Can Car Dealers Keep the Profits Rolling?

After a banner year, repairs and used cars become the focus

With heavy advertising and good old-fashioned salesmanship, savvy car dealers went all out in December to finish the year with strong sales. The reason for the extra effort: Jan. 2 marked the end of the 0% financing deals that Detroit carmakers offered up in mid-September to woo buyers. Says Rene Isip, who runs four dealerships in Dallas for Charlotte (N.C.)-based Sonic Automotive Inc.: "It's the best sales incentive program I've ever seen."

He'd better have made the most of it. Even though new programs are being announced--General Motors Co.'s (GM ) $2,002 discount, for example--deals as sweet as free financing are unlikely to come around again for a long time. And no one has benefited as much from Detroit's generous promotions as the nation's auto dealers. While the combination of big incentives and a weakening economy decimated profits at the Big Three auto makers, the reverse has been true for large U.S. dealer chains. The incentive-fueled sales boom turned 2001 into one of their best years ever as buyers poured in to take advantage of lower prices. Even Wall Street applauded the dealers' good fortune: Shares of the biggest chains--market leader AutoNation (AN ), followed by United Auto Group (UAG ), then Group 1 Automotive--doubled or tripled last year.

With the swooning economy, rising joblessness, and the end of the incentives all expected to slow new car sales in 2002, the question now is whether dealers' fortunes will stall out, too. Not to worry, says AutoNation CEO Michael Jackson. Used-car sales and the hugely profitable repair business should "offset the obvious decline in new-car sales." But not everyone is convinced. "Building profits will be a difficult task," says Tom Webb, chief economist for Atlanta-based used-car clearinghouse Manheim Inc.

One certainty: 2002 will look plenty different from last year. In 2001, Detroit jacked up incentives through November some 36% over the same period in 2000, to an average of $2,477 a car, which includes the interest-free offers. The financing break allowed dealers to pump up sales without cutting into their own profits. At the Medford (Ore.)-based dealer chain Lithia Automotive Group, for example, gross margins on new cars jumped to 9.4% in the third quarter, up from 8.7% a year earlier. Lithia expects another uptick in the fourth quarter.

But dealers can no longer count on that windfall this year. New-car sales are expected to fall 10%, to about 15 million. Instead, they are hoping to make up much of the difference with stronger used-car sales, where they book better margins. Houston-based Group 1, for example, makes 12% gross margins on used-car sales, vs. 8% on new cars. Still, those fat margins can't hide the fact that used-auto sales are unlikely to increase as much as new-car sales will fall. During the 1990-92 recession, for example, used-car sales rose by 400,000, as new-auto sales fell by 1 million.

This time around, the gap could be even greater, because the market for pre-owned wheels is coming under pressure, too. For one, the thriving car market of the past few years may mean fewer car buyers, period. Used-car sales are likely to grow by just 100,000 vehicles next year, to 12.7 million, according to Paul Taylor, chief economist for the National Automobile Dealers Assn. Worse, the fat margins may be a thing of the past. Thanks mostly to trade-ins from the 0% financing, used-car prices tumbled 6% in 2001, squeezing profits.

All the more reason for dealers to supercharge their efforts to boost revenues in the service and repair business. Last year's slowdown forced some consumers to keep their cars longer. As a result, service revenues at dealerships grew 4%, to $236 billion even as new-car sales fell 2%. Repair services and parts now make up 10% to 12% of revenues at the big dealer chains.

More important, repairs give dealers their fattest margins. At AutoNation, parts and services bring in just 12% of revenues but 35% of net profits. That explains why dealers like Group 1 are investing in new service bays for their dealerships. Says Group 1 Chairman Ben Hollingsworth Jr.: "Service business is why we've performed even in a recession." Looks like he'll have another chance to prove it.

By David Welch in Detroit

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