From the November 2022 issue of Car and Driver.
There’s a reason retired athletes, family trusts, and private equity like to park big chunks of cash in automotive dealerships. And it isn’t necessarily that they like cars. In the United States, the sale of automobiles annually accounts for close to a trillion dollars in economic activity, and it turns out that situating yourself somewhere near the receiving end of all of that money changing hands is a pretty good place to be. Lately, it’s been better than ever.
Yet all that is great and good about being a car dealer is about to change dramatically. Or maybe it isn’t really, depending on whom you talk to. In a time of plenty, carmakers and car dealers—whose interests are not always aligned—are bracing for big changes. How big and of what sort are what we’re here to consider.
Against all odds, the COVID-19 pandemic made for some extraordinarily fat times for carmakers and car dealers alike. After some grim months—sales fell off the table in April 2020 to an annualized rate of 8.8 million units, marking an almost 50 percent year-over-year decline—volume came quickly roaring back, as people realized they’d rather drive around in their own private automobile than ride the bus next to some dude with the sniffles. And even if shortages of chips and other components meant sales didn’t come all the way back, profits certainly did, with many carmakers—including Bentley, BMW, Hyundai, Lamborghini, Mercedes-Benz, Porsche, Rolls-Royce, and Volvo—notching record earnings in 2021.
Credit the immutable laws of supply and demand. Fewer cars to sell meant people paid more for them, with the average new-car transaction price rising to an eye-watering $48,301 by August 2022, up 10.8 percent from just 12 months earlier and capping what’s been a greater than 50 percent increase in average prices over the past 10 years. At the same time, with the new scarcity came a decrease in manufacturer incentives, inflating OEM profits, with the resultant higher transaction prices benefiting dealerships’ bottom lines as well.
Not long ago, new cars typically sold below the manufacturer’s suggested retail price (MSRP). But today they sell for an average of over $1000 above sticker, with outliers of five-figure differences seen on the window stickers of hot models, including reported $15,000 markups on Hyundai’s winning Ioniq 5 and a claimed $96,000 premium attached to Mercedes’s power baller, the AMG G63. All of these “market adjustments” go straight into these boldest dealers’ pockets. Adding to the lucre, used-car prices skyrocketed during the pandemic too. Through February 2022, prices for pre-owned machines had risen more than 40 percent in just one year, though they’ve begun to fall of late.
Car dealerships, then, have enjoyed some of their best years in history, with net profits climbing last year from the traditional neighborhood of 2 percent to 4, 5, or even 6 percent. To give one example, David Rosenberg, president of DSR Motor Group and owner of eight New England showrooms, tells us that until recently, “the average Toyota dealer in the Boston region in the best years made between $2 million and $2.2 million profit. [In 2021] the average net profit was $6 million. That’s a significant increase,” he says with wry understatement. Indeed, a report from Haig Partners, a Florida-based dealership-sale advisory group, found that in the year ending March 2022, publicly owned new-car dealerships recorded an average profit of $7.1 million, a whopping 242 percent increase over 2019.
So why, in the face of an abundance of good news, are dealers worrying?
Pump Up the Volume
Many dealers fear that manufacturers, whose business model historically wants them operating factories at maximum potential, will eventually solve their supply-chain issues. And when they do, the industry’s overcapacity will flood the market anew with vehicles, leading once again to excess inventory and a return to the endemic discounting carmakers had been trying to avoid, with little success, for the longest time before the pandemic.
One respected industry source who preferred not to be named explained the situation this way: “Car factories want at least 80 percent capacity utilization, because fixed costs are huge. And the OEMs’ suppliers have the same goal. One cannot just turn the supply chain off and on. So for lowest supply cost, we want to crank out one car per minute all year long. But demand follows no such rules. Maybe it’s January and no one wants to shop for cars; demand falls. Maybe it’s April and everyone has their income-tax refunds and wants to buy cars; demand soars. Maybe GM has launched the Aztek and no one wants it. Maybe Ford has launched the Bronco and everyone wants it. Demand whiplashes around while supply runs steady. Thus, inventory builds up and draws down. Car companies find it incredibly expensive to hold all of this inventory, so they unload it onto dealers. This reduces car-company costs.”
Overproduction also leads OEMs to essentially force dealerships to take more cars than they need. Holding inventory costs money, and, the source reminds, “when a dealer owns the inventory, they are highly incentivized to sell the product. It is their personal fortune they see eroding as every day they pay interest costs on unsold cars and pay idle salespeople.” So they cut prices. Which suggests an oft-unheralded benefit of the prevailing dealer model for manufacturers: the ability to offload vehicles no one wants to buy.
During the pandemic, carmakers realized that there are other ways to make money besides flooding the zone with product. If the model mix has permanently skewed toward more expensive cars, why bother making a broad range of models? Why not let the used-car market take care of the thrifty and lower-budget customers, and instead concentrate, the way the industry has these past couple of years, on the upper end of the market? Thus, as one professional industry watcher told us, “the single biggest question in the U.S. auto industry today is whether OEMs can stay disciplined enough to let this high-profit situation persist.”
Cut Out the Middlemen?
This brings us to another series of dealer worries. If people who can afford new cars are able to pay more and continue to exhibit the willingness to wait substantial amounts of time for delivery, perhaps OEMs might be tempted to adopt the direct-to-consumer sales model Tesla uses. The EV giant’s high sales prices, glacial delivery times, tech-bro share price, and eye-popping market capitalization are the stuff of envy for smokestack industrialists from Detroit to Stuttgart to Tokyo and back.
Wall Street has been hopped up about the direct-to-consumer model since the dawn of the millennium. Tesla’s mold-breaking success has only intensified the market’s cry for a system that cuts the dealer out of the equation entirely or, at the very least, reduces the dealer’s participation in profits. According to Sheldon Sandler of Bel Air Partners, a New Jersey–based dealership financial-advisory firm, automakers have been squeezing dealership margins for years, with the wholesale discount eroding from 10 percent to 6.
One high-level industry veteran who, underscoring the sensitive nature of the topic, also asked to remain anonymous, maintains that the old model is tired, inefficient, and ripe for change. “The solution is not giant real estate, giant portfolios [of brands], cars stacked everywhere, and giant service bays,” says this observer, who believes today’s dealership model is obsolete and the need for service facilities is overstated.
“The truth is, a lot of stuff is going to get solved through over-the-air diagnostics like it is with Formula 1—let’s say the first 20 percent of problems,” the source says. “The next 60 to 70 percent can get solved in the driveway. Fifteen to 20 percent, you’re gonna have to pick [the car] up, take it somewhere, and fix it. But that is a far better way to deploy capital than to have a $40 million 25-acre facility sitting on a highway at a time of [expensive] real estate, getting utilized at maybe 15 percent of its capacity. Do you need some facilities? Damn straight you do. Do you need 2000 of them across the country, mostly underutilized? Probably not.”
Doing away with dealers, marketing, and incentives has given Tesla a competitive advantage in the neighborhood of $5000 per vehicle, according to this industry veteran, who adds, “Wall Street recognizes that competitive advantage, which is why the stock multiples are through the roof.”
But has the industry overreacted to Tesla’s success? Mark LaNeve, president of Charge Enterprises, which builds charging infrastructure for EVs, thinks so. “There is a drastic misperception that EV owners want to buy direct because of Tesla,” says LaNeve, who also has been an executive at Ford, Volvo, and General Motors. “Tesla was so far ahead of the market in terms of EV product and its overall technology that customers would have bought the cars at the local landfill. I would argue that Tesla would have done just as well, maybe better, with a dealer network to help customers.”
Tellingly, representatives of several of the manufacturers we contacted were unwilling to speak on the record about plans for their dealers going forward. Some said they couldn’t compose a response ahead of our deadline, and Ford, Genesis, Jaguar Land Rover, and Volvo declined outright. Perhaps not coincidentally, all four of those entities have had sour encounters with their dealer networks as they floated new sales models that reduce or eliminate dealer participation.
Though carmakers always reserve the right to change their mind, others were clear that dealers are exempt going into the future. “We have learned a lot over the past two years,” says American Honda’s Chris Naughton. “Leaner inventory, even under 20 days’ supply, comes with some benefits. Many of our dealers have expressed that they don’t want to return to the old way of doing business with inflated inventories that can lead to cycles of unhealthy discounting and incentives. As a manufacturer, we need to focus on building the right models given the limited supply. We will pursue a simpler, more disciplined approach, one where we minimize inefficient trim levels and focus on our most profitable and in-demand models.”
Eric Cunningham, vice president, sales, service, and marketing, for Cadillac North America, says his company also sees its dealership network as a “business advantage” that “will remain a critical part of the retail and relationship chain with customers.” The events of the past couple of years encouraged the company to appreciate that “dealers don’t need to carry historical inventory levels to have a robust business. There is no reason for us or our dealers to go back.”
Healthy inventories give the industry an opportunity to maintain the MSRP pricing model, says Erwin Raphael, a regional director of operations for Amazon Transportation Services and former COO of Genesis. “The current five-to-10-day vehicle supply is a bit thin, but 60 to 90 days was entirely too fat. My opinion is that a 30-day supply is the sweet spot,” Raphael says.
“So what will the successful dealer inventory model of the future look like? I believe it will consist of shared pools of vehicles in local markets, owned by OEMs, from which the dealers can pull in near real time,” he says. “This model will allow customers to have access to the largest selection of vehicles while maintaining the benefit of shopping from their living room. In such a model, OEMs can resupply these shared pools on a kanban or as-needed basis, eliminating overproduction of vehicles. Dealers will compete on customer experience and quality of service as opposed to deals, and customers will regain trust in the system.”
We’re not sure customers ever had trust in the system, but if the auto industry can take the lessons of the pandemic and adjust business models accordingly, it may create a new dynamic for both automakers and their stubbornly resilient dealer body.
Red: States where direct sales are okay (with various qualifications, and sometimes only for Tesla)
Blue: States where direct sales are prohibited
Direct Sales: It’s Complicated
Thanks to a welter of protective regulations born of roughly a century of spirited statehouse lobbying, cutting out the dealer middleman is legally tricky. Rules about OEM direct selling vary by state and fall into roughly five categories:
1. Direct sales are permitted if there’s no competition with a franchised dealership of the same brand (either in the state or within a certain geographic area).
2. Direct sales are permitted upon showing that no independent dealer is available. (And since OEMs decide the qualifications, it’s not too hard to determine that nobody meets them.)
3. Direct sales are permitted, but only for manufacturers of zero-emission vehicles.
4. No direct sales are permitted except for Tesla.
5. No direct sales are permitted.