Strategy – Page 3 – Virag Consulting

The Case for D2C

A while back, I wrote a survey of Direct to Consumer VSC Sales. This was a “how to,” and today I am writing about the “why.” The short version is that D2C is a large and unserved market. Franchised dealers sell service contracts with 47% of new vehicles, which is great, but that leaves the other half unprotected.

Add 6% to reported F&I gross, plus 4 to 5 times that amount for the backfile

Depending on which “touchpoint” you wish to pursue (see here) this market includes roughly 67 million vehicles. That’s how many are on the road, less than six years old, with no coverage. Dealers are the group best positioned to serve this market. Of course, a dealer can only address his local share of the market, not the whole 67 million. See Profit Opportunity, below.

To succeed with D2C, you must have an existing relationship with the customer. That’s because success requires digital marketing, and anti-spam laws limit what you can do without a relationship. For example, an OEM can email their customer a solicitation for their factory-label protection products, but a TPA cannot.

So, the dealer has the inside track. He has the relationship, the contact info, and a service department to verify eligibility. Plus, every additional VSC aids in service retention. Depending on the dealer group, it may also have the other ingredients. Here’s the parts list:

Direct to Consumer (D2C) Operation

An advanced CRM with the ability to run a scheduled, multichannel contact program. Salesforce calls this a “customer journey.”
A source of premium finance, like SPP, Budco, or PayLink. Dealers will already have one of these, for their instore F&I operation.
A call center, which could be the BDC, to participate in the selling journey and also to deal with issues around premium finance.
A branded website capable of presenting and selling the service contract, including Visa checkout and premium finance.
A service facility. If you’re not a dealer (trying to cover all bases here) there are still things you can do with Pep Boys and mobile facilities like Pivet.

Depending on the dealer group. Obviously, if you’re Lithia, you already have a finance arm which could (with training) handle bounced Visa charges. They’ll need to comply with the PCI security standards. Maybe that’s best left to PayLink.

There is a host of such decisions, for which you will need expert assistance – but let’s get back to the “why.” We are going to make a gross profit calculation in three steps:

Direct to Consumer (D2C) Profit Opportunity

Compute the potential product gross that didn’t close with the vehicle sale.
Estimate the likely D2C conversion rate.
Add the backfile of customers from prior years.

Let’s look at AutoNation. Sorry, NADA Average Dealer doesn’t provide enough detail. Even the AutoNation data doesn’t provide much detail on product sales. Still, we can draw some inferences using the 2019 annual report, industry norms, and these remarks from then-CEO Cheryl Miller.

AutoNation reported sales of 283,000 (new) and 246,000 (used) with F&I PVR of $1,904. That’s the headline figure, including finance reserve. Owing to adjustments, the figure in the annual report is a little higher, and the calculation based on Miller’s summary is a little lower.

The $1,350 (new) and $1,050 (used) are averages across all units. We can infer that product gross was roughly $2,580 (blended) on 47% of units. That leaves the other 280,000 vehicles unprotected, with a potential gross of $720 million, equal to 71% of AutoNation’s reported F&I gross.

You can use 75% of F&I gross as a rule of thumb. In general, product gross is two-thirds of F&I gross, and this is derived from fewer than half of the vehicles sold (omitting ancillaries). The ratio of D2C opportunity to instore penetration is 53/47 of the two-thirds, which makes 75%.

This $720 million is the potential gross AutoNation left on the table in 2019. Okay, that’s not fair. It’s only on the table assuming every one of the D2C prospects will buy the product, which they won’t. Most won’t, in fact. The conversion rate is the product of three factors:

The number of contacts per customer, based on your touchpoints and your programmed journey.
The take rate, which is the percentage of people who take action by clicking the PURL link, scanning the QR code, or whatever. The industry norm here is 2-5%
The close rate, which is the percentage of takers who are closed by the call center or self-close on the web site. Expert closers can do 20-30%. Remember, this is within the self-selected “takers.”

The conversion rate is what counts, but we break out the components for management purposes. For instance, maybe the take rate is high but your closers are weak. Success requires a lot of contacts, with compelling CTAs and good closers.

Let’s say we utilize all of our advantages as a dealer – an aggressive journey on all touchpoints – bringing our contacts to 10. Multiply this by a conservative 20% close rate and 4% take rate. This gives us a conversion rate of 8%.

In our AutoNation example, this would mean roughly $58 million of additional gross. All of this arithmetic generalizes, too. Simply take reported F&I gross and multiply by 6% (8% of the 75%, above, makes 6%). So, now I can crack the Lithia annual report with F&I gross of $580 million, and reckon that D2C could mean $35 million to them.

This incremental income recurs annually, since it’s based on one year’s volume – but we start the game with a backfile of unserved customers from prior years. We might reasonably want to go back five years for new vehicle buyers and three years for used.

AutoNation is a convenient example because they sell new and used in roughly equal parts, so this works out to (blended) four years’ worth of volume. If your mix skews more toward new vehicles, then your backfile opportunity will be richer.

In short, you can use the 6% rule to compute the annual recurring, and then add a one-time opportunity of 4 or 5 times that amount for the backfile. This more than pays for setting up the operation. So, is it worth the hassle to earn an extra 6% of F&I gross? Ponder that next time you see the Car Shield ad on television.

DR and Dealer Websites

I was chatting with my pal Kiran Karunakaran about his new role at Fox Dealer. You may recall that Kiran’s DR solution, TagRail, was acquired by Fox earlier this year. At that time, I figured DR would be an absolute requirement for dealer websites, and I expected to see CDK bid for, say, CarNow. Here are the pairings:

Fox Dealer, TagRail
Dealer Inspire, Online Shopper
Dealer Fire, Precise Price
Dealer eProcess, SARA
Dealer.com, Accelerate

Note that, with the exception of TagRail, these DR solutions were all developed by their website partners. Missing are the pure DR startups I usually write about: Roadster, Modal, and Moto. Maybe they’re better off uncommitted. I decided to test this theory with a little research.

I went through Wards’ Top 100 Internet Dealers, identifying the website provider for each one, and their DR solution. The Wards sample skews strongly toward DDC, at 60%. The Datanyze survey (chart above) has DDC at 18%. Remember, I am not looking for market share so much as patterns in DR adoption.

For example, 20% of “top internet dealers” had no DR solution. That was a surprise. A few of these had cobbled together the Dealertrack frame with Trade Pending and a homebrew payment calculator – not DR as it is usually defined.

Same-vendor pairings for DR and website were rare

Some dealers use the same website and DR solution across all their stores, and some skip around. Herb Chambers uses DDC and Darwin faithfully except in his Chevy store, which uses CDK and Shop Click Drive. Paul Rusnak and Fred Anderson are faithful to Roadster and Gubagoo, respectively, but vary their choice of website providers. Of course, these choices are often mandated by the manufacturer.

Of manufacturer DR preferences, the best known is probably Shop Click Drive, followed by AutoFi. AutoFi is historically associated with Ford, and still used mainly by Ford dealers. I did find one Kia dealer in Peoria using AutoFi. Chrysler’s DriveFCA is powered by Carzato.

Same-vendor pairings for DR and website were rare, at 12%. These were almost exclusively DDC with Accelerate. I found one instance of Dealer Inspire with its mate, Online Shopper. Free-agent DR solutions did much better than those associated with website providers. Roadster, Darwin, and CarNow together accounted for 59% of DR in the sample dealerships.

As it happens, CDK did not acquire a DR solution. Instead, they sold their website business to Sincro, a digital marketing company. The Sincro announcement reminds us that what I am calling the “website business” may also include digital content, advertising, SEO, social, reputation, CRM, and lead-gen.

The right framework is not DR plus website, or even DR plus website and marketing, but a continuum across the customer journey. The journey begins with the various marketing services required to land the customer on the website, and ends with point-of-sale (POS) systems like menu and desking.

Recall that Roadster, Darwin, and Moto also play in the POS space. At the other end, there are pure-play marketing agencies that don’t do websites. You can evaluate strategy for these companies in terms of where they are concentrated along the journey, and where they are extending.

Dealer Fire moved up funnel, through their partnership with Stream, and Fox extended down a notch with TagRail. Darwin is unique in having moved to DR from point of sale. (I am using the linear model for simplicity. To account for CRM and reputation, you need the loop model.)

My goal here was to explore the synergy between DR and dealer websites, and the answer is that they’re not as compatible as they appear. Research showed much less crossover than I had expected, between marketing agencies on one side of the BUY NOW button, and DR specialists on the other.

Spinoff Startups in F&I

The popular notion of a startup is two guys in a garage, like Hewlett and Packard, but this is not always the case. Sometimes a mature company will give birth to a new business unit. I did some foundational work for Dealertrack and, at that time, it was the eCommerce department of Chase Auto Finance. In fact, a number of the startups I’ve worked with have been F&I spinoffs like Dealertrack. Today we’ll explore these for common themes and lessons learned.

One common theme is the role of outsourcing. You can begin with a core team, plus service providers, and then insource the functions systematically over time. I was an early employee of BMW Financial Services, which began as a department of the sales company and all functions outsourced to GE Capital. The head of this department, Kevin Westfall, had a plan to bring the operation under his control as a new entity with a new service provider.

I was recruited from Coopers & Lybrand, which was tasked with selection and contract administration for the service provider – outsourcing the outsourcing, so to speak. After a few years at BMW, I followed Kevin to AutoNation and the same strategy. We outsourced Funding, Customer Service, and Collections to World Omni, but kept staff functions and the Credit department in house.

You have a lot more autonomy managing a service provider than you do with permanent staff on the parent company’s org chart.

Outsourcing isn’t magic, though. If you can’t manage the function in house, then you probably can’t manage contracts and SLAs either. On the other hand, this is a great way to get around the parent company’s hiring restrictions. They may not be willing to hire the requisite staff for, say, a Collections department, but will sign a flexible contract with a service provider. Also, to be frank, you have a lot more autonomy managing a service provider than you do with permanent staff on the parent company’s org chart.

McKinsey’s Meffert and Swaminathan write about “breaking the gravitational pull of the legacy organization,” and this is such an apt metaphor. Many at BMW viewed the breakaway department with suspicion. There was political pressure to keep Kevin under control of the Finance department, an obvious misalignment, and passive resistance from some of the others. It was important in this case to set up our own HR department, and move it out of town.

It was the same story at AutoNation Financial Services. We had our own IT, Finance, Ops, and Marketing plus dotted lines to the respective “real” departments of the parent company. This gravitational pull is normal organizational behavior. Managers are always starved for headcount and, since the new initiative is hiring, they want their piece of it.

When your army has crossed the border, you should burn your boats and bridges, in order to make it clear that you have no hankering after home.

When ANFS was shuttered in 2002, most of our crew was absorbed back into the parent company. Obviously, having an escape route like this is not conducive to the kind of commitment required by a startup. Insert Sun Tzu quote here.

There was no such option for two of my consulting accounts, Route One and Provider Exchange Network. Route One, for example, was manned by senior managers from various captives. There was not much chance of these guys going back to their old jobs if Route One were to fail. I am thinking in particular of the founding CEO and CIO, Mike Jurecki and Joel Gruber.

Joel retained me as a subject matter expert in online credit systems, to work on the outsourced (there’s that word again) development of Route One’s core system. I called on Joel a few years after the project and we talked about the career risk he had taken. By that time, I was involved in a startup of my own, with no small amount of risk.

Paradoxical though it may sound, we believe companies need to take more risk, not less.

McKinsey cites the top ten ways to fail at digital transformation, and “excessive caution” tops the list. It’s my personal belief that you can never achieve anything unless you’re willing to take a risk for it. In any case, a big, risk-averse corporate parent is certainly going to impede the new unit.

Provider Exchange Network, likewise, was staffed by people hired for the purpose. We had, from the outset, our own IT, Finance, and Marketing. We did, however, run our hiring through the excellent HR department of Reynolds and Reynolds, and this is maybe the counterpoint to my arguments about autonomy.

The parent company is unlikely to have functional expertise useful to the new venture but, where it does, you should use it. BMW had zero expertise in consumer finance, but they had a terrific Legal department. At AutoNation Finance, we made good use of our parent’s FP&A capability. Also, the spinoff may be designed specifically to exploit some asset of the parent company, like its dealer network or OEM relationships.

So, my takeaways on this topic are:

Group Cohesion – The new unit should be united around a common purpose, with people hired for the purpose or as a breakaway department.

Cutting the Cord – The spinoff will have to win some turf battles with parent company managers who refuse to let go.

Leverage Legacy Assets – On the other hand, take advantage of the parent’s core competencies, especially those that are hard to duplicate.

Outsourcing – Find partners. Rent to own. McKinsey and others have stressed the importance of thriving in an entrepreneurial ecosystem.

Take Risks – Fortune favors the bold. No shortage of clichés here but, seriously, all of the literature talks about new initiatives that move too slowly and become roadkill.

I recognize that these points are open to some interpretation. They’re based, as you see, on my firsthand experience. That’s some good experience, though, so if you’re doing an F&I spinoff maybe you can profit from it. Best of luck.

Digital Transformation Playbook

I read a good book over Christmas break, The Digital Transformation Playbook, by David Rogers. This is a good book because it has both theory and practice, plenty of research and real-life examples, and practical “how to” guides.

Just when you’re thinking, “oh yeah, when has that ever happened?” Rogers comes up with an example. Many of the these include commentary from the people who worked on them. It’s clear that the professor gets out of his classroom for a fair amount of consulting.

Digital transformation is not about technology – it is about strategy and new ways of thinking.

Most books like this focus on digital native startups. That’s the sexy stuff and, in fact, where I have most of my experience. I chose this book for its focus on digital transformation, in existing companies and hidebound industries (like auto retail).

The book is organized around five strategic themes: customer networks, platform marketing, upgrading your value proposition, data as an asset, and innovation through experimentation.

I did grow a little impatient with Rogers’ incessant enumerating: five core behaviors, four value templates, three variables, two trajectories (and a partridge in a pear tree) but I appreciated the effort to boil everything down to a foolproof recipe. There are a number of these:

Customer Network Strategy Generator
Platform Business Model Map
Value Train Analysis
Data Value Generator
Experimental Design Templates
Value Proposition Roadmap
Disruptive Business Model Map
Disruptive Response Planner
Digital Transformation Self-Assessment

I was even inspired to start making value train diagrams of our business, and platform model maps:

On the theory side, Rogers reexamines familiar models from people like Drucker and Levitt. He shows, for instance, that Christensen’s theory of “digital disruption” is a special case, and broadens it.

By the way, this discussion of digital disruption is one of the most lucid (hype-free) that I have read. As usual, there is a checklist: analyze three features and choose one of six strategies. If that doesn’t work then, yes, you’re disrupted. Time to update your resume.

I read all the time, though I don’t often write book reviews (here is the last one) so Rogers’ fifteen-page bibliography was an extra treat. That should keep my Kindle stoked for a while.