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.

Detroit's Biggest Mistakes

Detroit’s Worst Mistake EverNov. 7, 2012 by Drew Winter in Ward's Automotive Final Inspection

Detroit auto makers wasted at least $50 billion during the past two decades in failed efforts to impress Wall Street and raise their stock prices.

History of Automotive Boondoggles

• Most Over-Hyped Automotive Trends of Past 25 Years
• Ward's 10 Best Engines: Chrysler 3.6L DOHC Pentastar V-6

I recently blogged about some of the auto industry’s biggest boondoggles of the last 25 years and asked readers to contribute their thoughts.

My email bulged with suggestions, especially related to the Detroit Three.

Many mentioned General Motors’ misguided attempt to reinvent itself with Saturn and ill-advised investments inFiat and Saab. Plus, there were vehicles such as the infamous Pontiac Aztek and the entire Hummer brand. Others mentioned questionable adventures at Ford, such as its purchase of Jaguar and Volvo, and numerous bad cars going back to the 1970s including the Pinto subcompact and Mustang II.

Readers also pointed to head scratchers at Chrysler such as the TC by Maserati, a gussied up K-car with a Maserati badge; the odd-looking Plymouth Prowler; and the disastrous “partnership” with Daimler that ended in divorce.

But to ferret out the absolute worst mistakes Detroit has made in recent history, I look to professional automotive observer and author Maryann Keller. She has been enormously influential since the early 1980s. After a 28-year career as one of Wall Street’s top auto analysts she now runs her own company, Maryann Keller & Associates. She is as tough and insightful as ever.

During a recent speech to the Society of Auto Analysts, Keller unleashes her own list of auto industry blunders, and her choices make most of the items above look like minor glitches.

Detroit auto makers wasted at least $50 billion during the past two decades in failed efforts to impress Wall Street and raise their stock prices, she says.

That incredible figure includes stock buybacks, excessive dividends and diversification efforts, all of which could have been spent making better products. GM alone doled out $20 billion from 1986 to 2000 on stock buybacks and actually borrowed money it did not have to pay dividends from 2005 to 2008.

Ford kissed off half the cash it had on hand in 2000 creating a special dividend of $10 per share, Keller says. GM and Ford also wasted billions buying rental-car companies that hid excess production capacity and threw away billions more for e-commerce efforts that looked sexy during the Internet bubble economy but ultimately yielded zip in revenue and profits. Also on her list are the names of financial-services companies, vehicle retailers, recyclers, junkyards and mortgage companies. All were purchased in an effort to add glamour and growth to auto maker bottom lines, but they did neither.

Of course, these strategies did not look quite so boneheaded at the time. In the late 1990s, auto companies were considered old-fashioned. No matter how many vehicles they sold and how much cash they raked in, their stock prices looked weak compared with the soaring value of technology and Internet stocks.

So auto makers tried to redefine themselves as something other than companies that built and sold cars and trucks.

And this was the Detroit Three’s biggest mistake ever: They tried to be something other than vehicle manufacturing companies. When they focused on being banks and mortgage lenders and impressing Wall Street, they took their eye off the ball of their core business. Design faltered, quality slipped and market share skidded. Disaster ensued.

Ford was first to see the error of its ways and avoided bankruptcy. GM and Chrysler were not so lucky.

But as Keller points out, “Wall Street didn’t make these decisions; the CEOs did.”

I currently am testing vehicles for Ward’s 10 Best Engines and as a judge for the North American Car and Truck of the Year awards. Detroit’s new products such as the Cadillac ATS, Ford Fusion and Dodge Dart are terrific. Detroit auto makers clearly have their eye back on the ball. It shows in vehicle sales numbers, on their bottom line and their stock price. Let’s hope they never again try to be something they are not.

dwinter@wardsauto.com

Fleet Sales and Push Marketing



In April I wrote a column on the auto industry’s continuation of “push marketing,” despite assertions from the industry acknowledging the ills created by the practice. I wrote the column in the context of Toyota’s public relations and sales challenges. In response to a severe sales downturn, in the wake of the safety recalls and associated adverse publicity, Toyota bought back market share with huge incentives. This precipitated a similar effort by Toyota’s competitors in an effort to keep pace. This effort included the recently bankrupt GM and Chrysler, who had specifically disavowed “puh marketing” as a part of restructuring. The incentives included rebates, subvented financing, dealer “trunk money,” and optimistic lease subventions. In the case of Chrysler there have also been additional payments to consumers who use leasing or residual based financing through credit unions and other independent lenders.

Along the same lines, I am reading a new book, written by ex dealer Mark Ragsdale, entitled “Car Wreck, How You Got Rear-Ended, Run Over & Crushed by the U.S. Auto Industry.” In the book Ragsdale rails against “push marketing” practices employed by OEMs to artificially boost sales. He details how “push marketing” has contributed to the issue of “negative equity” in consumer trade ins and how this has led to increasingly longer term financing, rebates, diminished resale value, and the vicious circle that has rendered a huge percentage of consumers “un-financeable,” even those who are employed.

“Push marketing” strategies also include aggressive fleet sales. Noted automotive journalist, Jim Henry, recently provided input on the most recent June sales figures by noting that “fleet sales for the month were up 59% over the same period last year to just over 200,000 units." To be fair, last year at this time Chrysler and GM were in the throes of their bankruptcies. The Asset Backed Securities market, which had provided financing for most fleet and rental units, was barely functioning. This year the huge increase in fleet volume has been largely due to the replenishment of daily rental fleets due to an increased availability of funding and pent up demand. As I rent vehicles these days, I am no longer provided a beat up 40,000 mile “beater.” While this rental replenishment is a good thing, and indicative of renewed health in the ABS market, it should not be construed as evidence of a real retail resurgence.

There is an underlying weakness in retail demand in the automotive market at a time when real good news is desperately needed. The retail SAAR for June came in at only 8.6 million units, according to J. D. Power. This is down from May 2010. While fleet sales are much more profitable than before for the D3 due to the recent restructurings, it is retail demand that the economy and the auto industry desperately needs. GM and Chrysler are positioning for initial public stock offerings, GM as soon as the first week of July. Used car values are at historical highs, which should somewhat alleviate consumers’ negative equity positions in their trade ins. But the average trade in is a much higher mileage vehicle these days due to consumers, fleets, and rental companies having had to hold on to vehicles longer. The OEMs are able to break even or make money on lower retail sales even while paying huge incentives. The Detroit 3 no longer are required to pay UAW members to stay home and watch Oprah in the case of a plant shutdown. But consumer confidence is still weak and unemployment high. The European financial problems have shaken investors, which has been reflected by the recent drop in the Dow Jones average. This has rubbed off on consumers. Yes, the country's economic recovery is proceeding at a slower pace than expected.

As long as financing for fleet and rental sales is available we might expect to see an even higher sales rate of these subsidized sales. Under “normal” circumstances we might be complaining about how these fleet and rental sales contribute to the rapid depreciation of like model pre-owned vehicles recently purchased by consumers, contributing to their negative equity situation. But in today’s environment, aggressive short term lease subventions and aggressive daily rental recycling just may be the ticket to bolster the industry until other fundamentals have time to fall into place. In addition, the current and future pre-owned market needs the availability of additional pre-owned inventory. As always, it’s a question of balance. Will the industry know when to hit the brake pedal on fleet and rental sales?

Wards July 2010