What UK retailers can learn from the US experience

The US auto retailer industry will have to navigate several megatrends over the next few years, such as the transition to electric vehicles (EVs) and balancing an agency model as OEMs target more direct to consumer sales, while ensuring an omnichannel retail experience. We expect a rising threat of cyber-related disruptions, considering the widespread outage at retailers across the US in June 2024. The market is likely to further consolidate over time as scale and technology investments become more critical to sustain competitive advantage as retailers navigate through these megatrends.

Dealer Management System (DMS) providers are capitalising on this trend by focusing on larger outlets and acquiring smaller ones while providing software applications that help retailers and auto makers manage their business – from acquisition and sale to finance and insurance (F&I), parts supply and maintenance of vehicles.

An omnichannel experience

The automotive retail market is evolving as consumers increasingly expect a seamless omnichannel experience so retailers can engage with customers through multiple digital and physical touchpoints. As customers move across these channels, retailers must ensure that applications and data move with them. This situation creates the need for a consistent – and clear – experience from start to finish when buying or servicing vehicles, something that is often enabled by DMS providers. Companies such as CDK Global, Reynolds and Reynolds, Dealertrack (Cox Automotive), Auto/Mate, AutoSoft, Tekion and PBS provide technology services that facilitate the sale of vehicles, consumer financing, repair and maintenance and inventory management, which are the backbone behind dealer profitability.

The US industry has been extremely profitable the last few years. Retailers experienced record margins in the supply-limited post-pandemic era, but we expect margins to continue to decline over the next couple of years as car prices decline. An increase in online transactions and improved labour productivity also helps retailers maintain better control of a key metric to manage profits – selling, general and administrative expense as a percentage of gross profit by reducing headcount.

Due to this greater productivity and cost control, we forecast margins to remain above pre-pandemic levels even as vehicle prices come down. DMS providers help with the integration of these online transactions with the rest of the dealership’s workflow technology to ensure a consistent and positive customer experience across their dealer networks. This helps them improve both customer satisfaction and their cost structure. Traditionally, retailers have viewed DMS as more of a transactional database and less of a relationship generator. Some of it is due to legacy technology, which does not enable associates or consumers to interact with the systems. Over the next few years, we believe newer systems will focus more on customer experience, both in a digital and a physical presence for dealerships to expand market share.

Transition to EVs and the agency model

As more auto makers revisit the agency model to cut distribution costs once the vehicle has left the factory, retailers will remain the point-of-sale contact to undertake test drives and handovers and provide aftersales support, but far fewer outlets will be required. The gradual shift to the agency model will also introduce uncertainty and risks for profitability levels. The key risks relate to managing complex, often divergent local regulations and tension between auto makers and dealerships due to potential cannibalisation of profits, especially relating to F&I services. At this point, the agency model impact is still minimal and primarily limited to Europe and EVs.

In addition, retailers will be able to lower many costs with the agency model, including reductions in headcount, large sales commissions and floor plan interest expense as the retailers will no longer have to hold the new vehicles on each lot.  Additionally, without the need to hold large amounts of vehicle inventory, retailers could repurpose their existing real estate for parts and services activities.

We expect the rollout to be faster in Europe where there are less stringent laws regulating the OEMs. In the US legal constraints and the resistance of some retailers could lead to a slower process. However, given Tesla’s success in selling cars without traditional retail outlets, we expect OEMs will get increasingly nimble and adjust their strategies. Given public commentary from the OEMs, we expect their focus will be on rolling out a more direct model for EVs first.

While we expect vehicle margins and finance and insurance (F&I) earnings will be under pressure, service and parts revenue will remain resilient because it’s more closely tied to miles driven and the age of the car on the road (or car parc). Still, as more electric vehicles are sold, the parts and service repairs may shrink, but we think this could be offset to some degree by greater use of retailers rather, than third party repair shops to fix electric vehicles, which are becoming increasingly complex.

As the importance on the quality of aftersales support becomes more critical in the agency model, it is imperative to have DMS solutions that are integrated with OEM data processing systems. This enables retailers to order vehicles and parts, receive vehicle records, process warranties and check recall campaigns and service bulletins. This can all in a seamless manner to sustain competitive advantage within their largest profit generating segment – parts and services.

Cyber risks

Thousands of North American retailers reported losses in recent weeks because of the cyber attacks and subsequent software outages at DMS provider, CDK Global. The cyber attack impacted various services including accounting, inventory management, finance/insurance, cash management, and sales lead management, leading to inefficiencies hampering auto sales and parts service.

Though we viewed this event as credit-neutral from a ratings standpoint as we expect majority of the ‘lost’ sales to be made up, this episode is a wake-up call for the auto industry as losses caused by such outages can escalate quickly and with some permanently lost service and repair work to competition.

To protect against future cyber threats, retailers need to proactively manage vendor relationships, invest in comprehensive cyber insurance and develop robust contingency plans. For instance, retailers that have alternate investments in technology for transactional processing are better positioned to process car deals, complete inventory stock ends in an expeditious manner during an outage. 

DMS providers handle substantial amounts of confidential information, including personal information of employees and customers, as well as data from OEMs, retailers, lenders and major credit reporting bureaus. As a result, their long-term success depends on the ability to store, process and transmit this information securely.