Industry Trends From the Road: Key Takeaways from State Automotive Annual Conventions

We recently attended the annual conventions of two state automotive groups – Kentucky and the Tri-State Convention consisting of Tennessee, Alabama, and Mississippi.  It was refreshing to attend live events again after the virtual world we have all grown accustomed to over the last fifteen months. Live events like these serve as a great venue for shared information about industry trends and cultivating business relationships.

In this post, we summarize certain sessions that our readers might find of interest. If the topics were similar, we present those topics together. We also layer in highlights from our conversations with dealers and other industry participants.

Cybersecurity for Auto Dealerships and Fraud and the Distracted Employee

Cybersecurity Issues

Over the last year, there have been several high-profile instances of cybercrimes and fraud, including the ransomware hacks on Colonial Pipeline and JBS. These topics that typically lurk in the shadows have been brought into the national discourse, and there were two sessions devoted to best practices to protect against cybercriminals and how to detect fraud from within an organization.

While we typically think of these sorts of things as something that happens to other people, speakers showed just how much they can impact the auto dealer industry and how the economic fallout of the COVID-19 pandemic has increased the motivation and prevalence of fraud.

• Auto dealers experience nearly six times the amount of cyber criminal activity than other industries
• Identity Theft crimes account for $50 billion in damages and recovery expense annually

One of the most common methods for committing a cybercrime in auto dealers is through the use of business email

One of the most common methods for committing a cybercrime in auto dealers is through the use of business email. Key management and particular controllers, payroll managers, and accounts payable clerks should pay special attention to the spelling of names in emails received and also the domain name portion of the address. The strongest defenses against compromises in cyber crimes attempted through business emails are the following:

• Strong Password – have unique and lengthy passwords for all of your various accounts
• Two-Factor Authentication
• Telephone confirmation for fund transfers before wiring
• Beware of unexpected urgency – Phishing emails prey on the urgency of the situation they create by saying that funds must be wired within a short amount of time to guilt the recipient into immediate action
• Cyber Security Training – Create a culture of training and accountability for your staff. Create a message from the top that permeates throughout your dealership

How to Understand and Protect Your Dealership from Fraud

Unfortunately, these threats are not exclusively external threats. Too often internal and trusted employees can be the culprits. Auto dealers should consider the following statistics.

• Over 50% of companies have been victims of embezzlement by their own employees
• Typical organizations lose 5% of their top line revenue to fraud
• Over 50% of employees committing fraud have been with the company over five years
• Median length of time to detect fraud is 18 months
• 58% of fraud cases have no recovery at all
• Anonymous tip lines are one of the greatest ways to detect fraud because someone within the organization is probably aware of what is going on

If fraud is occurring in your dealership and it is most likely being committed by longer tenured employees. What behaviors should you be observing as possible red flags?

• Employees living above their means, or the opposite, experiencing financial difficulties
• Employees that are unwilling to share their duties with other members of the organization and/or rarely take time off
• Employees who have recently divorced or are experiencing other family problems
• Employees that have an unusually close relationship with a particular vendor

Key Takeaways

Auto dealers should communicate to their employees the potential damage to the business from a ransomware attack or other similar threats. This includes training employees on what these schemes look like and creating a culture to protect against external and internal threats. Auto dealers must confront conflicting agendas to protect their dealerships: while you want to empower your employees to do their jobs well and trust them without micromanaging, it’s also important to not be too detached and “inspect what you expect” might be potential fraud. Finding that balance is critical. A three-pronged approach to internal fraud is key: deter, detect and prevent.

How can auto dealers put this approach into practice? Set up internal controls so that one employee isn’t responsible for all elements of transactions. Segregate duties among various employees. Rotate functions so that the same person doesn’t handle the same aspect of the business at all times. Besides being good practice against fraud, this also reduces systemic risk of the dealership that we in the valuation world discuss as a “key person risk.” Businesses whose operations are not specifically reliant on one person tend to be less risky and therefore more valuable. While typically this is thought of as the dealer principal or upper level management, it’s important to have these considerations throughout your organization.

The Dealership of Tomorrow and Regulatory Items in the Biden Era

Future Trends and Their Possible Impact

The pandemic had an acute economic impact on many Americans, and it accelerated many trends from before 2020. One of our speakers took a long view at these trends and offered his view of the future of traditional auto dealers.

Then, we look at recent trends in the industry from a more regulatory point of view. When the White House administration changes, particularly to a different party, there is likely to be change to regulations at the federal level, particularly considering Biden was a part of the administration that preceded his predecessor. How will these changes impact dealerships?

Despite the ebbs and flows of trends that come and go, dealerships have utilized all of their profit centers to their advantage, so when one area of the business is declining, another is likely benefiting. Even through challenges such as electric vehicles, autonomous vehicles, rideshare, and connected cars, the industry has proven it can adapt and remain viable.

No country in the world exclusively utilizes a direct sales model for retail automotive sales

When it comes to electric vehicles, speakers at our conferences offered some rebuttals to some prevailing arguments, particularly those proffered by proponents of direct to consumer sales. No country in the world exclusively utilizes a direct sales model for retail automotive sales. While some upstarts like Tesla have adopted that model, all countries still maintain and utilize some OEM/dealership model. While direct sales proponents insinuate that franchise laws are the only thing preventing a shift in the market, countries without these laws do business very similarly. If EVs are going to be successful, it will likely be dealers who have made the investment in personal relationships in their community who can help consumers understand the benefits and challenges of the new technology.

There has been plenty of talk around the topic of consolidation in the industry, but the total number of automobile dealerships or stores has only declined approximately 1.9% from 1970 through 2019. There are approximately 18,000 stores in the U.S., and it looks like this number may stay relatively consistent.

In the past decade, the number of owners has declined from 10,000 to 7,500. Despite the challenges related to the pandemic, the auto dealer industry only lost 31 dealers in 2020, or ~0.2%. While some dealers may capitalize on heightened valuations and exit with more Blue Sky value, there’s a sense that the total number of rooftops nationwide won’t similarly decline. Despite the recent uptick in investment by the public auto dealers, their share of the entire automotive market is less than 10% by location. If Lithia and others continue to acquire and Blue Sky values stay high, this could change. However, years of evidence does not seem to clearly indicate that public dealers necessarily can operate more efficiently than their privately held counterparts.

Will OEMs exercise restraint with their facilities and imaging requirements? The buying experience for consumers and their preferences shifted during the pandemic. Shutdowns and health fears led to more investment in the digital/online channels for vehicle retail sales. With dealers seeing less foot traffic at their dealership locations, will they want to downsize their facilities, or will the OEMs continue to require continuous upgrades and imaging requirements? Trends surrounding facilities that could evolve after the pandemic include unbundling facilities (i.e., sales and service operations not being conjoined on the same property), placing greater importance on convenience and flexibility.

From a regulatory standpoint, there appear to be more threats than opportunities

Possible Regulation

From a regulatory standpoint, there appear to be more threats than opportunities:

• Trade can be an area of opportunity now with the removal of 25% tariffs, but dealers should be aware of how the USMCA, which replaced NAFTA, may impact them
• Labor constraints have made operations more difficult across all industries, but the speaker pointed to the classification between W-2 employees and independent contractors as a regulatory issue to watch
• Fuel economy standards have changed depending on the current administration, which can make it hard for OEMs and dealers to make long-term plans when the goals for 2035 and beyond continue to be a moving target. Hopefully for dealers, these requirements will be tied to economic viability
• 50-60% of dealers report on LIFO, which is beneficial when inventory levels and/or values are increasing. When volumes dropped during the pandemic (which have been extended by the chip shortages), LIFO dealers are stuck recognizing income, which is unlikely to be changed despite NADA lobbying efforts
• F&I has increasingly become a profit source, with dealers recognizing more and more of overall profit from F&I rather than the sale of the actual vehicle itself. Will that lead to concerns from the Consumer Financial Protection Bureau that dealers are in effect selling products with interest rates too high, or is this just semantics of how profit is allocated?

Key Takeaways

While the external alternatives to traditional automobiles continue to arise and the imaging requirements may change in the future, traditional auto dealerships appear to be stable and on solid footing for years to come. Auto dealers should become active and stay in communication with their state associations and politicians to ensure their best interests are being protected during periods of regulatory changes.

Succession Planning

General succession planning forces individuals to confront uncomfortable topics including their personal financial circumstances and needs, circumstances and feelings of other family members, and circumstances of the business, age, and quality of key managers/employees. Auto dealers face additional decisions contemplating the OEM requirements for their children or other family members to become a dealer and what will be required for them to become a successful dealer. The approval of a second generation or other family member as a dealer principal is not guaranteed by the OEM. We have encountered this situation at the untimely death of a dealer principal.

A critical element of succession planning is determining the value of the business to implement the particular action steps

One of our speakers demonstrated the difference between “having a plan” and succession planning. Having a plan is more like the noun, or the passive part of the process. Succession planning is the verb, or the active part of the process.

A plan can consist of a Buy-Sell Agreement. The success of the process is to live by the terms of the Buy-Sell Agreement or plan and make it a living document rather than have it become a static document that resides in a file cabinet. A Buy-Sell Agreement may appear stronger if it includes a mechanism for the pricing of a dealership that accounts for its Blue Sky value. However, if the document simply indicates a static multiple (say 5.0x, for example) from when the document is drafted, it may not capture how the dealership and the market for dealerships change over time.

Key Takeaway: At the risk of appearing self-serving, we offer this truth: a critical element of succession planning is determining the value of the business to implement the particular action steps. Mercer Capital assists auto dealers around the country by performing business valuations to assist with succession planning and wealth transfers. Do you have a plan or have you engaged in succession planning with a financial advisor?

Conclusion

We’re glad to be back attending in-person conferences and talking with dealers in person. This leads to a better exchange of ideas on current trends and best practices. If you would like to discuss any of information in this post and how your dealership might be impacted, please contact any of the members of the Mercer Capital auto team.

Sources

• “Cybersecurity for Auto Dealerships,” John Iannerelli, former FBI Special Agent – KADA Convention
• “Fraud and the Distracted Employee,” Lori Harvey, CISA, CISM, PCI QSA, DHG – Tri-State Conference
• “Dealership of Tomorrow,” Glenn Mercer, Glenn Mercer Automotive – KADA Convention
• “Regulatory Items in the Biden Era,” Paul D. Metrey, NADA – Tri-State Conference
• “Plan Now or You Could Lose Everything,” Loyd H. Rawls, Rawls Group – KADA Conference

Originally appeared on Mercer Capital's Auto Dealer Valuation Insights Blog

Mercer Capital's Auto Dealer Valuation Insights Blog provides a weekly update on issues important to the Auto Dealer industry.