What, If Not Markups?

As a teenager driving my parents' car, one of my fears was going somewhere I wasn't supposed to go and getting a flat tire.

Flats were evidence I had gone beyond the parental boundaries imposed on me as I looked for fun. Looking back, getting flats (and the parental “guidance” that went with them) encouraged me to stay out of trouble.

It looks like “flats” are once again the evidence of boundaries pushed too far, according to a new study on auto dealership interest rate mark-ups. But maybe that's not so bad either.

Numerous dealers and lenders have been sued during the last two years, including Nissan Motor Acceptance Corporation, General Motors Acceptance Corporation, and American Honda Finance Corp, for allegedly discriminatory lending practices.

Lenders and dealers have been accused of applying loan rate mark-ups differently depending on customer, thereby discriminating against certain types of customers who may not be aware of their ability to negotiate loan interest rates.

Two primary solutions have been devised to address this matter: interest rate caps, which limit the mark-up a dealership can add to a loan interest rate; and flat fee commissions paid for each loan.

The former method still carries the potential for discriminatory pricing. The latter does not. It is therefore expected that lenders will eliminate interest rate markups, replacing them with flat fees paid for each loan they process on behalf of an automobile dealership.

The study is called “The Lenders' Challenge: Moving from Automotive Finance Margins to Flat-Fee Financing.”

It is based on one-on-one interviews with dealership owners, general managers, and finance managers representing more than 230 franchises.

It includes research findings, details challenges in transitioning to flat-fee financing, and offers recommendations to lenders on how to make this transition with their dealer clients.

Some highlights of the report:

“The vast majority of automotive retailers maintain a very reasonable profit on interest rate mark-ups of $400 per contract. The problem is they don't earn their profit in a consistent manner,” says the primary author of the study, Mark Rikess, president of The Rikess Group, a dealership consulting firm in Burbank, CA.

He adds, “Many customers pay less than the $400; a few pay much more. Sometimes income is generated almost exclusively in the finance department, rather than being balanced with profit from vehicle sales. That is why inconsistency, not profitability, is the real enemy in this equation.”

The study says that the dealers who favor a flat-fee see benefits for both their stores and the industry in general. A number of respondents also feel the retail auto industry is taking a lot of image hits because of a few bad apples.

Virtually all interviewed stakeholders feel interest-rate scrutiny is just the beginning for lawyers and regulators. The dealership people surveyed say other finance & insurance services are the next logical places for lawyers and regulators to look for alleged unequal customer treatment.

Many dealers in the past have given up trying to earn gross profit on the sale of the vehicle itself. But gross profit on vehicle sales must increase to counteract lost earnings from financial services products. Otherwise the pressure will only get worse in the F&I office.

Don E. Ray is a CPA with the Dixon Hughes Dealer Services Group. He's at 901-684-5643 and [email protected].