Cliff Banks - The Banks Report

Why the Dealer Franchise Model Will Not Go Extinct

(Republished from LinkedIn) March 21, 2018 — There’s a narrative being pushed at conferences, in headlines, on social media, in studies or customer surveys and in investor meetings that the dealership model is not long for this earth.

And this mindset is starting to take hold within the industry itself — consultants, vendors and even some dealers are predicting the end of dealerships. Use whatever metaphor you like — the sky is falling, the invaders are at the gates, dealers need to wake up before they are overrun.

From my perspective, the predictions and subsequent hand wringing are overblown and ignore the realities of the industry. However, this is not another column spouting how wonderful and customer friendly car dealerships are.

I’ve followed the industry for almost thirty years and have seen the good and the bad. There are many whom I respect and know to be upright and business owners with integrity. But we know some dealers have “honestly” earned the reputation they have today following decades of unscrupulous or not-so-customer friendly practices. And unfortunately, some dealerships are still engaging in those practices.

The narrative from the “sky is falling” crowd is progressing along two fronts.

One perspective argues that dealerships are such lousy businesses they will be pushed aside by “disruptors” such as Carvana or other “more customer friendly” companies. Amazon also is mentioned often as one that will kill dealerships once it decides to enter the automotive retail arena.

A second argument boldly proclaims the macro forces of the new mobility era will eliminate — or at least, reduce — private car ownership within the next 10 to 20 years.

My defense of the retail of the system isn’t about the businesses themselves, but about the strength of the model. At its core, the defense is about the market and industry dynamics that “protect” the overall auto retail business. You may believe some of these dynamics aren’t good for the customer — and you may be right. But that’s not what I’m debating here. Rather, I’m arguing the dealership retail model is well-positioned to defend itself from potential disruptors and other market forces that threaten its existence.

DEALERSHIPS ARE (NOT SO) LOUSY BUSINESSES

Let’s address the first argument — dealerships are lousy businesses and will be pushed aside by new players in the space.

At the risk of sounding like an industry “dinosaur,” I’ll appeal to history for my first point. Disruptors have threatened the auto retail industry for more than two decades — and none have succeeded yet. Maryann Keller and Ken Elias provided a comprehensive history of these players in their 2014 report Consumer Benefits of the Dealer Franchise System.

I get the point — just because it hasn’t happened yet doesn’t mean it won’t. Nevertheless, history is a strong indicator of how the future may progress. So yeah, you could say my first point is a challenge to potential disruptors — “Prove it.” And no one has proven they can do it yet. (Two recent disruptors have not fared well. Beepi — out of business last year; Vroom, based on media reports and our sources, has laid off nearly 50% of its staff within the last month while closing operations in Indiana and Dallas.)

But to be fair, since Keller’s and Elias’ report, new players have entered the space and much has changed. Technology, such as mobile apps and the ability to move data quickly and seamlessly have reduced some of the barriers to entry earlier would-be disruptors encountered.

Which leads us to my second point. Those same technological barriers to entry were also barriers preventing dealers themselves from offering a more customer-friendly and seamless experience.

Let’s flip that. Dealers today have access to all of the technology and solutions so-called disruptors have. And dealers are incorporating new technology and solutions into their businesses. By the end of the year, in every major market, dealers will be using vehicle subscription platforms such as Flexdrive and Clutch Technologies to provide high-level concierge-type services to their customers far beyond what a Carvana, Vroom or even an Amazon can provide. Fair, meanwhile, which will see huge dealer growth this year, provides a subscription-like model for used cars with attractive pricing for customers.

Meanwhile, the number of solutions available to dealers allowing for true digital transactions is exploding. (Review of Online Transaction Solutions)

Whether customers move en masse toward conducting the entire vehicle transaction online in the near future can be debated. And so far, customers haven’t shown a driving desire to buy cars online — less than 400,000 of the nearly 47 million car sales at new and independent used car dealerships were true online sales in 2016 — that’s Tesla, eBay Motors, Carvana, Vroom and all of the other small startups combined.

However, these tools will ultimately help dealers reduce the inherent friction that is part of the vehicle purchase — time — while improving the transparency and trust factor. Dealers are already beginning to adopt these solutions and the pioneers are building the playbooks that will show other dealers how to implement them profitably.

Anything a distruptor brings to the table today, dealers have access to the same technology. So let’s take that advantage off the table.

My third point goes to the inherent disadvantages in the disruptor model — or, for the more positive-minded, the inherent advantages in the dealer model.

Except for Tesla, new entrants to automotive retail are restricted to selling used cars only. Becoming a new car dealer is both expensive and time consuming. Automakers don’t hand out franchises easily. Furthermore, state franchise laws restrict dealerships to those businesses that have independent franchises from automakers. Yes, laws can change, but thus far, the franchise laws haven’t changed and there doesn’t seem to be anything on the horizon that will force a radical rewriting of those laws.

Don’t underestimate the importance of having that new car franchise. New car dealers have access either through trades or manufacturer-specific closed auctions to the best pre-owned inventory that independent dealerships or disruptors don’t have (and getting good inventory was a huge challenge for Beepi and is for Carvana — about 10,600 cars today and Vroom with only 2,400 — not nearly enough to be real disruptors). Carmax, along with other regional used car dealers have overcome that challenge, but it’s proving to be harder for most of the new online players.

The other issue with inventory are the reconditioning costs — both in time and financial. For online players that do not have the facilities or labor force to properly recondition a used vehicle making it ready for sale, this is a huge disadvantage. And it’s a costly endeavor. According to industry statistics, dealers can spend anywhere from $500 to more than $2,000 a vehicle in reconditioning.

(This is why Uber finally threw in the towel on its leasing program earlier this year when it sold the assets to Fair. It reportedly was losing about $20,000 a vehicle on half of the 40,000 vehicles in the program.)

Finally, there is the question as to how bad dealerships really are. Despite all of the bad stereotypes and negative headlines, there are metrics that show dealerships may not be as bad as we like to think.

The 18,200 new car dealerships in the U.S. conduct more than 360 million transactions each year (new, used car sales, service and repair, F&I combined). Meanwhile, the Federal Trade Commission gets about 86,200 automotive-related complaints annually — that’s complaints involving new car dealerships, independent used car dealerships and independent service facilities combined — so roughly 43,000 complaints about new car dealerships. That’s about 0.000012% of all new car dealership transactions. Sure, it’s not the only metric, but the data from the FTC does provide a better context than customer surveys or “if bleeds, it leads” headlines.

That’s not to say dealerships don’t have a lot of work to do to gain the customer’s trust, but maybe it’s not as much as we think.

NEW ERA OF MOBILITY A THREAT TO DEALERSHIPS?

The second front on the “dealerships are going extinct” narrative is a tad tougher to dispute. Market forces are moving quickly. Much of the conversation focuses on the threat autonomous vehicles pose to the dealership model, according to many in the automotive industry.

The truth is, we really don’t know how quickly autonomous vehicles are going to become a significant part of the market — and what the impact will be if and when they do.

From my perspective, 2018 is the beginning of what will be a five to eight year period of uncertainty in the industry. I think it’s going to take at least that long — maybe a few years longer — before the industry will have clear answers on what the future will begin to look like.

Some, like Bob Lutz (Lutz Predicts End of Automotive in 20 Years, Do the Math, It Ain’t Happening) see a quick and drastic restructuring of the entire automotive space. Others argue an influx of autonomous vehicles will drive down the need for personal ownership. In fact, one large dealership technology vendor already is preparing for a future (they say a decade or so) in which no more than 50% of all sales will be to private owners with the rest to fleet companies.

The challenge is that the numbers today aren’t showing a decline in ownership. The recent sales decline of new vehicles is part of the normal sales cycle so we can’t attribute that to the growth of Uber or Lyft. Although, they aren’t autonomous yet, numerous prognosticators argued the ride hailing companies would themselves reduce ownership. In fact, the opposite is true. Since 2016, the number of multi-car households is increasing based on the latest government data. Furthermore, the percentage of mllennials living in households without a vehicle is declining.

People predicting the end of ownership argue a generational shift from millennials along with the high cost of vehicle ownership will drive the decline in personal ownership — and hence, the end of the dealer model.

First, the millennial argument. We keep hearing the prediction that millennials aren’t going to want to own cars. The problem is, the data shows the complete opposite. In 2016, millennials accounted for 29% of new car sales. By 2020, that number will be 40%. The generation just got a later start — mainly because of the recession 10 years ago.

So the folks in Silicon Valley and other naysayers may keep throwing around the millennial argument, but it’s not based in reality.

Also, the idea that a large segment of the population will give up the convenience of owning a vehicle to ride around in a soulless autonomous fleet-controlled vehicle with strangers i — and all within a decade or two — gnores the psyche of the American consumer. Especially when we factor in the family dynamic, a drastic shift in behavior becomes much harder to see.

I realize there are models showing how consumers will suddenly wake up and realize owning a car that sits 94% of the time is a poor use of financial resources. The problem with this line of thinking is how to define vehicle usage. Yes, that vehicle might be sitting in the owner’s garage, but that doesn’t mean it isn’t being used. It’s certainly being used as a storage component. Golf clubs, baby seats, sports equipment — insert anything else here — think of the convenience of owning a vehicle. Running an errand on a whim; swinging through a drive-through (yes, we can do that in an autonomous vehicle, but not with other riders in the vehicle).

To come at vehicle ownership as a cost analysis exercise ignores the human dynamic of how we as Americans behave and what drives our consumerism. Much of it is based on convenience, not cost.

That isn’t going away soon.

Another big issue is how soon autonomous technology will be a reality. Certainly, technology is advancing at an unbelievable pace, but that last hurdle of incorporating true machine learning (Artificial intelligence) into the equation will prove to be the most difficult. Timing is anyone’s guess.

There was a setback this week with the tragic news of the first pedestrian killed by a self-driving vehicle in Phoenix. I don’t know how much of an impact this event will ultimately have. It appears the early conclusion is that the pedestrian was at fault (meanwhile, 16 pedestrians are killed daily by human drivers). It will delay some testing, and likely will impact negatively autonomous legislation that is currently in the works.

We’re going to have events like this. But the money driving the development is going to continue pushing the industry forward.

CONCLUSION

This is a fluid and evolving conversation. And the debate will continue. Hundreds of billions of dollars are at stake and there are intelligent people on both sides of the argument.

Certainly, my own thoughts will evolve on this — and have already. But on this date, March 21, 2018, my case for the continued survival of the automotive retail system is simple:

  • Personal vehicle ownership or control is not going away in the near — or distant — future, and will continue to be the main method Americans use for transportation.
  • Dealerships will continue to be the main source of personally-owned or controlled vehicles. The unique dynamics of the auto retail system will continue to prevent mass disruption from outsiders. Meanwhile, dealers will continue to adapt and improve their businesses.

Let the conversation continue…

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