Dealers’ High Profits, Strong Demand Expected to Sink

The recent failure of Silicon Valley Bank and other financial institutions, a consistently falling economic index and turmoil in the stock and bond markets, spells out the likely future of retail automotive—the party is over.

As many general managers and dealers have predicted in the preceding months, the high prices and booming demand for autos—which saw many dealerships selling cars for well over sticker prices — couldn’t last.

“Anyone following the economics the last five-plus years would say this (booming car market) isn’t sustainable,” Karl Brauer, executive analyst, iSeeCars, tells Wards. “Silicon Valley Bank, among others, is proof they were right. There are plenty of similarities between that and the car pricing world.

“You can’t have rising inflation and rising interest rates and rising car prices indefinitely. One of these is going to snap. And I don’t see inflation snapping anytime soon. I don’t see interest rates snapping anytime soon. So that leaves car prices.”

It seems logical that market recovery would naturally come after the chip shortage abated and the end of the pandemic brought businesses back to profitability.
But economic and automotive experts think the faltering U.S. economy means a downturn for automotive retail may come more quickly than predicted, as recently as a month ago.

Sales Prices of Some Popular Models Fall

Although the average new car prices remain almost 9% above the sticker prices, Brauer notes that in July 2022, cars sold for more than 10% above sticker prices. And there are plentiful signs that demand continues to slow and prices keep dipping.

“Chevrolet recently halted production of the Silverado, suggesting supply for this fullsize truck is in the unique post-pandemic status of outstripping demand,” says Brauer. “Other models priced right at MSRP include the Volkswagen Arteon, Cadillac Lyriq, and the Infiniti QX80. The Lyriq is a brand-new electric SUV, so it’s surprising to see it priced right at MSRP.”

Similar battery-electric vehicle models have sold well above sticker price in recent years.

The U.S. government’s recategorization of models that net $7,500 in federal tax credit likely also played a role in Lyric’s pricing, he says.

Brauer predicts dealers will have to cut prices to keep inventory flowing. That can create a market shift as those who would have bought used cars will instead opt for lower-priced new cars. He says that will stall sales for used cars that may have higher loan interest rates than new cars.

“So inflation is going to make it harder to buy big-ticket items, when you spend money on smaller ticket items,” such as groceries, he says. “The high-interest rates mean that not only are you paying more for the car, but you’re also paying more to borrow the money to buy the car.”

And dealers believe the current automotive market is weak. That’s evidenced by the Cox Automotive Dealer Sentiment Index (CADSI), now at 43, well below the threshold of 50. The index remained stable quarter over quarter and down 14 points year over year.

Hope for Recovery

Just before the economic downturns, Jonathan Smoke, chief economist of Cox Automotive, reported hope for a fuller recovery.

“Despite high-interest rates and stubborn inflation, the U.S. consumer continues to prop up the economy,” says Smoke. “Auto sales are slow by historical standards, but the sales pace has improved in early 2023, giving dealers reason to feel somewhat optimistic about the year ahead.”

The overall profit index—a measure of the attractiveness of a project or investment—declined to 42 in the first quarter of 2023, down from 44 the previous quarter and down significantly from 54 a year earlier. Although the profit index reached record highs in late 2021 and in the early part of 2022 –, particularly for franchised dealers, Smoke reports it declined for six straight quarters.

But most of that dip was due to weak profits of independent dealers. And before the economic downturn, Smoke predicted franchise dealers would continue to thrive.

“For franchised dealers selling new vehicles at or above MSRP, the profit picture continues to be very strong,” says Smoke. “The profit index for franchised dealers is down from the records seen in 2021 but still healthy and well above the long-term, pre-pandemic level. Unfortunately, for independent dealers, it’s a different story altogether.”

Whether that will be true for franchised dealers is not known.

Dealers Begin to Prepare for a Downturn

While everyone hopes for a positive economic recovery that leads to profitable auto markets, dealers are preparing for a significant downturn.

That’s wise, says Brauer. Even if the economy recovers, he says high car prices will certainly dip as inventory increases.

One area Brauer recommends dealers closely examine is the prices they pay at auction. Understanding the demand for models and potential sale price before bidding is vital.

Tyler Corder, chief financial officer of Findlay Automotive Group, Henderson, NV, says his company tightened spending several years ago. One strategy is to reduce floor plan costs—the loan that pays for inventory—and ensure stores are not overstaffed. The goal is to ride out a rugged economy and rising interest rates with little or no debt.

“The main thing we are doing to prepare for a downturn is to reduce our debt,” Corder tells Wards. “We’ve been actively reducing our real estate debt for several years. We’re also hoarding cash to pay for capital improvements. The manufacturers are putting tremendous pressure on dealers to spend lots of money on image upgrades and electrification. We are figuring out how to pay cash for all of these projects so that we don’t increase our debt.”