The Changing Auto Dealership Model

We are underway is a vicious shakeout. Who survives, will be far stronger in the end.

A recent study by consulting firm Grant Thornton showed that for average dealer sales to match last year’s average, about 2,000 dealers need to close. With sales imploding, the firm has raised the number to 3,800. About 600 of the 2000 new car dealership in the US have closed to this point. In September alone, that number was 61.

Paul Melville, a partner at Grant Thornton, says they “badly need retail consolidation” to have healthy dealers. “Significant consolidation is necessary, especially among Ford (F), General Motors (GM) and Chrysler retailers,” he says, “because U.S. sales already have declined more than 1 million units this year.”

The domestic automakers want their dealer numbers to be more like those of Toyota (TM) or Honda (HMC). Toyota has fewer than 2,000 U.S. dealers while Ford has almost 4,000. That means your typical Toyota dealer sold 1,628 vehicles in 2007 while Ford stores averaged 236. GM dealers averaged 202. The average for all new car dealers was 322.

Domestic manufacturers want their store counts and revenue counts to look like Toyota and Honda, because many less dealerships means selling more per dealership.

“The business model of huge, irrational inventories and huge, irrational marketing budgets with razor-thin margins, à la the Bill Heard model, is obsolete,” says Mike Jackson, CEO of AutoNation (AN), the USA’s largest chain of dealerships. “It’s dead. It will not survive this downturn.” Bill Heard, which sold over 7% of Chevy’s nationwide recently closed.

Jackson says the future of car sales — coming soon — will be fewer dealerships having less need to wheel and deal. They can hold the line on price, pumping up the profit per car, and focus on customer service.

“At the dealer level, a shakeout needed to happen,” he says. “It will be painful. It will be ugly. But it is also long overdue.”

This would explain why Berkshire’s (BRK.A) Warren Buffett and Sears (SHLD) Eddie Lampert are buying shares of both AutoNation and CarMax (KMX). It is clear both will be left standing after the shakeout is over and both will have substantially increased market share through the attrition of rival dealers.

In my interview with AutoNation’s Jackson recently he said he was content to sit back and watch the industry shakeout happen as it “was necessary”.

When will things begin to turn? Clearly late 2009, perhaps into 2010 for the industry as a whole. But, as Jackson also said, when it happens there will be “significant postponed demand for autos”. What that means is that fewer dealers will be selling cars for higher profit to a surge of car buyers.

That means Jackson and his shareholders stand to profit handsomely.

Disclosure (“none” means no position):Long AN, none
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