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Tuesday, May 19, 2009

The Dealer Debacle

The news about the shutdown of hundreds of Chrysler and GM dealers across the country has been covered ad nauseum (or add nausea?) on the local and national news. Despite the flurry of coverage and interviews of long-time dealers standing in front of empty lots, no one's really asking very useful questions about the process and the real impact to the economy at the national or local level.

Here are a few questions I haven't heard addressed.

How much PROFIT opportunity is really being eliminated by the closing of hundreds of dealers? For dealers of American cars who have been dependent on factory rebates and huge discounts from sticker prices for over a decade, it seems relatively little money was made off actual new car sales after factoring in interest payments as the cars sat on the lot, inventory taxes, insurance, etc. I've heard most dealers make their money off after-the-sale service because (amazingly) many buyers still feel obligated to take cars back to the dealer even for routine service.

If dealers actually made most of their money from service -- not sales -- and car quality doesn't miraculously improve by an order of magnitude, is there not the same net opportunity for service profits and employment hours off the same amount of cars that are being sold right now? If the market used to be 9 million and has now shrunk to 6 million cars sold per year, the same number of labor hours will be required to service those cars whether they were sold by 5500 dealers or 4400. There would seem to be a path to daylight for dealers who maintained a good reputation for customer service and honesty as a pure service play in the industry. It might be MORE profitable to focus on service rather than worrying about carrying costs for new cars featuring iffy styling changes for notoriously fickle buyers.

How will dealer closings REALLY affect local and state tax revenues? Assuming aggregate demand for new or used cars is NOT a function of the number of dealers, the total number of cars sold will remain roughly the same, whether 5500 dealers sell them or 4400. Granted, in some local communities, the closing of dealerships may shift city tax revenues from hamlet A to hamlet B but at the state level, overall tax revenues should be roughly a wash.

Why are soon-to-be-former dealers being forced to sell all of their inventory in an arbitrary one-month interval? The technical answer lies in the institutions backing the "bridge loans" used by the dealer to cover the inventory on the lot. It also has something to do with coverage for warranty work for cars bought from an "unauthorized" dealer, thought this is a fuzzy area. This may be the single most damning action GM and Chrysler can take to burn every last remaining bridge they have to potential buyers. The car is the car, regardless of who handles the retail sale. Forcing the wholesale liquidation of nearly 20 percent of the current national inventory when there is already weak credit and at least a two-month glut of unsold vehicles does nothing but harm:

* it pits soon-to-be-former-dealers against survivors in price competition, potentially weakening the survivors
* it depresses retail prices of ALL cars across the entire country
* it depresses resale values, again hurting survivor dealers and owners
* it undermines confidence in potential buyers of GM and Chrysler in those firm's true ability and interest in standing behind their products

How big is the harm? Do some simple math. Assume the domestic market has shrunk to 6 million cars or about 500,000 units per month. Most dealers have at least a two-month inventory on hand or at least 1,000,000 cars. GM's and Chrysler's combined share is about 35 percent of the market so the inventory on the dropped dealers' lots adds up to roughly 70,000 vehicles. If you figure the average car is about $22,000 dollars, this forced liquidation might drop prices on those units another 30 percent or $6600 per car or about $426 million. However, those price cuts won't just affect prices at the dealers going under. It will drive down prices on the ENTIRE backlog of roughly 350,000 GM and Chrysler cars. That's $2.31 billion. With a B.

What were the surviving dealers thinking for the past six months? Heck, some poster on the Fool (me, in fact) figured out in November that American manufacturing capacity was going to see a 33 percent cut. It doesn't take a genius to see the retail operations would see a similar cut. When dealers saw the backlog of cars building between November 2008 and May 2009, could they not see a liquidation coming that would further depress prices? Why did they take any more inventory and take on more loans for that inventory? Why did they not pursue more aggressive discounting before the predictable liquidation flood hits and (hopefully only temporarily) drops prices 30 to 40 percent? The wider losses that might have been suffered by accelerating clearance sales would have been NOTHING compared to the losses they will suffer on their inventory now.