The Year Ahead: Part One

As we ride, or rather sprint, into the New Year, we have seen the industry break sales records — some of which stood for a decade or longer. While the year began with some angst on the heels of a strong close to 2014, multiple factors have driven sales velocity.

Of course, many global factors, largely out of the control of the dealer, have played a key role. Low gas prices, global financial challenges, low interest rates and unstable markets in China, Brazil, and Eastern Europe have all had a direct impact on our industry. Here in the U.S. market, pent-up demand, a resurgence of leasing, an aging fleet and abundant low-cost capital have all fueled sales that will likely peak at a seasonally adjusted annual rate (SAAR) of nearly 18 million units.

Manufacturers have refocused on the importance of the U.S. market. They are offering exciting new products and sales incentives to offset diminishing sales in the global market that, until recently, were targets for major growth. Leading auto groups are taking stock of their challenges and driving new retail initiatives, such as Sonic’s EchoPark retail experience and AutoNation’s My AutoNation app.

Single-rooftop dealers and smaller auto groups are looking for ways to be innovative as well. The challenge remains in finding the focus, time and resources in a business that remains focused on individual transactions at the expense of long-term innovation.

Legendary Green Bay Packers coach Vince Lombardi liked to say, “If you’re not early, you’re late!” That may be true for team meetings, but in the auto retail game, it’s never too late to refocus on the key issues that affect your business. When you view your operation from a high level, the interaction and dependencies between departments become clearer, and you are able to be more proactive in anticipating challenges rather than constantly putting out fires.

So let’s take this opportunity to review some of the key issues that directly impacted the dealer network in 2015 and are expected to continue into 2016 — an election year, in case you hadn’t noticed. For Part One of our two-part series, we will discuss sales and incentives, compliance and recalls.

1. Sales and Incentives 

While there may have been some nervous moments when the SAAR dipped below 16.5 million units in February, followed by some ups and downs through June, the vector has been pointing straight up since July. Many market analysts responded by moving their annual forecasts into the high 16 million-unit range. We have since seen the SAAR move past 18 million units. Our analysis indicates that the total SAAR for 2015 will be into the high 17 million-unit range.

Analysis of current dealer inventory indicates that dealers will finish the year with approximately 4% more total inventory on their lots than a year ago. However, current sales velocity has driven down days supply to less than 60 days, far below the 82 days reported last January. Driving the gains are sales of trucks and luxury vehicles, which are typically the most profitable units for manufacturers.

With Ford’s launch of its “Friends & Neighbors” pricing and similar or matching incentives from many other manufacturers, average incentives per vehicle should rise even further. Since last year, average vehicle incentives are tracking at more than $3,100 per vehicle, a 14% increase from 2014. With the year-end push, we estimate that those incentives will exceed $4,000 per unit. Combined with dealer discounts, we are seeing discounts off MSRP of more than $10,000 per unit.

Dealers must closely monitor pricing of their vehicles using many of the inventory tools available. In fact, you should be monitoring pricing on a daily and weekly basis. Also be sure that you are properly accounting for incentives in your financial reporting, as well as repricing both new and used inventory daily or, at a minimum, on a weekly basis. This is necessary to balance sales velocity and optimize total gross profit.

I also recommend tracking any costs associated with certain lead or buyer programs that are applied on a per-vehicle basis. While these costs are generally accounted for under “advertising expenses” on the financial statement, they should be analyzed individually to understand the gross that is being generated from each transaction credited to the various lead channels utilized by your dealership. Be sure to also look at F&I gross, trades and where these customers are coming from. Customers with trades and within your market area will also contribute to additional gross in the long run. This analysis should be performed on a monthly basis and reviewed with your managers. You may see some data that will surprise you.

Manufacturers are also mobilizing to take advantage of this robust period and strong dealer profits to further direct customer experience and facility initiatives. These initiatives will continue to have an impact on all dealers. Of course, these programs and facilities upgrades are a condition of enfranchisement and are not optional, but you can plan ahead to cover these capital expenses.

What you need to do is prepare an estimate of these costs, factoring the three- to five-year cycle of which upgrades will be required. Begin to accrue for this capital expense in order to build a reserve fund. If you are a member of a homeowners’ association, you are already familiar with this practice. The same approach is utilized in the commercial real estate, hospitality and manufacturing industries.

2. Compliance

In 2015, the Consumer Financial Protection Bureau (CFPB), Federal Trade Commission (FTC) and state attorneys general continued to hammer the automotive industry. The current political environment has also taken direct aim at manufacturers, finance companies and dealers. In this age of “highly regulated consumerism,” recent and pending legislation and consent orders issued by government agencies require that dealerships be keenly aware of the impact they have on their business practices.

Aside from orders directly aimed at dealerships for compliance, orders issued to manufacturers and finance companies mandate initiatives that ensure the policies and processes implemented at your store comply with mandatory programs. These initiatives will define the rules by which your dealership will be required to operate. This is driving a new wave of dealer-owner and employee certification requirements, all of which will come at a price, including new technology and reduced margins, especially in F&I.

A recent study by the Center for Automotive Research (CAR) determined that the average dealership will incur costs of close to $183,000 just to maintain federal compliance standards for employment, business operations, vehicle financing, sales and marketing practices, and vehicle repair and maintenance. This breaks down to 21.7% of the average dealership’s pretax net profit, or an average of $2,400 per employee.

That’s why it’s critical your operation stay on top of pending laws and regulations that are currently in place. In fact, if you have yet to appoint a compliance officer, do it today, regardless of the size of your store. Someone, preferably an owner or a senior member of your regulatory team, must take ownership, because not being aware is not a suitable defense against substantial fines, consent orders and civil litigation that might be directed your way.

Your compliance officer’s first task should be to ensure that all processes that directly relate to compliance are documented. Responsibilities must be defined for every party involved. Employees must also be properly trained and held accountable. Audit these processes and update documentation on a regular basis. At a minimum, this can support your efforts to achieve and maintain compliance.

3. Recalls

Over the past couple of years, dealers have been pummeled by wave after wave of factory recalls. In 2014 alone, a record 63.9 million vehicles were affected by recalls. This year, there seemed to be a new announcement from the National Highway Traffic Safety Administration (NHTSA) every week, and the trend shows no signs of slowing. Obviously, the most critical recalls involve safety risk. Pending legislation at the federal and state levels — California once again leading the pack — will place the onus of recalls on dealers. Many of these proposals will even prohibit the sale of vehicles with certain types of issues.

All recall data is held by two parties: the NHTSA and the manufacturers. But in November 2014, analysts at AutoAp, a Beaverton, Ore.-based software company, announced that it had discovered nearly 30% of the data at safercar.gov, the website maintained by the NHTSA, was inaccurate. Additional research has shown a slightly smaller percentage of data provided by manufacturer and consumer-facing sites containing inaccurate or conflicting information that can yield false positives on certain VINs.

Adding to the pressure is there are a number of recalls that have been issued for which the manufacturer has not yet determined a remedy. In other cases, such as General Motors’ ignition switch recall and the Takata airbag situation, which affects multiple OEMs, replacement parts are in short supply. In the case of the airbag recall, the backlog could last for two years or longer. And the delays in getting these customers into the dealership for service have not gone unnoticed by regulatory authorities.

It is critical that dealers appoint a senior executive, much like the compliance officer, to track recall issues, because relying on your service department to manage them ignores the fact that all departments are directly impacted. For instance, when vehicles are prohibited from being offered for sale, it is critical that sales and inventory managers are aware. They should look for updates on a daily basis, as the vehicle history report pulled today may be invalid tomorrow. Inventory managers and vehicle appraisers also need to be aware of vehicles that may have recalls with a “waiting for remedy” status.

Keep in mind that California has had a law in place for several years that prohibits the sale of vehicles with specific classes of safety recalls. You can expect other states to follow California’s lead and for enforcement to be ramped up at every level. AutoNation, by the way, recently declared that it will not sell vehicles with open recalls. The move sent a very strong marketing message and perhaps should be considered by other dealerships.

Prior to delivery of any vehicle — new or used — be sure to run a vehicle history report the day of delivery to ensure the vehicle has no known safety recalls. The report should be shown to the customer when completing the delivery paperwork. And make sure customers sign an acknowledgement that they have reviewed this document. In fact, have them sign two copies: one for the deal jacket and another they can take home. At a minimum, this practice will provide evidence that your dealership did not intentionally deliver a vehicle with an open recall.

While the recalls have stretched service departments nationwide — forcing dealers to extend service hours and add second and even third shifts — they do present an opportunity to generate additional fixed warranty gross. And by that I mean mining your service-customer data and vehicle histories to identify those with open recalls. At the very least, this will allow you to contact customers who may not have been back to your dealership in some time.

The point is that dealers need to be proactive when it comes to these recalls, as the backlog at many dealerships, as well as pressure from consumer groups, has the NHTSA pushing regulations that would require manufacturers to provision for the aftermarket to be reimbursed for recall-related warranty repairs. If these measures are enacted, they could have a tremendous impact on your fixed operations.

For 2016, all indications point to more recalls, exceeding the nine-year high the industry realized last year. Expect the recalls to increase in scope, including many older vehicles — both on a manufacturer voluntary and mandated basis. Finance companies are also beginning to review their vehicle portfolios for “recall risk” and will not fund vehicles with open recalls — that is, without evidence that the recall has been resolved. Dealers involved in the rental segment will soon be prohibited from renting vehicles with open recalls as well. Fleet customers will be facing a similar situation, presenting additional opportunities for value-added services.

Lastly, for off-brand used vehicles, I recommend that you develop relationships with dealers of other brands to handle recalls on those vehicles; you can reciprocate by doing the same for your marques. If your group represents multiple brands, make sure your stores are working together and the exchange of vehicles is happening with maximum efficiency.

Tune in next month as we continue our discussion by focusing on technology and data, mergers and acquisitions, and personnel.

David Nathanson is a former multifranchise dealer principal and current head of the consulting practice for motormindz, a global automotive professional services and technology company. Contact him at [email protected].