Strategy Upshift: Is the mature captive model facing disruption?

The automotive industry is going through its most fundamental transformation in more than 100 years. A major contributor to its amazing global growth — leading to 1.5 billion cars on the planet — has been a high-performance auto finance ecosystem. On average, 80% or more of any given market of consumers doesn’t pay cash for a car but requires financial assistance either through a loan or lease. Key drivers to all of this are the so-called “captive finance organizations,” carmakers’ in-house financial services operations. Over the decades, captives have become a key strategic weapon in an increasingly competitive auto retail sector, where they have typically seen an overhang of supply over demand. As a result, as the business volume has grown substantially, they have proven to generate abundant profits and attractive returns. Today it has grown into a global trillion-dollar-plus segment in lease assets and finance receivables. It has been stable and lucrative; therefore, it’s no surprise the captive business has become a key pillar of most manufacturers’ business models. Captive financing was originally created out of necessity to reduce dependency on a volatile banking sector that had, depending upon the cycle, more or less of an interest in auto financing. The sales organization at OEMs has come to realize the multiple benefits of an in-house financial services organization. Some of these benefits include the flexibility to tailor special programs, increased speed of execution, and bespoke marketing programs to support the brand — hence the label “captive.” [caption id="attachment_56409413" align="alignnone" width="2560"] © Can Stock Photo / welcomia [/caption] The auto finance ecosystem is familiar with captives playing the major role in providing financial solutions to the end-user customer. They now finance or lease 40% to 60% of all new-car retail sales. This rise in penetration rate was also the result of manufacturers’ increasing requirements for their dealerships to offer highly subsidized lease and loan programs to consumers. It was a symbiotic relationship: Together, they worked hand in hand to keep the car shopper completely in-house from the beginning to the end of the buying experience. Captive financing programs, and the subvention that typically came along with them, were a dealership's bread and butter. While shoppers could come to the dealership with options that were pre-approved from their own banks and credit unions, no other third-party lender could match the appealing financing options being offered through the captive programs, leading to stronger dealer-captive partnerships and increased sales. What’s more, customers found the brand-related services easy to engage with and more trustworthy. Historically, captives’ hold on the market has been rising steadily to nearly 60% in 2020, up from 50% in 2019, and from around 40% market share in 2016, according to Big Wheel Auto Finance Data . A changing dynamic The captive finance model has become a strong source of profit for auto manufacturers and has contributed to high degrees of customer loyalty. All in all, it has proven its strong value to the overall business model. Should it be taken for granted that this enormous market will remain within their reach? In many respects, the captives have reached a peak in their life cycles. While paradigm shifts are taking place with a great focus on ACES — autonomy, connectivity, electricity and shared ownership — there seems to be little to no discussion about the future of the captive finance business model. The environment is changing. New mobility providers are appearing in the landscape and large dealership groups — such as Asbury Automotive , Penske Automotive and AutoNation — are thinking about creating or acquiring their own captive financing companies. Meanwhile, supply-chain constraints and chip shortages are working against the industry in general, creating an unusual situation in which vehicle sales volume is declining and demand has outpaced supply. As a consequence, subventions put into lease and finance programs are declining, as OEMs no longer need to offer these incentives to reach their sales targets. Today, we have a reversal of the traditional situation and a level playing field is being created while we watch. The captive business model is at a crossroads. If dealers are no longer able to offer special financing and incentives, there's no reason for buyers to utilize financing programs being offered in-house. They can come armed with their own prearranged payment plans through their own bank or credit union; these are options that can easily compete with programs they might find at the dealership. If the OEMs see too much business migrate from their captives, they lose volume and, hence, profitability. What’s next? This brings us to a provocative question: Is the captive model as we know it here to stay — or is it time to rethink it? As the future of mobility introduces new options, what’s the next step for car buyers, and what's the future of OEM captive finance programs? Is the captive model as we know it here to stay — or is it time to rethink it?

Are the automakers and their captives ready to become modern-day mobility providers? We know that’s easier said than done. Why? Because if you have a highly successful business model generating high profitability, who wants to invest hundreds of millions of dollars into new, unfamiliar business models, like ride sharing, car sharing, or vehicle subscription services? That is the key question. Now is the time that manufacturers must make pivotal decisions in the boardrooms: When push comes to shove, where should they invest their limited resources? Autonomous? Electric? New digital technologies and services to bring captives up to speed? Many OEM boards would be more inclined to invest in the familiar first two choices rather than the latter. Meanwhile, third-party digital financing companies like Afterpay , Chime and Klarna have set a new stage giving the average shopper more ways to manage their money and more options for those who might be credit-challenged, as well. While these types of third-party products don’t currently offer credit lines that would cover the expense of a car, now that they’ve proven successful on small to medium balances, they're paving the way for other services that could finance larger amounts. Take Upstart , for example. The AI-powered credit underwriting fintech started its services with unsecured personal loans before moving into auto refinance and now has plans to further expand into r etail installment contracts in Q3 . These online short-term installment loan services offer a variety of ways to pay without requiring excellent FICO scores, while also offering flexible plans that may allow the consumer to divide their purchase into smaller payments over just a few months or extend them out to a few years. They offer a solution to consumers who might have a high cash flow but less-than-stellar credit ratings. Learning by example These third-party providers are not necessarily the disruptors, but the manufacturers must learn from their example and come up with their own model if they are going to keep car buyers captive. What are their options? Most of the new mobility models have yet to prove that they are able to generate profitability on a sustainable basis. That makes it difficult for manufacturers to enthusiastically embrace these programs. The indirect financing process at the dealership has worked for American auto retailers for the last 50 years; and even though the industry has witnessed captive market share increase over the past few years, the captive model has reached a level of maturity in today’s marketplace, making now the time to fundamentally change. The captive sector is certainly smart enough to make an effort to be self-disruptors, but are they bold enough to make significant changes to move the business model into new mobility models? In order to continue to play the dominant role, they must embrace new mobility models, be prepared to invest significant capital in digital technology, and radically redefine the customer experience. How else will they retain their stronghold on the buyers and keep the “captives” for the next 50 years? Georg Bauer is president and vice chairman of Autonomy . Auto Finance Summit, the premier industry event for auto lending and leasing , returns October 26-28 at the Wynn Las Vegas. To learn more about the 2022 event and register, visit www.AutoFinanceSummit.com .

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