The US Automotive Market in 2008 

It seems like every day more and more people are talking about a probable US recession in 2008.  As a result businesses in every industry are exploring the potential repercussions of an economic slowdown.  The automotive industry is one sector that will certainly not be immune to a downturn in consumer spending.  However, the industry may be better prepared than other sectors due to its recent history.  Over the past 5 years many of the US manufacturers have been reengineering their business models to account for the rebalancing of market share that has occurred between domestic and foreign brands.   Many believe that the worst of the transition is over, but the market dynamics are poised to shift once again.  Throughout the past few weeks a number of noteworthy equity analysts at major securities firms have lowered their 2008 forecasts for US auto sales.  Sales projections have been revised downward from bullish estimates of 17 million new vehicles down to lower forecasts closer to 15 million new units.   When times get tough in the automotive industry, much of the attention focuses on the Big 3 OEMs and their Tier 1 suppliers.  But the retail dealerships who sell the vehicles to end consumers struggle as well.

The Dealer Challenge 

There are several key challenges for auto dealers in recessionary periods.  First, dealers must compete for a smaller number of overall sales.  Furthermore, dealers are challenged to win business from Internet-savvy consumers who are much better educated on the true vehicle costs, financing options and aftermarket accessories than ever before.   Another significant challenge for dealers is sales forecasting.  To win consumer sales, dealers must be able to offer the right car at the right place at the right time for the right price.  Consequently, a dealer must be able to estimate the exact product mix they need on their lot weeks, if not months, in advance.  If dealers underestimate demand for popular makes and models they risk missing sales opportunities.  If dealers overestimate demand then they will be stuck with excess inventory which they may need to hold on their books for long periods of time.  Ultimately the dealer may be forced to offer incentives or discounts to sell excess inventory.  The challenge of how dealers can forecast consumer demand for vehicles is one of the most complex issues in the automotive supply chain.  I will defer that discussion for a later post.  Instead, I would like to explore the financial implications of overestimating consumer demand.

One of the challenges with excess capacity is the risk of obsolescence and depreciation.   Vehicles which remain in inventory for extended periods of time may decline in value.  The risk is higher for units acquired during the summer months preceding the new model introductions in the fall.  It is not uncommon for vehicles to remain in a dealer’s inventory for 90-120 before purchase.  However, during a recessionary period of low sales, some vehicles might remain in inventory for periods of up to 9 months. 

Another challenge with excess capacity is financing the inventory.  At any point in time a dealer may have a few hundred (or thousand) vehicles in stock each of which ranges in value from $15,000 to over $50,000.  If you do the math, you quickly begin to understand the financial challenges associated with holding inventory.  A dealer with 500 units each valued at an average of $20,000 is holding $10,000,000 in inventory at that point in time.  How do small businesses such as dealers afford this?   

Note that there is an increasing trend towards consolidation in the US dealer market as chains such as AutoNation, UnitedAuto Group, Sonic Automotive and Group 1 Automotive continue to purchase smaller franchises.  However, the majority of dealers by numbers are small or midsize companies.

Dealer Floorplan Financing 

Instead of leveraging their own working capital for inventory, dealers rely upon specialized short-term lending programs from their banking partners.  The financial institutions offer a line of credit upon which dealers can draw from to fund “floorplan” inventory.  Floorplan in this context refers to vehicles both in the dealer showroom and on their lots or extended storage facilities.  Lenders assess interest and various fees in exchange for the financing services. 

Floorplan Financing - How it works

1.       The dealer places an order with the automotive manufacturer OEM.

2.       The manufacturer ships the vehicles to the dealer location.

3.       The invoice for the shipment is sent to the dealer’s preferred floorplan lender.

4.       The lender transfers funds to the manufacturer under the terms of sale.

5.       The cost of the vehicle is applied to the dealer’s line of credit.  Interest is assessed for the duration of the vehicle’s presence on the showroom floor (or outside lot).

6.       Once the vehicle is sold, the dealer pays the lender for the amount financed.

The steps above are an oversimplification of the process.   A much more complex set of loan servicing, technical integration and relationship management activities occur behind the scenes.

Technology Complexity 

For example, a significant challenge in the floorplaning process is tracking the inventory of vehicles and the associated financing activities.  A complex set of information flows between the automotive OEM, dealer and financial institution must be orchestrated to track and finance each individual vehicle.  To reduce the costs of financing fees, all parties are incented to automate workflows using technology.  Ideally, the process works as follows:

1.       Electronic invoices are extracted from the manufacturer’s accounts payable system and transmitted to both the dealer and financial institution.

2.       After processing the invoice, the lender transfers funds to the manufacturer using an automated clearinghouse transaction.  Associated remittance data detailing the payment transaction is routed from the lender to the manufacturer.

3.       Once the vehicle is sold to a consumer, the dealer pays off the floorplan loan to the lender.  A payment instruction is routed to the dealer’s bank transferring funds into the lender’s account.

4.       Throughout the process, all three parties – manufacturer, lender and dealer – can view the status of financing activities and the location of inventory through a common web-based portal.

Of course, the key to success for automation of the workflows is B2B e-commerce technology.  Without integration and digital document exchange between dealers, manufacturers and lenders, the process would be significantly more complex and risky.  This is yet another powerful example of EDInomics at work.  Visibility to inventory and financing activities becomes even more critical during recessionary periods.  Financing is typically arranged for a few months for each vehicle.  Once a pre-determined threshold of days has passed, the lender will begin curtailing their risk, by asking the dealer to pay a percentage of the inventory value. The payment reduces exposure for the lender in the event of vehicle obsolescence.  Both dealers and lenders will closely monitor their risk exposure for long-term inventory vehicles.  We can expect the scrutiny applied by banks will be even stricter in the coming years in the wake of the subprime mortgage crisis.

I will offer one final thought.  This is less relevant to EDInomics, but an interesting aspect of the dealer floorplan market.  It has to do with the relationship dynamics between lenders and dealers.  Lenders collect interest income and administrative fees from the financing offered to dealers.  However, the end goal for the banks is not the interest revenues from the floorplan financing.  The margins on these types of commercial financing are relatively low.  The real reason that lenders offer floorplan financing to dealer chains is to capture lead referrals for consumer auto loans.  75% of consumers financing vehicle purchases use the dealer’s recommended lending institution.  As a result, the dealer segment, collectively, has an incredible influence on the consumer auto loan market.  Traditionally, the captive financing divisions of major OEMs (e.g. GMAC, Ford Motor Credit, Toyota Motor Credit) have dominated the consumer auto loan market.  However, in recent years traditional financial institutions have aggressively targeted the fast growing auto lending sector.  With outstanding loan balances for auto financing are forecasted to reach $1 Trillion in the coming years we can expect competition to increase.  Retail consolidation is affecting the market as well.  Larger chains which sell multi-brand product portfolios have lessened dealer dependence on specific OEMs and captive finance institutions.

Steve Keifer

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