Strategy – Page 5 – Virag Consulting

Car Dealer Megatrends – Conclusion

This is the conclusion of my series on car dealer megatrends. The first three articles covered the long running trend toward consolidation, steadily improving process maturity, and disruption from new technology. Like all good megatrends, these three flow together, reinforcing each other to produce a sea change in the industry. Consolidation means bigger groups with more money to spend on technology, and the scale to exploit improved procedures.

Big dealer groups crave stability, and repeatable successes. In my trade, software development, we have a formal process maturity model. The bottom rung is where your success depends on “heroes and luck.” When you own 20 stores, you are less interested in one superstar killing the pay plan, and much more interested in a hundred guys making base hits. If you are not clear on this, I recommend the movie version of Moneyball, featuring Brad Pitt as Billy Beane.

We’re making less per transaction, but we’re doing more transactions.

I work mainly in F&I, but you can see the same general idea in the velocity method for new and used car sales. That idea is margin compression. The quote above is from Paragon Honda’s Brian Benstock and, last I checked, he was still hard at it.

The locus of high gross shifted from new cars to F&I, and then from finance to products. Smart people tell me the 100% markup on products will soon be ended, either by competition or by the CFPB. Today, when you read about the latest PVR record from Group 1 (or whomever) you will also read management downplaying expectations of further such records.

The executive, however, said the group’s F&I operations may have reached the peak in terms of PVR.

Dealership ROI is above 20% but, as you know, highly cyclical. The stock market has been around 14% lately and, arguably, less volatile. AutoNation has been chugging along at a steady 10%. Investors will accept a lower return, in exchange for stability.

AutoNation was founded in the era of big box retail. My colleague there, Scott Barrett, came from Blockbuster. It was always our intention to remake auto retail in the image of Circuit City, which, by the way, was the parent of CarMax.

I spoke with an AutoNation executive recently who told me that learning to live with margin compression is an explicit part of their strategy. It is an iron law of economics that, in a free market, competition will drive margins toward zero.

Have a look at this NADA chart. In five years, gross has been cut almost in half. This is a breathtaking diminution, and then you go on the industry forums and find people bitching that vAuto has cut used car gross, and TrueCar has cut new car gross, and now some idiot proposes to cut F&I gross by putting VSC prices online.

Marv Eleazer has called this a race to the bottom, and he’s right, but this is not a race you can opt out of. That’s not how competition works. Think of it as a race run in Mexico City. The smart dealers and big groups are already training to compete in the thin air of lower gross.

Dealer Megatrends Part 2 – Fintech

Car dealers today face a growing array of new systems and capabilities. These are primarily in F&I, thanks to disruptive new entrants in financial technology – fintech, for short. Mark Rappaport has a nice roundup here, from a lender’s perspective, and I maintain a list on Twitter.

AutoFi – Auto finance plug-in for dealer web sites. See Ricart Ford for an example.
AutoGravity – Customer obtains financing (via smart phone) before visiting the dealership.
Drive – Online car selling, with delivery, from the Drive web site.
Honcker – Customer obtains financing (via smart phone) and they deliver the car.
Roadster – E-commerce platform for dealers, with full sales capability (as I anticipated here).
TrueCar – Customer sets transaction price (via smart phone) before visiting the dealership.

The new entrants blur familiar boundaries in the retail process. They’re basically lead providers, but all aim to claim a piece of the F&I process. AutoGravity, for instance, provides a lead already committed to a finance source. TrueCar provides a lead already committed to a transaction price. If you’re unfamiliar with the canonical process, see my schematics here and here.

In my previous Megatrends installment, Consolidation, I cited the influence of PE money. It’s the same with fintech. AutoGravity, to name one, is backed by $50 million.

The new F&I space is also home to “predictive analytics.” Automotive Mastermind examines thousands of data points, to produce a single likely-to-buy score. Similarly, Darwin Automotive can tell you which protection products to pitch.

The technology’s proprietary algorithm crunches thousands of data points, combining DMS information with … social media, financial, product and customer lifecycle information

My specialty is F&I, but it seems pretty clear that predictive analytics has a place in fixed ops as well. In terms of the earlier article, you can see that consolidators have an edge in evaluating new technology. Speaking of fixed ops, they’re also better positioned to obtain telematics data.

McKinsey says fintech can help incumbents, not just disrupt them. That’s why I have focused on technologies a dealer could employ, versus apps like Blinker that are straight threats. Of course, you have to adopt the technology. Marguerite Watanabe draws a parallel with the development of credit aggregation systems.

Fintech will induce dealers to adopt an online, customer-driven process. I see this as an opportunity. On the other hand, those that fail to adapt will be left behind. This article is aimed at dealers, but the challenge applies equally to lenders, product providers, and software vendors.

Dealer Megatrends Part 1 – Consolidation

In the 2006 data, NADA noted a “moderate consolidation trend.” Since the recession, sales have recovered but the dealer population has not. My chart, below, is based on the last eleven years of NADA data. You can go back as far as you like. The dealer population has been shrinking steadily for fifty years.

This means the surviving dealers are selling more cars per store, but the real story is consolidation – the powerful trend toward fewer owners and bigger groups.

In 2005, the top 100 dealership groups were 9% of the total. In 2015, they were 17%. The Automotive News ranking is by gross revenue but, for simplicity, I am counting stores. I imagine that the big, efficient groups command more than 17% of the total gross.

Gee group’s purchase of 16 Tonkin stores, backed by private equity, is instructive. Both groups are family owned, with seven and 21 stores respectively. Brad Tonkin will join the combined entity as president. The Automotive News article also describes a Soros-backed purchase by the McLarty group, bringing its count to 19 stores.

The owners may be public, like AutoNation and Penske, private equity, or something in between. Larry Miller group, for example, is still family owned but independently managed. An IPO seems the next logical step. Broker Alan Haig predicts his buy-sell business will continue strong in 2017.

This is about economies of scale, obviously. The New York Times mentions efficiency in staffing, technology, and inventory management (as I did, here). There is a lot of money chasing this trend, and only so many operators who know how to exploit scale. That’s why Haig also has a recruiting arm.

Small dealer groups can compete online only by joining platforms that aggregate inventory.

If you are running a small group, you might want to start thinking about M&A. That’s not my area, though. I am interested in the related trends toward technology and process change. I’ll examine these more in my next post.

One example is online retail. Small dealer groups can compete online only by joining platforms that aggregate inventory, like TrueCar or Autotrader. What I am proposing is that the (relatively) little guys compete with the consolidators by consolidating themselves online.

Dealers should seek help from their OEMs and software vendors. Well, maybe not the OEMs. GM’s Shop Click Drive only searches inventory for a single dealer, and it makes you choose the dealer first. Not only will it not give you a price, it won’t even present a model list until you’ve selected a dealer. No one shops this way anymore.

Modern shoppers will have found a model and trim level, a price, and even a lender, before landing on a dealer. While Shop Click Drive has the machinery to structure a deal, and even sell protection products, some genius decided to make the “choose dealer” button its primary focus. Most GM dealers I looked at were also on Autotrader.

I did a survey of platform capabilities last year, with Cox Automotive far in the lead. The other guys seem still to be in the world of single-dealer web sites. I also noticed that these sites are mostly hideous, and lacking consistency in even simple functions like credit application.

The consolidators have strong tech teams devoted to online shopping. Dealers may fail to see the threat, because it’s not a physical presence. If you owned a hardware store, and Home Depot went up across the street, you would notice.

Raising the Bar

Armchair strategists are feeling vindicated now that AutoNation CEO Mike Jackson has abandoned his “asinine” plan to ground all vehicles under recall. I see the same argument whenever anyone tries to change dealer operations. They estimate the reduction in profits and write about that, as if that were the end of the argument. It’s not. That’s not how competition works.

If you talk about disclosing product prices online, you will hear that F&I gross is now $1,500 and who wants to screw that up? Same story with TrueCar and their diabolical plan to disclose transaction prices. You even hear this complaint about vAuto and the velocity method, which sounds to me like the most logical thing ever.

My back-of-envelope calculation says that AutoNation carrying an additional 10,000 units of inventory, at maybe 2%, would cost them roughly $5 million per year. That’s 0.02% of sales. For comparison, the related “Drive Safe” ad campaign was $10 million.

AutoNation, with investment-grade credit, enjoys a lower carrying cost than its private dealer competitors. Selling diverse brands, they are less exposed to a recall by any one manufacturer. They can also exploit their scale to mitigate the cost of such a policy, not to mention the PR benefits.

If federal regulators had followed Jackson’s lead, this would have raised the bar for all dealers. Two senators, now disappointed, were lined up to make that happen. Jackson’s policy, a minor challenge for AutoNation, might have proved fatal for smaller dealers. That’s how competition works.

It is a mistake to look at process change only in terms of the costs. Athletes training hard for a competition don’t think about how much it hurts. They think about how much it’s going to hurt the other guy.

Update: Motley Fool estimates the cost to AutoNation at $0.06 of EPS, a little higher than my estimate (and Jackson’s) due to the Takata debacle.