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Profit Margins Under Pressure from Inventory: Where Do Dealers, Cornered and Fighting Back, Go From Here?

2024-03-01

Profit Margins Under Pressure from Inventory: Where Do Dealers, Cornered and Fighting Back, Go From Here?

As 2024 has just begun, Audi's CEO unexpectedly announced the suspension of several ongoing BEV development projects and a slowdown in the rollout of electric vehicles—strategies aimed at preventing excessive pressure on dealer profits. Interestingly, the author learned from within FAW-Volkswagen that one of Audi's largest dealership networks in Guangzhou is now grappling with the awkward predicament of "double losses"—both in gasoline and electric vehicle sales. After the Spring Festival, this 4S store conducted a detailed marketing analysis of its best-selling model, the Audi Q5L, revealing that while it managed to sell over 1,000 units last month, the gross profit per vehicle was a mere 5,000 yuan. Yet, when factoring in the hefty marketing costs—averaging 12,000 yuan per car—the dealership actually incurred a loss of 7,000 yuan for each Q5L sold. Meanwhile, the e-tron series of electric vehicles has never turned a profit since its launch. Following the holiday season, the author casually discussed this issue with industry insiders and reached a shared conclusion: driven by intense price competition in the EV market, dealerships' traditional revenue pillars—commonly known as the "three golden buckets" (reduced accident claims, declining vehicle usage rates, and significant shifts in insurance industry regulations)—are rapidly eroding. As a result, dealerships have shifted from a mixed state of cautious optimism to widespread despair. Today, understanding why this crisis is happening—and figuring out how to respond—is becoming the daily challenge that every dealer professional must confront upon waking up each morning.

"Besides Tesla and BYD, no major automakers producing electric vehicles are profitable. Yet, traditional internal-combustion-engine cars still maintain some profit margins," Avatr's CMO Li Pengcheng shared during a conversation with the author, highlighting an industry-wide consensus. Avatr expects its losses to narrow significantly this year, though it remains firmly in the red. Meanwhile, Lotus, which recently went public via an IPO merger in the U.S., has already racked up losses totaling hundreds of millions of dollars over the past two years. Despite lithium prices plummeting nearly 80% year-on-year—still failing to fully trickle down to battery costs—battery costs continue to account for about 100,000 yuan per BEV vehicle on average. Moreover, most companies leveraging Huawei’s platform must also pay technology transfer fees of around 100,000 yuan per car. As a result, it seems the road to profitability for both EV and traditional vehicle manufacturers will likely remain challenging for some time. Meanwhile, while profits from internal-combustion-engine vehicles have declined sharply, they’re still managing to deliver solid returns. For instance, Toyota and Hyundai continue to enjoy healthy profit margins of 6% to 9% per vehicle, and FAW-Volkswagen reported an EBITDA (earnings before interest, taxes, depreciation, and amortization) of 39 billion yuan in 2023—only 1 billion yuan lower than the previous year. Yet, unlike automakers, whose fortunes remain somewhat mixed, dealerships are facing an increasingly dire situation. Whether selling gasoline-powered, electric, or even hybrid vehicles, new-car sales are no longer profitable. In the past, regional disparities existed, but since last year, many brand dealerships across China—from north to south—are struggling to turn a profit. Notably, losses among joint-venture brands have expanded, with fewer dealerships now breaking even. According to the "2023 First-Half Dealer Survival Survey Report" released by the China Automobile Dealers Association—which analyzed only data from the first half of the year—industry insiders reveal that the full-year outlook is expected to be even bleaker.
Nevertheless, we can still glean valuable insights from the data of the first half of 2023. For instance, last year in the first half, the proportion of dealerships operating at a loss continued to expand, with more than 50% of dealerships reporting losses, while 35.2% remained profitable and 14.5% managed to break even. Meanwhile, another report—the "Survey on Dealer Satisfaction with Automakers and the Business Conditions of Automotive Dealers"—revealed that since 2016, the percentage of loss-making dealerships peaked at 60% in 2022, compared to 43.1% in 2020, the year the pandemic first struck. In 2022, the breakdown of loss ratios among different types of dealerships was as follows: 73.8% for independent brands, 66% for new-energy vehicle brands, 63.7% for joint-venture brands, and 47.4% for luxury brands.
At the end of 2023, FAW Toyota announced in "A Letter to FAW Toyota Dealership Partners" that, due to mounting inventory and financial pressures faced by dealerships, the company would significantly reduce production until February 2024. According to the plan, even after already slashing production substantially in October and November, FAW Toyota will further cut output sharply from December through February 2024. From the perspective of dealership partners, allocations were already adjusted downward to 66,000 units in December, with additional reductions to 60,000 units in January and a further drop to 38,000 units in February 2024. FAW Toyota explained that these production adjustments are aimed at easing dealer pressure and ensuring high-quality sales performance at the retail level. Simply put, the decision to cut production reflects FAW Toyota's effort to alleviate dealers' inventory and cash flow challenges. Historically, when dealers struggled, automakers could step in to provide support—but this year, automakers themselves are facing severe budget constraints. Last year, FAW Toyota already operated under a nine-month budget framework, and now, for 2024, the company is scaling back its budget by another 20%. Similarly, major players like Volkswagen South & North, SAIC-GM, and the "Two Japanese Automakers and One Chinese Manufacturer" are all implementing budget cuts ranging from 20% to 60%. As a result, dealers are left scrambling to protect their own interests amid these tough economic conditions.
Compared to independent, smaller dealerships operating alone, dealership groups—thanks to their multi-brand, diversified business models—are better equipped to withstand risks and generally perform stronger financially. In 2022, the overall proportion of loss-making dealerships stood at 27%, while 18% remained break-even, and 55% turned a profit. Looking at the profitability trends of automotive dealership groups from 2020 to 2022, we see that in these three years, the average annual loss rate was 6%, with only 24% reporting profits in a single year and 22% achieving profitability over two consecutive years. Nevertheless, dealership groups are currently experiencing their worst period in nearly five years. Recently, Lang Xuehong, Deputy Secretary-General of the China Automobile Dealers Association, pointed out that in the first half of 2023, fewer than 25% of dealerships managed to meet their six-month targets—meaning most dealers were either unable to secure, or received only partial amounts of, various rebates, subsidies, and incentives. As a result, dealer satisfaction with automakers plummeted to its lowest level in nearly a decade, scoring just 73.1 points, down from 74.4 points in the previous year, 2022.

The automotive manufacturing industry, characterized by the acceleration of gravity, often sees its marginal benefits reflected in inventory levels. Once inventory exceeds the critical threshold, the situation deteriorates rapidly, becoming difficult to recover. HiPhi Auto had already accumulated enormous production and distribution inventory even before the official production halt. HiPhi dealerships, which closed before the Lunar New Year, were already overflowing with cars. Employees were already owed wages for months before the Lunar New Year, and their cafeteria meal cards had been suspended. This demonstrates that once high vehicle inventories, regardless of whether they are gasoline or electric, are unstoppable, the natural downward spiral of gravity is impossible to halt. Currently, inventory levels across the industry are bleak. In the past, the inventory coefficient was calculated based on quantity—for example, if the average inventory level for every 100,000 vehicles produced was 10,000, the coefficient would be 1.1. However, because this model was too coarse-grained, it is now calculated based on the age of inventory.

For example, in July 2023, the comprehensive inventory coefficient for domestic auto dealers was 1.70, a 25.9% month-over-month increase and a 17.2% year-over-year increase, placing inventory levels above the critical threshold. Among them, the inventory coefficient for high-end luxury and imported brands was 1.22, a 40.2% month-over-month increase; the inventory coefficient for joint venture brands was 1.89, a 26.8% increase; and the inventory coefficient for domestic brands was 1.69, an 18.2% increase. Ten brands had inventory depths exceeding two months, with BAIC Motor, Dongfeng Nissan, and Beijing Hyundai having the highest inventory depths. Following inventory reduction efforts at the end of last year, a large amount of production inventory shifted to distribution channels—in other words, from OEM parking lots to dealerships' underground garages. While inventory depths are no longer quantifiable, they are certainly worse!

Some dealers reported that an inventory coefficient of less than 2 was not a problem in the era of rapid growth and rapid sales, and even levels of 3 or 4 were not a major concern in the past. However, in today's era of inventory and even declining sales, an inventory coefficient of 2 could be a recipe for disaster. According to international industry practice, an inventory coefficient of 0.8-1.2 indicates a reasonable inventory range; an inventory coefficient greater than 1.5 indicates a warning level requiring attention; and an inventory coefficient greater than 2.5 indicates excessive inventory, leading to significant operating pressure and risk. The current inventory ratio has already exceeded the standard. A new round of price wars initiated by BYD and Wuling after the Spring Festival will induce some dealers to reduce prices and clear out some of their inventory, increasing the pressure on dealers to sell new vehicles and spreading to the used car market, leaving the entire market with a shortage of cash. Dealer profitability will also be further weakened. Adding insult to injury, the rate of store closures is certain to increase this year. Some Volkswagen and Audi dealers told me that they received notices after the New Year that any dealer with no sales for three months would be automatically disqualified, leaving them devastated. Even worse, some joint venture OEMs are directly purging dealers with excessive inventory, forcing them to close stores and merge with the grid without compensation. People jokingly call this "killing without burying!"

A post circulating online reflects the dealers' sentiments: "If there are still dealer investors who invested in stores in 2020, I wonder how noble their mission, dreams, and passions are!" Another dealer told the media, "In 2021-2022, several automakers had plans to reach or even return to the million-unit mark. A group of dealers jumped on these manufacturers' bandwagon. Now, with the overall auto market downturn, the original manufacturers' plans have been thwarted. Most newly joined dealers are starving, unable to wait for the OEMs to feed them!" If dealers aren't making money selling new cars, they typically have three main profit points after the sale: accident repairs, routine (or excessive) maintenance, and insurance renewals. But the competitive landscape of new energy vehicles has completely changed these three profit points.

First, the replacement of the three filters (excluding the air filter, which is too small and can be ignored) with the three electric motors has led to a decrease in maintenance frequency and store visits. Routine excessive maintenance, such as adding several tanks of exorbitantly expensive motor oil and still making money even after various discounts, is completely unnecessary for electric vehicles. Second, accident repairs, towing services, and various disguised charges are based on a stable travel rate and a low scratch rate. However, with the increasing intelligence of vehicles, often equipped with dozens or even hundreds of sensors, cameras, millimeter-wave sensors, and lidar, the rate of car scratches has significantly decreased. New energy vehicles are mostly stamped and formed in a single process. While this increases repair costs, dealers rarely recoup these costs because they cannot be processed using traditional sheet metal processes and require large panels to be replaced at the factory. Furthermore, the economic downturn and erratic weather have significantly reduced vehicle travel, causing repair shops to go from being overcrowded to empty, leaving them struggling to meet their needs. Some dealers and OEMs have even colluded to lower the factory-set automatic warning levels, to no avail. Third, while renewals and extended warranty premiums for major items may be suspected of sales fraud, the insurance sales pitch within contracts (which, like the endlessly complex insurance clauses, can be overwhelming) often makes consumers easily deceived and difficult to detect, or even prove, when they do discover it. This creates a profit-sharing relationship between dealers and insurance companies. However, with declining profits in the insurance industry during the period of interest rate cuts, insurance companies have begun to partially reclaim auto insurance operating rights through policy adjustments to maintain their profits. Dealerships' space for extended warranty and renewal services is gradually being closed off. Currently, only a small number of luxury and high-priced car models still have a sliver of profit margin in auto finance, which is being forced to continuously lower interest rates by financial institutions' consumer lending policies and competition from other industries. This is truly pitiful. Furthermore, with the mandatory use of new energy vehicles in local government procurement and taxi and ride-hailing services, group maintenance discounts are significant, but profit margins are even smaller. Dealers' after-sales profits from group orders are naturally drying up. The coexistence of opportunities and challenges is a hallmark of the stock economy. Sailors never complain about the weather; the path to innovation often lies in the details, hidden in corners obscured by emotions and overlooked by everyone.

Last year, I conducted an in-depth interview with Song Yunfeng, Director of After-Sales Service at GAC Trumpchi. If interested, I can provide more details later. The core concept behind this approach is the "Golden Triangle" service. This involves the use of intelligent OTA and customized services, which create profit margins for third-party subscription fees while improving customer satisfaction at channel stores, attracting repeat customers, and increasing after-sales loyalty, creating previously unattainable profit margins. Currently, Trumpchi's gasoline and hybrid vehicles are offered through one storefront, while new energy vehicles like the E9 can be serviced through a separate storefront. However, modern ERP systems can provide the same level of service and efficiency. We've often heard recently that gasoline and electric vehicles are priced the same, but I believe Trumpchi offers the same service for both! Real-time vehicle usage and data are shared across the cloud, from the OEM to each dealership, and even through each owner's mobile app. This ensures that, while ensuring owner privacy and complying with data management laws, it maximizes the early detection and resolution of vehicle issues. The interests of OEMs and dealers are deeply intertwined, allowing them to profit together and help dealers discover new profit points tailored to local conditions and specific stores. Key strategies include, but are not limited to: integrating big data with large and medium-sized platforms; re-engineering KPIs through "person-to-person" strategies to stimulate the initiative of frontline after-sales staff; and leveraging AI to provide personalized, in-depth service and superior experiences, creating new profit models and finding ways to prevent talent loss and reduce workload. This combined approach by GAC Trumpchi promises to break the paradoxical mindset. If everyone in the industry can learn from Trumpchi and find a path that suits them, then achieving Pareto progress, achieving win-win outcomes, and even breaking out of the vicious cycle of price wars is highly possible.

Improvements in the macroeconomic environment are imminent; after all, China's manufacturing strength and competitive advantage are strong enough. There's also hope for improvements in the external environment. However, it must be emphasized that all of this takes time. We certainly hope that dealers can persevere and finally see the light. However, as the Buddha himself, so too must dealers and OEMs strive to find solutions. This is not the first time, nor will it be the last, that the automotive market will face fierce competition and the survival of the fittest. Both Kairui Saichi Consulting and Chezhi.com, where I work, have mature and continuously developing solutions and research topics. I also hope that, beyond an article or two, or a casual chat, I can share with industry insiders the ideas and methods for navigating the competitive landscape and carving out new territory.