The last frontier: Dealers focus on aftermarket as margins shrink

Declining vehicle margins have dealers increasing their focus on a main profit center: the finance and insurance office. Lenders, meanwhile, are watching pricing dynamics as digital financing takes hold. [caption id="attachment_58337611" align="aligncenter" width="1600"] (Photo/Canva) [/caption] Finance and insurance (F&I) revenue, specifically aftermarket product sales, is often the “last frontier of gross profit for the dealer,” and as vehicle profitability declines, F&I will be a core focus of the industry, Zach Williams , manager of virtual F&I at JM&A Group , told Auto Finance News at the National Automotive Dealers Association (NADA) Show in Las Vegas on Feb. 2. Deerfield Beach, Fla.-based JM&A is a subsidiary of JM Family Enterprises . “Transaction prices are coming down, inventory is coming up, incentives are coming [back], so the second half of the year is going to be a margin compression conversation,” Williams said. As vehicle profitability shrinks , large public dealerships have indicated F&I is a concern amid high costs and elevated interest rates, Rick Kurtz , senior vice president and chief distribution officer at F&I solutions provider Protective Asset Protection , told AFN at NADA. “We see the downward pressure on F&I; it's cyclical and temporary,” he said. “As interest rates go down and consumer affordability eases as inflationary pressures are reduced, it'll come back around.” Retailers’ F&I revenue was mixed in the third quarter of 2023 , up year over year at Group 1 Automotive , Lithia Motors, Sonic Automotive and Penske Automotive but down YoY at Asbury Automotive . The trend has continued across retailers that have reported Q4 earnings. Group 1 and Penske’s F&I revenue ticked up YoY while Asbury saw a 10.2% YoY decline in F&I revenue, according to the retailers’ earnings releases. Compressed margins prompt aftermarket focus Compressed margins are a concern for dealers, and increasing F&I attachment rates is a reliable tool for propping up profits. F&I revenue accounted for an average of 23.8% of publicly traded dealership profits in Q3 2023, second only to the parts and services business, according to an AFN analysis of retailer earnings releases. Total retailer profit per unit, including vehicle gross profit plus F&I income, is projected to fall 28.5% YoY in January to $2,817, driven by a reduction in the number of vehicles sold above MSRP, Thomas King, president of the data and analytics division of J.D. Power , said during the company’s Jan. 26 sales forecast. “Thus far in January, only 18.5% of new vehicles have been sold above MSRP, which is down from 33.1% in January 2023," he said. Profits fell throughout 2023. The average publicly owned dealership made an estimated $5.4 million in the 12 months through September 30, 2023, a decline of 17% compared with yearend 2022, driven largely by rising floorplan costs and shrinking margins as supply increases, according to the latest report from dealership buy-sell adviser Haig Partners . Still, most dealers saw an increase in aftermarket product sales on a YoY basis in 2023, including vehicle service contracts, appearance products, tire and wheel protection, guaranteed asset protection (GAP) coverage and prepaid maintenance, according to survey data F&I provider Protective Asset Protection gathered in 2023 from 350 dealership executives. That data specifies: 41.6% of participating dealers indicated F&I product sales rose between 5% and 10%; 36.7% said F&I sales increased more than 10% YoY; 13% said F&I product sales were unchanged YoY; 4% reported that F&I product sales declined between 5% and 10% YoY; and 4% saw F&I product sales fall more than 10% YoY. The percentage of buyers who purchased at least one ancillary product also rose to 68% in 2023, up from 67% in 2022, 59% in 2021, and 55% in 2020, a Cox Automotive spokesperson told AFN , citing survey results gathered in 2023. Top protection products purchased, according to Cox, include: extended warranties; maintenance plans; GAP coverage; service contracts; and tire/wheel protection. Consumers opt for cheaper products While aftermarket product sales are strong, affordability challenges are prompting a change in consumer preferences and a decline in F&I gross profit. In fact, F&I gross profit per unit averaged at $2,271 across publicly traded auto groups in Q3, down 2.5% sequentially and 4% YoY, according to Haig. Consumers still are purchasing add-on products but are being mindful of what they buy, Shirley Jones , chief financial officer at Car Pros Automotive Group , told AFN at NADA. The dealership has seen a decline in gross profit margins compared with the past two “extraordinary” years as costs rise, she said. The group has nine locations across California and Washington, according to its website. “Our customers are continuing to buy a lot of aftermarket products, but they are minimizing their purchases of accessories — running boards, mudguards, window tinting,” Jones said. “They're keeping to those core service contracts, GAP and maintenance.” [caption id="attachment_58337612" align="aligncenter" width="1600"] (Photo/Canva) [/caption] Consumers’ access to disposable income is also constrained to “a greater degree than ever before,” Protective Asset’s Kurtz said. “You have this dynamic of ‘Can they afford a multi-thousand-dollar service contract when the interest rates and the price of vehicles are where they're at?’” he said. “Maybe it means instead of [offering] the most comprehensive level of coverage, it's covering only the major mechanical components.” Tech-focused service contracts trending The industry is also seeing adoption of service contracts specific to the vehicle’s technology as cars become more tech-heavy, Kurtz said. A failed back-up camera, for example, can cost a consumer thousands of dollars to fix, he said. “We are experimenting with tech-specific coverage,” Kurtz said. “Some consumers will say they trust the mechanical reliability in [their] vehicle, but [they] can't afford the tech piece to go down." In fact, 46% of dealer respondents in Protective Asset’s 2023 survey said technology features were a top reason consumers purchased voluntary protection products. Electrical components were the most common driver of product sales, while others included emergency roadside services along with secondary and major mechanical components. Consumer F&I preferences are largely similar across financial institutions, credit unions and other lender types, as well as across auto, powersports, and marine industries, Kurtz said. The F&I market is “becoming homogenized in terms of consumer demand and expectations,” he said. Pricing risk rises As dealers look to boost financing penetration rates and the sale of ancillary products, auto lenders must pay close attention to shifting trends to manage risk, AI-based auto lender Lendbuzz Chief Executive Amitay Kalmar told AFN at NADA. Aftermarket products are “a big part of the dealership profit center these days,” he said. “We're trying to support the sale of aftermarket or F&I products to ensure that the structures make sense, and the consumer is protected. You don't want to get the consumer into a deal structure that in two or three months, they're going to struggle.” Lenders generally provide guidelines to dealers on how much in aftermarket products they can add to the approved finance amount, Kaitlin Gavin , vice president of operations, titling solutions at Cox Automotive, told AFN . “ When it comes to funding the deal, validating aftermarket products is a critical step the lender performs prior to purchasing contracts for dealers,” she said. “ When it comes to funding the deal, validating aftermarket products is a critical step the lender performs prior to purchasing contracts for dealers.” -- Kaitlin Gavin, VP of operations, titling solutions, Cox Automotive Boston-based Lendbuzz is conservative on the financing allowance it provides dealers for add-on products and is largely focused on keeping the monthly payment within the customer’s budget, Kalmar said. “This needs to be the focus of dealerships — not stretching the consumer in terms of monthly payments — and get the consumer a product that protects them and is going to help them when the car breaks down,” he said. Despite tightening credit criteria in general during the past year, Lendbuzz hasn’t had to pull back on its dealer allowance much, Kalmar said. “We weren’t the most aggressive on the allowance we provide the dealership, so we didn’t have a lot to tighten there,” he said. “Some lenders were too aggressive and wanted to capture business and allowed for too [much of an allowance for] F&I dollars. That created weaker credit performance for a consumer that couldn’t afford the monthly payment.” Lenders challenged by limited data Determining add-on product allowances and gauging the ancillary product market are challenges for lenders. The number of aftermarket products combined with the variation in how products are priced and packaged — based on company, region and state — make it difficult to define the size and makeup of the ancillary product market, Cox Auto’s Gavin said. “Similar to many industries, the automotive industry suffers from an abundance of complexity and a lack of consistency when it comes to standardized business metrics for F&I products,” she said. The information available on the ancillary product market is largely based on data gathered from surveys, even for the largest aftermarket product providers. Further, variations in the price of products, such as GAP insurance, make it difficult to determine an industrywide average for individual products or to measure the market, Tyler Gray , director of sales at Lender Compliance Technologies (LCT), told AFN . These variations are due to differences in lenders’ back-end allowances and caps on financing for add-on products, state caps and state-by-state sales requirements. “No car deal is the same,” he said. “You’re negotiating the deal; a lot of dealer groups have internal caps on [GAP sale price].” “No car deal is the same." -- Tyler Gray, director of sales, Lender Compliance Technologies LCT provides automated compliance solutions for auto lenders, including tools to properly calculate GAP refunds and track and manage product cancellations. The company works with 21 lenders, including captives, credit unions, finance companies and fintechs, with captives providing the most volume, Gray said. Whether GAP is offered on an indirect loan versus a direct loan also makes a difference in cost, Gray said, noting that GAP costs between $400 and $1,500 on indirect auto loans and between $200 and $400 on direct loans. An estimated 40% to 70% of a dealer’s transactions include GAP coverage, while the number of aftermarket products purchased per deal averages between 1.5 and 1.75, he said. Ancillary products are also often bundled together and may be counted as a single product or multiple products, Protective Asset’s Kurtz said, noting that the company tracks products per transaction at the dealership level. The growth of digital F&I may bring more transparency to the industry, Kurtz said. Consumers want more control in the shopping and financing process, he said. “They want to start it one night at 1 in the morning, and then pick it up two days later at 3 in the afternoon, and eventually make it into the dealership,” he said. Virtual F&I gains steam With inventory building, consumers have more choices in vehicles, prompting dealers to focus on the customer experience and the features and benefits they can provide to be competitive, Kurtz said. Digital retailing and virtual F&I capabilities can provide flexibility for consumers, JM&A’s Williams said. “In today's modern convenience economy, people want a transparent, authentic and simple process,” he said. “At the heart of that is putting the customer at the center and empowering them to make [purchase decisions].” "People want a transparent, authentic and simple process. At the heart of that is putting the customer at the center and empowering them." -- Zach Williams, manager of virtual F&I, JM&A Group More than half of dealers who participated in Protective Asset’s survey indicated that offering F&I products online can help drive sales, while 68.5% said they favor allowing consumers to research F&I options digitally. Still, 53% of respondents said they remain concerned about an F&I manager not being present to answer questions and 11% said they will only allow customers to purchase aftermarket products at the dealership. “By enabling [ancillary product] knowledge for the consumer earlier, we found that helps dealers control more of the financing,” JM&A’s Williams said. “If we serve the information to customers, they show less propensity to go into their credit union or bank.” Of consumers who shopped at a dealership that listed aftermarket product information online, about 40% added an F&I product when going through the sales process in a case study conducted by automotive technology platform CarNow , Bob Lanham , senior vice president of retail development, told AFN at the NADA conference. “Some dealers will load their offerings into the digital retailing tool so the consumer can click and add it to their payment and know exactly how much the additional payment is for those products. Some dealers will add the offerings but not the price, while [others] won’t have the F&I products displayed [online],” he said. “Progressive dealers are starting to understand that if I put the consumer in control of the deal, it's a much better experience for both parties.” Digital drives F&I profits Dealers employing digital tools have reported higher F&I profits. “Anytime you can streamline the customers' experience and show value, it has increased our customer's awareness and sales of our aftermarket products and F&I.” -- Shirley Jones, chief financial officer, Car Pros Automotive Group One late 2023 Cox Automotive digitalization study found that 90% of dealers surveyed indicated positive outcomes when using digital tools, with 61% of those respondents specifying that digitalization drove higher F&I profits. “The tides are turning. COVID opened up a lot of dealer mindsets in enabling greater use of technology and digital sales tools,” JM&A’s Williams said. “We’re starting to see more dealers move towards that progressive funnel and willing to share information … in different ways.” Dealers utilizing JM&A’s virtual F&I capabilities, which allow consumers to work with an F&I manager remotely, see an average $106 increase in per vehicle retail profitability compared with traditional in-person transactions, Jonathan Jordan , director of retail strategy at JM&A, told AFN . JM&A completed more than 30,000 transactions through its virtual F&I platform in 2023, according to the company. “The virtual process is putting a highly capable, trained F&I manager in front of every customer, regardless of where that customer is,” Jordan said. While digital can improve F&I profits and aftermarket product sales for dealers, strategies on how to present ancillary product offerings vary from dealer to dealer, Protective Asset’s Kurtz said. “Some are adamant that they want to expose the consumer [to aftermarket product information] as early as they possibly can,” he said. “Some want to wait until they see that there's interest from the consumer. Some fear if they expose the consumer too early, then it's too much.” Car Pros Auto, for one, uses Darwin Automotive ’s digital retailing and F&I software, Jones said. Darwin is owned by J.D. Power and provides F&I menu software and tools for customers to select vehicle financing and protection options, according to J.D. Power. “Anytime you can streamline the customers' experience and show value, it has increased our customer's awareness and sales of our aftermarket products and F&I,” Jones said. Dealerships must educate consumers on ancillary products as well as present information sooner in the sales process, Jason Swiech , manager of F&I product marketing at automotive technology retailer CDK Global , told AFN at NADA. CDK’s research shows that dealerships see a 15% increase in F&I product sales when they present information digitally, he said. Ancillary products key in 2024 Aftermarket revenue has always been core to dealership operations, but market conditions over the next year will prompt an even greater focus on back-end profitability. “It’s going to be an interesting year because inventories are continuing to rise, incentives are starting to come back, and with affordability still a concern, F&I products are going to be key because consumers are looking at their budget differently,” JM&A’s Williams said. “Consumers are going to hold their vehicle longer so it’s more important that the protection products are there.” Early-bird registration is now available for the second annual Auto Finance Summit East 2024 , May 1-3 in Nashville, Tenn., which gathers lenders, dealers and fintech innovators in an event designed to bring the power of technology to a cross-section of industry players. Early-bird pricing ends March 15. Visit AutoFinance.Live to learn more.

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