programs,” where the dealer is expected to increase overhead to bring the dealership facilities in line with OEM standards.  This is not a good way to gain favor with an OEM one might be asking for factory approval to add another dealership.

Our industry is either blessed or cursed, depending on your outlook, with a variety of companies who are quite willing to collect dealer money to help the industry sell more cars and keep customers happy.  They tend to cite surveys done by others, or conduct their own in justifying their approach.  Some of these vendors have actual front line dealership experience and are much more than theorists.  Others? Not so much.  Vendors who would tell dealers to charge everyone the same have probably never worked in or owned a car dealership.  We now have “experts” telling us that our industry should provide a buyer experience like Disney, Apple, or Amazon.  When they have to start negotiating price, taking trade ins with negative equity, and dealing with complicated financing issues, they might have credibility.  Until then, now so much.

Frankly, many of us thought the issue was settled when the factory owned “Ford Collection” vanished from the face of the earth, but this really bad idea of “everyone pays the same” lingers on.  We had this great debate 20 years ago when Saturn was launched, and many opportunists cited the so called “success of Saturn” to “prove” the theory was sound.  Saturn lost money from the start, and never made money, which explains why it is currently extinct.  Saturns were sold for a loss from the start.  Not by the dealer, but the factory lost at least $1500. a car from 1991.  Most wouldn’t call that “success” even if their customers were happy.

I experienced a similar situation in Japan with Toyota about 12 years ago.  A client there asked me how I thought it would work out.  My answer was, “As long as demand and supply are properly balanced, and dealers stay disciplined, it will work great.”  I also mentioned the chances of that happening are “slim and none.”  In Japan, franchises are awarded by region, similar to the old Saturn model.   If the idea of charging everyone the same was ever going to work, it was going to work in Japan.  Imagine a single dealer owning every sales outlet in a particular region or state for a brand.  Toyota even created a new sales channel for the great experiment, combining Auto and Vista into a new one called Netz.  In Japan, Toyota calls their various divisions “channels” and they have 5.  Toyota cut back the markup on Netz vehicles to the point that there was nothing left to give away.  As a consequence, the degree of discounting was minimal from the start.  But sure enough, once demand waned compared to the factory’s need to build cars, along came the “trunk money.”  And dealers took advantage of it to discount, even though the same dealer owned all competitive dealerships.

If this isn’t a commentary on the human nature that drives a new car buyer, I don’t know what is.  Consumers tell surveyors they hate negotiation.  But the first thing they try to do when buying a car is negotiate.  It would seem that what consumers say and what they mean are two different things.

$2 billion and counting: the supplier conspiracy

The conspiracy of Japanese wiring and electronics suppliers to put the screws to Toyota and other customers has now led to the largest antitrust action in history. What we know appears stupendous in scope. To date 20 suppliers have paid fines totaling $1.6 billion in the US (an additional $347 million in fines in Europe and Japan brings the total to $1.95 billion). Some 21 executives have pleaded guilty to felony antitrust charges including jail time and financial penalties. Wired participants, secret locations, coded communication and an expanding list of auto parts and firms, spanning 10 or more years and at least 4 continents. Wild!

...once customers have been screwed for a while, it starts to feel normal

Then there's what we don't know. To date all of those charged have pleaded guilty. As a result, the Department of Justice (and their counterparts in Japan, the EU, Canada, Mexico, Korea and Australia) have not had to enter detailed charges into the public record. With no trial, no evidence need be made public – and even though every corporate law firm in Detroit is racking up billable hours beyond their wildest imagination, those involved have done a truly impressive job of keeping their mouths shut.

And with cause: private lawsuits in the US can seek treble damages, and at least 45 such have been filed (and for now consolidated in the District Court in Detroit). The fines that firms have willingly paid suggest those fines are well below the maximum – though back of the envelope calculations suggests DOJ used a rule of thumb of 8% of revenue for the early wire harness settlements. These and other firms may however have benefitted from the antitrust Amnesty Plus program, which provides for low or even no fines for those who 'fess up' early and help the prosecution. So the amounts could easily hit $5 billion. However, without evidence, such suits will go nowhere, and Federal courts have put a stay on those while criminal investigations are ongoing. Attorney General Holder has indicated that the Department of Justice is far from concluding their work; for their part, the Europeans raided six companies this month. But then there are those wiretaps of phones and tapes of meetings: it appears that the DOJ is limiting itself to central players, and going at them with such ironclad cases that they can avoid wasting resources on the morass of a jury trial.

NPR segment …Nine Suppliers Plead Guilty… [mea culpa: they interviewed me]

In some ways, the industry invites conspiracy. The design and engineering process for a new vehicle involves so many components that doing a full start-from-scratch purchase for each part in a vehicle is administratively infeasible; purchasing departments just aren't large enough. So when a Toyota comes out with the next generation Camry or a Ford the next F-150, they will naturally lean towards the incumbent supplier – they know the engineers, they will have the manufacturing capacity. With suppliers involved in the actual design process, they have to be selected before specifications are firm. Yes, the car companies pursue outside bids to try to keep the process honest, and when there is an entirely new component it's a fully competitive bid. Likewise firms with new technology can get their foot in the door – and those are exactly the firms I see as a judge of the Automotive News PACE award competition.

With so many vehicles under development – in the US alone carmakers will launch 365 new vehicles between now and 2015 – it's clear that purchasing departments have fallen down on the job of tracking costs. But these are not the highly engineered items where at present one or two firms control the technology, such as turbos or common rail diesel systems. When I look at a list of the components named in the guilty pleas, they are for the most part not items where new technology is changing the game: starter motors, alternators, seat belts, wire harnesses. While new materials are coming, in the case of harnesses leading to thinner gauges and now even lighter-weight and cost aluminum wires, these products are mature. But this is necessary: you can't readily fix prices when a good isn't a commodity. When you know your and your competitors costs are similar, then you can agree on what the price could be and the level at which your conspiracy can fix it.

Part of the reason is again administrative: car companies with few exceptions have no internal manufacturing capability for the items they procure. They thus rely upon comparisons with past prices, adjusted for changes in the price of materials and known or anticipated productivity improvements. Therein lies the opportunity for a cartel: once suppliers have started screwing their customers, the car companies can come to believe that it's normal. Bids look sensible given past prices. Since harnesses with their miles of wire and hundreds of connectors are one of the most expensive component purchases a car company makes, companies always seek outside bids – but thanks to the conspiracy either find few firms express interest, or come in with ridiculous prices. [For an example see "Ford Alleges…" Automotive News, Aug 5, 2013] This should raise suspicions, but apparently did not set off alarms. While Toyota was firm mentioned in initial guilty pleas, the list of victims now includes most of the industry's major firms. Toyota's purchasing department may have been overwhelmed in its go-go years of the noughts (ending with the early retirement of the firm's top 4 executives), purchasing departments throughout the industry clearly were not up to the task of sniffing out carefully coordinated price fixing.

With wire harnesses, 4 suppliers dominate the Asian market, with Delphi Packard (yes, the name I use is anachronistic) a strong contender elsewhere (and as the one major player not named in this segment, finding that it's suddenly gaining market share in Nagoya). So how did the conspiracy arise? In Japan (as elsewhere) suppliers share panels in engineering conferences and industry associations; ironically, as I found in my own PhD research in the mid-1980s, they may even play golf together at events hosted by their customers. Put them together in the ex-pat supplier community in the US and informal interactions become more likely. Or at least that's my supposition of how things got started, and why it remained undetected in some cases for a full decade.

With stays on the private lawsuits, with uncontested guilty pleas in all the criminal cases, and with those involved so far keeping their lips sealed, few details have come out on the US end. It may be that journalists in Japan can find out more – what goes into the public record may be different, Japan's Freedom of Information Act is stronger than that in the US, and when plied with drinks officials and mid-level auto industry managers may be more willing to speak less-or-more off the record. Journalists and stock analysts should also be asking Toyota about their purchasing operation, about how they could be bamboozled out of so much money and how they're working to fix that. Finally, all should be lauding the Japanese Fair Trade Commission, which in its pursuit of this case is showing that it is more capable than in the past – handling the domestic side of a multinational price-fixing conspiracy – and is willing and able to act in the interest of consumers.

Mike Smitka

Justice Department Press Release

Auto Dealers Take CFPB Issues to Washington DC

Excerpts from NADA Front Page; comments by Ruggles follow

More than 400 fran­chised auto deal­ers weighed in with Wash­ing­ton law­mak­ers ear­lier this week on the Con­sumer Finan­cial Pro­tec­tion Bureau’s (CFPB) effort to end the dis­counts that cus­tomers can nego­ti­ate when financ­ing a car or truck through a deal­er­ship. The vis­its to Capi­tol Hill were orga­nized as a part of the National Auto­mo­bile Deal­ers Association’s Wash­ing­ton Conference.

Deal­ers asked their sen­a­tors to sign the let­ter authored by Sens. Rob Port­man, R-Ohio, and Jeanne Sha­heen, D-N.H., request­ing that the bureau explain how elim­i­nat­ing a dealer’s abil­ity to “meet or beat” a competitor’s rate is good for consumers.

A key ally in the deal­ers’ fight, Rep. Gary Peters, D-Mich., told the deal­ers in a speech on Thurs­day that he’s “very con­cerned” about the CFPB’s recent effort to alter the $800 bil­lion auto finance mar­ket­place with­out a hear­ing or offer­ing analy­sis for pub­lic scrutiny.

“I believe it’s absolutely essen­tial that we have a very com­pet­i­tive mar­ket­place so that folks can get the low­est rate they can for their loans, and cer­tainly dealer-assisted financ­ing is about that,” said Peters, who along with 12 Democ­rats on the House Finan­cial Ser­vices Com­mit­tee sent a let­ter to the CFPB demand­ing greater transparency.

“The CFPB has not pro­vided any infor­ma­tion about its study or how they com­pare the numer­ous fac­tors that can affect auto inter­est rates,” said NADA Chair­man Dave West­cott, a new-car dealer in Burling­ton, N.C. “Even more shock­ingly, the bureau failed to exam­ine how this change could impact the cost of credit for con­sumers. In-dealership financ­ing has been enor­mously suc­cess­ful in both increas­ing access to credit, and reduc­ing the cost for mil­lions of Americans.”

Ivette Rivera, NADA vice pres­i­dent of leg­isla­tive affairs, said that sen­a­tors were recep­tive to the dealer’s request to sign on to the Portman-Shaheen Auto Finance letter.

“Early reports from our Hill meet­ings indi­cate that mem­bers of Con­gress on both sides of the aisle think that greater trans­parency from the CFPB is needed,” Rivera added.

Ruggles writes:  The issue is over dealer "rate participation."  Dealers "buy" money from lenders at "wholesale, and distribute it at "retail."  The CFPB alleges that all consumers aren't treated equally.  They have set out to regulate dealer rate participation via a proxy strategy.  Using laws against discrimination and an obtuse theory called "disparate impact," the CFPB seems to want to abolish rate participation and replace it with some kind of a flat fee arrangement.

WIKI on the subject:

"In United States employment law, the doctrine of disparate impact holds that employment practices may be considered discriminatory and illegal if they have a disproportionate "adverse impact" on members of a minority group. Under the doctrine, a violation of Title VII of the 1964 Civil Rights Act may be proven by showing that an employment practice or policy has a disproportionately adverse effect on members of the protected class as compared with non-members of the protected class.

The doctrine prohibits employers "from using a facially neutral employment practice that has an unjustified adverse impact on members of a protected class. A facially neutral employment practice is one that does not appear to be discriminatory on its face; rather it is one that is discriminatory in its application or effect." Where a disparate impact is shown, the plaintiff can prevail without the necessity of showing intentional discrimination unless the defendant employer demonstrates that the practice or policy in question has a demonstrable relationship to the requirements of the job in question. This is the so-called "business necessity" defense.

Disparate impact contrasts with disparate treatment. A disparate impact is unintentional, whereas a disparate treatment is an intentional decision to treat people differently based on their race or other protected characteristics."

Ruggles again: Even though disparate impact pertains to employment law, the CFPB, along with the FTC and the DOJ, have chosen the theory to try to bully the auto financing industry. What is especially interesting is how the CFPB proposes to determine how one is a member of a "protected class."   They propose to use zip codes and surnames, along with other data they are less than transparent about. 

A recent decision in California was settled where a Mitsubishi dealership was alleged to have provided better interest rates to Asians, than to the general population.

Don’t be Forced to Sign a Renewal Franchise Agreement

Posted on September 6th, 2013 by Richard Sox from Dealer Magazine

Some things never change. The factories keep telling dealers that when the expiration date in their franchise agreement arrives the dealers must agree to the terms of the renewal agreement the factory puts in front of them and, unfortunately, some dealer continue to believe the lie! DON’T SIGN A RENEWAL FRANCHISE AGREEMENT UNLESS YOU ARE SATISFIED WITH ITS TERMS.

As I have written in this column on several occasions, virtually every state motor vehicle franchise law provides dealers with significant protections against being forced to sign a renewal franchise agreement containing new and onerous terms. Those protections are most often not couched in terms of a prohibition on an adverse change to your franchise but, instead, in terms of a prohibition on failing to non-renew a franchise agreement without providing the dealer with notice and having “good cause” to do so.

The restrictions on franchise agreement renewal are most often found in the franchise termination section of your state law. In practice, those provisions mean that a manufacturer cannot simply rely on the expiration date of your franchise agreement as a way of saying “either you sign our [the manufacturer’s] new agreement or you no longer have a franchise.” Instead, the manufacturer must first give you notice of its intent to non-renew and then must demonstrate good cause in doing so. “Good cause” is generally understood to be a material breach of an otherwise reasonable provision of your franchise agreement. I am not aware of any franchise agreement which contains a provision requiring you to execute any renewal agreement presented to a dealer no matter how onerous the new provisions. I would further guess that any such provision in a franchise agreement would not meet the threshold test of being reasonable. Without good cause to non-renew, the practical effect is that your “expired” franchise agreement continues in full force and effect unless and until a new agreement is reached.

We have a number of dealer clients who have refused to sign a renewal agreement containing new and burdensome provisions (i.e. facility construction deadlines or specific sales performance goals). Instead of receiving a notice from the factory that their franchise agreement will not be renewed for failure to agree to the proposed new agreement, those dealers have either received a letter extending the expiration date of the franchise agreement from the manufacturer or received no notice at all in which case the franchise agreement is “extended” by operation of law.

Before signing a renewal franchise agreement, be sure to have an experienced motor vehicle franchise lawyer review the agreement and provide advice on any new terms. In many instances, the factory is willing to negotiate over the proposed new terms if they know that the dealer is aware of their right under the franchise laws to refuse to sign the renewal agreement as presented.

MANUFACTURER FACILITY AND IMAGE PROGRAM UPDATES

The area of manufacturer facility expansion and image upgrade requirements has been extremely active so far this year. Large, well-heeled dealers like Jack Fitzgerald and Norman Braman have pushed back against their manufacturers’ unreasonable facility requirements by bringing lawsuits in federal court. Several state legislatures have passed new and significant protections against manufacturer facility requirements. And NADA completed its study on the practical impact image upgrades have upon dealership sales and service revenue.

Unfortunately for many dealers, just days ago Braman settled his lawsuit with General Motors before the court had an opportunity to provide any ruling on his claims that General Motors’ refusal to pay his Cadillac store facility program incentives violated Florida’s franchise laws regarding payment of facility-related incentives as well as federal price discrimination laws. The settlement agreement between Braman and General Motors was, as all settlements between manufacturers and dealers, strictly confidential. It is fair to say, however, that a settlement in the very earliest stages of the case indicates that General Motors believed it had exposure under Braman’s claims. As a result, we suspect General Motors agreed to compensate Braman for unpaid per vehicle bonus monies and arrived at some mechanism for paying future facility bonus monies.

Fitzgerald’s lawsuit has been in limbo since shortly after its filing due to General Motors desire to negotiate a resolution there as well. As in the Braman matter, we suspect that General Motors sees significant exposure under Fitzgerald’s claims of a violation of Maryland’s franchise law which prohibits withholding per vehicle incentives from any dealer no matter whether or not facility requirements are met. Thus, we expect it will only be a matter of time before a confidential settlement is announced in the Fitzgerald case.

Recently concluded legislative sessions saw significant facility renovation protections added to state franchise laws. These protections have included prohibitions against (i) a manufacturer requiring a dealer to renovate his or her facility if the facility was renovated pursuant to manufacturer requirements within the past several years; (ii) unreasonable construction requirements; (iii) the use of sole-sourced construction materials if a less expensive equivalent is found and (iv) withholding per vehicle facility incentives where the dealer has substantially complied with the manufacturer’s facility program.

Amidst the court and legislative battles over manufacturer facility expansion and image upgrade requirements, NADA completed the second phase of its study on the practical impact to the dealership’s bottom-line of manufacturer-mandated facility renovations. Not surprisingly, the study concluded that where a facility size expansion was necessary to meet the growing demands of a dealership’s market such an expansion provided the dealer a return on that investment BUT where a manufacturer was requiring new imaging in effort to make all dealerships look identical, no positive return on investment resulted.

So with all that has gone on with dealership facilities so far this year what can we expect for the remainder of the year and into 2014. Keeping in mind that several of the manufacturer’s image programs have been around for quite some time without any change (i.e. Nissan’s NREDI, Infiniti’s IREDI and Toyota’s Image II), combined with improving dealership finances, we believe several manufacturers will be introducing new image programs by no later than the NADA convention in early 2014. Moreover, due to the substantial increase in vehicle sales the past two years and expectations for continued growth; we expect manufacturers to revise dealership’s size requirements to meet the additional sales and service customer demand. The projected growth in sales and service business is almost always inflated by the manufacturer and does not take into consideration the dealership’s ability to handle growth within the current facility.

With these expected new image and expansion requirements, dealers will have an opportunity to utilize the results of the NADA study to push back on new facility requirements or, at a minimum, negotiate a reduction in the scope of the construction. Likewise, dealers will have the opportunity to utilize the new franchise laws governing manufacturer-facility requirements to avoid unreasonable manufacturer demands. These franchise laws were extremely hard-fought by your state and metro dealer associations and, in recognition of those efforts, should be taken advantage of by dealers at every opportunity.

Richard Sox is a lawyer with the firm of Bass Sox Mercer PA (formerly known as Myers & Fuller PA) with offices in Tallahassee, Florida and Raleigh, North Carolina. The firm’s sole practice is the representation of automobile dealers in their quest to establish a level playing field when they deal with automobile manufacturers.

The Nano and the Model T: History Lessons Not Learned

Nano: no price is low enough

Back in 2007 the Tata Nano ultra-low-cost 4-seat car garnered attention; other companies were rumored to be starting their own projects. However, since its 2009 launch it has not sold well. While Japan has its "kei" cars (軽自動車), which are taxed less and until recently did not require proof of a parking spot, economy cars have not sold well. And while the "kei" cars are less expensive, they're not cheap, and come with amenities car drivers in developed countries expect, such as air conditioning.

...Tata fortunately didn't bet everything on the Nano...

We in the US have our own experience with a product similar in concept to the Nano: the Model T. At the onset it was still out of reach of the average American, but Henry Ford and his engineers improved production efficiency and otherwise lowered costs, so that while it initially sold for $850, when production ceased in 1926, it was selling for $350 [using the BLS inflation calculator, that's equivalent to about $4,800 today]. Or rather, not selling.

Instead consumers preferred two other vehicles. One was a Chevy, better appointed though at a higher price point. By 1923, customers could get a Chevy with an enclosed steel Body by Fisher painted in bright Duco colors, an electric starter and other amenities. The other vehicle to which price-conscious consumers gravitated was a used Model T. By the 1920s millions were available, and for farmers and others looking for basic transportation they went for half the price – or less if you were handy, as the Model T easy to fix.

Cars are aspirational products, and in India those wanting a vehicle opt for a Maruti Alto. Even though the base Alto costs 50% more than the Nano, in August 2013 Alto sales surpassed 17,000 units while the Nano sold under 2,000 units.

The other challenge is from below. Motor vehicles are durable goods (though less so on Indian than on American roads), and so the Nano faces competition from used cars. The Nano doesn't have a useable trunk, but all other models do – and a used Alto will set you back less than a new Nano.

Then there are motorbikes, for which India is the world's largest market. Bikes outsell cars by 7:1 – in August 2013 only 180,000 cars were sold, while the leading bike firm Hero by itself sold 460,000 units. At the most expensive end, a Hero Karizma will set you back over R100,000 [rupees], but most models run R40,000-R60,000. Compare that to the base Nano at R162,000 and the base Alto at R242,000. Bikes are utilitarian, too, and if you can hang on, they're capable of carrying more people than a Nano, for half the price.

Nothing New

Of course we've been here before, and we don't have to go back most of a century to find similar examples. In electric cars we had the Aptera at one end – a 3-wheel, strictly utilitarian vehicle – and the Tesla at the other. We know how that went. When Roger Smith wanted to experiment at GM, he set up Saturn. Now by refusing to overdealer he was able to claim a new "no hassle" purchasing experience, which many consumers liked, or to put it more bluntly, were willing to pay for. But by focusing on compact, utilitarian cars, Smith guaranteed the business would generate thin margins (and by insisting on all-new factories and designs, he built in high fixed costs). We also know how that went: Smith's successors could find no business case for continuing to invest in the brand. In contrast, what has GM successfully pushed in China? Not some stripped-to-the bone Chevy, but decked-out Buicks. They can't make them fast enough, the cash just keeps rolling in.

Tata fortunately didn't bet everything on the Nano. It also purchased Jaguar Land Rover, after Ford had restructured and turned them into profitable businesses. There is no upmarket for the Nano; it's already down the road and over the hill. There may be a higher-volume downmarket for JLR, which has passed the starting line with a good position and has yet to peak. Mixed metaphors, yes. Mixed performance, too. But an old story.

mike smitka

Fed Tapering and Interest Rates

If Past is Prologue

Ruggles AFN September 2013

Federal Reserve Chairman Ben Bernanke let it slip a couple of months ago that the Fed might begin to “taper its asset purchases” this fall. “Asset purchases” in this case is a euphemism for the Federal Reserve buying our own U.S. Government debt. The Fed has been buying about $85 billion in U.S. Government bonds each month for quite some time, representing about 60% of total U. S. debt purchases. Yes, they do this by “printing money,” another euphemism.

Markets didn’t like the sound of Bernanke’s comment and immediately retreated, the Dow from a record high of over 15,000. Certainly, markets hang on every word Bernanke speaks, reacting to the actual words as well as to what they think he means. Bernanke says the Feds future actions will be “data driven.” Analysts believe the Fed could begin their “taper” as soon as September if data for August looks favorable.

Mortgage interest rates have risen a full percent this year. Despite this, home prices have advanced remarkably. The “Sequester Spending Cuts” are still in effect, adversely impacting GDP numbers, yet the economy marches forward showing surprising growth under the circumstances. The specter of another debt ceiling fight, as Republicans threaten to hold the debt ceiling hostage in an attempt to renegotiate ObamaCare, hangs like a pall over the economy while fears of a Syrian/Middle East engagement raises fears of a sudden spike on global oil prices putting the world economy in jeopardy. Still, the U.S. economy marches on. Many analysts believe this is a product of incredible built up demand in the U. S. economy.

Normally, “money printing” of this magnitude weakens a country’s currency, which occurred initially to the U. S.dollar. That had many folks upset, but resulted in an export boom led by refined fuels as dollar denominated trade became less expensive to foreign buyers. Another effect of a weaker dollar was that Chinese goods became more expensive here, resulting in the loss of about 10,000,000 jobs in China. Surprisingly the dollar has recently strengthened. Now Japanese and Korean auto manufacturers are feeling price pressure on exports to the U.S. while making them grateful they have manufacturing in the U.S.

But the Fed has vowed to take away the punch bowl before the party really gets started to mitigate the risk of market bubbles and destructive inflation, while calling it “tapering.” At some point, we ARE going to have to find out the real “cost” of money. Many fear the “rubber band” effect of releasing the lid on something that should have been freed long ago. Corrections rarely go directly to the point of equilibrium and most often overshot the mark before eventually finding the balance point.

So what is the “real" interest rate if we no longer had an artificially low Prime Rate and say 2.5% measured inflation? I’ve read analyst estimates of 4.5% to 5.5% once the rate is allowed to find its own level. If this is correct let’s hope we don’t have to endure a period of “rubber band effect” after the interest is allowed to “float” before the natural equilibrium is achieved.

Flash back to 1970, the year I entered the auto business. The Prime Rate was about 7% compared to the current 3.25%. A mortgage cost about 7.75% for a 20 year mortgage compared to the current 30 year 4.5%. But a 36 month car loan was 12% compared to the current Tier 1 rate of about 3% for a 72 month car loan. There were no credit tiers in 1970, with only the local finance loan company to charge a higher rate for higher perceived risk for certain borrowers. Perhaps the much higher spread at the time was how lenders accommodated those with less than perfect, but not awful credit, thereby charging the best borrowers “too much” while the less credit worthy buyers caught a break? I didn’t know any different as I had no other basis of comparison. At the time I thought things had always been this way.

The car loan rate stayed around 12% until it went higher, much higher around 1978. By then we were decrying 48 month car loans and complaining about “stagflation,” a weak economy along with inflation.

Paul Volcker, Fed Chairman at the time, appointed by President Jimmie Carter, fixed all of that. But this remedy was not without considerable pain. Many of us who have been in the auto industry for some time recall vividly when interest rates were allowed to keep pace with inflation after the wage and price controls of the 1970s were lifted. The horror of 20% floor plan interest and 16% interest rate car loans will never be forgotten by those of us who lived it.

Today’s auto dealers pencil out projections of what a doubling of their floor plan rate would mean to their business, as well as a 2 – 3% increase in Tier 1 finance rates. And OEMs roll on as if none of this could happen, pushing dealers to spend more and more on their facilities while the Internet puts ever higher pressure on gross profit margins.