Big Lots

The recession has been brutal, but L.A. auto dealerships, a key source of local revenue, were in flux well before the economy tanked

There came a moment earlier this year when the car-selling business in Southern California pretty much stopped—and it shook up people in the industry like nothing ever had: One dealer saw sales plummet from 700 cars a month to about 180; another had a 100-day inventory of cars instead of the desired 45- to 60-day allotment because customer traffic was so slow; yet another was forced to lay off workers for the first time in 50 years.

“This year hasn’t been about making money. Our goal is to break even. That alone is a big job,” says Dave Conant, whose company has several dealerships at Cerritos Auto Square and other supercenters in the area. Conant lost money in the January-to-March quarter, the first time in his career he’s been in the red, and that came after major cost cutting. “It’s a big jolt to the corporate psyche,” he says. Of course, the Chrysler dealers who lost their franchises would love to have those problems. So would the GM dealers who have been targeted for closure next year.

Times are certainly tough, though what’s reshaping the business is more than the recession; it’s the widening gap between the weak and the powerful. As never before, size is what counts—among the 25 largest dealerships in Los Angeles County, 18 are part of either publicly held companies like Auto-Nation and Group 1 Automotive or large private corporations. Only a dozen or so companies control much of Southern California’s sprawling car market. Their growth has pushed out what had been the industry’s mainstay: small family operations that sell only a few hundred cars a year. In 1960, L.A. County had more than 1,000 new-car dealers, some of them with one- and two-car showrooms that had been converted from garages or gas stations. Today there are 644, and that’s with many more vehicles on the road and a much larger population.

Unlike the car-selling business of the past, when dealers were prominent members of a local community, the new owners are typically less noticeable. Many have their main offices in other states and are only minimally involved in day-to-day decision making (although some of the large chains do offer a minority stake to the former operator who stays on to manage the place). Customers walking into Miller Toyota in Culver City may not realize that it is part of Houston-based Group 1, which has 99 dealerships around the country. Mercedes-Benz South Bay and Lexus of Cerritos belong to AutoNation, which has headquarters in Fort Lauderdale, Florida.

Roger Penske, the legendary race car driver turned entrepreneur, epitomizes these power dealers. Penske is chief executive of Penske Automotive Group, a publicly held company based in Bloomfield Hills, Michigan, with 310 dealer franchises worldwide. A privately held offshoot, Penske Motor Group, runs Longo Toyota in El Monte, which is the nation’s largest Toyota dealership. In addition, Penske Automotive holds a 9 percent interest in Penske Truck Leasing and is the exclusive distributor of the tiny Smart cars, manufactured by Mercedes-Benz. Last June the company announced plans to take over GM’s Saturn service, parts, and distribution operations, though the actual manufacturing will be outsourced to another carmaker. Detroit auto supplier Dick Dauch calls Roger Penske “one of the five most brilliant people I’ve ever met”—as well as a “competitive cuss.”

If the shift to megadealers happens to ring a bell, it’s because having fewer but larger locations is part of a tried-and-true retail strategy. Over the years mass merchants like Wal-Mart and Best Buy have outmuscled neighborhood hardware and electronics stores. As a rule, they offer greater selection at a cheaper price. In the car-selling industry, mom-and-pops seldom generate enough revenue to make them viable in a market like Los Angeles, where the cost of doing business is so high. Japanese automakers, which have close to a 60 percent market share, prefer the bigger-is-better strategy: Chrysler’s bankruptcy papers note that the average Toyota dealership sells far more vehicles each year than the average Chrysler dealership. Little wonder, considering that as of 2008, Chrysler had 3,298 dealerships and Toyota had 1,242 nationwide.

For all the uproar about dealer closures, it’s worth noting that the industry has been going through its own weeding-out process for some time. When Chrysler announced the names of the 789 dealers that would be dropped as franchises, most folks I spoke to were surprised that only four were in Los Angeles County. That’s less than 1 percent of the total number of new-car dealerships—two of those four were already in the process of closing shop. It was practically a nonevent. “L.A. is a more sophisticated, more whittled-down market than other places,” says Aaron Jacoby, an attorney who handles automotive-related clients for the nationwide law firm Venable. “The dealers are scrambling to see which ones will be able to survive.”

Selling cars in L.A. has always been a high-risk, high-reward business. The headaches are legion: burdensome state and local regulations, inflated real estate, time-consuming litigation, heavy marketing costs. Then there’s all the competition. When people walk into a showroom armed with quotes from Internet sites and other dealers, the choice is to match those prices or risk losing the sale. That often keeps profit margins below 2 percent, compared with 3 percent-plus in other parts of the country.

But there is a flip side: Los Angeles is the nation’s biggest car market, with more than 7 million vehicles on the road and 1.2 vehicles for every licensed driver. A dealer can pump up the minimal profit on a car purchase by selling high-margin extras like special wheels and service-protection packages. Besides, volume has a way of curing many ills: The more cars sold, the more money coming in the door. Revenues at the county’s 25 largest car dealerships totaled nearly $4 billion in 2007.

When economies are booming and consumer spending is out of control, such as during the stretch from 2002 to 2006, dealers of almost any size would have a hard time failing. “There were probably a million-and-a-half extra cars added to the marketplace due to the housing boom,” says Fritz Hitchcock, the longtime proprietor of the City of Industry-based dealership group bearing his name. “People were refinancing their house and then grabbing some dough and buying a car. That really inflated the retail market.”

In such a climate, dealerships were being sold for many times the amount of money they brought in, especially if they had desirable addresses and featured popular brands. This is often referred to as “blue-sky value.” Once all the good locations were taken, buyers moved down the food chain. Jacoby recalls a client he thought was overpaying for a Chrysler dealership in Pomona. Within three or four years the client sold the property to an investment group, more than doubling his money. The dealership later went out of business. Hitchcock had the sense to unload three of his eight stores in advance of the recession. Since then, two of them have closed down. “I knew this was going to hit the wall sooner or later,” he says.

Valuations have indeed plummeted. Mike Kahn, who is based in Newport Beach and was building one of the nation’s fast-growing dealership groups, was forced out of the car business earlier this year when Nissan Motor Acceptance Corporation, the Japanese automaker’s finance arm, stopped lending his dealerships money to purchase inventory. One of his seven California stores, a 200,000-square-foot Toyota dealership in Oakland, had opened days before Nissan cut off his financing (Toyota Financial Services had already declined his request). Kahn, along with other dealers I spoke to, feels burned by the automakers that demanded as part of their franchise agreements bigger showrooms and roomier waiting areas—additions that the dealers were expected to pay for. When sales began to fall in 2007, many of them were left trying to service the debt.

Hard-boiled as the business might seem, with its pumped-up TV ads and quick-draw sales force, selling cars requires intricate merchandising and accounting. Dealerships are like financial centers, where huge amounts of money get moved from one bucket to another. The dealer’s most substantial investment centers on a practice called “flooring,” which is when millions of dollars are borrowed from an automaker’s financial arm to pay for an inventory of new cars. Once a vehicle is sold, the dealer gets money from the customer (or the customer’s bank), and that money is used to repay the automaker. The sooner that repayment is made, the better, though the dealer usually is allowed a float of at least several days. If he is struggling to make payments on other obligations—say, payroll or rent—having several hundred thousand dollars at the ready can be a lifeline.

The problem is that despite a lengthy float, the dealer must still find a way to pay back the loan. “In a rising market, guys who ran their business like that could be saved by having a big weekend where they sell 50 cars,” says Jacoby. “They have enough money to pay for last week’s money.” If they sell only 25 cars, “they’re in trouble.” This is why a bunch of less capitalized dealers are getting squeezed. So why doesn’t the dealer borrow less money and not have as many cars? Because a smaller inventory means that customers don’t have as much to choose from. Not stocking the Acura RDX in Basque red pearl could result in a lost sale if another Acura dealer has it ready to go. California customers, more than those in other markets, won’t wait. “You don’t want to get too small because then you don’t offer any choice. The factory will be on your butt,” says Hitchcock, whose Scion dealership alone has 23 separate lines of the brand.

The late spring sales results—generally sluggish but a little better than during the previous four months—could be the start of a turnaround that dealers have been waiting for, the point at which consumers in need of a new car are comfortable enough to take out their checkbooks. Bert Boeckmann, owner and president of Galpin Ford in the San Fernando Valley and for years L.A.’s largest- volume dealer, recently increased his inventory orders because he wants to be well positioned for the upturn. Business is down, but Boeckmann, one of the few single operators who can compete with the chains, expects sales to improve because customers will have fewer dealers to choose from. On his massive Ford showroom floor, he has small hybrids and monster SUVs, figuring there will be plenty of demand for both. “Buying cars is still buying cars,” he says.

Maybe, but the outlook is hardly assured. From 1999 to 2007, new-car sales never fell below 16 million annually; for two years they topped 17 million. This year sales are projected to fall to between 9 and 10 million nationwide. In California, the forecast is for sales of fewer than 1 million cars, which would be a 34-year low. Assuming that the recession ends and people start buying cars again next year, sales are not likely to run much beyond 12 million. A 17 million sales year won’t be in the cards for at least a decade. The question is, How do car dealers adjust to a shortfall of millions of cars?

Perhaps more important, how do local economies? As of May, auto dealers employed 31,300 employees in L.A. County (a 10.3 percent decline from the year before), and they generated 19 percent of total retail sales in the state. If people don’t buy cars, local governments suffer a sharp drop in sales tax revenues, which with the restrictions of Proposition 13 have become one of the only ways they can generate money. The closing of a dealership leads to, among other things, a budget deficit (along with a subsequent reduction in government services) and vacant land that cannot be easily used for anything else. The City of Cerritos, for example, has zoned its car mall area for dealerships only, and land that’s owned by the automakers themselves must often be used for selling their cars.

All this skews heavily in favor of the megachains that aren’t as dependent on short-term sales and have the wherewithal to work with communities in acquiring financially troubled dealerships. Penske, in a recent conference call with analysts, noted that the company had reduced its inventory and debt levels despite flagging sales. That leaves it in compliance with its credit agreements, which is a very big deal. But even companies like Penske will need to narrow their expectations. “The entire industry, both manufacturers and dealers, have to get used to a reduced number of sales,” says Jacoby. “They will have to direct the economy of their operations to that number.”

Meantime, some industry watchers foresee an entirely new breed of dealership. Some predict that virtually all shopping and purchasing will be done on the Internet. Others envision a stripped-down lot where customers would have a basic car model for test-drives and then use computer graphics and big-screen TVs to simulate the specific features that they want. Essentially, cars would be made to order (much the way Dell sells computers). This would drastically reduce the space that’s required to run a dealership, space that could be used for, say, restaurants, movie theaters, or offices.

I’m not so sure about any of this. Car buying has always been a tactile experience, and it’s unlikely that Californians will want to part with the joy of sitting in a new car and driving it off the lot. The key to who succeeds among dealers, though, will always come down to two things: price and availability. That means no matter how we end up buying our cars, it’ll probably be from someone with deep pockets. Bigness is no guarantee of survival, certainly not after this recession. It’s just that smallness doesn’t work anymore. 

Photograph by J. Bennett Fitts