Business Money – Finance and Banking for Business

Consolidation and the rise of the east

April 2006

Issues facing the motor industry

Terry Hogan

The high cost of car showrooms, the increasing dominance of large dealerships within car retailing and the failure of car manufacturers to adapt to consumer demand is changing the face of the motor industry as we know it, and the future does not look rosy for the car forecourt nor the previously leading car manufacturers.

The majority of dealerships are struggling in the current climate and this is particularly pronounced in London, where high land prices can result in the cost of building a car showroom being around £6-8m. The average “profit” for M25-based dealers in 2005 was –0.6% and, with the national average just 3.5%, it takes a huge turnover just to pay the bills. For many dealers, running a forecourt is becoming prohibitively expensive. Despite the high value of cars, low margins combined with rising showroom rates is resulting in dealerships that simply aren’t making money. Car showrooms are no longer naturally profitable and, as a result, many independent franchise dealers and used car operators are being forced to self-terminate as they can simply no longer afford to be in business. Forecourts are disappearing across the UK, many of which are being replaced with residential apartment blocks, for which the existing planning permission for a car park, often with two exits, makes them perfect for developers who can build upwards and usually receive little objection from local residents.

In the motor industry’s current climate, however, it is not only small-scale dealerships that are struggling. Lookers’ 2005 figures, for example, revealed that from a turnover of £1.23bn the company made only £16.4m profit before tax, figures that would be unacceptable in most industries but are seen as perfectly adequate in automotive terms, making them a takeover target. In fact, a number of medium-sized dealerships are finding themselves targeted by large conglomerates and the takeovers of Smith Knight Fay by European Motor Holdings and Reg Vardy by Pendragon – which has also made a bid for Lookers – are indicative of the developing trend towards consolidation within the car retail industry. Pendragon now owns close to 10% of the car retail market, the largest share in the motor industry, and this is a nod towards the future, which will continue to see the rise of large dealership groups and fewer dealers.

The impact of this consolidation is likely to be twofold. Areas of retail such as the food industry have already witnessed consolidation with the rise of Tesco and Asda and we can use the experience of this sector to assess the likely impact on car retailing. Small dealer groups are the motoring equivalent of the corner shop and, just as they have been affected by the rise of retailing giants, these smaller dealerships will continue to fall by the wayside with the continued growth of leading car groups. The only way this can be overcome is if they make a move towards specialising or enlarging their customer base with an online strategy.

One benefit that consolidation may bring dealerships, however, is increasing the reliance of manufacturers on large dealer groups. Manufacturers and dealers come to the market with very different agendas and dealerships are currently being placed under a great deal of pressure by car manufacturers. The massive overproduction of cars is creating a situation in which dealers are being “encouraged” to take on more stock by manufacturers and are consequently weighed down with vehicles they can’t sell. This is also leading to pre-registration on an enormous scale, which is then hidden by dealers and distorts the market. Although the resulting reduced car prices are great for consumers, the financial pressure being placed on dealers puts them in a difficult position. It is understandable then if these dealers choose to sell the franchise and cash in on their biggest asset – the land they sit on. If consolidation results in more franchises being controlled by one large dealer group, however, manufacturers will be increasingly dependent on that dealer group, rather than the other way round. Although one result for the customer may be rising prices, it will ensure a better service can be provided and strengthen the market.

And changes within the motor industry have not been exclusive to dealerships. Criticisms of failure to adapt to the market or satisfy consumer demand has been levelled at a number of car manufacturers. Ford and Vauxhall are continuing to experience falling sales, producing more than they can sell, whereas Japanese stars continue to rise. Toyota has seen particularly strong growth with its innovative hybrid cars and commitment to manufacturing excellence. It will sell nearly 9 million cars in 2006, making it the biggest car manufacturer in the world and overtaking General Motors (GM). The stock market value of Toyota at £113bn is over seven times that of Ford and GM combined. GM appears beset by problems, from the cost of pensions in the US to falling sales and heavy losses. The sale in April of part of the GMAC financial services division to a consortium of bankers and venture capitalists for $9bn should ease the threat of Chapter 11 bankruptcy and give GM a bit of breathing space to consolidate it’s business.

Prestige manufacturers like Mercedes-Benz and BMW have also lost their shine in the UK market and dealers are being forced to discount heavily to meet targets and gain sales bonuses vital to their profits. The future does not look bright for a number of car manufacturers, and consolidation seems inevitable. It is highly likely that groups will be forced to merge in order to be viable, resulting in fewer leading car manufacturers.

Leading manufacturers are also failing to appreciate the potential online market and the growth of online shopping. Consumers want transparent pricing and lower cost cars, which Internet car retail sites offer, and there has been an increasing move to shop and transact large sums online. But the online presence of the top five manufacturers is poor and it is an area they are missing out on. New-Car-Discount.com, for example, started out less than four years ago but is now ranked higher than any of the top five dealer group websites in the UK by Alexa Rankings and will have 1.8 million visitors to the site this year. Turning over £16m in 2005, the success of New-Car-Discount.com is a good indicator of the predicted growth of the online car market.

A number of changes are afoot for the motoring industry and to survive both dealers and manufacturers must ensure they rise to the challenge of consumer demand and adapt accordingly. Smaller dealerships are likely to struggle with the continued growth of larger groups and the move towards consolidation, although it could benefit relationships between dealers and manufacturers. In addition, we are likely to see future mergers between key car manufactures and the continued rise of the Japanese car market. And we haven’t even mentioned China once – that’s another story altogether!

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Consolidation and the rise of the east