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Getting a grip on ‘margin compression’

Implementing best practices can improve processes

The words on everyone’s lips this year have been “margin compression,” as profit margins up front continue to be squeezed by slowing new-car sales and smaller profits on every vehicle sold.

Experts say dealers can bolster profits and fight margin compression by enacting best practice and improving processes across their business – in sales, service, used vehicles and F&I.

The pressure on profits is clear: In 2018, the National Automobile Dealers Association reported that although the average net pretax profit dipped at U.S. light-vehicle dealerships, it remained in the black, at $1.36 million, buoyed by factory incentives.

But the gross profit in the new-vehicle department has dropped three years in a row, and dealers on average reported an operating loss for the first time since NADA began tracking the data 10 years ago.

For consultant Erin Kerrigan, that spells an opportunity to improve internal processes.

“What I think continues to present he most opportunity for profit improvement is tackling the expense associated with the sale of a car,” says Kerrigan, a former dealer and managing director of Kerrigan Advisors in Irvine, Calif., a leading buy/sell firm. “If you think about auto retail, the car is being sold the same way it’s been sold for decades. All other retail in the U.S. has changed."

“For these retailers, technology is changing the way they deliver the sale and also reducing the expense of the sale.”

Kerrigan says she worked recently with two dealership groups that use a one-price, one-person selling strategy: one posted, nonnegotiable price for a vehicle and once salesperson working with a customer from the moment the customer walks through the door through the F&I paperwork. Those dealerships have posted net profits three or four times the national average, Kerrigan says.

Address pain points

The caveat is that this model works only for a high-volume dealership. But Kerrigan says those that have done it have enjoyed a tremendous profit increase.

"They reduce the expense associated with the sale: getting rid of extra management, the F&I silo, flattening the sales organization," she says. "Each salesperson sells 20 to 25 cars a month, so they’re happy and turnover is very low."

“Think about it: You have all these layers of people who are all working to negotiate such a tiny profit margin on a vehicle sale,” she says. “The staff-to-margin ratio is very far off. New-car margins are probably not coming back, so you have to change the way you deliver the sale.”
Even if a dealer is unable to offer the one-price, one-person model, the elements to which Kerrigan refers – from one-price selling to fewer customer handoffs between the staff members – are emerging best practices that also address pain points that car shoppers routinely mention in surveys.

Scot Eisenfelder, a former AutoNation senior executive and now CEO of the relationship marketing company, Affinitiv, puts it this way: “We’ve got to start figuring out how to make money for the process the customer wants versus the process we want.”

Says Gabe Garroni, vice president of sales for Ally Insurance: “We’ve seen a lot of disruption in the industry, both in terms of the vehicles dealers sell and how customers buy them – how you buy F&I, how you take delivery. What’s clear is that it’s no longer a matter of if the customer wants something different but how they want it.”

Innovate dealership groups, Garroni says, have “taken a chainsaw to the traditional sales system, reducing the cost of selling, and done really well.”

Beyond improvements to the overall sales process, many dealers have looked increasingly to F&I to keep the bottom line strong. Appealing new products and a menu approach to selling can help boost the average F&I profit per vehicle.

“Dealers have shown a tremendous ability to increase F&I per vehicle,” Kerrigan says. But, she warns, “There’s only so much that can grow.”

F&I transparency

Continuing to boost overall F&I profit will depend on increasing penetration – because despite the increase in F&I profit per vehicle, Garroni points out that 55 percent of customers still leave the dealership without a service contract.

Eisenfelder suggests that having a conversation with customers who initially refuse prepaid maintenance contracts can improve sales of the products. “If a customer doesn’t buy their prepaid maintenance from the dealership, ask why,” he says. “It will come down to value, process and experience. And then ask, 'How can those be improved in order to increase penetration?”

The first best practice in F&I is transparency, Garroni says. “Be transparent and put everything out there on the Internet for the world to see: your inventory, interest rates, F&I products and prices,” he says. “You are selling great products; why should you be afraid of letting the customer see that you make a profit?"

“Then set a fair price for your F&I products, go through the options with customers to establish value, and let the customer choose the products that work for them. The message should be: ‘You make the decision; we’re here to help you.’”

Maximize used car profits

Besides F&I, many dealers have turned their attention to used vehicles, where profit margins ca be up to three times higher than those on new cars, says Jonathan Banks, vice president of vehicle valuations and analytics for J.D. Power. Dealers can maximize their used-car profits by using data, Banks says.

First, dealers should analyze sales data to understand specifically what sells in their market – what models, packages and options are most popular. But technology also now allows dealers to access VIN-level data on the vehicles they see in trade-ins and at auctions and strategically select inventory based on what sells on their lots.

“Smart dealers will leverage the granular data they have available on a vehicle they’re considering purchasing, to help them understand their market demand for things like content, color, and features.” Banks says. “That will allow them to optimize the inventory they carry."

“That’s a best practice in used cars today: No more buying inventory based on gut feeling or what you remember selling well on the lot.”

Consistency

The other best practice Banks recommends is what he calls omnichannel consistency. “When a customer comes into your dealership, make sure you know if they’ve interacted with you already – probably online, at your website or on social media or even by emailing or texting,” he says. “It doesn’t have to be a high-tech solution, but have a process that allows you to figure out immediately what a customer came in for and where they interacted with your dealership. Then, he says: “Respect the research they’ve already done. Don’t try to give them a vehicle price that’s not consistent with what they’ve seen.”

These process and structural improvements are most effective, experts say, with an accompanying long-term approach to sales and service – and an eye on long-term profits.

For instance, Eisenfelder says, “Dealers tend to focus on the competition to sell new cars rather than maximizing dollars over the ownership period of each vehicle sold.”

A better way

The approach to F&I, he says, is a case in point. Eisenfelder suggests that too many dealership employees – in sales, F&I and service – are trying to make money off the initial F&I sale. The dealership as a whole can miss out on the long-term value of vehicle service contracts and extended warranties that bring customers back to the dealership for years for ongoing service and often for their next vehicle purchase.

It’s a concept known as lifetime customer value, used by many retailers. “Are we trying to make money off a transaction or earn money from a long-term relationship?” Eisenfelder says. “The value of a customer having a prepaid contract is tremendously more than the money made off that one initial purchase.”

Similarly, in service, the best practice – and perhaps a more profitable one – is to approach the customer with a long-term view. Say a customer comes in for a routine inspection, expecting to pay a flat fee, and the service department instead finds three or four things that need to be fixed.

Eisenfelder suggests making a menu of the fixes, prioritizing safety issues and giving the customer options about what needs to be fixed now vs. what can be addressed in two or three visits down the road. “I’m paid to hit the home run as a sales adviser,” he says, “but there may be a better way of approaching that customer that is more profitable in the long run.

“Our franchised dealers are great at trying to maintain a car in mint condition. But as a vehicle ages, consumers become more price-sensitive. Maybe it’s OK to simply keep a 5-year-old car in good working condition. As the vehicle ages, we need to meet the customer where they are.”

Despite the hand-wringing about margin compression, industry leaders say the dealership business remains excellent, with robust profits and a solid future.

“The car business is a good one, though it will continue to be more challenging,” says Justin Harmon, dealer principal at Columbus’ Bob Caldwell Automotive. “I know some dealers are losing money, but I also talk to dealers who are making more money than they ever have."

Kerrigan agrees. “Fortunes are going to be made in auto retail for the next two decades for those who continue to innovate the business model and reduce the expense structure.”

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