Strada Auto Store

This dialogue on Wash Out with The Colonel is compelling, its providing insight to why certain situations are evolving the way they are, and it gives insight into issues that are not transparent to most folks. If you want to increase your understanding of the modern retail automotive business in light of present circumstances this dialogue is priceless.

Q- What decision process are the manufacturers using,  they seem to have a common front on the value of the Canadian dollar?

A- The value of the dollar was assessed as a temporary disturbance that would go away, and all the manufacturers could continue with their comfortable status quo.

Q- It would seem that manufacturers are on the wrong side of the fence. Are they losing the hearts, and minds of consumers?

A- It sure looks like they all ran for cover, jumped on the same side of the fence, using the same playbook, disseminating the same PR, and collectively digging a deeper hole for themselves. They are surely entitled to do whatever they want.

Q- Are residuals, and windfall profits tied together.

A- They need windfall profits to camouflage residual losses, and they need to move the metal to generate a bottom line for themselves. They need to make enough money to show a profit, and camouflage residual losses.

Q- Are they going to prevail?

A- Sure they will, a little bruised, a little bloodied, a little humbled, with the image, and brand a little tattered, they will prevail. The customers will prevail, more empowered, more influential than ever. The PR will be that in this age of pragmatic, bottom line oriented business, predicated by ruthless competiton, and an extreme need to perform, they had no choice.

Q- How did we go from Wash Out, to this?

A- Easy, its all about washing out transactions, washing out leases, and turning it into cash.

Q- The customers has nothing to do with wash out?

A- Correct, the essence of any business is to create customers, we are in the people business through vehicles...or we are supposed to be. Wash out is an internal skill and process. Upsetting customers over the wash out, is it the right course of action?

Q- Who will blink first?

A- Who do you think? The manufacturers will blink before the customers. Porsche blinked a few weeks ago, but they are not a volume player. Manufacturers of lower line vehicles can be more glacial about their decisions. The price difference is not acute on low line vehicles. Manufacturers of entry level luxury, and up are feeling the effects of their decisions and PR, and the force of customers empowered by technology, reinforced by the media. Soon one will blink, and open the flood gates. One gave a semi blink last week, exploring the landscape for a full blink.

Q- Its not a pleasant situation for the manufacturers, assailed by customers, having to deal with eroding values, and who knows how many other issues.

A- Its a little challenging, not the end of the world, a bump in the road, an altering of comfortable plans. Applying increased knowledge towards mid term strategies will help, being transparent will help, communicating with clarity will help.

Q- Will there be any good coming from this turmoil?

A- Absolutely! Being attentive to the basics, to the cornerstones of the business will acquire increased emphasis. Being open, transparent will increase. With all of the low hanging fruits picked clean, and the amateur battles won. Will they use professionals with a depth of experience, understanding, and knowledge base for the mid term strategic war.

Q- Why does something like this happen?

A- Just a few points a)- wash out is a dealer skill  b)- for some reason multi billion dollar corporations think that they have a superior intellect  c)- its human nature to always push the envelope until...#$% happens  d)- the relation between manufacturer and dealer/retailer is usually adversarial  e)- over confidence  f)- executing short term decisions to deal with mid term issues.

Q- Didn't customers realise that some deals were exceptional.

A- Customers have short memories when it comes to prices, and deals. If everyone is using the same playbook its normal. If manufacturers would have communicated that the deal was exceptional, literally too good to be true would it have made a difference. Its the reason some manufacturers make references to the Canadian transaction price.

Q- Colonel...captivating dialogue, Thank You for sharing your thoughts.

A- Guys, anytime...I hope the folks that followed this dialogue on Wash Out will have additional insight, see things with increased clarity.

Quote from A.G.Lafley of P&G....

We are having a captivating dialogue with The Colonel on Wash Outs. We started by looking at the historical significance of wash outs, in dealing with transactions involving a trade in. We progressed to washing out leases to recapture residual values, and convert the outstanding vehicle of the lease to cash.

Q- We now understand that washing out a lease has turned into a big business, with stakeholders in the residual risk, and additional stakeholders to convert the vehicles to cash.

A- Its nice to see that you are grasping that its a huge business, with a lot of entities involved, and actively participating in the process.

Q- Consumers / customers, especially those for high line units are incensed that manufacturers are not adjusting their prices as the Canadian dollar has increased in value. Manufacturers always mention lease residuals as one of the reasons.

A- The lease residual situation for manufacturers is delicate on a good day, and probably downright scary on a bad day. The rising value of the Canadian dollar, exacerbated by the empowerment of customers has pushed the situation closer to downright scary.

Q- Can you explain how the rising value of the dollar makes it scary?

A- The fast rising dollar, is applying extreme downward pressure on Canadian prices for vehicles. The lease that started in October of 2004, coming to term in October of 2007, with the residual being set in 2004, converted to cash in 2007 to close the lease. Do I need to say more?

Q- We understand, the 2004 aggressive residual is getting hammered in 2007, and the playbook for the game is altering.

A- You guys are good...in the constantly altering game of maximising residual recuperation to minimise residual losses, all the easy levers have been used, and its no longer enough. These folks need to move a lot of metal at big profits to keep the house of cards standing.

Q- Are you implying that the sale of new vehicles makes a contribution towards the residual losses of lease returns, when they are converted to cash. Its the reason manufacturers are glacial to alter the pricing of new vehicles.

A- I'm impressed you guys have good insight to grasp this aspect. Must be all the times that you go to auctions and understand what transpires at the auctions. Manufacturers are caught in a no win situation with the rising Canadian dollar, and have absolutely no desire to be transparent in how they deal with the back end of their leases. The customer does not care about the residual, or the back end of the lease process.

Q- Customers are upset, the media is siding with the customers, the dealers are caught in the middle.

A- Initially manufacturers were wishing, and hoping that the value of the Canadian dollar would subside, and it would be a temporary bump in the road. They were hopeful that it would all go away quickly. New vehicle dealers were not communicating to manufacturers the pulse of their customers, or if they did someone was not listening.

Q- Its not going away, customers are empowered, and are making themselves heard.

A- So they should, we have been urging customers to express their opinions. Manufacturers have created a PR black hole for themselves, have tainted their image, and are inciting more, and more folks to vote with their wallets.

Q- Multi Billion dollar corporations started playing a game of chicken with their customers, is that what you are saying?

A- Precisely, the customers are not on foot, the customers can delay the purchase of a vehicle for a few months. Who is in a position to hit it out of the ball park the manufacturers, or the customers?

Trajectory of the Canadian dollar....

We will continue...

Colonel this is a captivating dialogue...lets continue!

Q- You mentioned the third challenge is to wash out the lease?

A- When a lease comes to term, the financial institution that carries this lease wants to close the ledger on this particular lease. To close the ledger the leased vehicle must be converted to cash.

Q- From our conversation, the dealer washes out a trade in transaction by converting it to cash, the lease is washed out by converting the lease vehicle to cash.

A- Exactly, it should be a simple, elegant process, it should be an art form, it should be beautiful. One of the art forms of the retail automotive business is converting vehicles to cash. As you can just imagine, when you put multi billion dollar financial institution in a situation where they have to convert the back end of a lease to cash. The process becomes very pragmatic, with little or no art form remaining.

Q- How do these leases get washed out?

A- Often there are a few stakeholders assuming the residual value risk of the vehicle, consequently these stakeholders prefer the neutral environment  of a dealer only auction to convert the vehicle to money and wash out the lease.

Q- Who are the stakeholders in the residual value risk?

A- Its the manufacturer, and the captive finance company of the manufacturer. Its the manufacturer through its marketing and financial subsidiaries.

Q- What do you mean?

A- The financial side might support a residual to X, the marketing side to gain a market advantage feels that it requires a residual of X+2 points, both sides will agree on who will assume the risk of the additional 2 points.

Q- Are you saying that the manufacturer through its marketing arm assumes a residual risk, along with the financial arm.

A- Yes, is it starting to get interesting? Converting lease returns to cash becomes a mind game of variables between the stakeholders.

Q- One has the feeling that it can get complicated, convoluted, political.

A- It can, perhaps it does. Lets fast forward a few steps. If the marketing arm of the manufacturer is a stakeholder in the residual value risk, they are embroiled in the wash out of lease returns. Manufacturers have no appetite for wash outs, never did, and especially wash outs that have a 36 month delay.

Q- Are you saying that manufacturers are or have become like dealers, and are now involved with lease wash outs?

A- Yes, all under the heading of remarketing, with a positive PR spin for the remarketing effort, which in reality is maximising lease wash outs in most instances.

Q- Remarketing, Certified Pre Owned, special rates on CPO vehicles, special warranties on CPO vehicles, this stuff works in the market.

A- Sure it does, initially customers were paying a substantial premium for these lease returns CPO vehicles, lately customers are no longer prepared to pay a premium. CPO vehicles are widespread, the novelty has worn off.

Q- Are you saying that they are hitting a wall?

A- I don't know about a wall, but you do reach a point of diminishing returns. Once the low hanging fruits, and minor victories in small battles have been claimed. It tends to get more challenging. Keep in mind that spreadsheets, and powerpoints are exceptional tactical tools, but they are no substitute for a robust mid term strategy.

Q- Colonel....what happens?

A- A vicious circle is created...they need to move more metal, generate more profits, to overcome the incoming residual losses, and still have an acceptable bottom line. At the same time nobody really wants to talk about this stuff, since it looks like a house of cards.

We will continue...

We are still with The Colonel, our conversation is Wash Out....

Q- Is the wash out still relevant today with all the changes, and technology that have influenced the retail automotive business?

A- Good question, the easy answer is no, its not relevant, the technology camouflages many of the steps. The real answer is yes its still very relevant, dealers still take vehicles in trade. Until dealers take vehicles in trade as partial payment, nothing has changed as it?

Q- Its the same as it was 50 years ago, when a trade is taken as partial payment. What is different today?

A- Leased vehicles have made a dramatic difference during the past few years. In Canada for some manufacturers over 50% of models are leased.

Q- How have leased vehicles made a difference.

A- Initially leasing was done by dealers with their own in house leasing some 40 years ago, just like wash out, the basic parameters/cornerstones of leasing are not new. On a small scale lease returns were not a problem, it was easy to deal with a lease return. The dealer's leasing company sold the vehicle to the dealer's used car department, and yes the wash out chain reaction would start. In the early days manufacturers, and captive finance companies did not participate in leasing.

Q- Leasing created an additional channel....the vehicle that is not traded in....the lease return?

A- You guys are catching on quickly...yes the lease return which again was not a problem for many years. The residual value was set at the start of the lease, in a perfect world the vehicle returns, and is worth at least the residual value or more.

Q- If its not a problem, where is the challenge?

A- The first challenge was the increasing popularity of leasing, especially for higher priced vehicles, which generated an increasing number of lease returns. The second challenge was the fine tuning of the leasing variables to gain a competitive advantage in the market. The third challenge is washing out the lease.

Q- Colonel slow down a moment, the first challenge we understand. The second challenge intrigues us, the fine tuning of variables?

A- The retail automotive business has always been very competitive, manufacturers quickly discovered that leasing is a powerful lever to gain an advantage. In an age of spreadsheets, powerpoints what do you think evolved? The tweaking, and fine tuning of the lease variables, to gain a market advantage.

Q- What gets tweaked, fine tuned, adjusted.

A- Every component of a lease can be altered, in an attempt to gain a competitive advantage, and when all the components have been tweaked, the one that rears its head the most is residual value. There are mind altering discussions on residual values, there are companies that earn good money analysing residual values, auctions earn good money justifying residual value losses.

Q- Colonel, please explain you are ahead of us....

A- Its very simple, the actual residual value that makes pragmatic business sense does not work in the market. The residual value that works in the market, does not make pragmatic business sense.

Q- They are walk away leases, the customer does not care about the value?

A- Everybody knows that, but you need a residual value to structure a lease, and arrive at a magic monthly payment that will move the metal.  Especially when the rate alone is no longer an effective lever.

Q- Are you saying that residual values are aggressive?

A- You can call it aggressive residuals to move the metal, gain a competitive advantage, attract opportunistic customers, and in a saturated market to steal customers.

Q- We covered the second challenge which is to tweak the lease variables, correct?

A- Yes we did, keep in mind that residuals come to term at the end of the lease usually in 36 months. Its like a delayed result, in an industry that does not like delayed results.

We will continue....

In the retail automotive business Wash Out was a term used regularly to evaluate, and cost a transaction that involved a trade in.

Lets get The Colonel involved, we will ask him a few questions.

Q- Good Morning Colonel....How are you? Its been a while....

A- I'm very well, a great morning...lets get going.

Q- What is Wash Out?

A- Years ago all dealers did their accounting manually, every vehicle had its own accounting sheet with a stock number assigned to the vehicle.

Q- A new car dealer received a vehicle from the manufacturer, the accounting department of the dealer would establish, an accounting sheet for this and every vehicle that the dealer purchased.

A- Yes, and purchase is the operative word here, every time a dealer purchased a vehicle a stock number and an accounting entry was made for the vehicle.

Q- Any significance to the stock number.

A- Most dealers would have stock numbers that make sense to them, usually the model year is the first number when dealing with new vehicles, and prior to computers the other numbers would have been quick references for the various car lines, and the number of units.

Q- The dealer purchases a vehicle, assigns it a stock number, makes a journal entry, what is the big deal?

A- Its simple, its the journal sheet that was interesting, and kept on going.

Q- What do you mean?

A- In most cases when a new or purchased vehicle was sold, it involved a trade in, as partial payment, plus an amount of money, or it could involve 2 trade ins. The journal sheet would show the initial vehicle with a cost of 100, a selling of 110,  the trade and 60 dollars difference as a simplistic example.

Q- This is simple enough....or is it.

A- On this transaction the cost is 100, the selling price is 110, the trade is appraised at 50, for a difference of 60. In numbers its 110 minus trade of 50 = difference 60. The dealer received payment in cash, and in kind for the vehicle he sold.

Q- The dealer paid 100, but has not received all the money to pay the initial 100, he has a trade in to turn into money, to get all his money out of the transaction.

A- You guys are pretty good....first the dealer thinks the trade is worth 50, and he thinks that he made 10 on this transaction. Now he retails the trade in for 55 and takes another trade for 20 for a difference of 35. The numbers 55 minus the trade 20 = 35 difference.

Q- This is starting to look like a chain reaction.

A- It is a chain reaction, it still is a chain reaction, once the dealer takes this transaction and converts it all to money again, then and only then is the transaction Washed Out.

Q- If we understand this, the initial purchased vehicle was stock number 12345, the first trade was 12345 A, the second trade was 12345 B.

A- Precisely, its still an effective system to understand the horse trading nature on the business.

Q- How about the money?

A- Number 12345 generated a profit of 10, number 12345 A generated a profit of 5, and number 12345 B was sold wholesale at a profit of 0. Total gross profit on the wash out of the first transaction = 15.

Q- It seems too simple?

A- Its an example to depict the process, and steps in a wash out, the reality of arriving at the wash out is more complex with additional variables. We need to keep it simple for our example.

We will continue tomorrow....