‘Winning’ Means Surviving in Today’s Auto World
What segments in the vast automotive ecosystem will make it through the crisis?
May 18, 2020
As COVID-19 wreaks havoc across the globe, it is also fundamentally disrupting nearly every industry. The automotive sector, along with others such as aviation and hospitality, is near the top of the list of the hardest hit.
Unfortunately, the impact is already deep and far-reaching across the ecosystem, with car sales in April down 50%, used car values plummeting by 18%, and car rentals down a whopping 75% year-over-year, according to TrueCar, Manheim and Hertz respectively.
woman looking at car_1
While it is unlikely that all industry players will make it through (at least without tremendous government assistance), is there any hope? What will it take to be a “survivor” in the automotive arena as we adapt to our “new normal”? Let’s explore how some key segments of the automotive ecosystem will be affected moving forward.First, what are the fundamental forces affecting the industry? Here are the prevailing trends and impending factors:
Used-car values still have room to drop in the immediate term. With a mass influx of supply likely to flood the market as rental car companies and dealers seek to cut their losses, coupled with limited disposable income among consumers, market forces suggest used-car values will continue to fall in the coming months.
Government incentives are likely but will target new car sales and leases. Think “Cash for Clunkers” 2.0. U.S. legislators and automotive industry executives are actively discussing policy to promote new-car sales. Expect consumer incentives in the near term that are likely to support OEMs and have a strong environmental angle.
Consumer demand for cars may actually increase in urban areas globally, but will pull back in others. Public transit poses a significant health risk in the era of social distancing; people will seek safer alternatives. As was seen in Wuhan, China post-quarantine, cars sales may actually increase in urban areas in the immediate term, whereas areas where car ownership per capita is already high are unlikely to see a similar increase.
Digital retail will transform car buying and ownership. Some dealers have been resistant to the trend despite a strong push from OEMs and the emergence of ecommerce platforms such as Vroom and Carvana. However, the current reality makes automotive e-retail a near-necessity.
Manufacturing will be sub-scale. Putting aside demand concerns, the need for social distancing and the lure of sizable unemployment benefits (at-least in the short term) will make resuming manufacturing at scale near impossible, not to mention the global footprint and impact of COVID-19 as it relates to many OEMs and suppliers. Manufacturers need to prepare for reduced volumes.
So, what do these trends mean for different members of the automotive ecosystem? Will we see survivors, losers or both in each of them?
OEMs – Survivors
While the immediate outlook is unmistakably bleak, expect new-car sales to be propped up by well-funded government programs (similar to 2009’s Car Allowance Rebate System) incentivizing consumers to trade-in older and lower MPG vehicles for newer and more environmentally-friendly models.
With credit facilities taking on residual value risk, OEMs at least have a path to generating meaningful revenue in the near term. As far as American OEMs, Tesla is particularly positioned given their competitive advantage in electric powertrain technology, digital retail and a highly integrated supply chain. GM is also well positioned given their strong position in potential high-growth markets such as China.
Lenders – Both Survivors and Losers
With used cars taking a residual value hit and the potential for high default rates among consumers and dealers (particularly smaller ones), the collateral for vehicle leases and floorplans just isn’t there.
Large lenders such as Ally should be able to weather the storm given their portfolio diversity, however the credit arms of major OEMs (e.g. Ford Motor Credit) are in big trouble with a book of business entirely tied to vehicle residuals.
Suppliers – Both Survivors and Losers
Suppliers will have a similar fate as the OEMs by and large, with one key difference. Those that make components which are heavily contented in current and impending vehicle programs have a path to immediate term revenue. Those which are focused on R&D support and new-vehicle development are in trouble, as OEMs will likely delay R&D spend in the near term. Expect to see some supplier consolidation over the next 18 months.
Auction Houses – Survivors
At the moment, auction houses are reeling as consumer demand for used cars has tanked as many states have enforced shelter-in-place orders.
manheim detroit resized
In many cases, auction operations have been temporarily shut down altogether. However, auction companies generate revenue from fee structures which are largely fixed (i.e. do not depend on vehicle value), and therefore despite a reduction in used-car values, trading volumes may actually increase in the coming months as supply floods the market. (Manheim auction, Detroit, left)Manheim and KAR should be able to breathe a sigh of relief soon.
Rental Car Companies – Losers
Of all players in this ecosystem, this segment has the worst outlook.
The perfect storm of lost demand (U.S. travel, where rental car companies generate significant business, is down 95% according to the TSA), rapid asset value depreciation and high fixed costs (rental car companies’ physical retail footprint is massive) makes for a short runway.
Debt is unlikely to help here for a low-margin business with unlikely revenue in the near-term. Without a generous government lifeline or a change in business model (e.g. vehicle subscription/leasing), bankruptcy seems likely (unless companies have cash reserves to cover at least 12 months, which Hertz and Avis, America’s two largest players, don’t have at the moment.
Dealers – Both Survivors and Losers
In a highly competitive space with many participants, we’ll see many survivors and losers here.
In the best positioned to survive are those with cash on hand to weather the storm, a vehicle-service business to support revenue and the mindset to embrace e-commerce.
Smaller dealers reliant upon used-car sales are at the greatest risk, as are any dealers resistant to change.
Tarun Kajeepeta _3
While the outlook is undeniably bleak, I’m hopeful the desire to survive will drive some much-needed innovation and risk-taking on technology and business models for many segments of the automotive industry. (Wards Industry Voices contributor Tarun Kajeepeta, left)In times such as these, there are no guarantees or constants. Those who take risks and act swiftly will position themselves best for survival and earn the opportunity to participate in the new order that will drive the industry forward.
Tarun Kajeepeta is an automotive consultant and co-founder and principal at Piquette Partners, a Detroit-based investment firm. He can be reached at [email protected].
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