How To Prepare For A Down Cycle?
We all know it; our industry is very cyclical, and we need to anticipate ups and downs. All indicators are clear, and the industry data confirms that retail sales are experiencing a generalized decline. As I write this article, retail sales have decreased by 4.1% during the first quarter of 2019. For the past 12 consecutive months, monthly sales results have been lower in comparison to the same period last year.
Margins are so thin in the auto sales industry that the effect of a reduction in business volume can be felt very quickly on profitability. Over the past 10 years, OEM’s across North America, for the most part, have been growing, and that growth has driven increased profitability for the majority of automotive dealers. However, for most, the wind seemed to have turned in 2018, and the effect on profitability is already being felt. Indeed, the profitability of several dealerships was significantly affected between 2017 and 2018 with a simple decrease of 2.8% in the industry. Why? Because it is easy to increase spending to support a growing volume of business, but it is extremely difficult to reverse the rise in expenses when sales are stable or decreasing. The good news is that automotive dealerships are usually very resilient businesses that withstand cycles, and it is possible to prepare to minimize damages.
TIGHTEN YOUR BELT
Easy to say, but difficult to do; this involves making difficult choices. It is essential to understand the nature of your expenditures in order to adjust to declining demand. In times of growth, dealers often increase expenses proportionately to sales revenues. It will now be time to do the opposite. This means reviewing all contracts with the largest suppliers and cutting out discretionary spending that does not have a direct impact on sales.
FIXED AND VARIABLE COSTS
It is important to understand the nature of our spending in order to make good decisions. Companies with a high percentage of variable costs such as inventories, commissions and bonuses have a considerable advantage over companies with a high percentage of fixed costs; they are inherently more flexible. It is therefore essential to implement employment contracts promoting employee performance with incentives based on margins and generated revenues.
HAVING THE NECESSARY LIQUIDITY
(FILL UP THE PIGGY BANK)
The heart of the matter in business is to have the necessary liquidity to deal with the unforeseen. An important element to establish is a cash surplus; this will allow you to get through more difficult times. The effect of a downward cycle will be exponential on a company that has not filled its piggy bank to tackle more difficult months. The excess liquidity will allow you to continue to maintain a compelling inventory to meet demand, especially for the used vehicle sales department. Lack of liquidity is a double-edged sword that puts a lot of pressure on managers and prevents the company from implementing the initiatives required to increase profitability.
During a down cycle of new vehicle sales, there can be other growth opportunities. The largest, and often the least leveraged by new vehicle sales dealerships, is the used vehicle sales department. Used retail sales are fast growing in North America. Margins can be excellent for those who put much effort into developing a winning formula. It is often the department that can make all the difference for a dealership’s profitability and that could allow you to grow profits during a more difficult period in the new vehicle sales department.
A decline in new vehicle sales does not necessarily mean a decrease in fixed operations. In fact, the effect of the decrease in sales volume will take much longer to impact fixed operations as dealerships are currently benefiting from sustained sales growth which persisted for many years up until 2018. It is time to review processes in place and improve the department’s performance ratios in an effort to increase the gross margin as well as revenues per repair order.
Cycles are inevitable. It is impossible to predict their duration and magnitude, but it is possible to prepare for them. With the right strategy to control costs as well as a good mix between defensive spending control strategies and offensive growth strategies for other departments, anything is possible, even an increase in profitability!
Maxime Theoret, DSMA CFO, Maxime@DSMA.com