New transportation models will help determine which dealerships provide the consumer access, and in so doing will drive a dealership’s decision to buy, sell, or hold
Today’s hot topics are surrounded by uncertainty.
That uncertainty is running rampant in the general economy. When it comes to automobile retail, the minds of Canadian automobile dealers naturally migrate to thoughts around their role in the future.
A few things come to mind: for one, the current anxiety levels are quite normal in a period with so many perceived disruptive forces at play. Secondly, it’s normal to look at the situation today and question how you’re going to be involved in the future. It’s also normal to consider valuation implications as a big part of your decision-making process.
One of the features in this issue of Canadian auto dealer is about the question of whether dealers should buy or sell, grow or relinquish the assets. We’re seeing a softening in a new vehicle sales market that began in early 2015 in the U.S. and has trickled north of the border.
Demand for vehicles is still very strong, however the uncertainties created by an uncertain economy and the change in vehicle propulsion have consumers somewhat confused, keeping some on the sidelines. More importantly is the cost of ownership.
This issue is front and centre, as consumers are finding the cost of living in general to be somewhat out of control, let alone the rising cost of vehicle ownership. Vehicle quality is also at play.
The longer loan terms that consumers have been embracing over the past few years provide a natural downturn in the number of consumers coming to market. Vehicle acquirers from three and four years ago still have a few years remaining on their vehicle financing.
We removed these individuals from the normal vehicle replacement cycle and extended their ownership period by offering extended financing terms. It’s important to realize these customers will come back to the market — just not now.
The future
Let’s talk about the future of this business. We have been witnessing and will continue to witness, an incredible barrage of new initiatives in retail, finance and automotive. This touches on everything from what defines a supplier, all the way through to experimental retail alternatives in the retail industry. Many industries are experiencing a significant transformation.
This transformation does not negate the need for customer touchpoints in local markets. In fact, it might be increasing the demand for customer touchpoints. For this reason, I believe that dealers have an incredible opportunity as we head into the future.
That being said, the business will continue to evolve, one small step at a time, perhaps forever, since change is a normal part of life.
For the better part of the last 10 years, perhaps even longer for some brands, dealerships have been asked to significantly change their businesses. Dealers have complied and in some instances progressed further than the brands they represent. Some dealer groups have their own brands and are creating an enhanced brand promise and customer experience.
With their adoption of mobile and the Internet, customers have changed the game for shopping for new and used cars. E-Commerce capabilities continue to expand. Consumer acceptance continues. I do not see this stopping anytime soon. In fact, I see the pace of change becoming quicker as more and more innovation takes place and consumer adoption rates escalate.
Dealers should be prepared to change with the times and build organizations that can plug and play a variety of options, depending on consumer and customer preferences. Since the beginning of time, we have referred to ourselves as new car dealers. In fact, there is going to be much less dealing in the future, so the name may no longer apply. We should view and describe ourselves as transportation providers or mobility enablers rather than dealers. This is not just a big city phenomenon, but a consumer evolution impacting all dealerships —
regardless of size and location.
Our businesses have been evolving for a while, and will continue to evolve as more and more innovation in all industries begins to influence consumer behaviour and related support capabilities.
The moral of the story here is that we do have a future as vehicle mobility providers, but our role or responsibility is shifting to something resembling looking after the customer, and providing the customer whatever transportation services they require. Vehicles are gradually moving away, as the products we sell and services we offer are becoming more of what we provide.
We historically have thought of service as fixed operations, an internally focused view. However, to the consumer, services are much broader. To many consumers, vehicles are a necessary commodity required to earn a living and facilitate a lifestyle. We must rethink our positioning and role as dealerships. Our whole business is evolving to a point where, in the future, we will be viewed as service providers by customers in each and every one of our communities, regardless of size.
Valuation
How we adapt to our changing role will determine the basis upon which dealerships are appraised and valued at the time of sale. The valuation of dealerships is going to be significantly impacted. It doesn’t mean that they’re going to be lower, nor does it mean that they’re going to be higher — just that they’re going to be impacted.
Let me explain: valuation, or more importantly, transaction prices on a buy-sell are based on the dealership’s ability to generate future free cash flows. These cash flows provide the buyer with potential earnings upon which to base their potential return on investment, and forms the basis for the purchase price willing to be paid to acquire your dealership.
That purchase price is made up of a couple of components. Firstly, the tangible asset base within the company net of assumed liabilities. Secondly, the intangible asset called goodwill or blue sky that has been created by your dealership. This intangible is the difference between the agreed upon price and the tangible net assets being purchased based on future free cash flows that can be produced.
I’ve been at the buy sell game for over 30 years. The rules are no different today than they were back then. The difference is that what is creating those cash flows at dealerships is changing. No longer can we forecast with any great level of certainty into the future what new and used vehicle profits will be.
We know that for most brands, franchise dealers will still be involved in the new and used vehicle process. But to what extent? That is the wild card.
However, we do know with great certainty of the units of operation in our local markets. This fixed operations opportunity is largely based on capacity and utilization and has not been impacted much by market volatility.
Fixed operations has been the steady income stream over time, and provides the necessary cash flows to dealerships in periods of new and used vehicle sales volatility. In many ways, fixed operations has made dealerships recession proof.
The bulk of the goodwill in the future will be attributable to fixed operations potential, with a smaller portion attaching to the power of the brand. The impact of new and used vehicle sales has been a cherry on top of the ice cream sundae in recent years. Blue sky multiples for different brands has been the focus. Unfortunately, that cherry might be getting a little ripe for some brands.
So given today’s market and looking into the future, what makes sense from a buy sell standpoint? The news media has been all over the disruptive forces facing automotive and auto retail. These disruptive forces are predicted to have radical changes up and down the auto retail value chain. To some extent they are partially correct, but to a large extent, as they say: “the reports of my death are greatly exaggerated.”
Approaching from a practical standpoint, consumers (and we are all consumers), drive vehicles that need repair, regular maintenance, body collision repair and so on.
We like to have that work done either close to where we live, or close to where we work. That will not change.
Consumers also need access to vehicles. Access will potentially come in many forms. It will be provided by ownership, leasing, subscription, and a whole host of temporary transportation access models.
There is no reason why dealerships will not be providers of access. Given these parameters, valuation based on free cash flows should look favourably upon dealerships as good cash flow generators.
The varying access models that evolve over time will determine which dealerships provide the consumer access, and how fresh that cherry on top remains over time. This will drive the buy, sell — or hold decisions of dealers.
