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Build Resiliency Into Your Business

August 23, 2016 0 Comments


Will your dealership prosper or fail when the music stops?

It took less than 10 years, but dealers and OEMs have pulled every lever possible to achieve back-to-back years of record SAAR. The government has propped up the nation with pro- longed stimulus and loose monetary policy, impairing sustainable growth. There are no tools left in the toolbox.

The era will forever be remembered for its recovery, but there is reason to believe contraction is near. On March 9 of this year, the bull market celebrated its seventh birthday. In other words, the Dow Jones industrial average has been on the upswing with no 20 percent dips (the historic indication of entrance to bear-territory) since March 2009. It is the third longest bull run in history.

Some argue we have achieved a “new normal,” characterized by steady but minimal growth. But, recent stutters in the pace of hiring and trepidation from the Federal Reserve around raising rates are signaling higher risk for downturn. New factors, like the gig economy and record student debt are also challenging assumptions on what a “normal” retail sales environment will be in the future.

The dealers that build resiliency into their businesses will be positioned to successfully weather the ups and downs without risk of business failure or distressed valuation.

Many dealers have basked in the glory of record volume, unaware of a systematic erosion of the pillars of long-term financial health.

Evolution of mobility, recurrent negligence from manufacturers, and the pres- ent state of consumer finance are external threats to dealer sustainability. Poor reputation for customer experience, labor inefficiencies, and stagnant business models can unnecessarily put dealers’ net worth and legacy at risk.


According to a 2015 Customer Experience Research report by DrivingSales, only 26 out of 4,000 consumers prefer the current car buying process. Apple, Amazon, and others have trained modern shoppers to seek a different buying experience than dealers offer today. Dealers’ long-term opportunity is limited when disruptive technologies, like ride-sharing services, capitalize on these windows of opportunity.

Consumer pocketbooks are showing signs of being maxed out. Experian reports auto loans reached an all-time high in Q1 2016. The debt totaled over $1 trillion, up 10 percent from Q1 2015. Experian’s senior director of automotive finance recently told CNBC they are watching delinquencies closely. The retail financing market is extending loans. According to Federal Reserve Bank Data interpreted by IHS (see chart) the U.S. average new car loan length from a finance company was 64.6 months.

On an operational level, the industry’s labor cost is its single largest expense and efficient labor utilization by dealers is poor, and getting worse. Steve Szakaly, NADA chief economist, recently reported dealers are paying over 15 percent more than U.S. averages for labor and have been increasing wages at twice the rate of comparable sectors – all while experiencing turnover rates up to 3 times U.S. averages.

“Many dealers fail to quantify their true expenses when manufacturers redistribute margin on their financial statements,” David Spisak, president of ReverseRisk said. He spoke at DrivingSales Presidents Club in May and brought data to display the year- over-year decrease in profitability across many major brands. Dealers who have become increasingly reliant on volatile OEM programs may be in for a shock, should their OEMs come under financial pressure themselves.

The Kerrigan Auto Retail Index is a monthly index encompassing the seven publicly traded auto retail companies with operations focused in the U.S. Kerrigan Advisors announced May 18, 2016, that The KAR Index™ dropped 9 percent from 496.82 to 452.49 in just two weeks. Kerrigan Advisors attributed the sharp drop to higher inventory levels, gross margin compression in new vehicle sales, and weakening retailer sales forecasts.

Remember 2009?

Job loss and the spike in oil prices exacerbated poor consumer sentiment and consumers scaled back spending. Retailers, especially in automotive, experienced a substantial reduction in unit sales and net profit. Dealers of all brands felt the squeeze. Decades of questionable business practices exposed OEM negligence, resulting in the bankruptcy of Chrysler and General Motors.

Thousands of dealerships didn’t survive and the ones that did had to make radical moves. “We postponed facility projects and modernized our operations with the most relevant technologies,” Jon Lancaster, a dealer for 42 years, recalled. “We got serious about the used car business and critically evaluated our customer retention strategies.”

The dealers that were prepared, and financially nimble, lived to benefit from the past seven years of prosperity.

How resilient is your dealership?

The definition of resilience is the ability to become strong, healthy, or successful again after something bad happens. How would your store weather a 20 percent drop in volume, a 50 or 100 basis point rise in interest rates, or a labor shortage?

In December of last year, the Federal Reserve raised rates by 25 basis points. It was the first increase since 2006. The stock market retaliated quickly, largely signaling borrower weakness and the forthcoming (albeit gradual) strain on business in the form of higher debt expense and/or less revenue from consumers.

Resilient dealers will armor their balance sheet and interest expense is low-hanging fruit. Typically, dealers have a blend of vari- able and fixed-rate debt. Floor plan is traditionally variable. Three or five-year terms have become more and more common for real estate interest locks and these terms are very uncertain in the current environment. The most recent reports from the Fed. anticipate two more increases by year-end. Vigilant operators will lock in long-term fixed rates wherever possible.

Consider this: what are the results if the cap rate increases by 1.5 percent, or 150 basis points? In this instance, we’ll assume an annual triple net rent of $600,000 and apply the cap rate to determine building value.

                  7.5 Cap Rate                                                                 9.0 Cap Rate

                  600,000 ÷ 0.075                                                        600,000 ÷ 0.09

                  = $8,000,000                                                              = $6,666,666

As you can see, the 150-basis-point move from 7.5 percent to 9 percent affects loan-to-value substantially when value is reduced by $1,333,333.

The impending environment will also force dealers to make critical adjustments to down payments (affecting operating capital) and prioritize paying down debt. (See example below left).

Resilient dealers will maximize the “people piece.”

Despite the abundance of disruptors capitalizing on online or direct to consumer transactions, the 2015 Cox Future of Car Buying Survey uncovered that 81 percent still prefer to buy in person over online. So while consumers unabashedly do not like the process, they also overwhelmingly state the reassurance that comes with face-to-face interaction, product information and test drives, and exploration of financing needs are value-adds of the dealership experience.

The factors that consumers value in the dealership experience are mostly reliant on the human part of the transaction, not facility or over-the-top technology. Yet, the industry as a whole poorly leverages these assets, evidenced by abysmal turnover rates and general confusion about hiring and retaining young people, women, and staff whose collective diversity is representative of the dealership’s market.

According to the 2015 NADA Workforce Study, dealerships turned over 71 per- cent of all salespeople and a staggering 90 percent of female sales staff. Industry commentary around retaining and hiring millennial talent likens 20-somethings to another species, despite the age group surpassing every other generation in portion of the U.S. labor force in 2015.

Resilient dealers will critically evaluate what they give employees (far beyond volume incentives). Work/life balance, base pay, team environment and mentorship, growth opportunities, professional development, and community involvement will need to be thoughtfully considered as part of the dealership’s brand. Dealerships that execute the communicated employment brand with consistency will win long-term.

Volume drop is inevitable and even more complex to prepare for. Start with a realistic market-based forecast for new cars. Build the bottom line by strengthening individual departments across the dealership, specifically used cars and fixed operations. Holistic departmental strength should be centered on a defined business model, driven by a value proposition, and incorporate retention strategy.

Transformational organizational change is an opportunity to clean up labor inefficiencies and attract young talent.

Beyond the next “normal” cycle, how do dealers position themselves for structural changes in the market?

Consumers are rethinking personal vehicle ownership. Urbanization and technology-driven alternatives are largely responsible for the commoditization of transportation. Instead of an adulthood “must-have,” vehicle owner- ship is a deeper consideration of both affordability and lifestyle.

In the 2014 Global Automotive Consumer Study, while 64 percent of millennials said they “love their cars,” they were also three times more likely to abandon their vehicles if costs increased. According to the Federal Highway Administration, people age 85 and up represent the fastest-growing group of licensed drivers while trends for younger drivers (below age 60) are on the decline.

Some manufacturers are spearheading efforts to remain relevant through structural change. Toyota Motor Corp. recently announced a partnership with Uber to allow drivers to make payments to make lease agreements direct from earnings. Toyota Motor North America also recently announced a partnership with DEKA Research and Development to help launch a motorized wheelchair with balancing technologies to scale stairs and lift the user. Dean Kamen, the inventor of the Segway, founded DEKA Research and Development.

Charlie Vogelheim, reporter and longtime auto industry insider, has spent his recent years studying the blurred line between auto and tech. “In the Silicon Valley, there is a curious and remarkable and obvious sense of both collaboration and secrecy,” Vogelheim told DrivingSales News.

“I find it incredibly refreshing and exciting that I get the opportunity every 10 years to look at something new and different that’s really going to shake things up,” Vogelheim said. The Internet of Things is the fourth transformative tech he’s explored in the course of his career (PC, Internet, social media).

“Anybody that is in business needs to understand it; it doesn’t mean you need to change everything for it,” he said. ”Your customer base and even your employees are involved in it, and to that extent their interaction with you is going to have a basis in the new world they’re living in and the technology that they’ve become accustomed to.”

Resilience will also build enterprise value in event of sale.

Thorough scrutiny and critical operational adjustments will not only benefit dealers’ current P&Ls, but the strategies and tactics tied to creat- ing a resilient business are consistent with creating enterprise value (or “blue sky”) for dealerships.

In 2015, unprecedented activity in the purchase and sale of dealerships indicated investors’ positive outlook. The allure of the industry was further proliferated when new entrants, including private equity and Warren Buffet, made major group acquisitions.

“Times are awfully good. Maybe, too good,” Ryan Kerrigan, from Kerrigan Advisors, said. “It is a particularly good time for dealers to evaluate the potentially unsustainable components of their current profit model, (e.g., mark- ing up finance), and a great time to double down on the sustainable parts of our model such as fixed operations.”

Technology and globalization have tightened cycles, requiring businesses to be more nimble.

The legacy of automotive is its greatest hindrance in this respect. Long-term industry sustainability will require manufacturers to learn new, sustainable behaviors to protect both their own and dealer’s roles in distribution. In the near term, dealers should center their attention on creating modern places of business for both shoppers and employees. Will another downturn snap the century-old industry into reality?

At the 2016 DrivingSales Presidents Club, veteran dealers and industry visionaries gathered to discuss and identify indicators of the looming cyclical peak in auto retail. Tony Albertson (NCM Associates), Tom Gage (Cox Automotive), Jon Lancaster, David Spisak, and Ryan Kerrigan organized a session titled “Creating a Resilient Business.” The team offered the dealer principal and general manager attendees their guidance to mitigate risk and course-correct their dealership’s operations. Their insights inspired this article.


About the Author:

In her role at Lancaster Investments, Joy Hannemann supports Jon Lancaster’s start-up investments, real estate development, and worldwide speaking engagements. Joy writes for DrivingSales Vendor Ratings and is also a regular contributor to DrivingSales News on the topics of dealership best practices, employee development & engagement, leadership & culture, branding & social amplification, and
customer experience.