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AUTO NEWS: Beyond the showroom; how dealerships work

NORFOLK, Va. -- Don Hall, president and CEO of the Virginia Automobile Dealers Association, was speaking recently to a politician about the closing of auto dealerships when he realized that the politician had little idea about how the industry works.

NORFOLK, Va. -- Don Hall, president and CEO of the Virginia Automobile Dealers Association, was speaking recently to a politician about the closing of auto dealerships when he realized that the politician had little idea about how the industry works.

"His assumption, and the assumption that most people have, is that dealers, in fact, don't own their inventory -- that it's on consignment, and so their carrying costs or handling is very limited or very nominal until they sell a car," Hall said.

But that's not the case. While you may think you're buying a car or truck from General Motors or Toyota, you're actually buying from a middleman: the automobile dealer. Manufacturers provide the warranty, but it's the dealer who sells and services the car, much like Best Buy sells televisions made by Sony or Samsung. Dealerships have been in the news lately as struggling automakers have announced plans to drop dealerships -- 789 by Chrysler and about 1,100 by General Motors.

But while some Detroit manufacturers have received government loans, their dealers aren't entitled to a dime. And the economy has pushed some dealers to the brink. Eighteen months ago, 575 dealers operated in Virginia, some with multiple franchises, Hall said. By the time GM and Chrysler finish cutting franchises, he expects that number to be 475.



Dealers are independent businesses that sign franchise agreements with automakers. The agreements give the dealers the right to sell and service certain brands of vehicles within a specified geographical area.

Scott Smith, president of the Hampton Roads Automobile Dealers Association and general manager of Casey BMW in Newport News, Va., said the agreements contain requirements for profitability and working capital, yearly sales and customer satisfaction scores in sales and service. The agreements run between three and five years, and renewals usually happen without much fanfare.

"Typically, it's given; there's not a lot of tension about it," Smith said. While there's no fee to get a franchise, there are plenty of things a dealer must buy, usually from the automaker. That makes them customers of auto manufacturers, just like consumers.

"And they both get treated the same way," said John Linkov, automotive editor at Consumer Reports.

Beyond cars or trucks, dealers buy brochures, training materials, videos, signs and even furniture from the manufacturer.

"Dealers pay for everything that you see," Hall said.

Corporate control is so total that it's not unusual for a manufacturer to dictate the architecture of a showroom, its floor tile and its installer, dealers say.

"There's very little latitude," Hall said.


Most automakers have specific requirements to upgrade showrooms or build new ones. At Toyota, the program is called "Image USA II," which helps provide a uniform customer experience, said Toyota spokeswoman Sona Iliffe-Moon . "It includes consistency and standardization across the board to ensure there's adequate room for growth in sales and service," she said.

The program, and others like it, is a form of marketing to ensure brand identification, Linkov said. "If you wanted to sell a Hummer, you had to build a $2 million Quonset hut to sell a Hummer or you didn't get to sell a Hummer," Linkov said.

It's all about the familiar, about making a visit to the dealer more inviting.

"The experience puts you at ease coming in there," Linkov said. "It's familiar. That's why all Abercrombie & Fitch stores are a certain way."

Usually, local retailers finance the construction of a showroom and take out a line of credit from a bank or the manufacturer to pay for it, as well as the inventory of cars and trucks to be sold. The line of credit to finance the purchase of vehicles is called a "floorplan." In addition, auto dealers often have another line of credit for parts, usually ranging from $300,000 to $1 million.


Dealers can get into trouble when they sell fewer cars than they have arriving from the manufacturer. Consider a dealership with a $5 million inventory and a $5.5 million floorplan, or line of credit. The dealer continues to order cars, expecting to sell 100 cars a month. Usually, cars are ordered three to six months in advance. As long as the dealer sells 100 cars a month, there will be enough cash to pay for the new cars coming in. But say sales slow to 40 cars a month.

"In 90 days, you're now only selling 120 cars, but cars are still coming in and there's no way to shut off the valve," Smith said.


If dealers don't make their payments, their inventory can be seized. Many dealerships offer services that increase their costs, such as loaner cars, free transportation or extravagant waiting rooms with Bluetooth and flat-screen TVs. Those costs, necessary to stay competitive today, come as new car profit margins are thinner than ever.

"Customers think dealers have a 20 to 30 percent markup in a car," Smith said. The wholesale price and suggested retail price of a car or truck is set by the manufacturer. Increasingly, they're leaving little room for profit.

Manufacturers occasionally funnel incentives to dealers, reducing the interest rate or offering a cash incentive for advertising a certain car. But the benefit is marginal, Smith said.

Consumer Reports' Linkov said the extra spiffs manufacturers funnel to dealers used to be included in the dealer's margin, money that retailers get only if the dealer receives high marks in dealer surveys or sells a certain number of cars.

"There are all these different metrics that they have to hit to get money that used to be built into the price," he said. "But unless they hit the goals, they're not going to get the money, and if they don't know if they're getting the money, they're not going to give it to you."

He observed that most consumers have misconceptions about dealer margins.

"If you look at the invoice price versus the manufacturer's suggested retail price, you'll see there isn't a huge difference between those two," he said.

But, he said, most buyers think there's still thousands of dollars of margin, even on small cars.

"People still have that feeling, but it's not true -- just like saying all American cars are garbage and all Japanese cars are perfect," Linkov said.

Smith agreed, saying new-car profit margins are small. "It's less than 10 percent and as low as 3 or 4 percent," he said. "As your expectations are going up and margins are going down, that model doesn't work."

Consider a base Toyota Corolla. According to Consumer Reports, the manufacturer's suggested retail price is $15,350, with an invoice price of $14,352. The margin: $998, or less than 7 percent before a discount is offered. The only margin dealers can count on is the holdback, a payment from the manufacturer of 2 to 3 percent of the vehicle's price once it's sold. As a result, most dealers make their profit elsewhere, Linkov said.

"They're making their money on the back end of the store with service and parts," he said.

Dealers also look to used cars. Margins are higher because retailers get their cars through trade-ins or at auction. That allows them to control the wholesale price they pay for a vehicle.

"They can pick and choose what they want to sell," Linkov said. "With a new car, they're kind of stuck with it. They don't have a choice."

It's an unhappy situation, as most dealers find the profits thinner and thinner. But most of these retailers wouldn't want to do anything else.

"It is the true entrepreneurial capital risk equation you could ever ask for," Hall said. "They have everything at risk."

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