Can You Cut Your Way to Profitability or Sell Your Way to Profitability?
Auto dealers are facing turbulent times. Interest rate hikes combined with inflation and higher delinquencies are cutting the bottom line. The natural instinct is to hunker down, cut expenses, and weather the storm.
The first thing to go is often the advertising budget. Next, personnel cuts, reduced investment in inventory, and less borrowing follow. These actions, while instinctive, may permanently impact the long-term outlook of the dealership.
However, despite these challenges, resilient BHPH dealers continue to thrive, bringing in customers and selling more cars. Lenders are waking up to the savings potential in another area: force-placed insurance ceding fees. These fees, which are not reported on financial statements, can significantly affect a dealership’s revenue.
Don’t Stop Advertising
As lenders review their P&Ls to determine where to make cuts, they need to ask themselves: Can you cut your way to profitability or sell your way through to profitability?
The axe often falls hard on the advertising or marketing budgets. Naturally, during a recession, other expenses are prioritized – like payroll and running operations. Many stare down at the P&L and seize advertising.
Advertising is always at the top of everybody’s list. It’s a big number on the P&L. But cutting the advertising budget is dangerous. While half of all companies will do it, it rests upon a fundamental misunderstanding of the business cycle.
A great deal of evidence shows that companies that maintain or increase their advertising and marketing budgets through a recession have higher market share and sales during the recession and the three years that follow it. In other words, businesses that continue to invest in their marketing enjoy longer-term profitability, leapfrogging over competitors to emerge stronger on the other side.
As the Cost of Capital Rises…
Those under 40 came of age in a hearty economic environment. The cost of capital has been inexpensive for the past 15 years. In terms of the business cycle, they’ve enjoyed an artificially low cost of capital.
Today, some companies may have an expense problem. It happens naturally during good years. When companies are making money, it is easy to become complacent with expense management. In hard times, every item on the P&L gets scrutinized.
Banks have started to pull out and scale back from the secondary/subprime auto loan business. Some may even decide to sit this one out and avoid the delinquencies that go with it. The demise of banker support creates more customers for Buy Here Pay Here businesses. Unfortunately, the BHPH dealer faces downward pressure from the rising cost of capital and negative delinquency trends that can create covenant issues. BHPH businesses don’t want to raise prices, so they’re caught in a dilemma and turn to their P&L to cut costs.
The Hidden Opportunity in Ceding Fees
For those fortunate enough to have a force-placed insurance program (about 20% of lenders), you already know what doesn’t appear on your P&L – the ceding fee you pay in your portfolio for all your insurance products.
Your CPI/re-insurance ceding fees do not appear on your P&L. It’s an invisible expense that no one thinks about. Since CPI and other re-insurance ceding fees don’t live anywhere on a financial statement, they don’t trap anyone’s attention. Few, if any, ever think about cutting that expense or how to do it.
Reducing ceding fees can build your bottom line. Now that delinquencies are rising and write-offs have escalated, lenders risk breaching bank covenants because their losses are too high. They’ve got to look at ceding fees and realize there’s a compelling story there.
Lenders have an opportunity to expense manage in this area and sell through to profitability. When you expense manage, you profit manage. And when you start managing profits, you’re on the road to increasing profitability.
Opportunity Lies in Adversity
Warren Buffett understands the money-making opportunity in hard times. Dealers are confronted with 2020 car prices on their books, and they’re buried in those cars. But if you wanted to be a car dealer in 2020, you had to buy cars, you had to pay the market rate. If you want to buy cars in 2023, you’re going to pay the market rate. All cycles come and go.
Every crisis has the potential for opportunity. Markets bounce back. Recessions create millionaires. It’s easy to want to pull back when things get difficult, but those who press forward emerge on top.