Automobile dealerships: Here’s how they work

Virginian-Pilot

NORFOLK, Va. — Don Hall, president and CEO of the Virginia Automobile Dealers Association, was speaking recently to a politician about the closing of auto dealerships when he realized that the politician had little idea about how the industry works.

“His assumption, and the assumption that most people have, is that dealers, in fact, don’t own their inventory — that it’s on consignment, and so their carrying costs or handling is very limited or very nominal until they sell a car,” Hall said.

But that’s not the case. While you may think you’re buying a car or truck from General Motors or Toyota, you’re actually buying from a middleman: the automobile dealer. Manufacturers provide the warranty, but it’s the dealer who sells and services the car, much like Best Buy sells televisions made by Sony or Samsung. Dealerships have been in the news lately as struggling automakers have announced plans to drop dealerships — 789 by Chrysler and about 1,100 by General Motors.

Some Detroit manufacturers have received government loans, but their dealers aren’t entitled to a dime.

Dealers are independent businesses that sign franchise agreements with automakers. The agreements give the dealers the right to sell and service certain brands of vehicles within a specified geographical area.

Scott Smith, president of the Hampton Roads Automobile Dealers Association and general manager of Casey BMW in Newport News, Va., said the agreements contain requirements for profitability and working capital, yearly sales and customer satisfaction scores in sales and service. The agreements run between three and five years, and renewals usually happen without much fanfare.

“Typically, it’s given,” Smith said. While there’s no fee to get a franchise, there are plenty of things a dealer must buy, usually from the automaker. That makes them customers of auto manufacturers, just like consumers.

“And they both get treated the same way,” said John Linkov, automotive editor at Consumer Reports.

Beyond cars or trucks, dealers buy brochures, training materials, videos, signs and even furniture from the manufacturer.

Corporate control is so total that it’s not unusual for a manufacturer to dictate the architecture of a showroom, its floor tile and its installer, dealers say.

Most automakers have specific requirements to upgrade showrooms or build new ones.

Dealers can get into trouble when they sell fewer cars than they have arriving from the manufacturer. Consider a dealership with a $5 million inventory and a $5.5 million floor plan, or line of credit. The dealer continues to order cars, expecting to sell 100 cars a month. Usually, cars are ordered three to six months in advance. As long as the dealer sells 100 cars a month, there will be enough cash to pay for the new cars coming in. But say sales slow to 40 cars a month.

If dealers don’t make their payments, their inventory can be seized. Linkov observed that most consumers have misconceptions about dealer margins.

“If you look at the invoice price versus the manufacturer’s suggested retail price, you’ll see there isn’t a huge difference between those two,” he said.