Dealers in Driver's Seat

Most dealers selling extended warranty coverage are content to keep a commission, send the premiums to the insurer and walk away from that part of it.

That's the standard business model and the usual depth of dealer involvement. But a few thousand U.S. dealers do it differently. They're in the extended warranty business themselves. When they sell warranty agreements, they retain the premiums and use that money to leverage their banking with a typically large balance.

It's like self-insurance, with the dealer accountable for reserving enough to cover potential claims. It gives dealers more financial control over a lucrative part of automotive retailing.

It's not for everyone. But nor is it a discomfort zone for dealers who are fiscally responsible and who know what they're doing. Helping about 1,700 dealers with that is First Extended Inc. An admittedly quiet firm, it's the largest independent automotive service contract provider in the U.S.

“This has never been a loud organization with a lot of fanfare,” says CEO Patrick Donahue. “But it's been consistent. We provide professional services and efficiencies and literally put dealers in the extended warranty business.”

Dealers pay First Extended a fee to administer claims and, moreover, to “rent” extensive actuarial data on repair histories by vehicle models. That guides dealers as to what warranty premiums to charge for particular models, factoring in which ones are more or less likely to be back for warranty-covered service.

“Our secret sauce is that we're incredibly disciplined,” says Donahue during an interview at the firm's Dallas office. “We know what's needed as a reserve and how to protect a dealer's funds. We do trend analysis. For example, you know Hondas and Toyotas will do better in reliability than Dodges and Yugos.

“General Motors may know more about GM, but not about Ford, and vice versa. We're non-denominational. We're a ‘pure play’ company.”

Former Dallas dealer Carl Wescott founded First Extended in 1974. He used as a model what he was doing himself at his dealership. He began recruiting fellow dealers, urging them to get more financially active in the extended warranty arena.

Of First Extended's first clients, Donahue says, “The dealers who signed on 30 years ago were risk takers because that's what really attracted them to automotive retail in the first place. The idea for it started out as a promotion. If you were selling a three-year warranty, and threw in an extra year for free, the question became, ‘How much do I need to put aside to cover that?’”

Today, the risk is less, largely because of the vehicle-reliability data tracking. It helps dealers set warranty prices based on potential repair costs. The dealer assumes that liability.

“There's nothing easier than volume if you're willing to offer any price,” says Donahue. “But there's no risk if you price yourself properly based on the vehicle actuarials. That's intelligence. Everyone else protects it. We're open about it. So the dealers are better informed. All the secrets go away.”

Aon Corp. acquired First Extended for nearly $100 million two years ago. Donahue, CEO of Aon's Resource Group at the time, became head of the new holding.

He calls it a good fit for Aon. Aside from being a “trophy acquisition,” it doubles Aon's service contract volume, expands its offerings and provides access to an independent agent network opposed to Aon's salaried sales staff.

Donahue is the son of an insurance-broker father and a mother who raised six kids in metro Chicago. Their second oldest worked three paper routes as a boy. He earned a degree in accounting from Northern Illinois University.

“After graduating in the mid-1970s, I gravitated to automotive retailing,” Donahue recalls. “It's dynamic and offers great opportunities. And I've always loved anything motorized.” (He began with a motor bike bought with paper route earnings; his vehicle ownerships today include three Harley Davidson motorcycles.)

It didn't take long for the young college graduate to find Pat Ryan of Pat Ryan & Associates, who later founded Aon. Ryan pioneered F&I as a designated dealership department.

Says Donahue of his 29-year employer, “Pat Ryan is the person you'd pick out of a crowd as a leader if something occurred where you needed leadership. If nothing occurred, he'd find a reason to lead. He's charismatic and ethical.”

The son of a Milwaukee dealer, Ryan “was always interested in sales, but liked the financial side best,” says Donahue. “He showed it pays to dedicate dealership staff to F&I. The business has evolved today to the point that dealers couldn't survive without F&I.”

Donahue says First Extended is efficient and self-discipline, and looks for dealer clients of the same mind.

“You can't just jump in with someone who wants a lot of cash flow,” he says. “So you end up with more consistent, more hands-on dealers; people who manage different segments of their dealership. It takes it to the next level. And this is an important one.”