Saturday, May 23, 2009

Auto Companies and Their Dealers

Several days ago, I asked a good Michigan friend and writer:

When Chrysler or GM drop a dealer, or do not renew the contract, what happens? Is that dealer out of business? No more cars delivered? Could they buy cars from GM or Chrysler and resell them?

My friend replied with the following, and with his permission, I share it with you; it's a fascinating story that evolved over the decades. The American automotive scene - a permanent fixture for 100 years, is now dramatically changing ... hope you find this note as helpful and as informative as I have.

Thanks Darren!

The short answer? The dealer is out of business. No more GM cars delivered. GM ends the relationships to cut the number of dealerships carrying their product. Dealerships are the retail outlets for the automotive companies. Their operations fall under franchise laws that vary from state to state. Ending contracts with dealers can prove costly in some states depending upon how well the franchise laws protect (or are written in favor of) the dealerships.

In the past when dealers closed or went out of business on their own accord or on that of GM's, typically GM redistributed the closed dealer's inventory over the remaining dealerships. But with last week's announcement, we're in uncharted territory. So the $1,000,000 question this week is, where will GM bury all the bodies?

How do you redistribute so many vehicles over over the remaining dealerships? How can so many fewer dealerships handle servicing all the GM cars already out there? What can consumers expect in terms of service? There will be a lot of parking lots filled with GM cars where there had once been dealers.

The long answer? The GM-dealer relationship is quite convoluted. Mainly, because, dealerships are a franchise who operate under franchise laws.
But, unlike coffee or restaurant franchises, dealers don't 'produce' anything. They are a retail outlet. If you have a pizza franchise with Little Caeser's and you can sell pizzas faster than you can make them because your town loves you and your pizzas, you sort of own your destiny. At the end of the day, GM calls the shots on the product line, MSRPs (Manufacturers' Suggested Retail Price) and the number of retail outlets (dealerships).

With auto dealers (who only sell product, they're not producers), the automaker 'sell's the cars to the dealers who in turn sells them for a slight mark-up, usually only a few % really. There's not much reward in selling cars in of itself, so the dealers historically have relied on volume - like everyone else in automotive. Remove the volume and there just isn't much upside. But the dealers' real bread and butter comes servicing what they sell. It's why the conversation is so difficult. In many cases, dealers have really cemented themselves into the local community.

So the other night my father-in-law asked me, "What does GM care if Joe Schmoe wants to have a dealer or not? Who cares if there's 1,000 dealers or 2,000 dealers, or 3,000 dealers? It's not costing GM any money to run these dealers right?"

Well, yes and no. And this is where it gets convoluted with franchise laws, production output (push demand) at the GM factory and sales (pull demand) at the retail outlets - supply/ demand equilibriums.

If GM 'stocks' dealers with cars, the same dealer this year is selling 50% less the cars sold a year ago, then it means you have the same amount of dealers this year but they are selling 50% of the volume compared to last year, which means dealers are hemmoraging with inventory - so it's a race to the bottom on price. And if your GM factories are continually adjusting (or closing) due to slumping demand, then GM's retail outlet network naturally has to adjust for the demand. The dealership, in of itself, might not be costing GM any money to operate. But the dealer can't survive - the volume isn't there. And GM watches it's retail network become framented, over-stocked, 'under-priced'. For demand shifts like the one we've experienced, something has to give.

When it comes to closing dealerships, GM gets to decide which is a source of controversy. GM may choose one dealer over another, not necessarily on performance, but also on the dealer's lot and showroom size and location (since they'll have fewer dealers).

Since the early 2000's, we've had enough production capacity in N.America to produce 18 million vehicles/ year with demand being around 16 million/year peaking in year 2002-ish if memory serves (it's a little cooked these days). Demand has been severly dropping the last three years and fell off a cliff with the credit/ mortgage crisis in 2008. We're expecting demand for only 9 million vehicles!

Capacity was 18 million, demand now = 9 million. We're literarly cutting in half in the middle of the night. Even when the economy stabilizes and even sees an up-tick, we only expect demand to increase to 10, 11, maybe 12 million vehicles and that is purely speculation.

After it all shakes out I suspect the auto industry here in N.America to be like that in Europe; 6 or 7 smaller, niche auto companies (Ford, Nissan, Toyota, Honda, Fiat-Chrylser, Hyundai) vs. three large Detroit auto companies and a smaller southern auto presence. I don't know if GM will survive - I'm not happy about that - I don't wish it - they have lost much consumer confidence.

But bankruptcy for GM doesn't mean the end. You don't "go bankrupt". You file for bankruptcy protection. It's a tool to turn an ailing company around. I think GM needs to embrace the bankruptcy discussion and sell it to the public. In the last several weeks, they have in fact been easing into these conversations. The perception right now is that Ford is doing better than Chrysler and GM. That remains to be seen given the volume drop and operating losses. But they have a decent product line and they're winning the PR battle. The Ford names still carries weight. Bill Ford is applauded when he walks through production plants like The Rouge in Detroit. Should peoplle who are loyal to 'American' brand names, want to stay with an American brand name, Ford could possilby gain market share from GM and Chrysler.

But all of this is just one aspect of what is happening in our culture, our economy isn't it? Are we really in a shifting paradigm? Or is 'simplicity' the new marketing pitch? Are we selling that too? Time will tell. Incredible times to live in for sure. Scary too. Really scary. As objective as I can be on these matters, I remind my colleagues, my neighbors and friends, that I too am well in to the game and have as much skin in it.

Take care,

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