July 20, 2019: Used Jaguar XJ car for sale outside a Jaguar Land Rover showroom. Jaguar Land Rover Limited is a British multinational automotive company.
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For the first time since the Great Recession, the average U.S. new car dealer operated at a financial loss in 2018. After adding the income from all dealership departments (i.e., new cars, used cars, service and parts), the typical dealer lost $13,000 last year — compared to a $430,000 profit in 2013. To survive, dealers are now dependent on conditional income or “strings-attached” financial incentives from automakers. This shift in dealership profitability is reshaping an industry that is over a century old.
Retailing new vehicles is unprofitable for most dealers, with the average car sold for a $735 loss as of the latest data. Consumer adoption of online shopping sites forced dealers to lower retail margins as buyers pursued the lowest prices. New car pricing is another cause, with the average sale price reaching $36,000 in 2018, up from $31,000 in 2012. The switch in consumer preferences to SUVs plus added electronic gadgets, with the latter partially mandated by government regulations, increased vehicle prices to levels out of reach for most car buyers. As prices rose, dealers lowered margins to make monthly payments affordable.
Compressed margins meant dealers needed another source of income, and automaker incentives quickly became the solution. To be eligible, dealers must comply with their respective automaker’s brand standards. These vary by make but generally include almost all aspects of a dealership, like brand-compliant facilities, staffing, websites, shop equipment and other features. For example, one automaker requires its dealerships’ staff to answer any sales-related phone call within two rings, while another requires a specific imported floor tile in dealerships’ service shops. These strict requirements ensure a consistent customer experience but come at a huge financial cost — requiring dealers to build luxurious and cutting-edge facilities, purchase high-end technology, and hire staff among other cost outlays, which can add up to millions of dollars.
Given the cost of meeting brand standards, many industry observers question dealers’ rationale for pursuing incentive income, but dealers explain that non-participation has disadvantages. They face reduced inventory allocation, less access to more desirable models, and the worst consequence of all — reduced competitiveness with same-brand dealers. If one dealer in a market agrees to take the automaker’s money, then others must follow to match their competitor’s pricing. And as more dealers participated, selling vehicles below cost became a common practice, even worsening new car margins further. As one Florida dealer explained to Automotive News, “We are forced to put current customers into new vehicles much faster than normal. We lose $2,000 or $3,000 per vehicle to do it, but we need to hit our objectives to get our $100,000 bonus.” So, if dealers don’t pursue incentive-related sales objectives, their pricing will likely be higher than their competitors’, and they’ll quickly lose market share.
“Dealers are willing to dig deeper in their own pockets — sometimes operating at a loss — to go after those incentive targets that are set each month or each quarter. That operating loss is indicating that almost all the profit comes from OEM money.” – Patrick Manzi, NADA. 4/8/2019.
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According to one BMW dealer I interviewed, who asked not to be identified, the average 2018 gross profit for each new BMW vehicle sold in his New York City area dealership was negative $1,500 — down from a $1,200 profit in 2016. He explained that BMW provides him with a 5 percent incentive based on the cost of each vehicle he sells. While he admits his dealership is still profitable as a result of BMW’s incentive income program, he claims the automaker controls his dealership’s operations by controlling his profitability. “I’m no longer an independent retail store, but, instead, a delivery center for BMW. Nearly every aspect of my business — sales, service or parts — is tied to an incentive.”
State franchise laws prohibit automakers from selling directly to consumers (Tesla is a limited exception as it does not have franchise dealers). Thus, to continue selling their vehicles in the U.S., automakers have a vested interest in the profitability of their dealer network. “To a certain extent, this is a zero-sum game,” explained one California-based Mercedes-Benz dealer, who says his store is still profitable either way. However, he explained that as the industry continues to blur the lines between dealers as independent sellers and as automaker-controlled distribution points, there will be long-term ramifications, like less store autonomy and even fewer dealerships. Dealers who can’t meet brand standards are exiting the business, either selling their dealerships or, in extreme cases, closing them. According to Mercer Consulting, a 25 percent decrease in U.S. dealership ownership is expected by 2025, with difficulty meeting automaker brand standards driving the trend.
To counter incentive dependence and improve margins, dealers increasingly emphasize used car sales as well as making their service and parts departments competitive with independent repair centers. They’ve also focused on finance and insurance (F&I) packages, which bring customers back to the dealership for maintenance and service. Since 2011, the industry has seen double-digit revenue and profit gains in all of these areas, with service and parts sales growing nearly 50 percent. And while these tactics have increased dealer margins, they have not yet supplanted the income losses from new vehicle retailing. Moreover, automaker programs have expanded into these areas as well, with incentives tied to preowned sales, service, parts and F&I penetration.
Dealers’ dependence on automaker incentives is unlikely to change. As consumers increasingly switch brands, automakers are forced to move toward a customer-centric approach to differentiate their brands and build loyalty. They are aiming for consistency at almost all customer touchpoints — including the dealership experience. So far, this trend is beneficial to consumers, who receive a better brand experience and competitive pricing. However, for dealers, it means their businesses are increasingly controlled by automakers, and the operational independence they had in the past will fade further in the future.
