(Economic Environment = av a i Hy ro / oe ee i ee ee a A OREO a ed ee Managing Risks in the New Automotive Marketplace ECON aeMCOTRUT NOK OeFora ‘ess as changed hte: competitive pric ing. ateputation for qual predict best balance these goals made imp kers, the formula for suc dacureent ing, The manufacturers tbat guns maeket share during the pesform thelr peers im the nest five years as well. For car dealerships, howe tive Sales of carsand tricks collapsed during the recession, falling 18% and 21.2% 1m andseape has changed significantly 2008 andi 2009, respectively With sales searcer than ever, dealerships have had to step up the competition with other offerings —use cays and maintenane services —to stay allot Additionally, car dealers are embrac ing modern sales methods to ensu adequate financing for theit inventories tat adape to these new market conditions will nt and customers. Dealetsh only survive, but thrive in today’ auto ‘motive marketplace In the Rearview Mirror The severe economic volatility ofthe past two years shook the automotive indus- try tots foundation. The financial sec tor began teetering in. late 2008, and the subsequent redit erisis, combined with anxious consumers, devastated annual rnew-car sales, wich fell 18% in 2008 t0 LS million, down from 16 million ve icles in 2007. fn 2009, continued un. certainty and rising unemployment ent sales a further 21.2%, to 10.4 milion vehicles, The effets of this sour retal environment rippled throughout the sector, binging down two of Americas Tig Thre automakers, General Motor (GW) and Chrysler. i the same time agile competitors accelerated thelt gain mmarket share (Figute 1. These events ate drastically reshaping the automotive retail market The RMA journal Nove 2010 MERE 15))‘Change in New Light-Vehicle S AS mind wSnci00 Sina 60 ws 29 -Asautomotive giants stumbled, new-car dealers sullered through harrowing times. Amid collapsing vehicle sales, dealers’ industry revenue fll 15.13% and 28% in 2008 and 2008, respectively. For Acthe same ime, car dealers are adapting sles strategies to attract che Intermet-age consumer, while strengthening their used-vebicle and maintenance services offerings dealer ting ‘thousands of dealers, | Manufacturing and Brands Vor denice ie cilapiiig? Se falling sales |The Gireat Recession accelerated an ongoing shakeout sales strategies to were the least oftheir among automakers. Since the early 1990s, America’ Big ‘Tareeautomakers have been steadily losing ground to their German and Japanese competitors, Japanese automakers, [primarily Toyota and Honda, made inroads with customers by selling relatively inexpenstve, small, and reliable cars like the Honda Civie and Toyota Camry: German automakers leveraged their reputation for excellence in engineering to attract the Internet- age consumer, while strengthening their used- vehicle and maintenance services offerings. worries. During their bankruptcy restructint ‘ngs, GM and Chrysler set forth plans to cut franchise ties to lange swaths of their dealer- ship networks. GM alone plansto let 4,100 {ealership contracts expire in an attempt toring the siz of| its dealership network inline with its leaner rival (Toyota sells just as many cars as GM with just 1,200 dealerships nationwide), Dealers selling Hummer, Saturn, or Pontise ‘ars met a similar fate as the brands closed. Analysis con- ducted by IBISWorld suggests thatthe dealers who survive Uns great shakeout wil be higher-volume operations serving larger areas, Retooling Strategies Auto retailers and automakers are changing their business practices to beter serve customers and improve profitability. ‘On the manufacturing side, automakers are emphasizing, fuel efficiency and smaller cars to address the slide in the popularity oftrucksand SUVs, Truck and SUV sales fellat a 12.4% annualized rate from 2004 to 2009, while overall ve~ hcl sales fellat.a9.2% ama rate during the sime period (common 2010 Thea four dominate the luxury car segment ‘The Big Three found their niche with trucks and SUVs, which still account for more than half of the sales of GM, Ford, and Chayslr, (Other automakers’ truck offerings ‘Benerate less than 40% of sales.) However, once gas prices ‘began rising rapidly in 2005, sales of gas-guzzling SUVs ell Precipitously jeopardizing the automakers that were overly reliant on the segment. The recession’ effect on vehicle sales compouncled this existing instability, driving GM and Chuysler into bankruptcy. Ford avoided a similar late by ‘apping a $10.1 billion line of eredit in January 2009, Today’ upheaval inthe automotive marketplace repee- sents a unique opportunity for automakers to grab U.S. ‘market share, but companies reaching aggressively for volume sales should pay heed to Tayota’s experience. in 2002, Toyota set a goal to become the world’s numaber- one automaker with a target market share of 15%. Such 4 lofty goal required growth of 50%, and this push for growth seems to have resulted in everreach: A wave ofrecalls followed in the frst half of 2010, These recalls, along with allegations of lax quality standards, are already hiuing the companys market share, During the firs half of 2010, Toyota represented 15.9% of the U.S. market, down from 17% in 2009. While Toyota stumbles, three rival automakers are lining up for a larger piece of the USS. market: Hyundai-Kia Automotive Group, Ford Motor Company, and the Volkswagen Group. Since the start ofthe recession, Hyundal-Kla Automotive Group has made the largest gains in market share of any automaker in the U.S, market. Adecade ago, in the United States, Hyundai had a very poor reputation for quality, ‘which it sought to remedy with generous 10-year warran ties, While the quality problems seem to have died down, the warranties remain, Hyundai’ success is due not only to the improved quality ‘ofits vehicles, but also to its aggressive pricing and a string, ‘of successful redesigns and introductions. The Hyundai Genesis, a luxury sedan with a low $30,000 base Manu- facturers Suggested Retail Price (MSRP), won the 2009 North American Car ofthe Year award, while the Ria Soul, ‘budget-fiendly boxy car, sold mare than 28,000 vehicles in the frst six months of2010, a 156% increase over the same period in 2009, Assuring 2010 sales rates hold throughout the year, Hyundat ison track or 4% annualized sales growth inthe period {rom 2005 through 2010, and ts market share is forecast to climb to 7.3% from 43%. Meanwhile, the Ford Motor Company stands well ahead. of its cross-town rivals in revival efforts. Fords current turnaround began with the hiring of CEO Alan Mulally Jn 2006. At the center of Mulally plans has been a move toward streamlining paris and platforms used in Fords international operations.’ While this initiative will nt be complete until 2013, its benefits are already evident. Ford has made profits inv ery quartersince 2008 and acquited an addi- tional 2.4% of market shareoverthisperiod, Gains Ey Moreover, in order 10 [ft a meet new emissions yy aCe a requirements and con- ki sumer demands, Ford Meatenbide is rolling out smaller Chri Sa vo displacement engines [isnoidiwia! 0970 equipped with turbo yarep ae changers that offer per- formance comparable RG 3 tolaerenghesefae Wien os consuming ess uel, (Sl ow Solr ibeelionsare “tp os paying off: Fords US. market share grew ini from 15.1% in 2008 to 17.5% in the first half of 2010. The domestic automakers heed stain timaround eons also shows int sles figures for the pest ve years. From 3005 io 2010, Fors sales decined at 7.6% annualized tne, compared to 14 6% and 12.0% at Chrysler and GM, respectively [615 Word expects Fords US, sales o gow 27% through 2010, 021 milion vehicles Caen ib Volkswagen Group sama payee in the US. market wilh 229% marketshare in 2008. However, Wollsvagen isthe thr-argeet automaker iteration anudhas plans toile isU.S. market hae by 2015, Dusing the Bie yeas to 2010, Vllswagens U.S. sales increased at 2.43% annualized rate, Corel, Volkswagen sale are Being hur bythe “German premiu’—tha the bigher labor and tansportationcossin Germany, The 2010 Volk swagen Ja sold with a base MSRP of $17,735, whl ts dass competitors the Toyota Corolla and Honda Civic, sana $15,450 and $15,655, spectively Viliswagen ase thee by opening t yew manalacring eso ee an fas made the largest drop toabase MsRPof gains in market share $15,995,thanksprinci of any automaker in aly eachange rae , iilosg swine tom the U.S. market. the new plant. It also ‘ill be the first North American model to share all styl- ing components with its European counterpart. IBISWorld expects further profit gains fr Volkswagen (or, alternatively, lower base MSRPs) as the company increases the North ‘American-sourced postion of the Jetas components and Since the start of the recession, Hyundai- 2s sa 1085 5 am a8) asm 18 20 an, at 60 va 1s 130 ia uss aon ne 25 aus 1 ine um us wn or ara, ane ome oa ‘a an ase ome ow ws us one ua ran vusst st aos Kia Automotive Group The RQ Journal Novenber 2010climinates mote costly Furopean-produced pars. Voll sagen is on pace to increase annual U.S. sales 18.3% in 2010, General Motors and Chrysler underwent aggressive restructuring over the past year, reducing debt obliga- tons and excess production capacity while in Chapter 11 bankruptcy: Currently, ownership of both companies is divided among the U.S. and Canadian governments and. the United Auto Workers (AW) union. General Motors is planning an initial public offering later in 2010, allowing, the U.S. and Canadian governments to transfer their stakes toprivate owners. Meanwhile, Chrysler has parmered with Italian automaker Fiat, ‘These automakers are looking into alternative ways to ex tend credit access to the nomprime market and boost sales. According 10 GM, just 4% of their sales go to nonprime borrowers, while the industry average is closer to 21%, Retail Inlight of the automotive sector’ recent troubles, car dealers are rethinking many of the ways they do business, Most obviously, dealers have realized the importance of picking. the right brands to sell. During the past year, dealers selling Saturn, Pontiac, and tiummer vehicles—all discontinued ‘brands—have found themselves without prodtict. Dealer ships selling two to four brands of cars from a single facil ity have become increasingly common, even with brands In light of the automotive whch curently ows fom diferent manufacturers Ths brand diversty helps . 20% of Chiysler and sector's recent troubles, ‘ys oprionsto ines: | "mig te sk ofa sakien change in a bran tage ce car dealers are Atsstake. Chrysler and | popularity; Toyota recent reall woes area good example rethinking many of the CGM sew some of the | ofthis ask i worst sales declines | Sales of used carsin good eondtion from a partial ways they do business. during the past five | brand, also known ascenified pre-owned (CPO), isa useful ‘years sales were down, sn estimated 14.6% and 12.0% anmualy, espectively. Theit sales rebounds also have lagged more than other automak- sin 2010: Chrysler sales rose 12.6% inthe first half of 2010, while GMS sales vose 13.7% (Table 1). ‘The relatively weak performance of both automakers is partly a result ofthe stigma associated with @ government bailout as well as botdenecks created by their primary auto Jending partner, GMAC—now known as Ally Financial, Ally Financial, also bailout recipient, has since shied away fom lending to nonptime car shoppers, which has reduced (Chrysler and GMS penetration into that market segment. @ SN roe 2010 The AA Jou proxy for brand health Figure 2), Hyundai-Kia Automotive Group clea has the strongest momentum inthis measure: lis CPO sales rose 78.29% in 2009, (Hyxmndat had to be excluded from Figure 2to maintain scale.) Im addition to brand diversification, car dealers are putting stronger emphasis on their non-sales-dependent revenue stteams. New-car sales are highly cyclical and affected by trends in interest rates, manufuevurerincen- tives, unemployment rates, credit access, and individual vehicle orbrand popularity. While IBISWorld expects sales ‘of new vehicles to rise 14.5% in 2010, slow improvernent {in the economic factors is expected to keep sales wellbelow prior levels through 2015, This extencled weak- ness in sales makes the drive for alternative revenue all the more urgent, arts and service departments, in particular, ae a ma- jor subject of dealer investment, These departments have become more important to dealers during the recession, Indeed, their portion of total revenue increased as new- car sales plummeted. In 2007, sales from this segment accounted for 11.7% of revenue and have since risen to bout 14.2% in 2010, The reasonis simple: During difficult economic times, consumers extend the lives of their exist- ing vehicles, spending more on maintenance but forgoing new purchases. ‘Unfortunately, new-car dealers are notin the best com: petitive position for this market. With the exception of warranty work, repairsat dealerships are significantly more ‘expensive than at independent repair shops, IBISWorld analysis indicates that new-car dealers charge an average premlum of 34% over prices at independent repair shops Aaditionally. service personnel at dealerships are frequently trained only to repair vehicles sold by the dealership, Aware ofthis discrepancy, dealersare pushing co improve customer setviee, cut repair prices, and expand training for service employees, Deslers that improve service quality and ext prices can grow and maintain this recession-tesistan source of revenue. Dealers unable or unwilling to offer a better service experience have yet another way of diversifying revenue sources: to sell used cars. Used-cat sales are much less volatile than new-car sales, offering a better value to cash-strapped consumers (Figure 3). Used cars also are a synergistic product for new-car dealers because of new- SF i _ Annual Percent Change in New Light-Vehicle Sales by Manufacturer = Smt mee wn mS wSeeATY =5 car buyers’ trade-ins. Dealers routinely sll used vehicles acquired through trade-in at a 25% to 35% markup. New- car dealers already generate about 28.6% of revenue from used-car sales. New-car dealers looking to expand their used-car opera: tions should take a page out of CarMax’ playbook. CarMax, the largest used-car dealership, has consistently outpaced its more traditional rivals by offering a more pleasant buying experience. Sales commissionsate set ona per-wehicle basis (ather than by percent of sale), priesate fixed, and buyers are given a transparent, itemized price breakdown. A to- Dbust parts and services depanaentcrenesiue Dealers that improve ther econamies of cae for dealers choosing SeT ICE quality and this path, allowing for CUt prices can grow nodescreparsthaten- ane] maintain this hance the resale value of ‘ : incomingtadeins. Pecession-resistant Duringihe pat fve source of revenue. years, new-cat dealers have seen persehise sls prices desing, se consumers a spending more ime searching thei ext carandsoicing utes om mule dealers Moreshoppersace doing thei ‘esearch online: 87% of imma car shoppetstest-divea ‘ehilebeforea purchase, 73% vst the sbtomakerswebte and 74% vist a thinl-pary automotive website (sic as Edmunds, Kelley Blue Book, AutoTiader, and Cars.com) ‘Turing this wed talc int carsales ia rapidly growing business. Emblematic ofits potent, outsourcing gant Automatic Data Processing recently aged to buy Cobalt Group. an aulomotive-oented digital marketing company, a 25 is "The A Jo ee 200 »)for $400 million. Thousands of dealers nationwide buy leads from Cobalt and its compencors. Auto lending At the height of the recession, a swift pullback in lending. to dealers and consumers crippled the retail arm of the automotive sector. While lending and economic conditions have since improved, lenders are still demonstrating a de- creased appetite for risk, offering fewer loans to nonprime borrowers than in the past. However, IBISWorld expects the revival of subprime auto lending to lead any recovery in subprime mortgages. Unlike mortgages, he collateral in auto loans—ears—is more liquid owing relative homo- geneity and mobility. ‘Automakers with captive lenders, such as Ford Credit and Fiyundai Capital are betier equipped to offer loans, and attractive Financing to nonprime customers than are automakers without captive lenders. To increase its sales and lending capabilities to nonprime borrewers, General ‘Motors olfered wo buy subprime lender AmeriCredit for $3.3 billion in July 2010, The deal is expected to be finalized within the year. A shrinking appetite for risk can be inferred from the interest rates of new-car loans issued by auto finance eam panies. These rates cropped! offa clffafter January 2009, falling from 8.2% ta 3.24% as the eredit crunch faded and lenders tightened lending criteria Prior to the recession, interest rates on new-car loans ranged from 5% t0 6.5%. Lending eriteria seem to have loosened marginally in the fits half of 2010, and interest rates have climbed baclesnta the low 4% range. Further improvements In credit acess. are necessary ifthe industry isto return to historical sales rte. Risk Management Tokecwaays Antomotive lending wil play an integral role in the ongoing recovery of the automotive sector. Lenders can minimize their risk by understanding the underlying trends trans forming the automotive marketplace. On the retail side, dealerships tied toring brands ike Ford, Hyundai-Kia, or ‘Volkswagen stand to outperform dealerships tied to troubled brands lke Chrysler or GM, As the performance of given, ‘brand varies from year to year, dealers that aller vehicles produced by more tan one successful brand are better equipped to survive further turmoil Furthermore, dealers with a strong alternative revenue stream, from either usec-vehicle sales or maintenance services, are less risky than dealers focused solely on new-vebicle sales, And finally, clears that have already embraced Invernet-based sales methods, which allow for hhigher-volume sales, ae likely to see more dramatic sales ‘nereases than their traditional counterparts Lenders who consider these key success factors for tuto deaiers will minimize the default risk in their lencling profiles, while sill reaping profits from the reviving auto market, & (sy Tharmbens dec on BS sages ese fir. 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