Auto Retailers Should Approach the Vendor as a Resource Center

Includes: AN, AZO, DDAIF, F, GM, TM
by: Jerry Marks

Now as you know, I have been a little critical of AutoNation’s (NYSE:AN) combative attitude toward their vendors. But a combative attitude isn’t always a bad thing. Mr. Jackson is correct. There is far too much supply in the system, and the automakers need to rationalize said capacity in order to become competitive and serve their distributors best. The question becomes how do you approach your vendor? So today I wanted to address the idea of supply chain (vendor) relations.

Vendor relations is an age old issue and extends far beyond AutoNation. It is a conundrum every retailer/distributor has faced since the dawn of distribution. Whenever there is someone else (a “middle person or retailer”) in the (purchase) equation beyond the manufacturer of said good/service and the person receiving it, there is a natural friction that occurs between the vendor and the retailer. So the answer to my opening title question: “can’t we all just get along?” should be a resounding and self evident: NO!

If I am selling something, naturally I want the best return for my efforts. And if I am buying something, naturally I want the best value (service, etc.) for the lowest price. It is this natural friction that pushes businesses to be better, with society (at large) ending up the winner.

If you do some research on Supply Chain Management, or Supplier Relations Management what you often find are “experts” saying two things: 1) the relationship needs to be integrated (and so you should buy their software or program), and 2) it should be collaborative. Now I understand it is important all parties receive an appropriate return, so the process can be collaborative. But I think we need to begin with the premise and recognition that there is an inherent (and natural) friction that must occur. AutoNation should not be expected to go skipping down the street holding hands (like school children) with Ford Motor Company (NYSE:F), just like Ford/Visteon or AutoZone (NYSE:AZO)/Federal Mogul should not be found in the corner of the classroom kissing.

I bring this up because I think we lose sight of this fundamental and necessary business dynamic when we talk about supplier relations. It is our natural inclination to want to be liked by everyone. So of course, it becomes politically correct to say that we should work together in a cooperative and collaborative manner. What a bunch of bologna. You (the retailer or retail shareholder) only cooperate and collaborate to the extent that it enhances your ability to serve the customer (and hence generate the best return possible).

I don’t hear many customers walking into a car dealership, or a do-it-yourself [DIY] store, or a repair shop saying: “boy, I sure hope the store is making enough on the sale to me?” Usually they are really thinking: ‘boy, I sure hope they don’t rip me off too much.” So why should a retailer say: “boy I sure hope this manufacturer is making enough on the transaction?” It is this friction that pushes the manufacturer to serve the distributor better (and often times cheaper), and the distributor, in turn to serve the customer better (and often times at a lower cost).

So if one party (like a domestic auto or auto parts manufacturer) is not receiving an appropriate return, I suspect it is because competitors to the manufacturer in question are receiving a better return like Toyota (NYSE:TM), and so the retailer is demanding a comparable price/service level. You see this clearly happening with the do-it-yourself auto parts retailers and jobbers (the folks that sell the auto parts to the repair shops) who are finding competitive prices for similar quality auto parts with Chinese manufacturers (granted the quality part is debatable).

What is happening in the auto manufacturer/retail relationship is no different than what happens in any manufacturing/retail sector. More efficient players enter the industry, and the older more established players are forced to adjust. I truly hope GM (NYSE:GM), Ford, and Chrysler (DCX) are successful with said adjustments (turnaround plans). But only time (and some successful union negotiations) will prove whether these hopes become a reality.

Importantly, what makes the franchised auto retail business model so different (and why you hear so much noise in the press) is that the business model requires the retailer to completely tie themselves (and their future) to the manufacturer. In most retail relationships, if Best Buy (NYSE:BBY) doesn’t like the price or service they are getting from a television manufacturer (let’s say Sony (NYSE:SNE) for example), Best Buy can just untie their relationship (granted I am simplifying a bit) and order more tvs made by Hitachi (HIT). This is what AutoZone and a number of the DIY and jobber players are doing by looking to increase their “direct import” (foreign auto parts) procurement (purchases). The retailer is constantly seeking better, more efficient ways to procure the products, so they can yield a higher return (and serve their customer best).

In franchised auto retail, however, if you feel the product you are buying from the manufacturer has become uncompetitive, sure you can stop buying the product, but then what? You are locked into a franchise agreement that says you can only sell Chrysler vehicles (for example) out of that store. Now over time, you (if you are a large group) you can shift your “shelf space” around (so to speak), by buying fewer domestic branded dealerships and more import branded stores (and that is exactly what is happening in the market). I’m actually becoming a little bigger of a fan of the auto mall concept for this reason (because the stores can be more easily converted to different brands.) However, the auto mall concept has been experimented with since the 1970s, with little conclusive proof that it affords a competitive advantage (although FitzGerald Auto Malls don’t seem to be doing so bad). In any case, in the near, and even intermediate term, with a stand alone franchise store, you are left with few options.

So I can understand the inclination of leading auto retail groups like AutoNation to want to make a public stance, in the hopes of rallying all of the retailers (in a similar situation) around “the cause,” forcing the automakers to help make a store competitive with the foreign branded stores. It is a less public, but very real cat and mouse (tug of war) game that has actually been going on between the auto retailers and domestic manufacturers for the last 6+ years. To a certain extent, it is a (warped) part of that natural conflict I talked about between the manufacturer and retailer. Inventories are a real carrying cost for the retailer, so shifting the inventory levels merely shifts the cost burden from quarter to quarter and year to year.

But more important than a debate about whether a dealer should have more or less inventory is the very way auto retailers (of all types) approach the vendor. The “inventory debate” simply gives me a great example of how I think we all look at it in the wrong (adversarial) manner. I need to begin by saying I am not saying (as I stated above) that retailers and manufacturers are going to begin holding hands and work in a complete collaborative and cooperative manner. However, I do think retailers need to shift their approach to being more of a resource center for the manufacturer.

If you really think of yourself as an intricate “value add” component of the vehicle purchase (repair or part procurement) process, not just a “middle person” than the same resource (customer centric learning) approach you are providing to the customer should also be provided to the vendor you are dealing with. The customer is coming to you to learn about how best to buy or fix their vehicle. Who better than the retailer for the manufacturer also to turn to in trying to understand what the customer really wants, needs and can afford?

So on one end, in every interaction and approach with the customer, my emphasis (as a retailer) should be as a resource center, the best place for the consumer to learn best about the purchase or repair of a vehicle. And on the other side of the equation, I would similarly try to be an incredible resource center for the vendor. There is always going to be the above mentioned friction, but this time the friction comes with a point: to show the vendor what it is the customer wants. When you do this, I think any and every vendor should at least respect you. You may not always end up using them, but at least you did your best to show them what the customer wants and ultimately that should make them better competitors. And I think that’s got to count for something.

So, for example, when we turn to the “inventory debate,” I would not look at it as a battle between myself and the zone manager or manufacturer. Instead, I would focus on helping the automaker or zone manager understand their competitive position (you know being that resource center I just described). For those of you actually in the industry, I would encourage you to run the comparable numbers by vehicle line. Really show the zone manager the cost differential of a Toyota Camry versus the Ford Fusion or Mercury Milan. Help the folks at Ford understand how their product can and should be competitive with the foreign brands in your market.

But for us investors, I’ll keep the numbers pretty simple. I don’t think it takes a rocket scientist to go to Automotive News data center and see that the traditional Big 3 ended the month of November with an 87 days supply of inventory. This compares with 57 days supply for European and Japanese manufacturers and 72 days supply for the Korean manufacturers. I know days supply calculations have their problems. However, as long as they are computed the same way it really doesn’t matter (given the point I am trying to illustrate). What matters is the delta (difference) between the Big 3 brands versus the Japanese and European manufacturers.

If I am paying ~$4 a day in floor plan interest expense on a $25,000 vehicle, holding the vehicle for 72 days versus 57 days means I am paying an extra $60 per vehicle (or 26%). Most of you know that dealers price from cost. Sure from month to month or quarter to quarter, they may get squeezed a bit on the gross margin line. But 7% to 8%, or $2,000 per copy (vehicle), is a pretty slim margin. So what ends up happening over time, is that excess costs (and excess costs in the system) simply get added to the overall sale price of the vehicle. Now think about this. We’ve talked over the last couple weeks about advertising expenses, with dealers spending anywhere from a couple hundred to several hundred (in advertising dollars per vehicle actually sold). That $60 difference (versus holding the excess inventory) could be used so much more efficiently in (gulp) helping customers learn more about the product you have to sell. Or (even better) in simply lowering the overall cost to the customer.

And this is the point I am making. If you focus on being a resource center for the manufacturer. Helping them to see how they can be more competitive, they may not like the answer (that you plan to take your days supply of inventory lower), but hopefully they will respect that you are trying to make their brand more competitive in the market. Let me be very clear, I understand the practical and cultural limitations. But an auto retailer should never find themselves saying: “well, I’ll help out the OE, they’ve been good to me over the years.” If you find yourself saying or thinking that, pinch yourself and re-think your reason for taking more product. Don’t get me wrong, I think every auto retailer should always be trying to “help” the OE. But this “help” comes in the form of showing them how to make their brand more competitive, not by accepting more inventories that leave them less competitive.

And like I emphasized above, dealer inventories are just one example. What I am really trying to drive home (instead is the philosophy/approach). So in another area, I think I am one of the few analysts that still believes AutoZone and the other do-it- yourself [DIY] retailers should continue to push the “pay on scan” idea. The pay on scan idea basically copies the super market model, where suppliers “own” the inventory until the product is scanned across the check out counter. Everyone on Wall Street seems to think pay on scan is simply a way to unload the inventory carrying cost risk/burden from the DIY retailer to the manufacturer. But AutoZone’s payables are already 87% of the company’s inventory levels. Their goal is to get to 100% (and a number of the other DIY and jobber companies are following AutoZone’s lead).

The “push,” however, to get vendors signed up on the pay on scan program seemed to upset some vendors, and as a result, I get the impression AutoZone and the rest of the industry are backing away from pay on scan. True, in part, it is because the DIY retailer has found better ways to help the vendor (and get toward the 100% goal) by creating factoring arrangements (so the vendors borrowing rate on AutoZone receivables are lower).

Nonetheless, just because it is a different financing program, I still don’t see why the DIY retailers can’t focus more on linking up the vendor into their information system (so it still functions like pay on scan). AutoZone’s former CEO Steve Odland used to say: “we know our customers best, but the vendor knows the product best.” It sure seems to make a lot of sense to me then to help the vendor understand AutoZone’s customer (the originally stated purpose/goal of the pay on scan program).

Once again, if the focus is on just getting the payables extended out, yeah I can understand the resistance. But like I said above, AutoZone is almost already at its stated goal of 100% payables to inventories. So that part of the debate should be irrelevant. And now, instead of it being a controversial program that becomes a burden to the vendor (merely shifting inventory carrying costs), I really think it is something every vendor should want to be a part of because it will help them understand the demand for their products better (by zipcode).

Just my opinion.

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