Market Uncertainty

What a difference a few months have made.

Inflation is running much higher than the Fed’s target of 2.0%, the US central bank is raising short-term rates, and market expectations for further tightening are climbing. This has caused substantial market turmoil, with most major stock indexes down by double digits since the start of the year.? Many of the high-flying tech stocks that have driven market gains for years are down more than 30%.

The S&P 500 ended May at 13.9% below the all-time high it closed at on the first trading day of the year. The tech-heavy NASDAQ is down 23.7% over the same period.?

The Automotive Ventures Mobility Index ended May at 194.3, which is 34% down from its high in November 2021.

The SaaS Capital Index, which tracks the annualized run rate revenue multiples of the larger publicly-traded B2B SaaS companies sits at 9.3x, down from 16.9x last August, a drop of 45%.

The reset of valuation multiples in the public markets has started to hit private company valuations, although it may take a couple of quarters to trickle down to really feel the impact.

CONSUMER SENTIMENT

University of Michigan’s Index of Consumer Sentiment dropped to 58.4 in May, down almost 30% from the prior year. Reasons cited include continued negative views on current buying conditions for houses and durables, as well as consumers’ future outlook for the economy, primarily due to concerns over inflation.

It doesn’t help that Russia’s invasion of Ukraine, which started on February 24th, doesn’t seem likely to find a resolution anytime soon.?

There will not be a lack of funding for startups as the store of dry powder (record of $1.81 trillion in January 2022) will continue to support fundraising. However, funders will be extra cautious with the stock market on the cusp of bear territory, and the possibility of a recession looming in the near future.

Advice to Startups

Sequoia Capital, the successful 50-year-old venture firm, has become known over the years for issuing memos to warn founders in its portfolio about market shifts. Their “R.I.P Good Times ” memo in 2008 and “Black Swan ” memo in March of 2020 have become legendary. This month, Sequoia published their “Adapting to Endure ” memo to their portfolio companies, and it’s worth noting some of their content.?

Sequoia is calling this period of turbulence a "crucible moment."

Just as they noted back in 2008, the same advice applies:

Manage what you can control:

1. Spending
2. Growth assumptions
3. Earnings assumptions

Focus on quality

Lower risk

Reduce debt

Y Combinator’s Perspective:

Y Combinator, a Silicon Valley kingmaker, is advising its portfolio founders to “plan for the worst”.

“The safe move is to plan for the worst.? If the current situation is as bad as the last two economic downturns, the best way to prepare is to cut costs and extend your runway within the next 30 days.? Your goal should be to get to Default Alive..”

- Y Combinator memo titled “Economic Downturn”

The investment firm suggested startups cut their expenses and focus on extending their runways within the next 30 days. For those who don’t have the runway to “reach default alive,” YC is strongly suggesting that they consider raising money.

“If your plan is to raise money in the next 6-12 months, you might be raising at the peak of the downturn. Remember that your chances of success are extremely low even if your company is doing well. We recommend you change your plan,”

- Y Combinator memo titled “Economic Downturn”

Dealership Profitability

Despite all of this, dealerships continue to print record profits.?

How Will Dealers Come Out of this?

Regardless of the economic uncertainties listed above, the overall macro view of the automotive segment is strong. J.D. Power reports that in addition to the 2.9 million new vehicles that weren’t sold into fleets over the past two years, there is an additional 1.9 million retail units that were lost during the same period. Add the two figures together, and we have nearly 5.0 million new vehicle sales that must be fulfilled before the market equilibrates back to normal.?

Will the OEMs Maintain Discipline?

With all the talk about “Build to Order”, keeping “Days in Stock” down, and better matching of supply/demand on the production line, time will tell if OEMs can maintain discipline without being tempted to get back into an environment where they overproduce to claim market share gains.?

If history is any indication, it’s very likely that we’ll get back to our old ways of inflated inventory, which will, in turn, drive increased incentives to help liquidate units. Thanks to J.D. Power for this data on how the years after the 2008 recession played out. Discipline be damned.?

OEMs are also maintaining pressure on dealerships to hit Sales Effectiveness targets, which measures a dealership's performance relative to the market area of responsibility and average dealership sales penetration. Dealerships that have below-average sales will be driven to sell more vehicles once availability returns, which drives down prices. Dealerships that are far below the average are targets for consolidation.?

Accelerating Rate of Change for Dealerships

The changes facing auto dealers keep coming.?

News this week out of Europe about the evolution of the dealer body away from franchisees and towards more of an “Agency” model.?

The agency model, which is being talked about more and more in the press but is not very well defined, is an evolution away from a more typical franchised dealership model to “agents” who sell product on the OEM’s behalf. This model is more attractive to the automakers because they see the potential to reduce operating costs and eliminate discounting.

The Concept: As an OEM moves towards a direct-sales model, the dealers need less expensive facilities - to store fewer vehicles; consumers order the vehicle ahead of time so inventory costs are lower; advertising costs are lower; and, there isn’t any competition on price as all vehicles sell at MSRP.

Outside of the U.S., Mercedes-Benz is also moving toward a more direct-sales – or "agency" – model, and is targeting 80 percent of European sales through this method by 2025.

This week, 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.

They were quick to add that there are no plans for a U.S. dealership consolidation at the present time.

At the same time, Mercedes is targeting 25% of all of their international sales to be online by 2025.

The automaker says the moves will cut distribution costs and allow it to rein in incentives as the automaker seeks to move even farther upmarket with higher average selling prices.

And it isn’t only Mercedes who is making big changes overseas.

Just last week, Stellantis has said it would end all current sales and services contracts with European dealers for its 14 brands, effective June 2023.

The plan is to move the Stellantis distribution structure in Europe towards an “agency model,” where carmakers take more control of sales transactions and prices while dealers focus on handovers and servicing, no longer acting as the customer’s contractual partner.

The new Stellantis distribution structure would be operational in all of Europe’s 10 largest markets by 2026, and they envision allowing their dealerships to capture 5% front-end profit on new cars sold.?

We will be keeping a watchful eye on how this dynamic unfolds over in Europe and its implications on the U.S. market.?

We continue to make dealership visits, asking owners to articulate their vision of what the future looks like and identify operational gaps that might be filled by technology solutions, a process that will ultimately define the areas of investment for the DealerFund. I look forward to sharing our findings with you in future Intel Reports

Wrapping Up

As Sequoia noted in their March 5, 2020 “Black Swan” memo communicating the potential impact of COVID-19 on their portfolio companies:

Having weathered every business downturn for nearly fifty years, we’ve learned an important lesson — nobody ever regrets making fast and decisive adjustments to changing circumstances. In downturns, revenue and cash levels always fall faster than expenses. In some ways, business mirrors biology. As Darwin surmised, those who survive “are not the strongest or the most intelligent, but the most adaptable to change.”

? -? Sequoia Capital, March 2020 “Black Swan” Memo

It’s an exciting time for this industry, and I look forward to working with you to create the future.

Steve Greenfield is CEO and Founder of?Automotive Ventures , which is raising its first?DealerFund ?to help auto dealerships navigate through the next decade of unprecedented change and participate financially in the AutoTech startups they help to grow. The DealerFund looks to build a critical mass of the most progressive dealerships, work closely with these investors to understand their biggest challenges and needs, and then identify companies to invest in that uniquely address our dealer investors’ needs.

Note:?This article was?originally published in the June Automotive Ventures Intel Report. Download your free copy here .