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TrueCar.Com Truly Infuriates Many Dealers

by David Ruggles
WardsAuto.com, Dec 19, 2011 8:58 AM

Scott Painter says he wants to help dealers sell more cars. So why is the founder of TrueCar.com under attack by auto-retail people on social-network blogs and elsewhere?

Painter contends he is the dealer's friend when selling them his Zag/TrueCar lead-generation program. Then he says he is the consumer's friend in their price battles with dealers. Is it possible to take both sides of the same issue at the same time? He also says he wants to transform the industry by "commoditizing" new vehicles, which eliminates the need for salespeople and marginalizes losses. Have we been down this road before?

TrueCar has grown dramatically, making enough inroads to raise $200 million from venture-capital investors with which the firm promptly purchased Automotive Leasing Guide, the industry's highest-profile residual value predictor.

In a nutshell, TrueCar as an online lead provider offers dealers a deal that seems hard to refuse. They only pay for online leads that are closed as sales.

In the fine print is an agreement to give TrueCar access to information in dealership management systems. After all, how will TrueCar know how much to bill at the end of the month for the closed and delivered leads without verification?

But the firm also harvests data, in particular transaction-pricing information that TrueCar shares with car consumers visiting its website. After seeing what other people paid for the same vehicles they are interested in, they can make an offer.

Painter says that pricing data does not come from DMS units. Even if it doesn't, it puts additional pressure on dealers under the guise of providing "a public service." Is there another industry where consumers feel they have the right to know a seller's actual true costs?

Scott Painter under fire from dealers.

Eventually dealership people, led by Jeff Kershner, figured out what was going on.< Now, an industry movement is swelling against TrueCar. There is plenty of information on industry social-network blogs, with more being added by the minute. Hundreds of people have weighed in. Jim Ziegler's blog has had more than 12,000 views.

"There really is only one way to stop this nonsense with vendors," says dealer Tamara Darvish of the Darcars Automotive Group in Maryland. That requires "a gentleman's agreement" among dealers not to exchange DMS data for leads, she says. "Unfortunately, greed and ignorance often take priority with some, rather than logic and long-term planning."

TrueCar's Devin LaCrosse provides the other side of the story. By enabling participating dealers to provide upfront, no-haggle price quotes, TrueCar has helped over 5,500 dealers nationwide sell over 400,000 new and used vehicles, he says. TrueCar lowers dealership selling costs "by providing high-quality customers and no need for haggling, and provides free transaction-based pricing data to help dealers price vehicles scientifically."

Some would say TrueCar is not incrementally increasing vehicle-sales volume, just lowering dealers' gross profits. Some dealers are doing more volume at the expense of others, but there is no evidence more vehicles are sold. Kershner, Ziegler and others think dealers unwittingly are enabling Painter to transform the auto business based on his perception of how it should operate.

Why are dealers going along with what seems like a self-defeating initiative? Many were caught unaware. They need to thoroughly read their contract with TrueCar. Dealers who have just learned what is happening are up in arms. Many are as angry at themselves as they are with Painter and his firm.

Everyone can draw their own conclusions. But some people are taking it very seriously. Ziegler calls it "the Battle of Armageddon for car dealers."

WardsAuto Dealer Business columnist David Ruggles is a former dealership general manager.

The War with TrueCar

Open Letter to the Automotive Industry from Scott Painter, Founder & CEO of TrueCar, Inc.

Responses by Ruggles

Monday, December 12, 2011 12:01 am

Painter: Our world is changing. Unprecedented access to information and a massive shift in consumer behavior has resulted in a challenging new automotive retail landscape. It has also enabled a consumer appetite for data transparency. To hide from evolving consumer behavior is to deny change. At TrueCar, we embrace this opportunity. We also believe that transparency is the centerpiece of trusting relationships. Some in the industry disagree. We would like to make our position clear.

Ruggles:Transparency is NOT the objective of auto dealers. Survival is, followed by net profit. It takes gross profit to have some net profit left over at month end. Is there another industry where consumers feel they have the right to know a seller's actual true costs? What gives consumers the right to that information in the first place? Providing transparency is NOT your only aim – making money in the doing is! The behaviour by consumers wanting to know a car dealer's bare costs is NOT something new. In 1970 credit unions would arm their members with "dealer cost." There were books available on every news stand. The delivery of the information is what is different.

If you want total transparency, give consumers actual bare cost down to net net net. Then allow the negotiation to be based on the gross profit, say a thousand or two. Do you really think consumers understand gross profit? Do they understand the expenses that are paid out of gross profit? More importantly, do they care?

Over the course of time car dealers have had their margins trimmed dramatically by their OEMs. When I started in the business the margin on large cars was 22.5% with a 2.5% hold back. "Trunk money" was available only for special promotions, but it was nowhere near as prevalent as today. The profit a dealer makes these days has moved to "trunk money," as the dramatically narrowed margin and increased availability of information to consumers has dictated it. And you are looking to disclose this information as if consumers have some kind of inherent right to it.

The auto business is a business of negotiation. AND consumers can shop. Consumers aren't bound by the same rules that auto dealers are. You seem to be saying that you would like to remove the negotiation aspect of the business while making money for your own company in the doing. It's not like you are performing some needed public service. You think an "efficient" market for new vehicles is good for everyone? How does that jive with the dealer, who has made substantial investment, making a reasonable return? If they don't, who will be around to provide other essential services to the consumer? The factory?

You're a business man and have closed some deals where negotiation has been required to reach agreement. You also know that in negotiation if neither party gets their feathers ruffled at some point, money has been left on the table. I suspect that in your very best negotiations, you negotiated without appearing to negotiate at all. I suspect that is how you have gotten so many dealers to sign on initially. That might even be how you gathered in $200 million in venture capital. I take my cap off to you for being such an artful negotiator. But don't in the same breath talk about transparency. Your objective is to make your deal while adopting the APPEARANCE of transparency as a negotiating tactic. How do you expect to make money in a negotiating business like the auto business with true transparency? You call it transparency to share transaction data, where ever you happen to get it and however the consumer interprets it. Real transparency is when only the margin is negotiated because the consumer knows our costs as well as we do, but of course they lack the knowledge of what has to be paid out of that margin. To repeat - you are selling the illusion and perception of transparency, but in the doing you are feathering your own nest by portraying yourself as the "good guy" to the consumer who readily accepts the dealer as the "bad guy." The amazing thing is that any dealer has cooperated with you.

And what of the sales people you intend to replace? Or do you deny that that is one of your aims? It seems you are on record about that.

Painter: Our goal at TrueCar is to foster healthier relationships between manufacturers, dealers and consumers through data transparency.

Ruggles: Forget about healthier relationships. Profitable business relationships that are also "healthy" are the kinds of relationships to have. The euphemism "data transparency" means disseminating propriety information to consumers, information that is none of their business. They can shop at the touch and click of a mouse. What more are they entitled to?

Painter: To deliver on this promise, we require a high standard from our 5,800 dealer partners – an upfront competitive price and a commitment to a great customer experience.

Ruggles: Where does the great customer experience come from in a race to the bottom on price? Where does the money come from to accomplish that?

Painter: A discoverable upfront price is the cost of getting noticed. Contrary to popular concerns this does not create a “race to the bottom.” The lowest price only secures the sale 19.2% of the time within the TrueCar network. The sale is still won by location, selection and good old-fashioned customer service.

Ruggles: No race to the bottom? Easy for you to say! If only 19.2% buy based on the lowest price, why would you even try to provide consumers with the lowest price? The cynic in me tells me that your motive is not public service, but your own profit. Let's tell it like it is. That being the case, how on earth would you expect dealers to be your allies in the endeavor? Well, that's easy. A host of dealers with their heads up their asses have already signed on providing initial validity to your premise. In case you haven't noticed, there is a burgeoning group looking to enlighten our fellow dealers.

Painter: At TrueCar, we believe that upfront price is at the core of a good buying experience for dealer and consumer. Informed consumers buy more confidently and are more satisfied. At TrueCar, we publish the most accurate reflection of the retail market that has ever been available. The goal is to establish an objective, credible and transparent baseline for fairness – both for the customer and the dealer. That being said, TrueCar does not set this market. Our dealer partners set their own prices 100% of the time.

Ruggles: Its great that you believe that "upfront price" is at the core of a good buying experience. In our mind, a good buying experience is where the dealer makes a substantial but reasonable profit, the consumer is happy, and a long term profitable relationship is formed. The price is negotiated. Trades are taken. Consumers can shop if they feel they aren't getting what they want.

Whose definition of fairness are we using? Yours? The consumers? As previously mentioned, ask a consumer what they think a fair margin is on a new car and the answers will be all over the map. Most aren't business people. It doesn't even occur to most of them that there are substantial costs that have to be paid from gross profit.

Bottom Line: You are trying to create a system based on wildly variable consumer perceptions, while destroying the system that has worked for years, and to make a few million in the doing.

AND after you have taken down sales people and the dealer network, do you then turn you program on manufacturers? Where does it end? Dealers don't need any more downward pressure on gross profit. And those who help you provide additional pressure on their own gross profits just haven't woke up to that fact yet.

Painter: Dealers earn their business every day and we believe that their marketing programs should too. TrueCar is the only fully accountable source of new business where our dealer partners only pay when they sell a car. Gone are the days when dealers have to assume all of the marketing risk and pay for advertising and for leads as a primary way to secure new customers.

Ruggles: I suspect that more and more dealers will be opting to take their "risk" back in return for not being complicit in their own demise.

Painter: TrueCar requires DMS integration for tracking of this accountable model, the core of what makes us unique. We use DMS feeds from our dealer partners for tracking and optimization of introductions made to the dealership. We don’t use our dealer partners’ information to populate the TrueCar pricing curve. That information comes from entirely separate sources of anonymized data that represent nearly 90% of all vehicle transactions in the U.S.

At TrueCar, data integrity, security and privacy are job #1. Our policies, systems and technology have passed the scrutiny of partners like USAA, Consumer Reports, American Express, AAA and many others. TrueCar has never, and will never, sell or repurpose DMS data for any reason.

Ruggles: IF security and privacy are job #1, you have failed miserably. The credibility gap between TrueCar and dealers is growing. Even if it is true that your access to a dealer's DMS doesn't provide actual transaction data, the fact remains that your company is making money by putting additional pricing pressure on dealers under the guise of providing a "public service."

Painter: In spite of all this, we recognize that change is threatening for some. Ours will always be a high-touch industry. The service of our dealer partners and highly-trained sales professionals becomes increasingly important the more consumers know. At TrueCar, our commitment is to relieve those professionals from needing to resort to high-pressure sales tactics or misdirection. These tactics have been an albatross for our industry and they are at the heart of why consumers have become generally mistrustful of the car shopping experience in the first place.

Ruggles: Change? This isn't change. TrueCar simply puts the dissemination of proprietary dealer information on steroids. Do us a favor and let dealers return to their high-pressure and misdirection tactics of days gone by when we delivered 17,000,000 new vehicles a year. The only way most consumers will be satisfied is to be guaranteed to win the negotiation. And they can't even define what it would mean for them to win. You say consumers have become "generally distrustful of the car shopping experience?" Please tell me, is this some kind of new phenomenon that recently arose so TrueCar could come to the rescue?

Painter: Is TrueCar good for all dealers? There will always be those that resist change. To our dealer partners, we applaud your understanding that truth, transparency, and customer service is at the center of success in our changing market. And, to those that still have questions, we invite an open dialogue. One of the great virtues of transparency is that we have nothing to hide.

Ruggles: The change dealers want to resist is further downward pressure on their gross profits, at a time when their manufacturers are pushing them to spend more and more money on their facilities, thereby further increasing their costs. As a 40 year industry veteran retired from the day-to-day of retail, I can speak my mind. I hope others will do the same.

David Ruggles

The Industry's Recovery: The Devil is in the Details

...I'll cheer when the glass is half full...

The media claims the auto industry as a bright spot in our recovery. If this is good news ... well, read on.

First, sales remain well below peak; we will close out the year as a whole with less than 13 million sales, against a peak SAAR [industry jargon: seasonally adjusted annual rate] of 17 million. So we're still down 24%. Nevertheless, the glass is at least half full, because that's 30% better than the sub-10 million unit level of late 2008-early 2009.

That story is grimmer when we examine the value of motor vehicle and parts shipments; they are still  down a full 33%. But again, at $30 billion shipments are still up 30% from their nadir.

 

Quarterly data from the FRED database of the Federal Reserve Bank of St. Louis. Click graphs to enlarge.

Well, then there's employment. That's up, by about 80,000 in retail and 90,000 in manufacturing. Given the abysmal state of our job market that's something for which we should be thankful. But again, it's from a really, really low base. Well into 2007 manufacturing employed over 1.0 million; compared to January 2007, at nadir the industry had lost 400,000 jobs. Retail saw less of a drop in percentage terms, about 15%, but compared to January 2007, in absolute terms employment at the nadir at dealerships shrank by about 246,000 and parts retailers by 58,000. If we combine the two, January 2007 employment was 2.94 million; the nadir was 2.25 million. Today (Nov 2011) we're at 2.40 million.

Generated by Smitka from BLS data. Click graphs to enlarge.

In the auto sector, retail and manufacturing, we've added 150,000 jobs. Not bad. But we were down 680,000. So at +22% we've not even regained a quarter of what we lost. It's not that things could be worse; things have been much worse.

I'll cheer when the glass is half full.

Mike Smitka
Professor of Economics, Washington and Lee University
Judge, Automotive News PACE "Supplier of the Year" competition

The Politics of the GM-Chrysler Bankruptcies

By David Ruggles

During the recent Republican debate held in Mitt Romney’s home state of Michigan, the presidential hopeful was asked about the “rescue” of General Motors and Chrysler. The premise of the moderator’s question was that since the automakers are now doing well, did Romney “regret his opposition to the rescue?” Romney answered, “The government finally followed my advice,” referencing his November 2008 op-ed in The New York Times entitled, “Let Detroit Go Bankrupt.” [Click to read the full article.]

Despite the inflammatory headline, Romney’s article was temperate and well-reasoned. Some readers might have assumed that the “bankruptcy” Romney recommended was a Chapter 7 liquidation, but that was not the case. The piece was written in the context of events of the day, in particular the Detroit Three CEOs appearing before Congress to request a “bailout.” The initial request was for $25 billion in loans or loan guarantees. That appeal later grew to $35 billion, while the total investment necessary to do the job, which has largely been repaid or secured with stock, ballooned to $81 billion.

In his op-ed, Romney stated that it would be better if the two companies in question, GM and Chrysler, were allowed to go through a “managed, pre-structured bankruptcy to allow them to restructure themselves.” Without such a restructuring, but with a “bailout,” Romney argued, the companies would continue on their current unsustainable path and would ultimately have to liquidate. “But don’t ask Washington to give shareholders and bondholders a free pass — they bet on management and they lost,” Romney said in his piece.

Reached by telephone for this column, Steve Rattner, former chief of the Automotive Task Force, called Romney’s 2008 piece “prescient.” He praises Romney’s op-ed as “95% correct.” According to Rattner, the “Romney plan” was followed almost to the letter. The exception: there was “no debtor-in-possession financing available through private lenders, requiring the U.S. Treasury to fill that role,” he said. (Remember the financial system meltdown of 2008-9 – see the note at the bottom.)

After the “government finally took my advice” comment, though, Romney should have left it there. The Democrats seem to be trying to mischaracterize Romney’s stated position in the New York Times article by applying “liquidation” bankruptcy to Romney’s headline, instead of the reorganization he clearly recommended in the body of the column.

Even more confusing is that Romney himself currently seems to be mischaracterizing his own original position. Bloomberg writes: "In Michigan after Wednesday's Republican candidate debate, Mitt Romney defended his opposition to the government bailout that saved jobs in the tens of thousands at GM and Chrysler. (Again, see the note.) According to Romney, instead of asking the government to intervene, the companies should have entered into private sector bankruptcies immediately.”

Never one to waste an opportunity, former Michigan Gov. Jennifer Granholm, a Democrat, said in an interview with Bloomberg that “Romney's view was ‘a knife in the back’ to his home state."

Rattner, too, is puzzled. “I can’t understand how Romney can go from being so out in front of the auto company reorganizations to disavowing his almost perfect original position. In fact, GM CEO Rick Wagoner stubbornly refused to consider Chapter 11 bankruptcy for GM and had to be removed for the reorganization to go forward.”

By the time Pres. Barack Obama was inaugurated, the Bush administration had already advanced $17.4 billion in “bridge loans” from the Troubled Asset Relief Program to the two ailing automakers. Congress had turned down a “bailout” package despite Vice Pres. Dick Cheney admonishing his fellow Republicans, “Do you want to be known as the party of Hoover forever?”

Perhaps Romney is criticizing the Bush administration for the “bridge loans,” but last anyone checked, George W. Bush is not running for President again.

What is clear is that the rescue of the auto industry will be a hot topic in the upcoming 2012 elections. The President and the Democrats will be taking credit for what so far seems to be a good move, despite flaws in the “rescue’s” execution. The Republicans seem determined to claim that the “rescue” was a “bailout” and shouldn’t have been done.

In Republican frontrunner Romney’s case, he seems to be having a difficult time making up his mind what he thinks. His camp did not respond to a request for clarification of his position in advance of this column.

David Ruggles has spent his career in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & Japan. Ruggles has been a dealer for Mercedes-Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru, and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Japan. He blogs at autosandeconomics.blogspot.com and writes regular columns for several publications.

Note: on this blog Ruggles and Smitka repeatedly examined this issue during 2008-9, arguing that, due to the interlinked nature of the supply chain, made visible in the aftershocks to the industry of the "3/11" Tohoku earthquake, the liquidation of GM would have forced suppliers and hence Toyota, Honda and the rest of manufacturing to close. Without inventory, dealers would have followed, while even repairs on existing vehicles would have become difficult because spare parts production would also have shut down. Remember, there was no private financing to handle normal Chapter 11 bankruptcy – the only alternative would have been immediate liquidation.

The Resilient U.S. Economy

If the stock market is the pulse of the American economy, the outlook might be better than expected.

In a conversation I had with noted Wall Street analyst and international trader James Vena, he asked a very interesting question: “Where was the Dow a year ago?” Answer: About 12,000. “And where is the Dow today?” About 12,000.

Vena pointed out that the economy has withstood some serious challenges this year, including:

• A debt crisis that would threaten the European economy and the Euro currency itself.
• A significant cheapening of the U. S. dollar.
• A disruption in oil supply from Libya caused by a series of uprisings in the Middle East and a corresponding spike in fuel prices.
• An earthquake and tsunami in Japan that would disrupt world trade including components for global auto production.
• Flooding in Southeast Asia that further disrupts the global supply chain.
• An attempt by a U.S. political party to hold a lifting of the country’s debt ceiling resulting in a lowering of the credit rating.
• The bankruptcy of a major legacy U.S. airline.
• Continuing U.S. housing foreclosures and a further decline in home values.

The U.S. economy is far from out of the woods. But it has withstood a serious assault in the past year and not slipped into a double-dip recession. Will the upcoming election year bring about new challenges, or will the economy get a break?

Mike Smitka as devil's advocate: but it's housing prices that are weighing down household balance sheets, not the stock market. Until you get into fairly high incomes shareholdings are primarily indirect, through retirement plans -- are Americans really going to cut back on their contributions further in order to buy a new car???? And sitting at 9%-plus unemployment for 2 years is "resilient"?

The Ford-GM Stock Equation

As with the economy, the stock market will continue to evolve. So far this year, though, auto stocks, specifically, have hit some hard times.

Surprising to many is the fact that the stock of General Motors has dropped to about $21 per share from its $35-per-share post-IPO high a year ago. Even more surprising is that Ford’s stock has dropped to about $11 per share from $18 in the same time frame. This decline, despite impressive sales gains and profits, and improved fixed costs, now that both companies' VEBAs have capped legacy costs while their UAW contracts have removed the threat of strikes and wage hikes.

Of course, in the past year there have been headwinds: high oil prices, the Japanese tsunami, and the debt crisis debacle, to name a few. Both companies have taken hits on quality, with GM experiencing bad PR due to some Chevy Volts that burst into flames during crash testing and Ford being slammed in a J.D. Power quality survey.

Despite these obstacles, the two companies have stood firm. GM announced the reopening of the old Saturn plant in Spring Hill, Tenn., to build the Chevy Equinox. Both companies continue to increase volume, marketshare, and profits. They have both been reducing incentives while maintaining sales momentum.

Once GM’s stock price gets to a certain level, expect the Treasury Department to sell quantities of the taxpayer’s GM stock. The outcome: a somewhat depressed price.

So what is your prognostication for the upcoming year? Buy? Sell? Hold?

GM recently began paying a dividend on preferred stock while Ford just announced a 5 cent per quarter dividend, its first since 2006.

David Ruggles has spent his career in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & Japan. Ruggles has been a dealer for Mercedes-Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru, and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Japan. He blogs here at blogspot and writes regular columns for several publications.

From whence will they come? -- profits, that is.

In North America the pricing umbrella created by the need of the Detroit Three to fund retiree health care is unwinding, while the Europeans are fleeing the Euro to add capacity here; the Japanese began diversifying out of their yen cost base 15 years ago. In the short run, that may improve profits for the Detroit Three and the Germans at the expense of the Japanese, but will ultimatlely enhance rivalry and lower profits for the industry as a whole. Europe remains in the doldrums, and the excess capacity in China will become more apparent as sales slow to a merely torrid pace. Ditto India. Brazil? South Africa? Sure, there will be markets that grow, but will they grow faster than new capacity is added? I can't think of an exception.

That pressure is obscured by shifts among market segments, particularly in the move away from small cars in the US and China that boosted profits for some firms. It is also obscured by exit, the role of which is inadequately recognized. In Europe VW snapped up SEAT, Skoda and others while Ford and GM consolidated formerly autonomous UK and German operations. In Japan Toyota absorbed Hino, Isuzu, and Daihatsu and now has a large though not yet controlling stake in Fuji Heavy Industries, Subaru's parent. Meanwhile foreign partners have unloaded their stakes in Mazda and Mitsubishi, which face a shrinking domestic market and a yen whose value makes exports unprofitable. No one is likely to value them solely for their engineering capabilities; their demise is only a matter of time. The US looks different partly because of large capacity adjustments by the Detroit Three, but we've also seen the demise of AMC, Suzuki, Isuzu, and Mazda while Mitsubishi's plant continues to run at unsustainably low capacity. If we include the elimination of brands such as Saturn and the cessation of exports by various firms, exit is significant. Inside Korea, Hyundai gobbled up Kia while GM purchased Daewoo and Renault picked up Ssangyong. The survival of brand names makes it hard to know what operations remain. Ditto Australia, where the Ford and GM affiliates were at one time stand-alone companies.

You might say "but China." Few outsiders are aware that there were 120 firms in that market, which was dominated by a host of minuscule operations owned by the governments of provinces and large cities. They had captive markets -- the models made in Shanghai couldn't be found on the streets of Beijing, and vice-versa. Of course some of these firms and subsequent private entrants (Geely, Chery and BYD) continue in business. But the market is dominated by those Chinese firms that poured their efforts into joint ventures; they've created jobs and been able to keep a slice (as a first approximation, half) of the profits, and some of them have quietly gobbled up failing regional firms. That's important because, while the central government in Beijing has been able to eliminate the domestic trade barriers in industry after industry that impeded the creation of a national economy, the legacy of local fiefdoms remains visible in the vehicle market. VW and GM, strongest in Shanghai, have done very well. Who will "own" Sichuan Province, with a population of over 100 million? It won't be a local firm, because their exit continues.

So as I look across the world (OK, on a good day I can only see 40 miles from my mountain ridge home), well, what strikes me is the likelihood that in the aggregate profits will continue to erode. Consumer preference for choice offsets that, allowing an amazing diversity of product to survive in the marketplace. From time to time individual firms will themselves with the right vehicle in the right place, and do quite well. But that will be offset by poor profits elsewhere. In the background, there's the pressure to invest in new technologies. No one can risk not pouring resources into R&D, as regulatory pressure for safer products, lower emissions and higher fuel efficiency keeps raising the technology bar. But with expensive new and less expensive old technologies continuing side-by-side in the marketplace (and typically the dealership), it won't be possible to raise prices sufficiently to generate generate commensurate profits.

With lower industry profits, the losses for those firms that fail to hit a sweet spot will be worse. It will thus be much harder for firms that find themselves on left tail of the distribution of profits to survive. Chances are Saab won't be the last manufacturer to fold in the 21st century's second decade.

Followup: For a story focusing on this issue from that standpoint of one product, see"Toyota Threatened..." by Alan Ohnsman at Bloomberg.

Mike Smitka

Where are the French?

...they must have all the love they need at home...

Mike Smitka

First it was the Japanese. Then a couple Germans and the Koreans. Now the rest of the Germans. The Italians have one foot in the water. But except for a fleeting presence through American Motors, both with Simca as a subsidiary and later with Renault as an owner, the French -- who dominated the global industry in its formative years in the 19th century -- are nowhere to be found. Why?

Now it may be that Renault's control of Nissan represents de facto entry. Certainly purchasing is handled on a global basis, and there's cooperation in engineering. It may be that some Nissan products currently on sale in fact use a Renault platform (Perhaps one of my readers can fill in the gap.) But the absence is puzzling.

That's even more true of PSA (Peugeot-Citroen). The last time I looked (I'm probably showing my years!) they were doing well in Europe and solidly profitable. They keep up with technology, as seen in the customer base of the winners of the PACE Supplier of the Year innovation award for which I'm a judge. They're simply not here.

So what is their strategy? Do they believe that sufficient technology resides in the supplier base that they do not need sheer size to fund the R&D for tomorrow's products? Are they making enough money in small cars that they've chosen to "stick to their knitting" -- not venture into segments with which they have no experience -- and are therefore passing up the US market with its cheap gas and penchange for fuel guzzlers?

I don't know, but I've started to think about the variance in such "macro" strategy across the top vehicle assemblers. Suzuki strikes me as the closest analog, but they have a strong base in India, though it's probably no longer accurate to say that they dominate the market through their joint venture Maruti. Then there's Daihatsu, but they were gobbled up by Toyota and so, for better or for worse, are shackled to the small vehicle niche. Daihatsu long ago exited the US market; Suzuki seems likely to. So maybe PSA made a sensible strategic decision, and refused to join the herd in entering (and now exiting) the US.

My curiosity is piqued, but I have no answers.

Can an Automaker Incentive Battle Goose the Economy?

David Ruggles

As the economy wallows in the doldrums, is there any cause for optimism? The outcome of the European debt crisis is still unknown, and we know how markets despise uncertainty. There are still plenty of uncertainties associated with the so called “Arab Spring” uprisings in the Middle East, and those could be with us for a while. While fuel prices have somewhat moderated, they remain high. The country’s credit rating took an unnecessary hit, although plenty of money seems to still be seeking to buy our debt. When the Dow fell dramatically after the downgrade of our credit rating, much of the money that left equities found its way into our “downgraded” Treasury bonds. Either the European debt crisis or our government being hamstrung by ideologues has sent the Dow on a downer after the debt ceiling crisis “semi resolution.” The 12-member “Super Congress” still has an important job to do, and there is additional uncertainty attached to that, that will take weeks to resolve.

Bob Lutz - "Car Guys versus Bean Counters" Book Review

"Car Guys vs Bean Counters"
The Battle for the Soul of American Business
By Bob Lutz

Japan's Twin Earthquakes and other disasters

Japan is well on its way to recovery from the March 11 earthquake that rocked the country’s northeastern region and generated a tsunami that swept clean swathes of the coast.  Automotive output is recovering; between them, Honda, Nissan and Toyota plan to hire over 5,000 temporary workers in an attempt to catch up, which feeds back to help the rest of the economy, as well as the Tohoku earthquake region where Toyota's newest plants are located. But a second and wholly man-made disaster now threatens the return to normalcy.

Despite the magnitude of the March temblor, Japan was well prepared. Few deaths stemmed from buildings collapsing, trains stopped automatically, and factories were relatively unscathed. As roads were reopened and utility service reestablished, the auto industry was ready to resume output. And all along most of the economy trundled on; despite the horrendous scope of damage, the impact of 25,000 deaths and the total destruction of a swathe of coastal land in a society of 127 million is limited. Rapid recovery seemed certain, as was the case after not merely the 1995 Great Hanshin earthquake which struck almost direct under Kobe, but even the 1923 Great Kanto earthquake, which destroyed the Tokyo metropolis.

The auto industry was a hiccup in that process. Today's cars are hi-tech products, and the supply chain is correspondingly complex. Let one example suffice. Making a semiconductor chip takes two months from start to finish, and the ceiling fell in ― literally ― at a plant where an invisible speck of dust results in a bad part. Doing basic repairs, getting the clean room clean again, and then debugging machines is a multi-month process. Given the uniqueness of the chips, symptomatic of their "hi tech" nature, it was just as difficult to transfer manufacturing to a different facility, despite excess capacity elsewhere. Japan is a big place, however, and a river of engineers poured in to help. As a result, even the Renesas' "fab" is back in production, albeit at reduced rates.

The global industry remains vulnerable to disruptions; factories are prone to be unique. One reason is that the industry has not settled upon standards–though a July 26 article noted a new effort in that direction. [See a Japanese-language article in Sankei on a METI-coordinated committee on the issue. It cites Toyota saying that by 2013 they might be able to start purchasing under joint standards, but such standards would not apply to more than 30% of semiconductors.] Part is that things are evolving too fast. But firms also view chips, specialty steels, paints, engine parts, and now batteries as strategic. And there are no institutions in place: the old standard-setter, the Society of Automotive Engineers, is a shadow of its former self. With little commonality, dual-sourcing is not an option, magnifying risk.

Hindsight is not foresight. It's impossible to take into account (much less insure against) every eventuality. While a few mayors along Japan's coast had insisted on unusually high flood walls ― maybe reflecting (possibly corrupt) ties to the construction industry rather than prescience ― disaster scenarios didn't anticipate the magnitude of the tsunami. That increased the human cost, even if relatively few plants were located on the coast: most were inland, where land was cheaper

One exception was power plants, which needed access to water for cooling. We all know about the destruction of a set of four of the six nuclear plants at Fukushima I. Less known is that the Onagawa nuclear plant, run by Tohoku Electric Power, was both directly hit by the earthquake and by a higher tsunami; after all, an idle but undamaged plant isn't "news". However, it was of a modern design, on higher ground, and better managed ― and shut down without problems. Even more telling, a second set of four reactors, the Fukushima II complex, were also effectively unscathed. Yet the Onagawa plant and the other well-run utilities with intrinsically safe nuclear plants are being tarred and feathered by TEPCO (Tokyo Electric Power). In the background not-in-my-backyard politics at the local and prefectural level made construction of new electric generation capacity of any sort a slow process. So there is little excess capacity, exacerbated by the division of the country into incompatible power grids. Every power plant has to be brought back online if the country is to avoid brownouts for the years to come.

Unfortunately, Japan now suffers from a second earthquake, entirely man-made. The disaster now unfolding reflects politics.

Why? Prime Minister Naoto Kan of the ruling Democratic Party of Japan (DPJ), facing a divided Diet (parliament), was too quick over the past year to offer compromise to the opposition Liberal Democratic Party (LDP). (Perhaps that reflects his background as a community activist and lawyer, where the key skill is being able to hammer out compromises where common interests are central.) In the process, he alienated many in his own DPJ, without ultimately gaining the cooperation from the LDP that he needed to pass legislation. Then, under pressure from all sides, Kan struck off on his own with a populist measure to keep all nuclear power plants closed once they shut down for maintenance under a routine 13-month cycle. Within a year, then, all will be closed and remain off-line. Most are of the more modern Onagawa design, but they may now never be permitted to resume operation despite providing 30% of Japan's electricity. The economic impact of this will be huge and last for years, even as the economic disruption from the Tohoku earthquake itself ends.

Still, it is useful to remember the basic competitiveness of the auto industry, with multiple suppliers and assemblers following a wide array of strategies. Contrast Nissan, relatively unaffected by the quake, with Toyota. Twenty-five years ago Nissan began moving its production inside Japan to Kyushu, 1,500 miles south of the quake's epicenter, while reducing capacity in the Tokyo region. [Nissan had also been planning to boost output and so had built up inventories of chips and other items with long lead times before the quake struck on March 11th, so there was an element of luck involved, too.]

Toyota's strategy was different. It had acquired Kanto Jidosha and Central Jidosha in the Tokyo area in the 1950s, which together with Toyota Auto Body account for 30% of the company’s Japan-based output. In the 1990s, rather than paring capacity, they added plants to the northeast of Tokyo ― right where the earthquake struck.

That extra capacity left Toyota vulnerable to a second earthquake: an appreciation of the yen, at ¥78.5 per dollar as I write this, over 50% stronger than the ¥121 level of July 2007. With the extra capacity, and a commitment to pay employees whether there was work or not, Toyota increased its dependence on exports; Nissan did not. Toyota also has a byzantine web of domestic subsidiaries, a structure as unwieldy as the General Motors of old, with internal politics to match. So domestic production was attractive not only to alleviate union pressure but to protect the turf of incumbent executives and middle managers.

Now the earthquake itself will have a fleeting impact. Japan is after all a large place, with 127 million people. Horrific as 25,000 deaths may be, that and accompanying losses to the capital stock are tiny relative to the size of the economy. Capital can be fixed, and the size of the economy makes that relatively straightforward: a cumulative 4,200 engineers and other skilled workers poured in from the rest of the domestic semiconductor industry to revive production at the Renesas plant. The same story applies to electric power lines, roads and bridges, and other infrastructure, including the Sendai airport that was but recently under water. Many farmers were unable to plant this year's rice crop, the fisheries industry is only partially functional, and tourism is dead -- and all are important to the rural Tohoku region. But Toyota's plants are running again, and those of their suppliers.

Yes, the Tohoku earthquake was a disaster, as is the ongoing rise of the yen. The impact of both is amplified by dysfunctional politics ― electoral and corporate. Nevertheless, the industry as a whole is remarkably robust: its size and the variety that comes from rivalry lessens the impact of even major disasters. Toyota may be hit, and its recovery will be far slower than most observers seem to believe. A few American consumers may be disappointed, Toyota's U.S. dealerships moreso. But the global industry will hardly notice.

Mike Smitka

Taxpayers, The Auto Bailouts, and Politics

Last November, General Motors’ IPO set a record for money raised at 20.1 billion dollars. This is all money returned to the taxpayers’ Troubled Asset Relief Program (TARP). The success of the IPO was not only driven by new investors, but also by stockholders and lenders who had been “stiffed” in GM’s Chapter 11 bankruptcy of 2009. The company recently reported its highest quarterly profit in more than a decade, helped by demand for fuel-efficient cars and a big gain from selling its stake in its former auto parts business. The biggest U.S. automaker said Thursday that it earned $3.2 billion, or $1.77 per share, in the first quarter. It was a great start for the year considering the spike in U.S. gasoline prices, a trend that would have sunk the company just a few years ago when it relied on gas-guzzling pickups and SUVs for profits. Earnings will accelerate if U.S. auto sales continue to creep back up toward the 15-million to 17-million vehicle-per-year sales rates the U.S. industry last saw in 2007.
"GM is making a lot of money at ‘depression levels’ of sales. As the market improves it should make even more money." said Dave Cole, chairman emeritus of the Center for Automotive Research.
The U.S. Treasury will remain GM's largest shareholder for now. It will likely take several years to unload the entire stake to keep from diluting its stock price. Taxpayers still own about 33% of GM shares. The stock price will need to rise to about $48.00 for the U.S. government to break even on its follow-on stock sales. At $48 per share, GM would have a market value of more than $90 billion.
Chrysler Corporation paid back more than 7.5 billion in loans to the American and Canadian governments in May. Chrysler had until 2017 to repay the loans, so this was six years ahead of schedule. The company has now paid back most of the loan money that saved it from going under. The government loans were high interest loans, about which Fiat/Chrysler Sergio Marchionne recently opined. Instead of merely complaining about “loan shark rates,” the company did something about it. The high interest on the U.S. Government loans certainly induced Chrysler’s partner FIAT to borrow the money to pay off the bulk of Chrysler’s outstanding government loans. Chrysler raised just over 3 billion through a bond sale and took out 3 billion in lower interest loans to come up with the money to pay back the government loans. This will save more than $300 million a year, according to the company.
The automaker still owes taxpayers about $2 billion. Treasury could get most of that back by selling its remaining 8.6 percent stake in the company, which it was given in exchange for the loans. Chrysler’s IPO has yet to be scheduled but FIAT just announced it is increasing its stake in Chrysler to 51% from the current 46% in advance of the upcoming IPO. As Marchionne recently observed, “The longer we wait, the more it costs,” referring to FIAT’s intention to buy shares from the U.S. Treasury.”
Chrysler’s recent earnings have also been strong, despite a market impacted by high fuel prices and a weak, but recovering, economy. Both companies stand to do extremely well as the economy improves and the SAAR rises to recent historical levels.
Both companies have announced initiatives to increase production and rehire thousands of workers. Chrysler alone has added more than 8,000 jobs since its bankruptcy.
In the meantime, Ford continues to do well in the still recovering economy despite having to bear the weight of interest on debt it accumulated to ride out the economic storm without having to seek taxpayer involvement. Ford has benefited from union concessions it received to maintain parity with its competitors.
The auto industry bailout, financed through the Bush Administration’s TARP program, spared the GM, Chrysler, AND Ford from liquidation and saved hundreds of thousands of manufacturing jobs at those companies and its suppliers.
To add perspective, had either company been forced into liquidation, the cost dropped on the taxpayers in the form of the Federal Pension Benefit Guarantee Fund would have been at least $38 billion. This in addition to the damage that would have been done to the North American industrial base, including military procurement at a time of two wars.
While Americans have been known to pile on “losers,” failures, and those who make mistakes, they love “redemption.” While there are those who refuse to buy a GM or Chrysler vehicle OR buy their stock because they were bailed out by the government, the companies’ strong sales and profit results indicate that, on balance, they are achieving a large measure redemption. The popularity of Chrysler’s “Made in Detroit” advertising campaign is further evidence.
In the meantime, the 2012 election campaign is getting underway and yes, it looks like the bailout of the auto industry could end up being one of many points of debate. One can expect Democrats to replay videos of Republicans who opposed the bailouts ad nausea. Already an ad paid for by the Democratic National Committee recaps positions taken by Mitt Romney, Newt Gingrich, and Tim Pawlenty.
Romney takes a significant hit in the ad. The former Massachusetts governor, whose father was governor of Michigan as well as the top executive at American Motors is being reminded of the hard-lined position he took in a 2008 New York Times Op Ed, “Let Detroit Go Bankrupt.” Yet Romney and others continue to use opposition to the bailouts as a campaign point, advocating a free-market system free of bailouts and subsidies. They maintain that even now it still looks like the bailout came at quite a cost to taxpayers, despite substantial evidence to the contrary. They maintain that allowing the automakers to go into liquidation wouldn’t have been such a terrible thing, which is easy to say since it didn’t happen.

Democratic candidates will point to the relative success of TARP and the auto company bailouts and paint a picture of what would have happened had TARP not been enacted and either company had liquidated.

As politics heats up leading up to the 2012 national elections, expect debate over the auto bailouts to play a major role in determining political winners and losers.

David Ruggles has spent his working life in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & Japan. Ruggles has been a dealer for Mercedes-Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru, and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Japan. He blogs at autosandeconomics.blogspot.com and writes regular columns for several publications.

Contango

And other issues not commonly understood by consumers about the world oil market

The higher the price of gas at the pump, the more sensitive consumers are to allegations of oil market price manipulation. Most consumers are unaware exactly how any manipulation takes place, but they can't square the doubling of the price of a gallon of gas when the price of a barrel oil doesn't double, so they are suspicious there is a culprit to be blamed. Oil companies become the bad guys as they report high profits.

Cars and Roads

I'm now teaching my annual 4-week-long Spring Term course on the auto industry at Washington and Lee University, Economics 244, which will include one week in Detroit. Ironically, it has left me too busy to blog on the auto industry. So this will be short.

It's very easy in our narrow focus on the manufacturing and distribution of cars to overlook the revolutionary impact that comes from greater mobility. A note on a World Bank project in Laos highlights that. (Here's the link.)

The blog by Victoria Minoian traces the changes the follow from building a road that allows motorized access. Rural farmers can now grow vegetables for town and city markets, and not merely for own consumption. That is, they can earn a cash income. Doctors can access a village otherwise cut off on frequent occasions by high water. Children can get to school &endash; though perhaps by bicycle rather than motorized vehicle. There's little point in building good roads without motorized vehicles; but without roads, vehicles are also of little use. Of course the location of the village from which these examples were drawn reflects that constraint: it was alongside a river (the Mekong, not just a little river). The village wasn't necessary poor by local standards. But while boats and rivers make a difference, roads and motor vehicles make a bigger one.

Mike Smitka

Long Term Residual Outlook

I have been privileged to discuss residual values and the pre-owned market with a number of industry experts over the years. An thought that was born in a late 2008 discussion over a beer with Matt Traylen, then Chief Economist for Automotive Leasing Guide, has since become full-blown reality.

At the time, the stock market was tanking, new vehicles sales had slowed to a crawl, the auto manufacturers were begging for money before Congress, the acronym TARP had just been coined and the economy and our lives were looking bleak and uncertain.

Most lenders had announced in previous weeks that they were getting out of the leasing business, or dramatically “pulling in their horns.” The asset backed securities market had disappeared, pulled down by the mortgage backed securities market and we were hearing unpleasant terms like “toxic assets.” This reminded me of some earlier dark days in the auto industry when a dealer or leasing company might take particular vehicles to auction and they wouldn’t even draw a single bid, a particularly difficult position when one had a payroll due.

It was easy to understand how a bank holding a lot of “toxic assets,” but little cash, could become a “zombie bank,” a term invented to describe the Japanese banks after their own real estate bubble burst. That is a bank with a “strong” balance sheet but no cash to loan or to return to depositors who arrive “electronically” at the bank to make a withdrawal. Marking these assets to market was not practical because values could not be established as no one would bid on these mortgage backed securities or their “first cousin,” auto loan backed securities. Regardless, “mark to market” would have rendered the U.S. banking system insolvent and caused a complete meltdown. A strong case can be made that the U.S. banking system WAS, in fact, insolvent but for a few accounting entries.

After acknowledging that most of the major players had announced their exit from the leasing business, the collapse of available financing for fleet and daily rentals, and the dramatic drop off in overall new vehicle sales volume, Traylen and I asked, “Where will pre-owned inventory come from down the road?”

While used vehicle sales plunged from a high of about 44 million units in a single year to about 35 million units in 2009, it became apparent that once demand began to trend upward toward historical volumes, there would be an acute shortage of available inventory.

Within a few months, GM and Chrysler went through bankruptcy and Cash for Clunkers plucked another 600,000 potential pre-owned vehicles out of the system and fed them to the crusher. What was really crushed was the Buy Here Pay Here business. What the government called a “clunker,” they call “inventory.”

Today, there is considerable pent up demand for pre-owned vehicles and the banking system has recovered to the point that ready financing is available again. There are still serious issues to be resolved in the economy, not the least of which is high unemployment, but demand is building.

Other than unemployment, the biggest impediment to full economic recovery is the fact that 25% of American mortgages are in negative equity territory. The large numbers of foreclosures have left empty and/or abandoned houses in neighborhoods across the country further depressing home values. Few neighborhoods, regardless of affluence, are immune from this.

Economist Alan Greenspan, past chairman of the Federal Reserve Bank, recently stated that he did not believe the economy could reach full recovery momentum until the real estate market experienced at least a 10% increase in home values. It just is not clear how long it will take for home real estate to become stabilized, let alone regain value. On the other hand, the rebound of the stock market has restored almost 16 trillion dollars of mostly American wealth.

Against this mixed backdrop of economic news and general economic uncertainty, there is much more demand than available pre-owned inventory, which is driving wholesale pre-owned prices ever higher. We see pent up demand in the new vehicle business by the steady increase in sales results.

New vehicle incentives have a considerable impact on pre-owned values. If incentives lower the true transaction price of new vehicles, the value of same make/model pre-owned vehicles drop a commensurate amount.

Restraint of late on the part of auto manufacturers to refrain from over production is keeping dealer inventory levels in line with demand. It is likely that OEM restraint on overproduction and incentives will be ongoing as they have new policies and labor agreements in place. The fact that dealer floor plan arrangements with lenders are much more restrictive than before has also helped maintain this equilibrium. Few dealers have the liberal floor plan arrangements these days that once allowed for the massive stocking of vehicles on behalf of a manufacturer looking to “force the market” with incentives.

But now that financing for leasing has recovered, OEM captive finance arms are focusing on shorter terms to try to create additional supplies of pre-owned inventory. Financing for the daily rental business has allowed rental companies to begin to return to more traditional replacement cycles. The same is true for fleets. But the shortfall that began in 2008 will not be able to be made up in the short term.

So what is the outlook going forward and how will it impact residual values?

Experts say we will continue to experience pre-owned shortages for at least as long as 5 years. Some niches will be more acute in this respect than others, and segment values could change with fuel prices and other issues.

But the tremendous shortfall in pre-owned inventory supply will take years to balance out as demand increases in line with economic recovery. In talking to experts like Tom Webb, Chief Economist for Manheim Auctions, Tom Kontos, Chief Economist for Adesa Auctions, Ricky Beggs, Managing Editor and Vice President for Black Book, Rene Abdalah, Vice President of Residual Value Insurance Group, Eric Ibara, Director of Residual Value consulting at Kelly Blue Book and Traylen who is currently head of M.A.T. Consulting, the consensus is that the shortage will be with us for at least 5 years. Residuals are expecting to stay quite strong!

However, in projecting residual values, there is a somewhat different outlook between Abdalah of RVI and Ibara of KBB and their counterparts at Automotive Leasing Guide. Both companies are convinced that as long as fuel prices increase gradually, American consumers will adapt without drastic short-term consequences. Consumers will tend to buy the largest vehicles they can afford.

Other than “early adopters,” most consumers will only pay a technology premium for “electrics” and hybrids if the government pays it for them through tax credits or other subsidies. When fuel prices suddenly spike, as they did in 2008, fuel economy becomes the consumer’s primary motivator. However, experience shows this is a short-term circumstance.

As we have seen repeatedly, and as recently as the price spikes in 2008, high fuels prices are followed by oil gluts and extreme fuel price declines as oil producers rush oil to market to capitalize on the high market prices, creating over supply. In 2008, the cycle began in April when the price threshold broke $4./gallon. By the time January 2009 arrived, a gallon of regular was $1.90.

So while there may be some price spikes along the way, Ibarra and Abdalah expect the overall fuel price trend will be gradual. As a consequence, manufacturers will have to deal with substantial Corporate Average Fuel Economy (CAFÉ) fines if consumers do not naturally purchase a product mix that lends itself to the auto manufacturers’, and the government’s, CAFE objectives.

In the past we have seen manufacturers prefer to pay significant consumer incentives to move vehicles they need to move to avoid the CAFÉ fines. With CAFÉ requirements at extremely high levels, it is logical to expect the focus of OEM incentives to be on fuel efficient vehicles. The CAFÉ standard for 2016 for cars is 39 mpg and 30 mpg for trucks. This will drive down the values of like make/model pre-owned vehicles. Lessors need to consider this very real possibility looking down the road.

At the same time, manufacturers can be expected to raise the price of larger less fuel efficient vehicles and reduce incentives to try to make more gross profit per unit, while somewhat depressing volume to enhance their CAFÉ calculation. As a consequence, Kelly Blue Book and RVI Group residual projections are higher for “heavies” than ALG’s projections while ALG’s projections are higher for smaller fuel efficient vehicles.

If a cataclysmic event takes place and oil goes to $200. plus per barrel, and stays there, all bets are off anyway.

Lenders, fleet operators, and private capital leasing companies will have to make their own overall residual setting decisions and come to their own conclusion about each size and fuel economy segment. However, there is no doubt that overall residual values will stay historically strong in the years to come as strong demand for pre-owned vehicles overwhelms the available supply.

David Ruggles has spent his career life in every phase of the retail automobile business and has consulted and trained with hundreds of auto dealers in the U.S. and Japan. Ruggles has been a dealer for Chrysler, GMC, Mercedes Benz, Ford, Mazda, and Subaru. Author of the Ruggles Report, and a regular contributor to the National Bureau of Asian Research, he blogs at autosandeconomics.com and writes regular columns for several trade publications and The Daily Post.

David can be reached at ruggles@msn.com and by phone at 312.925.1863

Dealers Push Back

Emboldened by recent healthy profits and the prospects of a recovering economy, auto manufacturers are pressuring their surviving dealers, at least the ones that have survived arbitrary terminations and recession, to upgrade their facilities. This, at a time when Dealers are desperately trying to repair their balance sheets and reconstruct relationships with their bankers after a bloody few years of just trying to “hang on.” Dealers have enough problems dealing with recalcitrant banks just to maintain reasonable floor plan lines and capital loans without having to ask for facility renovation money. Perhaps after a few years of recovery and bolstering their balance sheets, Dealers might be in a better position to entertain the idea of facility upgrades. And for the ones who can get financing or have cash, does it or will it make economic sense given current trends?

Manufacturer’s demands and requests are often supported by “focus groups” where consumers are asked what value they put on a dealers facility. Everyone seems to like a nice clean facility. Let’s face it, shiny granite, marble and wood DO make an impression. So do boutique expresso bars, nail salons, shoe shine stations, and other “foo-foo” features. The problem is, as much as consumers like these things, a growing number aren’t willing to pay for them. The consumer thinks the value of their business is the 35K they just paid for a new vehicle, not the $2k the Dealer retains out of which they pay their expenses.

Increasingly, consumers care less and les about fancy facilities as their PC and monitor tend to be their showroom of choice. While a facility on a high traffic piece of property might bring consumers in to take a sales person’s time to answer questions and take a demo drive, the negotiation is much more likely to take place “on line” these days. This IS the “new normal.” This is where high overhead becomes a disadvantage. As one consumer said to a Dealer friend, “I can’t drive your overhead, why would I want to pay for it?” This same Dealer, who shall remain nameless, is being pushed by his manufacturer to erect an elaborate sign to replace the one that existed when that manufacture terminated his franchise. Having regained his franchise through arbitration the OEM just can’t understand that the old sign was “grand fathered” and the new one has to meet CURRENT city code. The sign is a small part in a major push to “encourage” the Dealer to invest more in an already impressive facility. But this is just another day in the life of a dealer.

Dale Pollak, chairman of vAuto, is right when he wrote in a recent article that there is no need for dealers to do warranty and repair work on a high dollar piece of property. Is the added convenience worth the extra overhead?

The retail auto business is trending in such a direction that Dealers need to be more conscious of overhead costs than ever before. Manufacturers need to “get a clue.” If their Dealer can’t compete because of unnecessarily high overhead mandated by the manufacturer, it becomes increasingly difficult to find another investor Dealer for that point.

And as the Internet provides a more efficient market for each new generation of consumers, high cost facilities become even more of an albatross. In other words, expect the current trend away from “in showroom” negotiation to “online” negotiation to accelerate.

Manufacturers and some Dealers seem to ignoring a demographic fact. Consumers my age tend to put a lot of value on relationships, proximity, and convenience. But younger consumers are different. They have never known life without the Internet. They feel empowered by it. They are much more likely to use the “Taj Mahal,” high overhead dealer for information and service and warranty work, but to use the Internet for negotiation. They will travel for the cheapest price. I wish this weren’t so, but it is what it is.

As such, we’re in virgin territory in the retail auto industry. The new “book” is still being written. Manufacturers cling to commonly held dogma, as do many Dealers. But the future will only be loosely based on old models. The day is coming when Dealers will have to bid for a consumer’s business on line!

The pre-owned business will most likely increase in relative profit importance in tomorrow’s dealership. Warranty income will probably continue to dwindle due to the increased quality of vehicles. Financing and after market income is under the scrutiny of Elizabeth Warren and federal bureaucrats.

The future will belong to those Dealers who are prepared for it, and not encumbered by yesterday’s standards.

So when the manufacturer comes calling Dealers may need to learn how to, “Just say NO!”

Written by David Ruggles for Auto Finance News

"Turning Oil Into Salt" book review.

Book Review of "Turning Oil into Salt," a book by Gal Luft and Anne Korin

If you believe in global warming, you believe we need to get off of fossil fuel. If you believe we need to reduce the strategic value of oil, it is a somewhat different calculation. People get these issues confused. Reducing our dependence on fossil fuel is generally considered the province of "Green Liberals," "Al Gore Disciples," "Tree Huggers," "Global Warming Alarmists," etc. That isn’t totally true as evidenced by the video at made by unlikely partners, Newt Gingrich and Nancy Pelosi.

The Impact of the Japanese Earthquake on the Industry: Quick Assessment

It's still too early to judge the impact of the quake on Japan's auto industry. Toyota had expanded to the northeast (Tohoku) during Japan's "bubble" and so is the most vulnerable. Nissan has plants east of Tokyo that would be close enough to the epicenter to potentially have damage. And ports in the area are swept clean of surface equipment and full of debris. There's vivid TV footage of a jumble of Infiniti's on fire at the port of Hitachi in Ibaraki Prefecture, about halfway between Tokyo and Sendai.

For the time being the ground is still shaking; a quick check of the Japan Meteorological Agency website shows more than 200 aftershocks, many in themselves significant earthquakes [As of 11 am EDT on 12 March]. Of course most would be hardly noticeable in a stamping plant – but not all. Plants in the area may not attempt damage assessment for a day or two. It's unclear whether major roads have any hard-to-repair damage; there are no reports of collapsed tunnels. That would be important as ports may be slower to recover.
My initial, largely uneducated guess is that small car production at Toyota's plants may require a couple weeks to recover; all it takes is one blocked road to one supplier or a hard-to-repair die to stop production. Even then, plants may not be able to run at full capacity for some time to come because electric power is likely to be rationed to large commercial users in that part of Japan.

More in a few days. David Ruggles is likely to pitch in; his wife was en route to Tokyo at the time, only to have her flight diverted to Anchorage. Sooner or later she will make it there, and be able to help us add texture to our posts.

Mike Smitka

40 Years of Watching Oil Prices Impact the Auto Industry

When the price of oil rises SUDDENLY, usually caused by some world event, there is a rush to produce and sell at the higher world market price. This mitigates the shortage in a short period of time and invariable produces a glut. As the price rises, greed drives some members of OPEC to sell over their agreed upon allotment creating a "black market" supply. Sometimes Saudi Arabia tries to counter this by cutting back on it's on production, despite the higher world price. Other oil producers rush available supplies to market. In the U. S. oil patch, dormant wells are revived as the higher price makes it practical to borrow money to repair and update pumping and storage equipment. Small producers in the oil patch generally fix up their equipment when the price goes up and run the equipment until it fails or needs a general overhaul. If the market price is still high, they go ahead and spend the money to make repairs. If not, they shut down the well and wait for the next price spike. The bankers they do business with understand this cycle.

Are gas prices high?

Jim Treece at Automotive News had a neat little column in today's Automotive News ("Gas too high? Aw, stop griping"). I'd played around with data in the past; here are two graphs. One presents the inflation-adjusted price of gasoline, from 1919 through 2010. Prices are up -- but we're coming off of almost 20 years of the lowest gasoline prices in US history. The second adjusts in a different way: GDP per person, using a 2000 hour work-year to ask how many minutes it takes to buy a gallon. I could have used average hourly compensation (but what of retirees?) or average consumption; that would change the details but I don't think it affects the basic picture. And any such method would have its own drawbacks.

Mike Smitka

Another Round with Rattner

I’ve been “stalking Steve Rattner for months now in an effort to get to the nuts and bolts of the auto industry bailout and subsequent restructuring. There are those who have hung the “car czar” moniker on him, and he tries to be flattered by it. But as Rattner explains it, his great great grandfather was a fur trader in Russia and would turn over in his grave at the thought of any of his offspring being referred to as any kind of czar.

I have followed the workings of the Auto Task Force in the news, agonized daily with my dealer friends in the industry, watched hours of CSPAN hearings, attended Rattner’s presentation at a Federal Reserve Conference in Detroit in May 2010 in advance of his book “Overhaul, An Insider's Account of the Obama Administration's Emergency Rescue of the Auto Industry” read the book, wrote a book review on it for a variety of publications, participated in an internet teleconference for press members, and now I have attended his presentation to the International Motor Press (IMPA) in New York City Thursday January 20, 2011.

Any undertaking of the size and magnitude of the auto industry restructuring will have it’s critics, and the government’s revamp of the auto industry is no exception. With any endeavor of this size, mistakes will be made. In my own view, shedding dealers was a mistake. Rattner himself watches the sales progress being made by GM and Chrysler on a regular basis these days for signs of progress. Dealers are the customers of the manufacturer. Shedding customers will not sell more vehicles. The report provided by the Special Investigator of the Troubled Asset Relief Fund agreed and excoriated the Task Force for enabling the dealer terminations. When I asked Rattner about the dealer terminations in May 2010 he said the Task Force tried to make sure all parties involved made sacrifices. The Task Force regarded dealers collectively as a single constituency. As the economy and business climate improve, GM and Chrysler will need additional dealers to maximize market share, or will lose ground to competitors.

Rattner fielded a variety of questions and the occasional speech. When asked about GM’s IPO, he says he believes the government can now afford to be patient and wait to sell their GM stock at a premium as the stock continues to rise. He believes GM’s stock is still a bargain at current value, even compared to Ford. I didn’t ask if he owned stock in any of the auto companies, but in the interest of full disclosure, I own some of both GM and Ford. The taxpayers own about 26% of GM and a larger percentage of GMAC/Ally. Chrysler is still controlled by the U.S. government, although Fiat just increased it’s holdings based on meeting previously established benchmarks.

When asked why “car guys” weren’t part of his Task Force, which was made up of people with no real interest in cars but plenty of real world expertise in business restructuring, Rattner was ready with an answer. He asked everyone to recall when the “car guys” Rick Wagner, CEO of GM, Alan Mullaly, CEO of Ford, and Robert Nardelli, CEO of Chrysler came to Capital Hill to beg for a bailout. They came in separate private jets, for which they were soundly scolded by members of the Congressional committee. Mulally came because he knew that Ford would crater if either GM or Chrysler went down, as it would send a ripple of disaster through the supplier base. Such a disruption would have shut down all North American auto production and would have pushed Ford into bankruptcy as well. The three CEOs testified that for a mere 25 billion dollars, allocated based on company size and need, a disaster could be averted. Also on the auto maker side of the discussion was respected economist for Moody Ratings, Mark Zandi. Zandi took direct issue with the CEOs, stating it would take 75 billion dollars at a minimum, and up to 125 billion dollars. The bailout was ultimately 82 billion dollars, which is being repaid or redeemed rapidly. It is obvious the “car guys” were in complete denial as to their financial condition, even Ford’s Mulally. I have thought from the beginning that Ford was not so much smarter and forward thinking than the other car companies in their move to borrow money while they could, to sustain them in case of a severe downturn. It was more a case of the Ford family wanting to protect the status of their favored status of the stock. The family lives off the dividends of that stock.

Why was Rick Wagoner removed? Wagoner was steeped in GM corporate culture and was in complete denial about the condition of the company and the need for bankruptcy. Finance specialists like Rattner “bet more on the jockey than the horse.” Not knowing how much his company would need to survive was really the straw that sealed his fate. The report GM filed after the Bush administration bridge loan was so deficient there really was no other choice for the Task Force other than to replace Wagoner.

Why was the UAW favored over other constituent group? Rattner says is more a matter of perception than anything else. First, world class car companies need skilled workers to build the vehicles. Bankers and bondholders can’t build cars. In addition, he went through a list of concessions imposed on the UAW. The 320 job classifications previously in place are no more. There is no more “jobs bank,” where the Detroit 3 paid workers to stay home to watch Oprah and drink beer.. The union has agreed to serious wage and work rules cuts. Their heath care fund has been turned into a VEBA. Fortunately it has been funded by stock, laying a lot of risk on the union but looking like it will pay off well based on current stock value. The union pensions had already been funded UNLIKE the pensions of the white collar workers and the executives like Wagoner. GM had decided that it was better to bet their executive’s pensions on GM than on the stock market or other investments. That bet didn’t pay off, but the Task Force included a generous pension replacement for white collar workers. The value of bond holders and stockholders had already been determined by the market. The stock was trading at less than fifty cents at time of bankruptcy declaration, and GM bonds were next to worthless. In fact, many bondholders had bought their holdings at distressed prices and were looking to make a killing. Many held bonds that were “insured” by credit default swaps that would only pay off in the case of a complete default. That group of bondholders WANTED to be wiped out, to the consternation of the legitimate bond holders. Rattner then asks rhetorically, what should they have done different with the UAW given the real world situation they were in?

Rattner is the guy that engineered the nuts and bolts of the restructuring and is clearly relishing the current tide of success of GM and Chrysler. Despite my disagreements with some of the actions of his “Task Force,” his book is must reading for those interested in economics, the auto business, and politics. “Car Guys” probably wouldn’t have terminated dealers, but would they have gotten anything else right?

David Ruggles has spent his working life in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the US & Japan. Ruggles has been a dealer for Mercedes Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Nagano Prefecture Japan. He blogs at autosandeconomics.com and writes regular columns for Ward’s Dealer Business, Auto Finance News, and the Daily Post.