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VSC Market Booming

September 2007, F&I and Showroom - Feature

by Gregory Arroyo - Also by this author

With all the doom-and-gloom talk floating around, F&I Director Marv Eleazer said his Valdosta, Ga.-based Langdale Ford Company has a policy. “Our dealership chooses not to participate,” he said.

Despite troubles in new-vehicle sales and automakers turning to incentive programs and extended warranties to remain competitive, dealers and F&I providers alike say it’s a good time to be in the vehicle service contract (VSC) business. However, one analyst said the very thing that’s helping dealers move vehicles is the same thing that’s helping F&I managers move more F&I products.

“One explanation for rising [VSC] penetration that I’ve heard is menu selling,” said Jesse Toprak, senior analyst for Edmunds.com. “Another factor that’s enabling aftermarket product sales is extended terms.”

Ann Tomlanovich, director of Chrysler Service Contracts, said the company’s service-contract sales are doing well with maintenance, convenience and GAP plans tripling since 2002. Now she faces the prospect of continuing the service unit’s growth despite Chrysler rolling out a new lifetime powertrain warranty in late July. However, she’ll be doing so with a lifetime mechanical coverage program wrapped around the new factory warranty.

“The new mechanical coverage is clearly the most expensive plan we offer,” she said. “Happily, I can say that a week into the new powertrain warranty and we’re selling quite a bit of them. Extended loan period could be helping that.”

While there is no direct data to link extended terms to VSC sales, loan terms are stretching out. According to the National Association of Finance (NAF)’s 2007 Nonprime Automotive Financing Survey, 76 percent of new-car contracts were longer than 60 months. The Consumer Bankers Association (CBA)’s 2007 preliminary study, released in March, showed 61 percent of new-vehicle loans were longer than 60 months, up from 55 percent last year and 45 percent in 2005.

Toprak sees average terms standing at 63 months, and said 72 months is quickly becoming the norm. Another trend he’s seeing is dealers, feeling the pressure to move vehicles, sacrificing front-end profits in hopes that their F&I departments can make it up on the back-end. Not a new way doing of business, but Toprak sees it intensifying.

“The importance of the F&I office won’t diminish in the foreseeable future. It’s quite the opposite; there will be more burden of dealership profit on F&I,” he said. “Our internal numbers show that front-end profits have been declining in the last six years.”

Finance reserve is also on the decline, according to the CBA’s 2007 preliminary study. While competition on the lender side is partly to blame, a series of lawsuits against the industry for allegedly charging minorities higher rates on auto loans could also be impacting reserve. Eleven of those lawsuits were settled as of April. The industry is also dealing with the spread of the Car Buyer’s Bill of Rights since it went into effect in California last July. It set finance reserve caps at 2.5 percent for loans of 60 months or less, and 2 percent on loans of 60 months or more. Illinois, Massachusetts and Minnesota are other states that have considered or are considering similar legislation.

Also hurting dealer profits is the Internet, enabling consumers to shop across states for the best price. The situation is putting more pressure on regions, forcing dealers to compete on price at a national level. Toprak said he doesn’t expect the loss of front-end profits to end anytime soon, especially as automakers look to use incentives to clear out current model-year vehicles to make room for 2008 models. As he said, most vehicles are hitting the lots with incentives already attached.

“It’s concerning, but that’s the reality of today,” he said. “F&I guys have more to fall back on because they have more to sell. I think the greatest pressure is on the salespeople whose salary is based on front-end profits. Those are the ones who have to worry the most, because this trend is not going to get any better.”

Dealerships Counting On F&I

The focus placed on F&I is nothing new. After falling from 1998 to 2005, gross margin on new-vehicle sales rose 2.3 percent in 2006, according to the 2007 NADA Data report. Aftermarket income made up 27.6 percent of new- and use-vehicle department gross in 2006, up from 26.3 percent in 2005.

Penetration of VSCs is also on the rise since it hit its lowest point in 1998 at 20.1 percent. Penetration reached 32 percent in 2006, closing in on the 35-percent high registered in 1986. F&I providers and industry experts have been preaching to dealers the impact VSC penetration can have on other aspects of the dealership, namely service and parts. And dealers have responded.

Sid DeBoer, chairman and CEO of the Medford, Ore.-based Lithia Motors, partly attributed the group’s 11-percent increase in second-quarter earnings to parts and service sales.

“The highlight of the quarter was Lithia’s parts and service business, which continued its strong performance with same-store sales growth of 4.6 percent on top of 8 percent growth in the second quarter of last year,” he said in a press release. The company’s F&I profit per vehicle also increased by $43 in the first half of this year when compared to the same period last year.

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