Whilst there are factors that can influence a dealership’s return on sales ratio, such as locality and franchise mix, the two percent model has long been the yardstick of an acceptable profit benchmark an automotive dealership should make before taxation.
The way in which Dealers reach their benchmark profitability level, however, has changed over time, and will continue to do so into the foreseeable future.
With the Australian Securities and Investment Commission’s (ASIC) review of finance and insurance F&I commissions concluding, the significant contribution the F&I department makes to dealership revenues is likely to notably reduce.
How, however, will it be replaced?
The assumption is that over time, once the market adjusts, additional gross profit contributions will naturally come from vehicle sales (‘gross on the metal’).It is, however, important to understand that the changing landscape to how Original Equipment Manufacturers incentivise dealerships will greatly affect this assumption.
Currently, OEMs determine dealership’ bonuses and rebates, predominantly via a dealership’s ability to reach certain sales targets. Recently, however, there is an ever-increasing trend to set dealership bonuses and rebates based upon non-financial metrics – metrics such as achieving high customer satisfaction or ensuring a high level of brand consistency.
These metrics aim to boost the overall client experience, increase customer loyalty to the brand and encourage repeat business. Timing of OEMs’ dealership bonuses and rebates are also noteworthy, as many have varying terms, some governed by annual agreements and others over much shorter timeframes. These differences in timings ultimately affect how such incentives influence the operations of the dealership.
More so, what is becoming more evident is the ever-increasing significance that OEM incentives and bonuses have on a dealership’s profitability. With an increase in profit contribution from rebates and bonuses, the ‘on the metal’ gross profit contribution from vehicle sales is actually reducing.
This reduction in gross profit margins from vehicle sales comes from dealerships’ inability to negotiate higher sales prices with customers due to the restrictive nature of OEMs’ incentive schemes, often setting price caps on the sale price of specific vehicles on promotion or limiting the upselling of vehicle extras.
Whilst such restrictions assist OEMs in improving transparency with their customers, it ultimately hogties dealerships to the objectives of the OEM. It is expected that the significance of KPI money to the dealerships’ profitability will only increase.
The diagram below shows the pool of gross profit contribution from new vehicle sales typically seen in a benchmark dealership. Scenario A is the expected outcome of less F&I commission; however the trend is towards scenario B. At this rate, who knows – maybe the dealership’s income of new vehicle sales will be purely fixed via the OEM.
In summary, dealerships that will prosper in the short to medium term are those that not only hit factory volume targets but also achieve these targets in line with the strategic objectives of their OEM, thus maximising the bonuses and incentives on offer. What this does is create a homogeneous product offering and removes the entrepreneurship from the Dealer Principal.
Food for thought?