Anatomy and Physiology of the Used Car Business

[Pages:32]the way we see it

The Anatomy and Physiology of the Used Car Business

A Global Analysis With Particular Reference to Four Key Markets: U.S., Canada, France, Germany

Contents

Introduction

3

Executive Summary

4

Market Overview: Highly Contrasting National Markets

7

Global Trends Affecting the Used Car Business

12

Comparative Analysis of the Four Markets

15

Success Strategies in the Used Car Business

23

Conclusion: A New Approach to Used Car Sales

30

Acknowledgments The data contained in this report was collected by the Car Internet Research Program II (CIRP II). All analysis and interpretation of the research and data has been made by CIRP II in collaboration with Capgemini. The research and writing of this study was led by Professor Christian Navarre, together with Alina Kotov, Lihsin Hwang, Jean-Yves Barbier and Magdalena Jarvin. Translated from the original French by Karen Twidle.

The Car Internet Research Program II is sponsored by: Capgemini, PSA Peugeot Citro?n, Renault SA and The University of Ottawa.

? 2007 Car Internet Research Program II and Capgemini. Reproduction in part or in whole is strictly prohibited.

Introduction

Automotive the way we see it

Until recently, car manufacturers and dealers have tended to focus on their new vehicle business to the exclusion of used cars, often viewing the used vehicle trade as an unwanted byproduct of new car sales and a necessary cost of doing business. It seemed obvious that new cars, with their higher sticker prices and wealthier buyers, should be the focus of dealers' sales efforts. Incentives have beeen used to move the new car inventory, which was tirelessly promoted by both dealers and original equipment manufacturers (OEMs).

Over time, however, competition in the new car market has resulted in a surprising new state of affairs: used cars have begun to add more to dealers' bottom lines than sales of higher-status new cars. Moreover, as the quality and reliability of used cars have grown, consumer attitudes have also evolved. As a result, manufacturers have begun paying greater attention to the crucial role used vehicle management plays in improving residual values, new car sales and the building of manufacturers' brands. This attention is likely to continue to grow; indeed, investing in used car management is increasingly becoming a necessity in a market characterized by relentless competition, slimming margins and ever more demanding consumers.

This report examines the used car business worldwide, with a particular focus on the United States, Canada, France and Germany, to find out what drives the used vehicle business, how and why OEMs and dealers compete

in it, and how they can be more successful in taking advantage of the opportunities it offers.

Indeed, these opportunities are vast: Fueled by greater longevity, the used car market worldwide has grown significantly. In France, for instance, used car unit sales increased from 4.7 million to 5.4 million between 1990 and 2005, at the same time as new vehicle sales declined from 2.3 million to 2.07 million units.1

Franchised dealers' used vehicle operations now act as a hedge against uncertainties in the new vehicle market and even support new vehicle sales. Moreover, the management of used inventory can have a significant impact on a brand's image and residual values, making it more important than ever for manufacturers to take an active role in their dealer network's used vehicle management.

In short, the used car business is here to stay. With declining margins in the new car business and the aging of vehicles on the road, it is likely to be a growing and increasingly important component of franchised dealers' sales, both in North America and in Europe.

This report provides a detailed picture of the used car business and its role in the global automotive industry.

1 Comit? des Constructeurs Fran?ais d'Automobiles (CCFA).

The Anatomy and Physiology of the Used Car Business

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Executive Summary

Buying a new car is the end point of a process that, on average, takes six months2 and involves much research and complex decision-making. In the past, the power struggle between customers and dealers generally played out in favor of the latter.

The development of the Internet has changed the power struggle between dealers and consumers. Buyers can now potentially gain the upper hand. Customers are increasingly knowledgeable about cars, their quality, residual value, prices applied, finance charges, availability, and, more and more frequently, the exact profit margin that the dealer makes in closing a deal. Dealerships have had to adapt. The most shrewd and dynamic have managed to turn customer intelligence to their advantage, by focusing on what consumers really want, namely transparency and respect. (For more on this, see "Inside the Customer/Dealer Relationship," published by CIRP and Capgemini, 2006.)

Has the used car market changed in the same way as the new car market? Although in some countries, used car sales represent two or three times the volume of new car sales, there are very few studies that fully explore the used car business.

The four main countries were chosen for this study for the following reasons:

The United States and Canada are part of an integrated economic system, with the majority of the population speaking the same language and affected by similar trends, constraints and influences. The same brands are found in both countries, with competition around the same models. Distribution is also carried out in both countries by the same system of exclusive dealerships.

France and Germany both work within the same European regulatory framework in terms of car distribution. The two countries have strong national traditions in the automotive industry and develop brands that have worldwide coverage. Distribution networks are well developed.3

Key Findings Our research identified a number of key findings that characterize the development of the used car business:

The importance of the used car market is growing significantly. In both the U.S. and France, for example, the used-to-new vehicle ratio (which demonstrates the level of used market activity) has increased since 1999 from 2.4 to 2.6, showing a steady growth of used vehicle sales by volume. In addition,

used vehicle sales in the U.S. are today more than twice as profitable for dealers as new vehicle sales (roughly 2.7% profit margin, compared with 1.2%). Moreover, the used vehicle financing and insurance segment is often the most profitable operational unit of a franchised dealership, posting 11.3% profitability in 2005 in the U.S.4

The key to growth will be transparency and symmetry of information, as consumers continue to apply the same approach to research and collection of information in their search for used vehicles as they do in the new car buying process. We expect to see greater use of the Internet, more savvy consumers and more product proliferation. As with new car sales, the relationship between dealer and customer will need to be based on respect and trust, as well as ease of purchase. Such a symmetrical relationship will presume that buyers and sellers possess the same information by which to determine a product's quality. For example, the growth of CarMax has been partly attributed to this approach.

The Internet is increasingly becoming the information source of choice for used vehicle buyers. Although consumers still use local

2 CNW Marketing Research, Inc., Purchase process Wave IX. 3 In the case of Europe, and for a small number of variables, there are differences between data stemming

from two main sources: Datamonitor and the ICDP research program. These differences are explained where necessary. 4 CNW Marketing Research, Inc., Document 925: Profit margins at dealerships.

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Automotive the way we see it

newspapers and word-of-mouth when researching used car purchases, they are turning to the Web in increasing numbers, highlighting the importance of having a strong Internet strategy for used vehicle programs. A recent study from J.D. Power points out that more than twice as many late-model used vehicle buyers in the U.S. find the vehicle they purchase through the Internet than through both newspaper and magazine classified ads combined.5 Dealers that have focused more attention on multichannel communication strategies are beginning to reap benefits, with an increasing number saying their Web activities have improved sales and extended their trading range.6

The maturity of the used car market varies considerably according to country, and geographic proximity does not necessarily result in similar used car markets. It was initially hypo-thesized that the markets in Canada and the United States would be similar to each other and different from the French and German markets. However, in many cases these relationships did not hold and surprising patterns emerged. Each national market has its own peculiarities, which are a combination of socio-cultural, economic and historical circumstances. For example, the used-to-new ratio is similar between France and the U.S, with Canada being surprisingly low.

The most important success strategy in the used car business may be the development of trust-inducing initiatives such as certified used vehicle programs. These programs provide the best protection against channel competition and allow dealers to improve margins significantly while offering an additional source of revenue for OEMs. In the U.S., where the certified vehicle market is strongest, sales of manufacturercertified vehicles have more than tripled between 1997 and 2006, totaling approximately 1.5 million units in 2005. Other countries are moving in this direction as well.

Franchised dealers are in a strong position to benefit from growth in the used vehicle market, supported by OEM involvement in marketing and certification programs, access to high-quality off-lease vehicles, online inventory pooling and a more professional image in the mind of the consumer. In the United States, franchised dealers earned higher gross profits on used vehicle sales than independents,7 had the highest closing ratio (with 44% of visitors making a purchase, compared with just 27% for independent dealers),8 and benefited from signif-icantly greater customer loyalty,9 with more repeat customers across all vehicle age groups.

5 J.D. Power and Associates, 2006, Used Study. 6 Waller, Hwang and Navarre, "The 335 Kilometer Franchise," CIRP (Car Internet Research Program),

November 2005, p. 32. 7 CNW Marketing Research, Inc., Document 34: Gross profit: Used vehicles. 8 CNW Marketing Research, Inc., Document 197: Shoppers who became buyers ? new, used. 9 CNW Marketing Research, Inc., Document 997: Used vehicle loyalty to dealership.

The Anatomy and Physiology of the Used Car Business

5

 Used and new vehicle sales are interrelated and complementary; both are a function of dealer excellence. Successful dealerships tend to have strong sales in both the new and used vehicle departments. An American study found that new vehicle sales per dealer correlated positively with used vehicle sales, despite the counter-cyclical nature of the used car business.10

Management of new car incentives is critical to ensure profitable used and new businesses. With the increase in the quality and image of used vehicles and the popularity of certified programs, late-model used cars are increasingly becoming a substitute for new vehicles and vice versa. As a result, incentives in the new vehicle market act to depress used vehicle prices, lowering residual values and new vehicle sales prices and reinforcing the incentive cycle. This impact is particularly pronounced for latemodel used vehicles and for more expensive (and image-conscious) market segments.11

Greater professionalism will increasingly characterize the international used vehicle market over time. Although less professional players can survive in the used car business when the sales cycle is long and purchase quantities are small, eventually the cream will rise to the top. This presents a tremendous opportunity for automotive companies.

Key Findings in Individual Markets

United States The United States has the most developed auction and wholesale market, resulting in

the highest share of independent dealers of the four countries studied. Dealer attitudes toward the used car business tend to be the most entrepreneurial and growth-oriented. The American car market is also characterized by a more developed "car culture" than the others. As a result, emotional factors tend to play a bigger role in the used car buying process. The U.S. has the highest vehicle ownership per capita of all markets studied; moreover, multiple vehicle ownership is common and consumers change vehicles relatively often.

Canada Canadian consumers tend to be more risk averse than their counterparts in other markets.

They are also more cost-conscious, with monthly payments a major driving factor behind purchase decisions. They tend to keep vehicles longer than in the United States, resulting in a less active used vehicle market. Use of online channels, such as eBay, is less developed. It seems that Canadian dealers display a risk-averse attitude toward investing in online distribution.

France The French used vehicle market has exhibited very strong growth in the past decade,

reaching a level of activity equal to the American market. French dealers display the strongest aversion to selling "older" vehicles: Only 17% of the

vehicles they retail are 4-plus years old; in contrast, 41% of vehicles sold by U.S. dealers (and 47% of those sold by Canadian dealers) are 6-plus years old. Consumers in France show the greatest propensity to shop for certified vehicles, making certified programs an important differentiating factor in this market.

Germany Germany has the most advanced online used vehicle market, used heavily by both sellers

and buyers. Used vehicles in Germany already have the longest warranty among all markets. As a

result, certified vehicles are not a strong differentiating factor in this market. Since 2003, dealers' share of the used vehicle market has been recovering from six

consecutive years of decline.

10 CNW Marketing Research, Inc., Document 116m: Same store new-used sales. 11 CNW Marketing Research, Inc., Document 521: New prices impact on used prices.

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Automotive the way we see it

Market Overview: Highly Contrasting National Markets

The accompanying table (Used Vehicle vs. New Vehicle Market Sales ? A National Comparison) looks at new car and used car sales by unit volume for eight countries. The ratio of used car sales to new car sales acts as an indicator for the expansion of the used car market.

The used car market is most active in the United States, France and the UK. In these markets, the used car business generates considerable economic income. In contrast, the used car market is weaker in Canada, Japan and Spain.

The case of Canada and the United States shows the extent to which two national markets, strikingly similar when it comes to new car sales (same brands, same cars, same distribution channels), can differ markedly in terms of their used car market. This notable difference can be partially explained by Canadian consumer habits and attitudes. It would seem Canadian consumers are more cost-conscious, risk averse and inclined to keep their cars for longer. The difference is also due to the higher degree of conservatism among

Canadian dealers, in contrast to the entrepreneurial drive and taste for innovation more characteristic of their American counterparts.

The drive to expand the used car market, the will to ensure transaction transparency, the capacity to develop long-term competitive positioning, market intelligence and understanding depend for the most part on dealers and manufacturers. These factors can change far more quickly than the socio-cultural elements involved in consumer behavior. Furthermore, as long as they have the necessary strategic will, manufacturers have the power and wherewithal to weigh heavily on the structure and development of markets.

Explaining Used Car Market Performance The case of Japan is both specific and extreme. Due to a number of reasons, the market has the lowest used-to-new ratio. The Japanese market is subject to rigorous environmental and road test regulations, in addition to high disposal costs, which makes it relatively expensive to own older vehicles. The consequently

high depreciation rates make Japanese used vehicles far more suitable for the export market. However, it is difficult to say whether the relatively high cost of ownership is more or less important than the socio-cultural factors, which also make used car ownership less desirable in Japan than in other markets. Japanese consumers generally prefer to buy new products, viewing used goods as linked to lower social status.

In fact, each national market is colored by the socio-cultural setting. Beyond the impact of culture, however, it is necessary to examine the way markets work in economic terms.

Market theory is based on the idea that prices act as indicators of the quality of products bought and sold. In principle, the higher the price of a product, the higher its quality, and vice versa. Classical economic theory also posits that buyers and sellers possess the same information by which to determine the quality of a product under transaction. This is defined as a symmetrical relationship between buyers and sellers.

Used Vehicle vs. New Vehicle Market Sales ? A National Comparison

UK New Car Sales 2,567,000

U.S. 16,995,000

France 2,070,000

Germany 3,320,000

Italy 2,262,383

Canada 1,583,000

Spain 1,517,490

Japan 5,852,067

Used Car Sales 7,701,308

44,138,000

5,400,000

6,650,000

4,586,894

2,300,000

2,080,754

5,984,800

Used Car/New Car Ratio

3.0

2.6

2.6

2.0

2.0

1.5

1.4

1.0

Source: CIRP, adapted from various sources, including CNW Marketing Research, Inc. (U.S.), DesRosiers (Canada), Japan Automobile Dealers Association (Japan) and Datamonitor (France, Germany, Italy, Spain, United Kingdom) Note: All sales in units. All data for CY2005, except Italy, Spain, and UK, which are CY2004.

The Anatomy and Physiology of the Used Car Business

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However, for some goods, including used vehicles, sellers can decide not to reveal the real value (in terms of quality) of what is being sold. This means it becomes possible to put a good quality price on mediocre quality goods ("lemons").12 Buyers are in no position to determine the real quality of what they are buying. Sellers, on the other hand, are well aware of the quality of what they are selling. This situation is a typical one of asymmetry between buyers and sellers, which is to the latter's advantage.

If price no longer functions as an indicator of quality, if there is asymmetry between buyers and sellers, and if the latter are unscrupulous leading to buyer caution, markets tend to underperform as both prices and volume decline. For the market to expand, sellers must ensure that they gain consumer confidence by getting rid of, or at least minimizing, asymmetry of information.

Assessing the Purchase Quality Buyers have two main strategies by which to ascertain the real quality of what they wish to buy.

1. Secure the transaction. This amounts to the consumer buying goods only when the seller relinquishes his hold on information and agrees to reduce information asymmetry by giving the buyer real quality guarantees. Note that this type of behavior is motivated by long-term, rather than short-term, gains. The solution lies for the most part in the hands of the seller.

2. Secure the relationship. In the absence of a transparent transaction, the buyer tries to gain information about the seller's integrity. A seller who has a solid reputation for honesty stands to lose much by veering away from the right path. The solution here lies essentially with the buyer, who will choose a potential seller among family, friends, acquaintances and networks.

Undoubtedly, buyers will try both strategies. However, it is clear that strategies based on securing the transaction are the easiest to implement for professionals (especially dealerships) if their starting point is long-term gain.

Securing the Transaction The automotive industry has come up with many ways to secure a used-vehicle transaction, including:

Incentives such as sizable warranties, free car repairs, breakdown service or a "satisfied or reimbursed" policy. It is increasingly prevalent for car dealers to include a warranty on a used car. Of course, these usually cover a short time-span (9 to 12 months), compared with the longer guarantee periods provided by manufacturers for new vehicles (two to three years, sometimes more). In the case of cars that move more slowly, dealers might consider special pricing or a lower financing rate. In the case of a "satisfied or reimbursed" policy, customers can change their decision and return the car during a short time period after the purchase (usually around one week).

12 Akerlof, George A., Nobel Prize winner 2001, theorized the used car market in the 1970s. The founding publication, and savor the title, was: "The Market for `Lemons': Quality Uncertainty and the Market Mechanism," in The Quarterly Journal of Economics, Vol. 84, No. 3 (Aug. 1970), pp. 488-500.

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