The pace of change across the automotive industry continues to accelerate.
Consumer demand for better shopping and buying experiences, focusing more on convenience and trust, are expectations being set in categories outside of automotive.
The relationship between automaker and dealer continues to be strained. While we won’t experience in the U.S. the bold push to an “Agency Model” like we’re seeing in Europe and other parts of the world, the contours of the relationship are being tested.
A lot of this pressure is due to Tesla having finally achieved scale efficiency. The direct-sale EV manufacturer is now translating every $100 of revenue into an industry-leading $26 of profit after production cost, achieving the highest profit margin among the 10 largest automakers. This provides a huge competitive advantage by allowing it to reinvest more money back into improving its cars and developing new products.
Ford, perhaps the most vocal of the legacy automakers, is keeping a close watch on Tesla’s margins and operating model. The OEM restructured the company, breaking it into three segments: Ford Blue for its internal combustion and hybrid vehicles, Ford Pro for the commercial business, and Ford Model e, which covers electric vehicles, advanced driver assistance systems and digital services.
Automaker evolution won’t be achieved without significant cost. Ford lost about $3 billion on its Model e business over the past two years and the business unit isn’t expected to be profitable until late 2026. Thank goodness that Ford’s commercial and internal combustion engine business units were profitable enough to offset losses incurred by making and selling electric vehicles.
Honda has a joint venture (JV) with consumer electronics goliath Sony, and has named their new vehicle the “Afeela". But the automaker rankled many of their franchised dealers by communicating that as the new vehicle comes to market they may look for non-Honda/Acura dealers to represent the brand.
In parallel with its shift to 100% EV, Jaguar is reducing stores by offering dealers extra allocations of hot-selling Land Rover units if they give up their Jaguar franchises. It's unclear how many dealers have already accepted the offer, but it could be as many as 40. Jaguar Land Rover started 2023 with 395 U.S. dealerships.
By 2025, the Jaguar brand plans to dramatically move up into the ultra-luxury area of the market, and accept the tradeoff of lower sales volumes. We have heard out of the U.K. that Jaguar will offer three ultraluxury all-electric SUVs, with prices starting around $122,000. With this strategy, I’m not surprised that a lot of dealers aren’t buying in, and are instead electing to surrender their locations.
Many of the automakers believe that if they’ve learned anything during COVID, it’s that better matching of supply and demand allows every vehicle to sell at (or above) MSRP, nearly eliminates rebates and incentives, and helps both dealers and OEMs to generate more profit.
As a result, many of the automakers want to control more of the consumer experience, and transition to a build-to-order model. From my perspective, it’s very doubtful if the impulsive U.S. consumer, with their seemingly insatiable need for immediate gratification, can be conditioned to wait in a build-to-order environment. As soon as one automaker breaks from this trend and instead has comprehensive inventory in stock at the competing dealership location across the street, I think that any build-to-order discipline will be thrown out the window, and we’ll be back to an environment where OEMs are overproducing vehicles to chase market share. Mike Tyson once said, “Everyone has a plan until they get punched in the mouth.”
And finally, the technological sophistication of vehicles is accelerating at a blistering pace, whether from Advanced Driver Assistance Systems (ADAS), software enabling connectivity, Over-the-Air (OTA) updates, or the unbundling of vehicle features into monthly subscription products. Ironically, while the drive components in an EV (vs. ICE vehicle) are far fewer and more simple, the technology and software in the vehicle (coupled with the fragility and cost of the battery) are resulting in average repair costs that are higher, and “total loss” thresholds that can be surpassed in even minor accidents.
The points above only summarize a fraction of the changes coming to the automotive space. Despite this accelerating pace of change, the uncertainty that these trends provoke, and the threat of resulting profit margin compression, I continue to be energized as I speak with dealers discovering new ways to increase profitability as they prepare for a dynamic and somewhat unpredictable future.
The Automotive Ventures Dealer Fund
Venture Capital (VC) has historically delivered higher returns than other investment benchmarks such as the S&P 500 and Russell 2000.
The DealerFund is vertically focused on automotive retail, raising money from auto dealerships. The fund appeals to dealer operators who enjoy exposure to new and innovative technology products that both benefit their operations and is positioned to deliver outsized investment returns. We have been investing out of the fund for almost a year and will close to new investors at the end of this month (April 30th).
Given we’re on the cusp of closing the DealerFund to new investors, I thought I’d take the opportunity to detail the fund’s investment thesis areas.
Back in 2018, when Tesla introduced the Model 3, Consumer Reports panned the vehicle, reporting that the new Tesla model had worse braking performance than a Ford F-150 pickup truck.
Within days, Elon Musk convinced them to re-test the vehicle. Upon retesting, they were surprised to find that the same vehicle had reduced its 60-to-Zero MPH braking distance by 20 feet. The only change? A software update.
This event opened the eyes of the legacy automakers. If Tesla could change the driving dynamics of a vehicle through a software update (without a technician touching the vehicle), what else could be pushed to the vehicle via software, and how could automakers both save costs (recall and warranty work avoidance) and potentially generate incremental revenue (unbundling vehicle features into pay-by-the-month subscription products)? The opportunities were seemingly limitless.
Fast forward to today, and experts believe that OEMs will save more than $60 billion annually through Over-the-Air (OTA) software updates (warranty and recall avoidance). In addition, many legacy automakers are forecasting more than $20 billion in incremental, high-margin software subscription revenue, by unbundling vehicle features and evolving towards more of a “Feature on Demand” model. The topic of Software Subscriptions is so important, it’s deserving of its own investment thesis area for the DealerFund, which we’ll cover in more detail a little bit later.
There’s also a war to decide who will “own” the dash experience within the vehicle. Automakers, fearful of conceding the in-cabin experience to tech giants Apple and Google, are spending billions of dollars bringing software competency in-house.
In general, the path of least resistance has been for the driver to simply allow Apple CarPlay and Android Auto to mirror their smartphone screens on a vehicle's interactive display. The automakers fear that Apple and Google will continue to take over more and more of the dashboard screen real estate in the vehicle.
Just last week, General Motors announced plans, for their future EVs, to phase out Apple CarPlay and Android Auto technologies that allow drivers to bypass a vehicle's infotainment systems, shifting instead to built-in infotainment systems developed with Google.
However, OEM software independence is going to require a significant investment, and it’s worth noting that software and screen user experience are two areas in which legacy automakers haven’t exactly excelled in the past. Just think about yourself for a minute - do you use the native navigation system in your car, or do you just port the navigation app (Waze, etc.) from your phone? (warning: your answer may be different if you drive a Tesla).
How does the DealerFund benefit from these changes? We are specifically looking for solutions in a few different areas, outlined below.
The average vehicle now has between 70 to 100 electronic control units (ECUs), and the higher computing power and integration require over 100 million lines of software code. By comparison, a Boeing 787 Dreamliner has only 14 million lines of code.
All of this makes for fertile ground for computer hackers. With each passing year, there are more vulnerabilities to penetrate across the rapidly increasing “surface area” of today’s modern car.
From the DealerFund’s perspective, more complexity means more opportunity to invest in companies that help prevent hacking and that may provide consumers with peace of mind that their vehicles (and their personal data) are safe.
Fixed Operations Optimization
We believe that auto dealers will play an important role in OTA software updates to consumers. We are seeking innovative startups that can help dealers both service customers receiving OTAs and provide them with the opportunity to generate incremental revenue from vehicle connectivity.
Vehicles will be capable of real-time communication back to both automaker and dealer. This should seed a new generation of startups that can help predict required maintenance, allow OEMs and dealers to communicate with the driver, and influence them to return back to the franchise dealer to get work done.
In addition, we believe that connected car data will drive innovation within Finance & Insurance (F&I) to deliver more profit at the point of sale, but also increase consumer loyalty back to the dealer.
DealerFund Thesis Area: Consumer Expectations
Amazon ended last year with 168 million Prime members, each paying $139 per year in return for fast and free delivery. To put this into perspective, there are only 131 million households in the U.S. So, we now have more Amazon Prime customers than households.
There is no doubt that Amazon is important to the U.S. consumer. According to a study conducted by eMarketer, 61% of US consumers begin their product searches on Amazon.
But I have a challenge for you. Try to price compare on Amazon. The user experience makes it very difficult to feel confident that you’re getting the best price on a product. And that’s part of their strategy.
We’ve conditioned the next generation of shoppers to trade “price discovery” (AKA finding the best deal) for convenience and trust. To self-reference, I find myself frustrated when a product I want isn’t available on Amazon because I enjoy the ease of use, fast delivery, and the liberal return policy. And apparently, 168 million others in the U.S. are also willing to pay a premium for this convenience.
Turning back to automotive, COVID accelerated online vehicle shopping, dealers were forced to adopt digital retailing tools, and in many cases offer home delivery of vehicles. But with all of the buzz around consumers wanting driveway delivery of vehicles, how can we gauge actual consumer demand?
CarMax is a living, breathing “petri dish” that allows us to track the percentage of shoppers who prefer at-home delivery for car buying. Through CarMax’s “omnichannel” offering, consumers can opt into either home delivery or picking up their vehicle at the store. And according to CarMax’s Q3 2022 earnings call transcript, only 12% of consumers are choosing at-home delivery over coming into the retail location to finalize their car deal. This will be a metric for the industry to keep an eye on to gauge real consumer demand for home delivery.
How does the DealerFund benefit from the evolution of consumer preferences? A few of our investment thesis areas are listed below.
Digitization of Processes
Few would argue that the automotive shopping and buying experience needs to improve (at least from the consumer’s perspective). Evolution of many of the dealer’s legacy manual processes will help. Think about things like migrating from paper to electronic documentation, and electronic title and registration for the DMVs.
Superior Customer Experiences (Both Online and In-Store)
Consumers will continue to demand and reward more transparency and convenience, both online and in-store. As our Amazon example illustrates, providing a better experience may mean less price negotiation and more profit per unit sold. For example, F&I “attach rates” seem to be higher when the consumer is provided with more transparent information upfront, so they’re better educated and equipped to decide which protection products are best for them.
Are there benefits to speeding up the process and making it less cumbersome for the consumer both in sales and in service? When a consumer wants to buy, we should be focusing on removing friction and making it faster and easier to take their money. The result is a happier customer and more profit for the dealer.
DealerFund Thesis Area: Consumer Regulations
A more regulated environment seems to be inevitable for dealerships and new startups will be needed to help dealers navigate the often confusing and ever-evolving landscape of increasing regulation and compliance.
As an example, The Safeguard Rule is a set of regulations developed by the Federal Trade Commission (FTC) to protect the privacy and security of consumers' personal information, requiring dealers to develop and implement a comprehensive information security program to protect the personal information they collect from customers.
Preparation required spans across administrative, technical, and physical safeguards to protect the confidentiality and integrity of personal information. This includes conducting risk assessments and ongoing monitoring of security risks; providing training to employees about how to properly handle personal information; and overseeing service providers who have access to personal information.
Car dealerships that fail to comply with the Safeguard Rule can face significant penalties and legal consequences.
In addition to The Safeguards Rule, the FTC is preparing to become further involved through recent proposals that target bait-and-switch advertising and Finance-and-Insurance (F&I) products sneaked into deals without consumer consent. The FTC's proposed regulations would ban certain F&I coverage and physical vehicle add-ons. Add to that a ban on misleading customers with advertised pricing incorporating lease terms, listing a vehicle that isn't available or including rebate terms not available to all.
The DealerFund is looking for solutions to help dealers navigate these and other regulations that might emerge in the future; technology and software solutions that help remove complexity and help protect dealers against this expanding regulatory environment.
DealerFund Thesis Area: Electric Vehicles
The evolution from Internal Combustion (ICE) to Electric Vehicles (EV) is well underway, with many consultants forecasting that half of passenger vehicle sales in the U.S. will be plug-in electric by 2030. But a lot has to happen between now and then to prepare for this electrified future, including investments in battery technologies, EV incentive optimization, EV charging infrastructure, and “second life” and “end of life” solutions for the batteries themselves.
The automakers are struggling with the timing and amount of investment needed to make this transition. If OEMs act too early and get ahead of consumer demand for EVs, it could inflate their costs and hurt sales of gas-powered vehicles, profits from which are needed to fund investments in electrification. At the same time, lagging behind rivals in EV offerings could cost automakers the chance to establish themselves in a key growth area over the next few decades. At risk are the trillions of dollars that automakers are collectively committing to enable this transition.
The U.S. government is laser-focused on stimulating demand for EVs, but this change also demands a wave of innovation around charging infrastructure. The Biden Administration’s $7.5 billion EV charging initiative plans a national network of 500,000 electric vehicle chargers along highways, including a requirement that all EV chargers funded through the Inflation Reduction Act (IRA) must be built in the United States. But rolling out more charging infrastructure isn’t without its own unique challenges. J.D. Power reports that 21% of EV chargers are currently out of service.
How will the DealerFund be positioned to benefit from these changes? Here are a few areas that are of particular interest to us, from an investment standpoint.
Dealers are being asked to make significant investments (in some cases more than $1 million per location) in new EV charging stations. How can they ensure they’re making the right investments and not either overspending and/or making investments they’ll regret in the future?
How are automakers and dealers ensuring that the consumer has the right home EV charger to optimize their EV ownership experience? What role will dealers play in helping the consumer select the best EV charger, schedule a seamless installation, and then ensure the proper functioning of that home EV charger over the lifetime ownership of the vehicle?
There will be opportunity for new companies to play a role in alleviating the pressure on the electrical grid. Some grid operators are already struggling to keep up with electricity demand in certain areas and at certain times. We’re already hearing that required investments in capacity are likely to result in higher electric rates.
And it’s becoming apparent that “Vehicle to Grid” (V2G) will be a big investment opportunity. Some automakers are now promising anyone with an EV an enormous home battery on wheels that can reverse the flow of electricity to power the entire home through the main electric panel. What role should dealerships play in helping their customers install the right EV chargers, but also potentially monetize their electricity, reducing their monthly electrical costs?
We expect to see a wave of new startups that help consumers figure out which EV chargers to buy, simplify having those chargers installed, and cut through the confusing equation of EV incentive optimization, which relies on factors such as car country of origin, whether the battery and its components were sourced and built on American soil, the price of the car, the customer’s salary, and their geography.
Where there’s complexity there’s opportunity, from an investment standpoint.
DealerFund Thesis Area: Margin Compression
As both new and used vehicle inventories return to more normalized levels, we believe that dealers will enter a new phase of profit margin compression, exacerbated by challenges in Fixed Operations: EVs having longer service intervals and more of the historical warranty and recall work being replaced by Over-the-Air (OTA) updates.
As investors, we are on the hunt to find companies that help dealers defend against profit margin compression. A big area of interest for us is Robotic Process Automation (RPA), where repetitive tasks are replaced with automatic scripts that reduce or eliminate human labor. Automation can be used to automate repetitive tasks, freeing up employees to focus on more strategic work that adds value to the business.
A new generation of artificial intelligence is rolling out across American workplaces. Consulting firm McKinsey estimates that 25% of work activities in the U.S. across all occupations could be automated by 2030.
How will the DealerFund position ourselves to benefit from these changes? Some of our investment areas of interest are listed below.
New AI-based tools are improving the productivity of knowledge workers. Investment firm ARK Invest believes that AI should increase the productivity of knowledge workers more than 4-fold by 2030.
The focus for us is to enable dealers to get more done with fewer employees. We believe there will be a number of new automotive technology startups focused on harnessing AI to eliminate more of the repetitive (and mundane) tasks at the dealership, and in the process freeing up employees to work on higher-value tasks.
As more processes become automated, dealers will benefit from reduced costs and higher profits. We believe that there will be a segment of new startups whose sole purpose is to help dealers take costs out of their operations.
DealerFund Thesis Area: Servicing Vehicles
Today, auto dealerships generate more than half of their profit from Fixed Operations: the combination of service and parts. Despite its importance, this area of the business hasn’t experienced nearly the amount of innovation that marketing and sales has benefited from over the past 15 years.
Over-the-air updates (OTA) may result in a reduction in the amount of warranty and recall work coming into dealership shops.
EVs will have longer service intervals (fewer moving parts, no oil or spark plugs to change), so dealers will see those vehicles less frequently.
But conversely, no matter how “Right to Repair” laws play out, the average independent repair shop is going to lack the technician skill and unique tools required to work on many of these vehicles as the technology becomes more sophisticated. So, the defect rate of vehicles at the end of their warranty period may dramatically shrink, and dealers may find that their service bays are actually busier than ever.
There are other innovative emerging technologies that may drive consumers back to their franchise dealer locations for service. For example, tire manufacturer Michelin began investing in RFID technology a decade ago, and by 2024 all of their tires will be equipped with RFID so the company can further integrate its tires with automakers’ platforms.
How will the DealerFund position itself to benefit from these changes? Some of our investment areas of interest are listed below.
Fixed Operations Optimization & Efficiencies
While a ton of innovation has occurred in the “Variable Ops” (new and used car sales) area of the dealership, Fixed Operations (parts and service) has been largely neglected. We believe there will be a wave of new innovation focused on driving efficiency across parts and service departments, helping optimize technician productivity, and squeezing more profitability out of operations.
We look forward to identifying the next generation of auto technology entrepreneurs who want to help dealers across their fixed operations.
DealerFund Thesis Area: Software Subscriptions
Traditionally, automakers didn't install anything on a vehicle that they couldn't charge for. When you build hundreds of thousands of vehicles each year, every extra nickel or dime in parts matters. But in the electric vehicle/infotainment/subscription era, that strategy is changing. With the average age of vehicles at a record high (12-plus years), average transaction prices increasing, and loans stretching to eight years and longer, automakers are thinking about how vehicles can generate revenue long after they leave a showroom.
GM is aiming for $20 billion to $25 billion in annual revenue from subscriptions by 2030. Both Stellantis and Ford have both said that they are aiming for subscription revenues in the same ballpark.
All of this isn’t theoretical. Software-based vehicle upgrades generated more than $1 billion in revenue for Mercedes-Benz last year. That's only a fraction of the more than $150 billion in global revenues the automaker earned in 2022, but the business could explode after 2025 when Mercedes launches its own operating system that will open the door to more digital services in vehicles. That's also when Mercedes will roll out a robust menu of on-demand services, including charging and automated driving features.
Dealer participation in these new, high-margin subscription revenues are sure to vary. For example, General Motors says they will include their franchised dealers (and compensate them in some form) as part of its strategy around future software sales after a vehicle purchase.
How can the DealerFund position itself to capitalize on the upcoming wave of software subscriptions? We believe there are a whole range of potential new businesses that need to be built to deal with the uncertainties around “features on demand”. For example:
In the future, how is a dealer going to handle the trade-in and sale of an off-brand used vehicle? For one, the appraised vehicle may look very different a week from now when the current owner cancels many of the vehicle features that they’re paying for on a monthly basis. A naive dealer may over-appraise a vehicle.
Then, how does the off-brand used car salesperson know how best to demo the off-brand vehicle? Are they going to have access to the possible features that can be activated and paid for on a monthly basis?
Will an automaker compensate a off-brand dealer if they re-activate a subscription and allow that OEM to resume collecting monthly subscription revenue?
And back to that current owner. Who is going to help them remember and cancel all of their current software subscriptions?
What does the window sticker of the future look like? Will some areas be “greyed out” to show options that have been installed in the vehicle but not activated at the time of purchase?
How are wholesale auctions going to deal with all of this? The vehicle they inspect may look (and perform) very different by the time it runs through the auction lanes.
How do you set a residual value on a vehicle that may have features added or subtracted over time at the whim of the consumer?
How is the Service Writer going to be made aware of additional features that the consumer has activated since their last visit to the service lane?
Who does the consumer call if they have issues or problems with the new vehicle feature that they’ve just tried to activate, but isn’t working as expected? Does the answer differ on new vs. used vehicles?
From our perspective, many new companies will need to be built to address these issues (and others we haven’t even thought of yet). If you’re an entrepreneur that wants to work on these problems with us, please let me know.
Clearly, there are a lot of exciting investment areas for the DealerFund to sink our teeth into. If you’re a dealer and you’re excited to invest in these areas, please let me know.
Conversely, contact me if you want to discuss the best way to encourage entrepreneurs to work on these problems and/or have an early-stage company we should be looking at.
Automotive Ventures aims to deliver long-term capital appreciation by investing in early-stage automotive and mobility technology companies that are best positioned to benefit from the industry’s biggest trends.
As always, we remain committed to seeking out and investing into innovative companies with strong potential for growth and profitability.
We believe every investor should have a strategic allocation to innovation, not only to access potential exponential growth opportunities typically absent from other asset classes, but also to hedge against the increasing risk that industry incumbents will be disrupted.
As a team, we remain focused on identifying the most promising opportunities, supporting our portfolio companies in their efforts to scale and succeed, and generating strong returns for our investors. We believe that our strategy of investing in early-stage technologies will continue to pay dividends in the years to come.
Thank you for your ongoing support, and we look forward to working closely together with you to create the future of this industry.
It’s an exciting time to be in the automotive and mobility space, and I appreciate you being on this journey with us.
Steve Greenfield is General Partner of Automotive Ventures, which is raising the DealerFund to help auto dealerships navigate through the next decade of unprecedented change and participate financially in the AutoTech startups they help to grow.
Note: This article was originally published in the April 2023 Automotive Ventures Intel Report.