Haig Partners in the News

Dealers fear losing control as factory incentives burgeon

  • Apr 10 2017
  • Jamie LeReau
  • Automotive News

Each quarter, dealer Steve Kalafer grudgingly participates in factory incentive programs put in place by some of the 16 brands in his group.

If he didn't, his new-car departments, and in some cases entire dealerships, would be unprofitable, he says.

"We would be as red as the scarlet pimpernel," said Kalafer, chairman of Flemington Car & Truck Country Family of Dealerships in Flemington, N.J. "You are assuming these programs are voluntary. And the manufacturer will say it is, but it's not. When your sole source of supply -- the manufacturer -- sets the programs unilaterally, the alternative is to not be a car dealer."

Thousands of dealers face a dilemma similar to Kalafer's, industry consultants and dealers say. Over the past five years, incentive programs have proliferated while new-car gross profit margins have dwindled. About 40 percent of car dealers are not profitable in their new-car departments until they get factory spiffs, according to dealership consultancy NCM Associates.

The programs now reach beyond new-car sales. In some cases, auto-maker incentives supplement sales staff pay. The growth in targeted rewards, say dealers and consultants, increases manufacturers' power to shape dealership operations.

Automakers pay dealers if they sell a certain number of new cars, but also if they achieve customer satisfaction goals, buy a designated amount of parts, make facility improvements and, in some cases, write a certain amount of loans with the automaker's captive finance arm.

Many dealers say automakers' intentions may be honorable, but the number of programs and ever-growing complexities embedded in them create a bad business model.

"It's death by a thousand cuts," said Jim Appleton, president of the New Jersey Coalition of Automotive Retailers. "You've had a slow-moving but very clear transition from a business in which the dealer was a retailer to an agency arrangement where a dealer is essentially an agent of the manufacturer and is paid in a pay plan that is completely in the manufacturer's control and changes on a whim."

¦ Bad business?

All-or-nothing bonus targets are risky but hard to resist

Factory incentive programs favor bigger dealership groups that have the manpower, capital and inventory to meet targets. And they can influence other dealers' behavior, experts say. If one dealer is discounting new-car prices to hit a sales target, for example, his competitors must follow or lose sales. 

There's another hitch. Most volume-based new-car sales programs are all-or-nothing, meaning dealers must meet the sales target to receive a bonus. If dealers come up even one car short, they won't recoup revenue lost from discounting cars to juice sales. 

Some dealers will buy new cars from their own inventory to hit a sales goal, and then stick them in loaner fleets. It's a practice known as "punching" a car. It's bad business because it inflates inventory and can raise dealers' floorplan costs, experts say. 

"Do these programs affect behavior? Absolutely," said Tim York, managing partner at dealership advisory firm DHG Dealerships in Birmingham, Ala. 

Yet as gross profit margins on new vehicles erode, factory incentive programs have emerged as the baseline for dealers' survival. 

According to data from the National Automobile Dealers Association, new-vehicle gross margin as a percentage of the selling price fell to 3.3 percent in 2015, compared with 4.4 percent in 2010. In dollars, that's an average gross of $1,320 per vehicle in 2010 compared with $1,088 in 2015. Both figures exclude finance and insurance revenue.

¦ The seduction

'Enormous' spiffs offer retailers fix for new-car losses

Factory incentive programs are seductive because they offer dealers a path to recapture that vanishing profit margin, dealers say. 

York has dealer clients who earn $250,000 a quarter in incentive checks, he said. Big dealers who sell 150 to 200 new vehicles in a month can receive $100,000 for that month. 

"Even with some manufacturers paying holdback, new-car departments at most dealerships are not profitable until they get that factory incentive money because gross profits [per vehicle] have dropped so much," York said. 

Holdback is a percentage of either the sticker price or invoice price of a new vehicle that the automaker repays the dealer after the car is sold. Holdback percentages can reach as high as 3 percent, depending on the automaker, according to Edmunds. 

Dealer Ray Ciccolo, president of Village Automotive Group in Boston, said while he still receives holdback from some brands, incentive programs have grown so lucrative that it's almost mandatory to chase them. 

"That money can be enormous," Ciccolo said. "It can be $2,000 a car. If you sell 50 to 75 cars, you're talking huge amounts of money each month. Now you can understand why you wouldn't be profitable without it." 

The money received from factory incentive programs is typically accounted for as "additions to income" on a balance sheet, said Steve Emery, performance partner at NCM Associates in Dallas. It is critical income, often representing 15 to 20 percent of the total dealership gross profit.

¦ The hazards

Managing intricate programs becomes a job in itself

But the money comes at a price. Many managers spend dozens of hours a week monitoring the complex programs.

"I had a dealer who counted all the programs he was managing throughout his dealership, and it was 57," Emery said. "It's changing the nature of the business. Managers are spending more time figuring out how to manage these programs than on how to win sales and service customers." 

In fact, some dealers have employees who do nothing but monitor factory incentive programs.

In Kalafer's case, he has assigned a general manager and a sales manager at each of his 10 stores to monitor the programs he participates in. 

"We have to audit these," Kalafer said. "If you're wrong by two cars and the timing of it, you could get charged back $100,000 to $150,000 or more because most of these programs are cumulative." 

Also, automakers' compliance standards in dealership departments such as parts, business development centers and loaner-car fleets boost costs by requiring additional personnel and hours. 

Dealers fear there is "less room to be entrepreneurial," Emery said. 

Then there is the irritant of a manufacturer changing the rules midway through a program, suddenly disqualifying a dealer, Emery said. 

For example, the general manager of an Asian luxury-brand store, who spoke on the condition of anonymity, said the automaker changed its quarterly requirements for buying off-lease vehicles. The change, coming just three weeks shy of the end of the quarter, cost the store tens of thousands of dollars because the manager already bought the original number of off-lease vehicles required to earn incentives. 

And if a dealer misses a target by the thinnest margin, it can be painful. One general sales manager at a General Motors dealership said his store came up three cars short of the January monthly sales target so it did not get a $25,000 incentive check. The dealership's new-vehicle department had lost $30,000 that month from heavily discounting new cars to hit the goal, said the manager, who spoke on the condition of anonymity. 

"Had we gotten our incentive, we wouldn't have lost $30,000 that month," he said. "We would have lost $5,000."

¦ New criterion

Store buyers value fixed ops over new-car sales

The ever-increasing reliance on factory incentives is also changing how buyers assess a dealership purchase, buy-sell advisers say. 

New-vehicle sales are no longer the predominant gauge of a dealership's financial health. In fact, about three years ago, buyers started shifting their focus to fixed operations, specifically customer-pay service work, as the barometer for profit potential, said buy-sell adviser Mark Johnson, president of MD Johnson Inc., near Seattle. 

 

Klebacha: Hard to find buyers

"Fixed-ops is the one area that the manufacturer cannot manipulate, especially customer-pay," Johnson said. 

Johnson has handled more than two dozen buy-sell transactions since this time last year, he said. In each case, the buyer's discussion centered on "fixed [operations] gross and fixed growth." 

Another wrinkle: Dealers of brands that create pressure to pursue incentive programs often struggle to find buyers skilled enough to run the operations. That can ding the premiums a buyer is willing to pay, said Nate Klebacha, partner at buy-sell advisory Haig Partners in Fort Lauderdale, Fla. "You have to have a superior operator when it comes to those franchises," he said. 

¦ Some losers

Roughly 30% of stores miss factory targets

Typically, most dealers try to meet manufacturer metrics, but about 30 percent miss factory goals, Appleton said. 

"These manufacturers get $1 worth of effort for 70 cents of the cost, because nearly all dealers will put forth the effort to try to meet the targets," Appleton said. 

At Nissan North America, "All Nissan dealers take part in programs related to new vehicle sales, aftersales and customer satisfaction," wrote Brian Brockman, Nissan's director of group communications, in an email to Automotive News. Not all dealers achieve the targets, Brockman said, but "the vast majority" do.

Nissan created the programs with dealer input through its national dealer advisory board, Brockman said. Dealers are "independent businesses" that can choose to participate in the programs or not, he said. 

"These programs reward performance for reaching mutually beneficial goals that drive greater customer satisfaction," he said. 

Dealer input led to at least one factory killing an incentive program. Ford Motor Co. ended its new-vehicle sales volume incentive program late last year. "It was not a very popular program," said Ford spokeswoman Sara Tatchio. "We work very hard to work with our dealers to listen to them. So between that and focusing on the customer and not the quotas, it is the right way to go." 

Several other automakers declined comment or did not return calls about the topic. 

¦ Not an option?

Land Rover dealer profits closely tied to targets

For some brands, participation in incentive programs is not optional if a dealer wants to stay in the black. 

"I know for a fact, if you're not image-compliant, you're not profitable with Land Rover, period," said buy-sell adviser Johnson, after having seen many Land Rover dealers' financial statements. 

He said Jaguar Land Rover's Business Builder program is a moneymaker for those dealers whose store meets the factory's image requirements. The tiered plan pays an incentive to dealers who meet image standards while also meeting targets such as customer satisfaction and sales volume. 

A dealer could earn at least $4,500 from the factory on the sale of a $100,000 vehicle, Johnson said. But program terms are strict, and a dealer might lose thousands of dollars due to the fine print, he said. For example, in some cases, if a dealer sells a vehicle to a customer who lives in another JLR dealer's assigned territory, the selling JLR dealer may not qualify for the factory incentive on that sale. 

The program does allow for a dealer to sell a certain factory-set percentage of vehicles to customers from an unassigned territory, a JLR spokeswoman said in an email. "As a result, almost 100 percent of the network currently achieves their targets," she said.

¦ Different strategies

Penske values factory perks; smaller group opts out

For dealers with strong fixed operations and big scale, such as Penske Automotive Group, factory incentives are valued perks. 

"We rely on bonuses, but they're not the reason we're profitable or not profitable," said CEO Roger Penske. "It's certainly a portion of our bottom line. There's no question about that." 

Penske said factory incentive programs are now a part of the "DNA of the industry." For example, Penske Automotive bought a store last year and as part of the deal, it agreed to the manufacturer's request to upgrade the facility. The manufacturer is "holding back 2 percent of my margin until we're complete," Penske said. "They accrue it, so we'll ultimately get it, but those are the things the manufacturers are doing to be sure that you meet many of the requirements." 

Ed Robinson, CEO of Midwestern Auto Group, is familiar with factory plans. He was once a factory guy running BMW's captive finance arm. Now, as a retailer, Robinson avoids chasing automaker quotas for incentives because "I will have to restructure my whole business." 

Robinson's group has eight dealerships that sell 15 brands, mostly luxury. He wants to boost new-car sales but doesn't want to heavily discount the cars to hit quotas. He needs profitability per unit sold, he said. 

"It is a juggling act, but the long-term effect of relying completely on manufacturer bonuses will put the company out of business," Robinson said. "If you can't make money in the new-car department, how are you going to keep employees? I have to make a payroll every month." 

Earlier this year, Robinson froze the number of vehicles allowed in the company's service loaner fleet to dissuade managers from buying vehicles in pursuit of volume, then putting them in the loaner fleets. He expects that move to trim his annual floorplan costs by 15 to 20 percent, he said. 

Ciccolo and Robinson, like many dealers, resent automakers offering salespeople spiffs for hitting factory-set targets. 

"Where's the loyalty -- to the dealership group, or to the manufacturer?" Robinson said. "If the manufacturer wants to start paying our employees, then they can take on our health care expenses, too."

¦ Wary acceptance

Some brands' programs change stores' car prices

Some dealers discard a brand that overemphasizes factory incentive programs. The Flemington group's Kalafer sold his Nissan store, Flemington Nissan, in May 2016. 

The store, which he'd had for 36 years, was historically profitable. But he no longer wanted to chase factory incentives. The programs had reached a "level of irrationality," he said, that was destroying the brand value for customers and the retailer. 

"A consumer could walk into three different Nissan dealerships in their market within one hour and get a price on a $36,000 vehicle that might vary by $7,000 to $10,000," Kalafer said. 

He still owns an Infiniti store because that brand's value remains strong, he said. 

Many dealers have a love-hate relationship with factory programs, said Appleton, of the New Jersey dealer coalition. Most warily accept that it's the way of selling cars today. 

"There are some dealers who see this as an existential crisis to the point that they don't see a future in the car business. They are a small minority," Appleton said. "The rest of the dealers have concern, but they have confidence that whatever the rules of the game are, they'll learn them and they'll learn how to win. I hope they're right."

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