The Sub-Prime Cinderella Story: Who Has The Glass Slipper?

After five years of consistent increases, used car prices are expected to collapse in 2014. According to NADA, the average price of a used car rose by 18 percent from 2007 to 2013, and is now roughly 10 percent higher than the average price of the past two decades. That bubble is expected to pop as NADA predicts 42 million units to hit showroom floors nationwide. Of that 42 million, 16 million units will be a result of lease-end models being returned to franchise dealers.

For an independent dealer selling used cars, this poses a significant obstacle. Beyond the drop in price per retail unit sold, other kinds of dealers will lay claim to 38 percent of the available used car inventory. However, there is an upside. According to a 2014 Equifax study, there is pent up demand for more than 26 million vehicles. With the labor force participation rate declining and moderate wage and employment growth, it’s a good assumption that consumers will continue the trend of preferring to buy used over new.

These recession-wary consumers are more willing to shop for the best price and financing available. This partly explains why used vehicles accounted for 62 percent of all vehicles financed for the fourth quarter of 2013, according to Experian.

While we ended the year with an almost even split between independent and franchise dealer market share in used car financing, independent dealers are well positioned to tap further into the current consumer market. For example, picture what you think a typical independent dealer customer looks like:

• What’s their credit score?
• Do they rent or own their home?
• Are they employed?
• If they have gainful employment, in what industry segment are they employed?

The reality of today might surprise you. With the impact of the recession weighing on bank accounts, even prime consumers are now browsing independent dealership lots. Once you lower your eyebrows, try this number on for size: 11.4 percent of buy-here-pay-here customers fell into the prime and super-prime category in the fourth quarter of 2013.

But what’s even more interesting is the subprime category. This category has become the consumer segment that holds significant value to all dealers: franchise, independent and buy-here-pay-here alike. Of all buy-here-pay-here customers, 88 percent fall within the nonprime, subprime and deep subprime categories. 1 These same customers make up 37.3 percent of franchise dealership customers. 1 While franchise dealers are new to woo this category, they are aggressive, and in some cases offering more than what independents have in their quiver.

When it comes to providing value and creating lasting customer relationships, franchise dealerships have service departments and a deep bench of F&I products to protect and repair the customer’s vehicle. Providing benefits such as these, which have significant impact in preserving the customer’s bank account, has been an uphill battle for independent dealers, specifically in the F&I department.

With an inventory ranging from zero to 70,000 miles, franchise dealerships have significant options in providing consumer protection products. Beyond the manufacturer’s warranty, F&I product providers underwrite extensive vehicle service contracts, maintenance plans, appearance protection products and some forms of insurance, like GAP.

The benefit of this deep bench is they have a better opportunity to increase their value proposition with the customer. By providing extensive coverage on various aspects of their vehicles, they can give their customers significant protection for their bank accounts, while increasing dealership profit per retail unit with upgrades or extended coverage.

Independent dealers paint a different picture. Vehicles on an independent dealership lot have been through approximately three ownership cycles and typically range in mileage from between 30,000 and 150,000 miles. With this in mind, their F&I bench is significantly limited in comparison.

The majority of consumer protection products tailored for independent dealers limit coverage to mainly the powertrain of these older-model vehicles. The reasoning behind this is pretty straight-forward. Older model vehicles are expected to break down more and therefore F&I product providers are more hesitant to create extensive protection products for them as they would expect a higher number of claims submitted.

However, in this value versus cost environment, nonprime and subprime consumers have a new level of expectation in the terms of the products available to them from both franchise and independent dealerships. The recession has forced companies across all industries to re-evaluate the customer service experience, as well as their value proposition. There is no difference in the auto industry. Now, it’s not only prime and super-prime customers that demand the highest level of service, but rather all customers expect to have the same level of respect for their business. While some customers may not be able to afford a traditional vehicle service contract, they are still very interested in purchasing mechanical breakdown protection for their vehicle.

For this reason, F&I product providers are re-evaluating the products they develop for independent dealerships. For example, EFG Companies, a consumer protection product provider based in Irving, Texas, developed a vehicle service contract called Best ReGuards that extends past the powertrain specifically for independent dealerships. This product focuses on several extended coverages while maintaining a low cost price-point:

• Engine
• Turbocharger/Supercharger
• Transmission
• Transfer Case
• Air Conditioning
• Electrical
• Fuel
• Seals & Gaskets

Another trend in consumer demands goes beyond mechanical breakdown to include benefits around personal safety, such as roadside assistance. Again, the majority of roadside assistance plans available for independent dealers only provide limited services, if any. However, no matter their credit score, people from all walks of life need the ability to take care of themselves and their family in the event that they are stranded due to a breakdown. With that in mind, EFG paired the following roadside assistance benefits with the mechanical benefits of their Best ReGuards VSC for independent dealers:

• Towing
• Flat Tire Changes
• Jump Starts
• Lockout Service
• Nationwide Coverage

Beyond the product itself, the company also backed it with the same product administration that franchise dealers receive. This further emphasizes and ensures the level of customer service on which independent dealers can rely, and that positively impacts their relationships with their customers.

You can see how growth in options such as this gives independent dealers a more valuable toolkit to address each customer’s specific need when it comes to protecting their vehicle. They also fortify independent dealership’s customer appreciation model, which increases their customer retention. With revamped F&I products that provide more comprehensive coverage and service, independent dealerships are positioned to:

• Increase their product portfolio to generate greater profits
• Cultivate customer relationships by providing new market opportunities
• Match consumer buying trends to the dynamics of their dealerships

As supply is expected to outpace demand in 2014, independent dealerships need to expand their product portfolio to be more competitive in the market. Considering how few independent dealers have access to provide F&I products, you are going to see more providers recognizing this growing opportunity and focusing product development efforts on this fresh dealer segment.