Warren Buffet's Berkshire Hathaway buys auto retailer VT Inc.

From Slate Magazine: "Warren Buffett's Latest Deal Has Officially Made Car Dealerships Cool"

I don't think so. I have a LOT more to write on this as someone who has spent a career life in the retail auto business AND worked in the van Tuyl organization. This time, Warren might have bit off more than he can chew

This is a REALLY BIG DEAL!!!!

People LOVE Their Car Dealer, But Hate Yours

Steve Finlay - WARDS June 2013

People carry on a love-hate relationship with car dealers.

They typically love their dealer, as evidenced by rating websites where grateful customers say things like:

• “He cares about his clients and is extremely helpful with any questions or issues.”
• “I have always been extremely pleased with the service and professionalism.”
• “It was honestly the BEST customer service I’ve received in my whole life.”

But many consumers dump on dealers in general. Disliking from afar is a human flaw. Disdaining faceless groups is a building block of bias.

So when the National Automobile Dealers Assn. said the traditional franchised-dealer system actually protects consumers, angry Internet users began pounding their keyboards.

“Yes, everyone I know leaves a dealership thinking, gee, that dealership is really interested in protecting me and my interests rather than their own interests,” one sarcastic wag wrote in the reader comment section of an online story mentioning NADA’s claim.

“Very disappointed to see that NADA thinks we’re a bunch of morons who will buy this line,” someone else commented. “I could respect them more if they would just come out and say they were trying to squash a competing business model.”

Another person proclaimed: “The arrogance of trying to tell us they are just watching out for our best interests is stunning.”

All this bluster is tied to electric-vehicle maker Tesla deciding to short-circuit the conventional dealer system by selling its vehicles directly to customers.

Tesla has opened small showrooms here and there where shoppers can check out the single-product Model S, then order one online from the manufacturer.

Some consumers think that’s the way to go. They see dealers as needless middlemen who hike up vehicle prices, even though one could argue prices would rise if dealers weren’t competing against each other, and a customer instead had to buy a particular vehicle from only one source: an auto maker.    

Many foes of the franchise system seem woefully uninformed about how it works. Yet, they praise Tesla founder Elon Musk for trying to “revolutionize” how cars are sold. But auto companies, not dealers, came up with the franchise system.

Auto makers did that because they deemed it better for someone else to sell and service products, especially if that someone covers the facility costs. Accordingly, dealers collectively have invested billions in their stores.

Auto makers realize their core competency is in making vehicles, not selling them. Every now and then, an auto maker will give auto retailing a shot. In the late 1990s, Ford unsuccessfully tried in certain markets, such as Tulsa, OK, and Salt Lake City, UT. It took years for the smoke to clear from that bomb.

A newspaper columnist decries the fact that if you want a Ford, you can’t march down to your local general car store to get one. No, you must buy it from a Ford dealer.

That’s because auto makers want it that way. They don’t want big-box auto stores selling different brands, side by side, under one roof. You’d find plenty of dealers willing to do that, but good luck finding a manufacturer.

Dealer associations and Tesla are battling legally and legislatively over the EV maker’s desire to sell cars directly to consumers. Meanwhile, Tesla stock looks like a bubble ready to burst.

“Elon Musk has done an amazing job of driving up Tesla’s stock price,” Bill Wolters, president of the Texas Automobile Dealers Assn., tells me. “He’s a master of P.R. What puzzles me is that he has never tried the franchise system, yet he insists it won’t work for him.”

Throughout automotive history, start-up companies selling limited-appeal products in unconventional ways have suffered high fatality rates.

I’m not saying the dealership franchise system is perfect or that it will last forever. But I bet it outlives Tesla Motors.

Can “Friction” Be Eliminated in the Buying/Selling Equation?

Ruggles in WARDS October 2013

At the recent J. D. Power event held in Las Vegas in October Scott Painter, TrueCar CEO, introduced a new theory, something most of us had never heard. According to Painter, elimination of “friction” from the car buying process could lead to a 20 million SAAR in the near term. He seems to believe that the “agony” and trepidation car buyers feel about the car buying experience costs the industry sales, as if many consumers are so fearful of the car buying process that large numbers of potential car buyers essentially hold on to their current vehicle so they don’t have to venture into a punishing game where there is a chance they might not “win.” According to Painter, there are many things that the industry would have to do to achieve the elimination of the harmful “friction.”^{Note 1}

One of those “friction” causing items, according to Painter, is the practice of OEMs offering “trunk money” to dealers,

which makes it difficult for consumers to know the true cost of a vehicle to the dealer. “Trunk money” includes any payment back to the dealer from the OEM that reduces the dealer cost of new vehicle inventory below that of invoice less hold back. Invoice and holdback information is already readily available to consumers. He seems to think that the consumer is entitled to know dealers’ bare cost information so that only the dealer gross profit margin is negotiated. Somehow he believes this would help reduce the harmful “friction.” Of course, this flies in the face of the needs of OEMs who would also like to build new vehicles at a profit, and need to be able to negotiate prices from suppliers based on volumes that sometimes have to be “forced” via various “back of invoice” incentives. This includes “stair step” programs and other incentives designed to boost volume. After all, OEMs need to achieve volume commitments made to suppliers to achieve the best pricing, as well as other economies of scale.^{Note 2}

Painter seemed to be longing for the days when TrueCar used their infamous bell curve to advise consumers of what they should pay for a new vehicle while relying on dealers for the revenue to fund that initiative. This caused extensive pushback from dealers and forced TrueCar to adopt a different business model, one more conducive to dealers being able to achieve a more acceptable gross profit on a transaction. Despite the dealer push back against TrueCar, other vendors have picked up on the “bell curve” model. Many analysts believe these self serving initiatives to reduce friction in the purchase process have not increased volume but have resulted in the same volume being done at decreased dealer gross profit.

In addition to OEMs changing their own business model and giving up their tools to balance their production, what else could be done to eliminate the harmful “friction?” Consumers don’t seem to mind a dealer making money as long as they don’t have to hear about someone else getting a better deal than they received. Isn’t the answer to that “price fixing?” If everyone pays the same margin, won’t that satisfy consumers? Perhaps TrueCar and certain other vendors, who are bent on creating a frictionless efficient market in new vehicles, should spend their time and resources lobbying the FTC so dealers won’t have to go to jail for “price fixing.” After all, isn’t the most righteous objective happy consumers, not real competition with consumers having the ability to shop? The FTC (Federal Trade Commission) holds the impression that competition at the dealer level benefits consumers. Maybe they’re wrong?^{Note 3}

Is there another business where consumers have as much information about the products they buy? Aren’t car buyers free to shop? Aren’t they free to use their own buying strategies? How can they ever be completely satisfied?

In recent times, dealerships would take cheap deals as a way of achieving increased market penetration and providing “plus business” they wouldn’t otherwise have received. These special “cheap deals” have often been funneled through a dealership’s fleet department. To achieve an acceptable average, some buyers had to pay a higher margin than others to achieve a reasonable average. But instead of “frosting on the cake,” these “cheap deals” have become more the norm as evidenced by the extreme margin compression seen on dealer’s financial statements.

It is amazing to many auto retail veterans that those who have set out to make money by reducing “friction” in the auto purchase process can be characterized by one glaring deficiency. Very few, if any of them, have any real experience dealing with real car buyers on a day to day basis. These are not people who understand customers. They don’t know the difference between what consumers say and what they really mean. Steve Finlay’s recent column, “Consumers hate dealers, love theirs” provides excellent insight on this.

Let’s do the math. We have margin compression brought about by the proliferation of dealer’s proprietary information via the Internet and vendors focused on making money for themself by reducing transactional “friction” with the resultant dealer gross profit reduction. We have margin compression on the used car side, again brought on by the Internet. We have increased margin compression on dealer rate participation through CFPB (Consumer Financial Protection Bureau) initiatives. At the same time we have OEMs working to raise dealer’s costs through their image programs. Is there anything wrong with this picture?

Notes by Smitka

Note 1: This is synoymous to a claim that the short-term price elasticity of demand is extraordinarily high – a 4% reduction in price ($1K with an average $25K price) will lead to a 25% increase in sales. Nonsense! Furthermore, big rebate programs pull forward sales – examples include cash for clunkers in the US and short-term government tax rebates, such as the "Eco-car" program in Japan.

Note 2: As someone who works on suppliers, such incentives may be tied to "take or pay" pricing with suppliers, but is more likely due to the benefits of keeping assembly plants running at a steady pace.

Note 3: I am teaching "Industrial Organization" this term, which examines topics such as collusion. As per Ruggles' rhetorical question, there's no particular reason to think the FTC is wrong. Indeed, we have an experiment in this in the initial Saturn dealership network. The evidence (papers presented at the MIT IMVP) suggest that the reason this model worked was because the car was popular (= little need to discount) and dealerships were "thin" on the ground so that it was challenging in those pre-internet days for consumers to play one dealership against another. One either of those two pieces of the equation is taken away, fixed price retailing doesn't work.

Velocity Overdrive, the Road to Reinvention

A Book Review

by David Ruggles and comments in italic by Mike Smitka

Dale Pollak’s third book, “Velocity Overdrive,” is another winner and is must reading for dealers and any student of the auto business. That includes auto manufacturer executives.

Dale’s ability to put into words the changes the industry has been experiencing has helped hundreds, if not thousands, of auto dealers, both new and used. He has rightfully pointed out that the delivery of information via the Internet has brought “efficient market” economic principles to the pre-owned business in particular, compressing available “spread.” New data driven management methods that are based on rapid inventory turn at lower, but real world gross profit for the specific market, actually produce considerably higher total gross profit through higher velocity, a concept difficult for some to grasp. In some areas of retail the benefits of sacrificing margine to increase inventory turns is commonsense. Automotive retailing is catching on: Daily, market realities are making believers out of skeptics.

My favorite chapters include 8, “Dealership Department Silos,” and 14, “The Extra Mile in Reconditioning.” In these chapters Pollak dares to challenge long and stubbornly held beliefs that the pre-owned department exists to be pillaged by the fixed operations departments. After all, it was thought, sales people and managers sell from their cost, not based on any kind of rational retail market value. And gross profit booked by charging retail prices for internal reconditioning, or “retail recon,” is retained regardless of what happens to the used vehicle, they thought. There are dealers who have followed this “retail recon” policy for another reason. They would rather pay management compensation based on fixed operations rates than sales manager rates. The Internet has changed all of that. Dealers still in denial on the issue especially need to read this book!!

In my mind, the idea that “you can’t manage what you can’t measure” has cost dealers a lot of money. What one could have gotten, should have gotten, but didn’t get, is never quantified. In “econo speak” that means “opportunity costs,” or opportunities unrealized. Figuring opportunity costs is hard, sloppy comparisons and the failure to dig up relevant data abound. There's less excuse for the following common errors in our internet world: Trade-ins under bid and/or units wholesaled instead of retailed because of “retail recon” cost money that can’t be totaled. And many dealers remain oblivious of this fact. My own piece on this blog on the issue can be found here.

The pre-owned business has long been a combination of art and science. The science side has become more important than ever although some old dogs like me might think things have gone overboard in some cases. For example, I’m not thrilled about managers failing to walk around a vehicle and actually drive it before hanging a number on a trade-in because they are relying on an appraisal tool. But then neither is Pollak. Some managers think all they need is their technology driven appraisal tools.

As far as science is concerned, Pollak has already conceived and implemented the most essential and highly used technology tools in use in the industry. His company, vAuto, now offers a new technology tool called Provision®, an inventory management tool. It distills market data into management metrics that dealers and used vehicle managers use to easily and quickly understand the risk and rewards inherent in every vehicle.

Looking forward, Dale dedicates a chapter to trends that will result in further margin compression for dealers. Younger buyers are more internet enabled then older ones and they have different values than older generations. They don’t think in terms of the value a dealer relationship offers them. They tend to be ruthless in their pursuit of the best price, using the internet to obtain it. Unfortunately, in the middle of this generational driven trend OEMs are pressuring dealers to build ever more expensive facilities in an era when consumers are less willing to pay for them. Increasing fixed costs when margins are falling does not lead to a happy ending. Pollak cites Glenn Mercer’s comprehensive study on the subject on behalf of the National Automobile Association (here on the NADA site).

This book is well worth the investment even if a dealer only reads the chapter, “A Peek Inside Dale’s Crystal Ball.” Dealers who ignore Dale’s advice do so at their own peril. Increasingly, the “efficient market” that is the auto business will tend to leave only the leanest operations standing. For a Dealer in search of significant ROI, buy the book and read it.