We’re coming off the two most profitable years ever in automotive retail, and if we’ve learned any lesson, it’s that artificially limiting supply can dramatically drive profitability.
The automakers have taken notice and have a keen interest, going forward, in both limiting supply and providing the consumer with pricing transparency while eliminating discounting.
OEMs have generally decided that they’d like to control more of the consumer experience, especially as shopping and buying behaviors shift online.
Automakers are attempting to redefine themselves as technology players, as the vehicle’s operating system, software-enabled over-the-air (OTA) updates and subscription services and enhanced autonomous ADAS systems are going to increasingly differentiate how consumers decide on which makes/models to buy.
Automakers are planning on a future where the “software-defined vehicle” enables a new wave of subscription products to be sold to the driver post-purchase (think: horsepower increases, activating rear heated seats, or unlocking range on a battery). Over-the-Air (OTA) updates to the car’s software will reduce visits for service and potentially enable far stronger loyalty and customer lifetime value.
OEMs are also concerned about the hundreds (literally) of new automakers that have emerged in markets like China over the past few years, many of whom will have global brands and may bring the fight into markets where legacy OEMs have enjoyed defensible market share.
The legacy automakers have committed to spend billions of dollars to retool production lines from internal combustion engines (ICE) to electric (EVs) in an anticipated bet that consumer demand for EVs will continue to grow strongly.
THE AGENCY MODEL
Automakers are taking the opportunity, as they transition to EVs, to redefine the consumer experience and the distribution channel.
In many cases, the legacy automakers are looking at new online-only OEMs (Tesla, Rivian, Lucid, etc.) and are exploring how best to mimic elements of their business models. Earlier this year, Ford Motor Company CEO Jim Farley said, “When that second quarter last year profit came out for Tesla, and they showed a $15,000 premium, it totally changed my world. It was an epiphany. It was like the angel sung, it was like, oh! my God, we can make more money on EVs than on ICE vehicles.”
Automakers are feeling that the strategic direction of their automotive retail model will likely determine the future success of the entire company. And they feel a sense of urgency to try out new retail models in the short term.
The “Agency Model,” while not consistently defined, is an evolution away from a more typical franchised dealership model toward “agents” who sell products on the OEM’s behalf. This model is attractive to the automakers because they see the potential to reduce operating costs (primarily marketing and inventory expense), eliminate discounting (theoretically, consumers pay the same price at every dealership), and normalize the customer experience.
Retail partners often remain involved, but in a new role as “agents” that receive a commission or handling fee for providing certain services. OEMs interact directly with customers and take responsibility for the sales transaction. The dealer remains the face to the customer but is no longer the contractual partner and acts as an agent.
Many of the big consulting firms are pushing the agency model for the benefit of OEMs, projecting that the transition may help them realize up to 8% of retail price in efficiencies, through:
Elimination of discounting (all dealers will price new cars identically, at MSRP)
Reduction of dealer and consumer-facing incentives and rebates
Centralizing and eliminating of “back office” costs
Elimination of headcount
The agent model offers OEMs the chance to control the sales channel, gain direct customer access, control prices, and increase sales efficiency.
Rather than a full “Direct to Consumer” (DTC) model like Casper or Warby Parker, which is what new EV automakers like Rivian seem to be executing, an Agency Model is a bit of a hybrid between full DTC and the historical franchise model.
Nearly all major OEMs are running online sales pilots. Some include dealer involvement, some do not, but all are trying to test the consumer’s appetite for online sales as a more direct and cost-effective form of sales.
For dealers, the direct sales model may come with benefits. If all new vehicles sell at MSRP in the future, dealers won’t have to worry about margin-eroding discounts. If they don’t have to hold inventory in stock, their carrying costs will be reduced. This may even mean less investment in real estate.
Lithia & Driveway President & CEO Bryan DeBoer notes, “[Holding inventory is] what drives our leverage ratio up and takes a lot of our capital. When you think about that part of the model, we would really be shifting, in the event if this did occur, to a high margin and low SG&A type of model rather than a lower margin and higher SG&A type of model…If you look into Eastern and Western Europe, there is acceleration of the agency model…it looks like that the margins are somewhere between 6% and 10% on the front-end margin of the business. So, remember that some of the F&I is also being reduced in the agency model.”
With larger dealer groups such as Lithia, receptivity to the agency model increases, while the concern goes down. This is due to the fact that bigger groups are more likely to be the preferred channel of distribution (vs. smaller players), will have more say in strategic decisions, and have a greater influence and “voice at the table” to partner with OEMs.
We are seeing evidence of automakers moving more quickly towards an Agency Model in international markets.
Earlier this summer we saw Stellantis terminate sales and service contracts with European dealers for its 14 brands, effective June 2023. And Mercedes-Benz announced plans to cut 15 to 20 percent of its dealerships in Germany and about 10 percent of their dealerships globally, as part of a broad overhaul of its distribution network.
Toyota has piloted a transition to the Agency Model in New Zealand, as has BMW in South Africa. And Volkswagen is is planning a direct/agency sales model for their new all-EV ID. models in Germany.
But we’ve also seen evidence of friction in this transition. There are currently lawsuits brought by both Mercedes and Honda dealers in Australia against their respective OEMs, as both automakers pushed through an evolution from franchise to agency model.
Back here in the U.S., concern exists among dealers that OEMs may “spin-off” the EV divisions of the legacy business and try to apply a different arrangement/agreement with their dealers/agents. This is why VW’s announcement of the Scout brand raised eyebrows, as did Ford’s announcement just before NADA this year about the separation of their EV and ICE divisions. More recently, Ford announced that they would support three tiers of dealers: ICE-only and two different EV-tiers.
WHERE DOES ALL OF THIS LEAVE THE FRANCHISE DEALER?
These trends may fundamentally reshape the automotive value chain, drastically impacting the economics of the dealer. Potentially disruptive trends across the industry will continue to accelerate and will require dealers to respond in how they position their businesses into the future.
What we know is this: dealers will continue to play a crucial role in delivering on growing customer expectations for a seamless, multi-channel purchasing and ownership experience…and OEMs will require healthy dealer networks in order to deliver on these customer experiences.
Dealers need to remain vigilant: staying abreast of the news cycle, attending their dealer meetings, and looking for nuances in communications from their OEM. Staying lean and nimble is going to be important, as will be keeping a mindset to embrace change and being ready and open to adapt.
FINAL REMARKS ON THE AGENCY MODEL
I expect we will see continued “creep” towards more of an Agency Model here in the U.S.: online ordering/reservation of new EV models, reducing and capping commissions on certain models, less control over inventory, and fewer incentives.
What’s unclear to me at this point: all of the above is predicated on automakers being able to control their historical urge to produce more vehicles in a race to win market share and to run their factories at full capacity to recover huge fixed costs.
As OEMs take the inventory risk on their balance sheet (in contrast to the historical model of “wholesaling” new cars to dealers as soon as the vehicle is off the production line), what kind of tolerance will they (or the Wall Street analysts who cover their stocks) have for inventory backing up for the inevitable EV model that is a “dud” and isn’t received well in the market? Only time will tell.
As the saying goes, “May you live in interesting times”.
This saying feels particularly appropriate given the accelerating pace of change in the auto industry.
At Automotive Ventures, we are working with a handful of progressive dealers who aren’t shy about embracing a future filled with ambiguity, who believe that having access to early-stage technology startups and innovative entrepreneurs help position them to weather these challenges.
If you’re a dealer who wants to discuss participating in our new DealerFund, please let me know.
If you're an AutoTech entrepreneur working on a solution that helps car dealerships, we want to hear from you. We are actively investing out of the new DealerFund.
It’s an exciting time for this industry, and I look forward to working with you to create the future.