Q: Are there any risks that dealers must be aware of that could impact their profitability and valuations?
A: The short-term threat we see is the possibility of a recession. Some economists predict that we’re likely to have a recession in 2023, which would reduce demand for vehicles and potentially impair the incredibly high profits on vehicles that dealers are enjoying today. As profits decline, so would valuations.
In the Q4 2021 Haig Report, we highlighted some medium to long-term threats that dealers will need to consider:
Tesla and Other New Entrants: Tesla now has become the leading luxury brand in the U.S. and its next product launch, the Cybertruck, is aimed at the heart of the domestic brands. Other new entrants, such as Rivian Automotive and Lucid Motors, also are entering the market, as well as new brands being launched by traditional OEMs, like Polestar. These new entrants will likely experience mixed results in the marketplace, but there’s a good chance that competing dealers across the country will lose customers and profits as a result. Perhaps a greater threat to dealers is that new entrants may push traditional OEMs to force the agency model on dealers (see below).
The Agency Model: Traditional OEMs have seen that millions of customers are willing to go to a website, order a vehicle and then wait for it to be delivered. And these OEMs also see they no longer need to produce millions of vehicles for dealers’ storage lots, guessing at which vehicles customers will actually want, and then heavily advertise and provide incentives in order to get customers to purchase the vehicles. Their profits per vehicle are far higher when they produce only what customers want to buy. And finally, they see that retailers are making massive profits. This new set of facts is causing a number of OEMs to reconsider their relationships with their dealers and consumers. Ford’s plan to separate into two divisions, the Model e Division that will produce only EVs and the Blue Division that will produce only internal-combustion engine (ICE) vehicles is an example of a potential Agency Model in play. Customers who want to purchase an EV will have to order from Ford’s Model e website.
It doesn’t appear that customers will be able to purchase Model e vehicles directly from dealers. This is a profound change as the OEM will now set, instead of “suggest,” retail pricing and the OEM will be the point of contact with customers. The customer can choose which dealer will deliver the vehicle, but the price will be determined by Ford, which also will decide how much to pay the retailer. The buyer will become Ford’s customer, rather than the dealer’s customer. This agency model, where the dealer becomes an agent and is not a retailer, is common in other areas of the world. It is our understanding that dealers in these areas make far less profit than dealers in the U.S. And Ford is not alone in its thinking. OEMs have been envious of Tesla’s stock market valuation that is partly based on this direct sales model.
Electric Vehicles: Some dealers are concerned that EVs will require much less parts and service work than ICE vehicles, which will hurt their service departments.
Consolidation: While still a highly fragmented industry, consolidation in auto retail accelerated in 2020 and 2021. Groups like Lithia Motors, Group 1 and Asbury Automotive Group bought dozens of stores to expand their nationwide network of dealerships, accompanied by digital retailing tools that will allow them to sell and service customers who prefer online shopping. These auto groups and other dealers are increasingly convinced that large scale will matter more in the future than it has in the past. They plan to offer consumers a larger selection of vehicles and more ways to shop than smaller dealers can offer. If successful, they will gain market share and please their OEM partners and shareholders. Their gains would come at the expense of smaller dealers that cannot match these capabilities. Haig Partners offers potential remedies for dealers for each of these concerns. But due to space constraints, we can’t explain them in detail here. However, you can read about these remedies on pages 14 and 15 in the Q4 2021 Haig Report. These risks are real. However, dealers are highly resilient and we expect they’ll find ways to mitigate these risks. We are still bullish on the franchise system.
Haig Partners offers potential remedies for dealers for each of these concerns. But due to space constraints, we can’t explain them in detail here. However, you can read about these remedies on pages 14 and 15 in the Q4 2021 Haig Report.
These risks are real. However, dealers are highly resilient and we expect they’ll find ways to mitigate these risks. We are still bullish on the franchise system.