Maryann Keller Speech to the NADA/JD Power Conference, NYC, MArch 2013

For the over four decades I’ve been involved with the auto industry, first as an investment analyst and now as a consultant and director serving on the boards of both automotive companies and auto dealers. Over those four decades, I’ve heard many arguments made against the franchise dealer system…which dealers never fail to disprove time and time again.

One myth promulgated in the 1990s - and now resurfaced by Tesla - is that factory stores save money by reducing distribution expenses wrongly estimated at 30% of total expense. Let’s put aside for the moment that the percentage itself is nonsense, Ford’s ill-fated Auto Collection experiment proved conclusively (as told to me by a former Ford executive last week) that corporate guys are not risk takers and lack the entrepreneurial spirit to manage dealerships. Big corporations control from the top but selling cars requires street smarts and adapting to local market and competition. Ford ended its experiment after a couple of years of market share losses amid mounting evidence that factory stores do not deliver a better customer experience nor reduce costs, in fact they proved to be bad at both. GM, perhaps after watching Ford’s travails, and despite repeating the same nonsense about reduced costs through factory ownership, canceled its plans to buy 10% of its dealers, plus the Saturn stores, and operate them in through what it called GM Retail Holdings. Ford’s failed experiment demonstrated that, franchise laws notwithstanding, dealers are essential partners in the long process of a car’s journey from the factory to a customer’s garage. Franchise laws protect dealers from arbitrary actions by automakers and given the financial commitments they continue to make in response to factory demands in image programs, equipment, training and even vendor selection, the laws are entirely reasonable. Given the intense competition in auto retailing, it’s hard to understand how anyone could suggest that franchise laws hurt consumers.

Franchise dealers’ cumulative investment in land, equipment and facilities easily exceeds $100 billion. Dealers fund 60 days of inventory and another month of inventory in transit that would otherwise fall to the car maker. The inventory buffer allows automakers to adjust future production levels. For a company like Ford US inventory funding equals about $15 billion at any point in time.

Tesla may be the first start up to launch a car and change the retail process as well but it is definitely not the only company that saw dealerships as a costly impediment to customer bliss. A few years ago I was involved with one such company funded by venture capitalists, and led by a non-automotive executive, that invested in a small car promising to build to order sold though mall-based stores. The car never made it to production and the company folded after consuming the investors’ capital. . Despite evidence to the contrary and lacking any real world understanding to the business, a journalist writing on Yahoo Autos last year stated “Instead of building cars and selling them to dealers who hawk them to shoppers, Tesla wants to build only cars to customers orders, eliminating part of the auto industry’s massive overhead costs in inventory. By selling cars directly Tesla’s executives believe they can make their customer happy, and eventually sell more cars for less money.” Well we will see if it is fact is more economical for the factory to pay the rent, salaries, delivery and service or have someone else do it using his or her own capital. And build to order works only as long as there is an order bank…what happens when the orders dry up…do you send the assembly workers home, tell your suppliers to send to stop producing until you call?…..unfortunately auto assembly really doesn’t lend itself to build to order. It is capital and labor intensive even when work is farmed out to suppliers.

Every dealer knows that the vast majority of customers want their car that day not a date convenient to a manufacturer. The dealer has always been the buffer with the automaker facilitating inventory management through various incentives and production adjustments. It is the dealer who finds the market-clearing price for a vehicle even at the sacrifice of his or her profits. Others have tried experiments in selling away from the traditional retail dealer location on the notion that a big box retailer or mall would mitigate advertising expenses by placing cars where the customers are.

Early in the 2000s, Asbury struck a deal with Walmart to sell used cars in the parking lots of Walmart stores. Asbury would take the cars to where the retail customers were at America’s busiest retailer. A few dealers have experimented (as Tesla is now doing) renting inline space in large shopping malls as storefronts to sell cars. So far, the history of non-dealership settings to sell cars – with perhaps the exception of the infrequent offsite tent sale – hasn’t worked. The Asbury/Walmart experiment ended in less than two years when both parties discovered there were too few car buyers among the static population of regular customers who shopped for food and other necessities at their local Walmart each week.

I suspect that once the novelty associated with Tesla wears off, it too will also discover that mall locations aren’t ideal places to market or sell cars. The enclosed shopping mall typically has several large anchor stores – Nordstrom, Macy’s, Neiman Marcus, etc. – and perhaps eighty to one hundred or so “in line” shops like GAP, the Limited, Zale’s, Sunglass Hut, Apple, etc. A large successful mall might have more than a million or more visitors a year – and that’s about 3,000 folks per day. Those big numbers can dazzle but they aren't what they seem. Much of this traffic represents repeat visitors, as it did at Walmart, coming each week or so to see the changing merchandise at her favorite stores – new fashion and seasonal clothing, makeup, shoes or the latest Apple gadget. Everything can be purchased on a credit card. I used the pronoun “her” deliberately because the vast majority of mall stores are dedicated to women and children not the men who would be the targets for an expensive, high tech performance car.

Furthermore, new car models are only really new only every four to six years. The merchandise doesn’t change very often – so on the second or third visit to the mall, the car store looks exactly as it did last month or even the month before. What was fresh once is now stale with the passage of time…so visitors to the mall just skip past that new car display.

What the uninformed forget – or figure out after an attempt or three – is that automotive retailing is very different from traditional retailing. The product car dealers sell is expensive, generally requires financing, and often involves a trade. It often includes helping shoppers match their budget to a car that might not be their first choice but rather one they can afford. The process is slowed by required disclosures and regulations resulting in a pile of documents that have to be signed even for the most straightforward transaction.

A car weighs 4,000 pounds and takes up 50 square feet of space. It can’t be delivered overnight to one’s front door by Fedex. And most folks don’t have a big enough credit limit on their Visa card to pay for it. And what do they do with their trade? Or get it serviced?

While we are talking about myths, how about the still repeated one that people hate dealers so, if given the chance, they will buy a car online. I almost don't know where to start in taking this one apart…..In the early days of the Internet, Silicon Valley funded and lost hundreds of millions, maybe even a billion dollars, on ill-fated ventures that promised to do just that. CarOrder.com, Greenlight.com, and CarsDirect.com (in its original configuration), among others, all promised to avoid the dealership experience. A few actually did that by buying cars from dealers and then reselling them at lower prices to customers until they blew through their capital. Build to Order.com proposed that you would place your order for a fully customized car while lounging in a company-owned showroom entertainment center. Again here the premise was to build these cars using an automaker’s parts and technology but avoiding high labor costs and dealerships and give the customer the exact car they wanted. Build-to-order.com never built anything for anyone. In 1999 and 2000, I ran priceline.com’s experiment with selling cars online, which like most others of the era no longer exists. The essential elements of the priceline model were replicated by TrueCar.com and of course they too ran afoul of franchise laws for the same reasons as priceline. What I learned then – and this is still true today – we could connect buyers with dealers and that the price of a vehicle was the easiest part of a deal. The other elements are harder to control and often the cause of frustration for the customer and the dealer. People don’t like to hear that their trade isn’t worth the value they saw online or that their poor credit doesn’t qualify them for the no down payment, zero percent loan. There are few people who would think about buying a house online from a few photos taken make rooms seem larger than they are or the neighbors Beware of dog sign. Buying a car is comparable to buying a house, why should we think it should be as easy as buying a pair of shoes from Zappos with a return receipt in the box in case they don’t fit.

Although many automotive websites claim to have “sold” millions cars, even today twelve years after priceline decided to concentrate exclusively on travel, automotive websites link a buyer to a dealer who actually sells the car. The Internet has mostly replaced the newspaper as a source of information about cars and dealers but it has not reduced advertising expense per vehicle or made buying a car as easy as buying a book.

Add up all the monthly traffic to all automotive sites, including automakers, dealers and independent sites – and you’d get more than 100 million possibly close to 200 million unique visitors using the web to get information about buying or selling a new or used car. Except there’s one problem if this traffic is somehow suppose to represent potential sales…the total number of new and used cars sold by dealers at retail and excluding fleet each month is only about two million units, and that is probably generous given that not all retail customers go online..some might just release the same brand of the leased car they are returning to the dealer. So the real shoppers – however you want to define that number – are only a small fraction of the total visitors. So just like newspaper, radio, or TV advertising, dealer spend on the internet is likely no better targeted – once again dispelling the notion that the internet would solve the age-old problem of knowing which 50% of a dealer’s advertising works.

And what was once promised as to the beauty of the Internet for used cars…listings of available cars with pictures, even videos, and stated pricing would make it easy for shoppers to find the best car at the best price. But what has happened is that for any given vehicle, within a similar bandwidth of age, mileage, trim, the price range for specific models is usually within a few hundred dollars, not enough to make price the deciding purchase factor. The Internet hasn’t created a pricing advantage for any seller and customers simply have confirmation that similar cars within a market are priced the same. With the exception of hard to find cars, the differentiating factors are having the car the customer wants, proximity of the dealership and the dealer’s reputation in providing a good customer experience.

In summary, technology is a wonderful thing…and dealers have adopted it nearly full tilt. Sophisticated software to manage every aspect of the business is now de riguer…BDC’s to support internet sales…and eDocuments will eventually become the norm. But the point is that the system of franchised dealers – using their own risk capital to fund their businesses and guarantee millions of dollars of inventory, promote their own brand and that of their OEM, provide the expensive tools needed in their service departments, and manage the endless headache of a workforce – will not be superseded by technology or factory owned mall stores. Factories have learned that they cannot do a better job than independent businessmen at the retail level. And new start ups – many of whom will come and go – with new systems of selling and servicing retail automobiles will all reach the same conclusion: the dealer network is the best way. Thank you for listening today.

“Moral Motors” vs the Traditional Franchise New Car Dealer.

First, some ground rules.  This is not to imply that the “traditional” franchised new vehicle dealers aren’t “moral.”  But there is a perception among many consumers and certain consumer watch dog groups that certain “traditional” dealer practices are “unsavory,” at best.

It is a given that a new car dealer needs about a 10% gross profit on each transaction, front and rear combined, about $3000 in today’s market based on an average new vehicle sale for the Dealer to break even and provide a small measure of ROI.  Most consumers and advocacy groups don’t disagree with this, when asked in a survey.  Where these groups differ with the “Traditional Dealer” is when all buyers aren’t charged the same 10% margin.  The idea that one consumer could get away with paying a $1000. gross profit while another pays $5000. to maintain the $3000. average seems outrageous to them.  
Of course, 10% doesn’t seem like much to a consumer until they figure out that that is about $3000. on a $30,000. vehicle.  Consumers tend to have no understanding of the difference between gross profit and net profit.  Perhaps they think the factory absorbs facility overhead, taxes, utilities, staff, etc.  Many consumers also tend to think that new inventory is provided on consignment by the manufacturer.

So let’s do some arithmetic while making the assumption that all other factors are equal.  Let’s assume that two dealers have equal overhead expense, and that their sales staffs are equally adept at product knowledge and “building value.”   The “Moral Motors” dealer never asks for full gross profit and hence, never receives it on any car deal.  After all, they want everyone to pay the same margin.  In addition, the “Moral Motors” dealer passes on the “cheap deals” out of principle, when efforts to justify the price fail in the face of a better price from competitive “Traditional Dealers.”  The “Traditional Dealer” gains extra volume via the “cheap deals” he/she can accept, and gains the additional trade ins, F&I income, and warranty and repair opportunities.  He/she also gains in Units in Operation, which can be leveraged down the road into repeat business.  Plus, there is the additional gross profit that comes with at least making an effort to make full price or additional gross profit and giving everyone the opportunity to pay it.  So add in this extra gross profit to the extra profit from being able to take the “cheap deals,” and the math is easy.  The “Traditional Dealer” sells more cars and makes more money.

Advocates of the Moral Motors business model try to make the case that word of a “no hassle” buying experience will bring additional buyers to their store to make up for the loss of gross profit from the deals and gross profit they turn down.  Great experiments in the past to prove this concept have failed miserably, despite the fact that advocates can always come up with the occasional anecdote.

The comparison gets even more interesting when the two dealers want to buy another dealership.  The additional “cheap deals” of the “Traditional Dealer” translates into additional market share.  Auto manufacturers look at 3 primary factors when considering the approval of a buy/sell agreement.  First, does the purchasing dealer have a record of consistent profitability and the money available to properly fund and operate the additional dealership?  Second, does the purchasing dealer maintain a satisfactory CSI score?  And third, how does the purchasing dealer penetrate his/her current market?  Any dealer who has ever tried to get factory approval for a buy/sell knows how important market share is to an auto manufacturer.  Despite this fact of life in the auto industry, we weren’t able to get any specific comment from any of the OEMs we contacted, other than in very general terms.

Consumer advocacy groups would like us to think that the “Moral Motors” dealer carries higher CSI. but they are unable to cite more than anecdotes.  There are MANY “Traditional Dealers” who maintain more than satisfactory CSI scores.  Without satisfactory market share, the “Moral Motors” dealers will be found wanting, all other things being equal, and will not likely be approved for expansion even if the other two critical items are without issue.

“Moral Motors” can make money if his or her overhead is controllable, especially if his/her dealership is in a market with other less aggressive dealers.  But it also means the dealer has to take a strong stand with his OEM regarding “factory image programs,” where the dealer is expected to increase overhead to bring the dealership facilities in line with OEM standards.  This is not a good way to gain favor with an OEM one might be asking for factory approval to add another dealership.

Our industry is either blessed or cursed, depending on your outlook, with a variety of companies who are quite willing to collect dealer money to help the industry sell more cars and keep customers happy.  They tend to cite surveys done by others, or conduct their own in justifying their approach.  Some of these vendors have actual front line dealership experience and are much more than theorists.  Others? Not so much.  Vendors who would tell dealers to charge everyone the same have probably never worked in or owned a car dealership.  We now have “experts” telling us that our industry should provide a buyer experience like Disney, Apple, or Amazon.  When they have to start negotiating price, taking trade ins with negative equity, and dealing with complicated financing issues, they might have credibility.  Until then, now so much.

Frankly, many of us thought the issue was settled when the factory owned “Ford Collection” vanished from the face of the earth, but this really bad idea of “everyone pays the same” lingers on.  We had this great debate 20 years ago when Saturn was launched, and many opportunists cited the so called “success of Saturn” to “prove” the theory was sound.  Saturn lost money from the start, and never made money, which explains why it is currently extinct.  Saturns were sold for a loss from the start.  Not by the dealer, but the factory lost at least $1500. a car from 1991.  Most wouldn’t call that “success” even if their customers were happy.

I experienced a similar situation in Japan with Toyota about 12 years ago.  A client there asked me how I thought it would work out.  My answer was, “As long as demand and supply are properly balanced, and dealers stay disciplined, it will work great.”  I also mentioned the chances of that happening are “slim and none.”  In Japan, franchises are awarded by region, similar to the old Saturn model.   If the idea of charging everyone the same was ever going to work, it was going to work in Japan.  Imagine a single dealer owning every sales outlet in a particular region or state for a brand.  Toyota even created a new sales channel for the great experiment, combining Auto and Vista into a new one called Netz.  In Japan, Toyota calls their various divisions “channels” and they have 5.  Toyota cut back the markup on Netz vehicles to the point that there was nothing left to give away.  As a consequence, the degree of discounting was minimal from the start.  But sure enough, once demand waned compared to the factory’s need to build cars, along came the “trunk money.”  And dealers took advantage of it to discount, even though the same dealer owned all competitive dealerships.

If this isn’t a commentary on the human nature that drives a new car buyer, I don’t know what is.  Consumers tell surveyors they hate negotiation.  But the first thing they try to do when buying a car is negotiate.  It would seem that what consumers say and what they mean are two different things.

The Nano and the Model T: History Lessons Not Learned

Nano: no price is low enough

Back in 2007 the Tata Nano ultra-low-cost 4-seat car garnered attention; other companies were rumored to be starting their own projects. However, since its 2009 launch it has not sold well. While Japan has its "kei" cars (軽自動車), which are taxed less and until recently did not require proof of a parking spot, economy cars have not sold well. And while the "kei" cars are less expensive, they're not cheap, and come with amenities car drivers in developed countries expect, such as air conditioning.

...Tata fortunately didn't bet everything on the Nano...

We in the US have our own experience with a product similar in concept to the Nano: the Model T. At the onset it was still out of reach of the average American, but Henry Ford and his engineers improved production efficiency and otherwise lowered costs, so that while it initially sold for $850, when production ceased in 1926, it was selling for $350 [using the BLS inflation calculator, that's equivalent to about $4,800 today]. Or rather, not selling.

Instead consumers preferred two other vehicles. One was a Chevy, better appointed though at a higher price point. By 1923, customers could get a Chevy with an enclosed steel Body by Fisher painted in bright Duco colors, an electric starter and other amenities. The other vehicle to which price-conscious consumers gravitated was a used Model T. By the 1920s millions were available, and for farmers and others looking for basic transportation they went for half the price – or less if you were handy, as the Model T easy to fix.

Cars are aspirational products, and in India those wanting a vehicle opt for a Maruti Alto. Even though the base Alto costs 50% more than the Nano, in August 2013 Alto sales surpassed 17,000 units while the Nano sold under 2,000 units.

The other challenge is from below. Motor vehicles are durable goods (though less so on Indian than on American roads), and so the Nano faces competition from used cars. The Nano doesn't have a useable trunk, but all other models do – and a used Alto will set you back less than a new Nano.

Then there are motorbikes, for which India is the world's largest market. Bikes outsell cars by 7:1 – in August 2013 only 180,000 cars were sold, while the leading bike firm Hero by itself sold 460,000 units. At the most expensive end, a Hero Karizma will set you back over R100,000 [rupees], but most models run R40,000-R60,000. Compare that to the base Nano at R162,000 and the base Alto at R242,000. Bikes are utilitarian, too, and if you can hang on, they're capable of carrying more people than a Nano, for half the price.

Nothing New

Of course we've been here before, and we don't have to go back most of a century to find similar examples. In electric cars we had the Aptera at one end – a 3-wheel, strictly utilitarian vehicle – and the Tesla at the other. We know how that went. When Roger Smith wanted to experiment at GM, he set up Saturn. Now by refusing to overdealer he was able to claim a new "no hassle" purchasing experience, which many consumers liked, or to put it more bluntly, were willing to pay for. But by focusing on compact, utilitarian cars, Smith guaranteed the business would generate thin margins (and by insisting on all-new factories and designs, he built in high fixed costs). We also know how that went: Smith's successors could find no business case for continuing to invest in the brand. In contrast, what has GM successfully pushed in China? Not some stripped-to-the bone Chevy, but decked-out Buicks. They can't make them fast enough, the cash just keeps rolling in.

Tata fortunately didn't bet everything on the Nano. It also purchased Jaguar Land Rover, after Ford had restructured and turned them into profitable businesses. There is no upmarket for the Nano; it's already down the road and over the hill. There may be a higher-volume downmarket for JLR, which has passed the starting line with a good position and has yet to peak. Mixed metaphors, yes. Mixed performance, too. But an old story.

mike smitka