In recent years, many automobile manufacturers have modified their dealer incentive plans to focus on a wide range of performance measures and, in a few cases, this has resulted in disagreements between manufacturers and auto dealers. As experts in the automotive industry, A&M has helped numerous clients navigate through the financial and operational issues involved in these complex matters.

In this issue of Raising the Bar, Cristal Brun explores how the shift from volume-based incentive bonus plans (primarily focused on sales) to targeted incentive-based bonus plans (focused on a wider array of criteria) can impact competitive position, profitability and the customer experience.  

The Automotive Industry: Competition is Fierce

In recent years, competing and surviving in the retail auto industry has become increasingly challenging. The industry managed to emerge from one of the greatest financial downturns in history and has experienced historically high sales volumes as economic conditions have improved. With increased discretionary spending and elevated confidence, consumers bolstered the demand for new vehicles. However, after seven straight years of strong vehicle sales and an upward trend in demand, the U.S. auto market appears to be nearing the end of historically high sales,[1] resulting in fierce competition as automakers (referred to as Original Equipment Manufacturers, or OEMs), such as Chrysler, Ford and Volkswagen, fight to maintain their volume sales and market share. Those that stand out will also be those that manage to reinvent their business model and improve margins in creative ways, such as incentive-based bonus plans.

OEMs have historically spent millions of dollars annually in factory-to-dealer incentives to move inventory, increase volume sales and ultimately gain market share. Certain incentives provide supplemental financial assistance to the dealerships and are cash discounts off the vehicle price given to the dealerships in order to increase new vehicle sales.[2]

However, in recent years, and as the auto market has evolved, OEMs have modified their incentive bonus programs to provide more targeted incentives. The shift from volume-based incentive bonus plans that primarily focus on sales to targeted incentive-based bonus plans has the objective of maintaining the OEMs’ competitive position, maintaining profitability and ensuring customers remain loyal to the brand, as further discussed below.

Historical Incentive Bonus Plans: Timing is Everything

Historically, OEMs have incentivized dealers by providing floorplan[3] assistance, advertising credits and volume-based incentives. Inventory cost is the largest expense for a new car dealership. In fact, during the past year, new car dealers spent more than 85 percent of their revenue on vehicle inventory.[4] Dealerships pay for this inventory when they purchase the vehicles from the OEM. The amount paid is the price reflected on the invoice from the manufacturer to the dealer, or the invoice price.

To help manage inventory costs, OEMs have traditionally offered what is known as a holdback incentive plan. Under a holdback incentive plan, dealers typically earn back a percentage of the base manufacturer’s suggested retail price (MSRP) or a percentage of the invoice price from the OEM to the dealer. OEMs pay dealers the holdback at a predetermined time after a new vehicle is sold to a customer.[5] Hence, the term holdback is used because the funds are held back by the manufacturer and released after the retail sale. The timing of the holdback payment incentivizes dealers to not only sell vehicles, but to sell vehicles as quickly as possible because a dealer receives the benefits of the holdback when the vehicle is sold to the customer.

Depending on the OEM, the holdback percentage can range up to 3 percent of the MSRP or invoice price.[6] If a car dealer sells its inventory rapidly, the holdback bonus received can help improve its profit by reducing its inventory carrying cost (i.e., costs to keep the car on the lot and finance the new vehicle). Although these programs reward dealers for new vehicle sales, dealers who, for example, invest in facilities or have excellent customer satisfaction are not compensated directly for their investment in the brand.

Similarly, dealerships have received advertising credits to supplement costs incurred by the dealership to generate volume sales and promote the brand, which were historically made through traditional channels such as TV spots, radio ads, newspapers and billboards.

However, in recent years the automotive industry has evolved. Digital marketing has replaced traditional media, social media is influencing buying decisions,[7] new vehicle gross profits have decreased and certified pre-owned vehicles have become a necessary part of the business. Correspondingly, OEMs have shifted from offering bonus programs that focus solely on volume sales, to plans that also reward and incentivize dealers to invest in the brand, while simultaneously enhancing competition in the marketplace, creating brand and nameplate awareness and improving customer service.

Incentive Bonus Plans Redesigned: Improving Customer and Brand Loyalty

In an effort to optimize the performance of their dealer networks, OEMs are focused not just on volume sales, but on the customer experience as well as customer and brand loyalty. They have therefore adjusted the traditional incentive bonus programs to focus on these targets. These new incentive bonus plans, in general, are structured so that dealers become more invested in the brand.

Generally, under these targeted incentive-based bonus plans, dealers may continue to earn a bonus percentage of MSRP, but also, the dealer has an opportunity to earn additional bonuses if they meet certain requirements. For instance, under an incentive-based bonus plan, a dealer might earn holdback of one percent of MSRP from the OEM, and might also earn an additional four percent of MSRP, if they meet certain requirements, for a total incentive bonus of up to five percent of MSRP.

The targeted incentive-based bonus plans may focus on different performance elements, such as: 1) facility standards, 2) customer experience and 3) used-vehicle (i.e., Certified Pre-Owned) performance targets, among others. For example, BMW recently launched a dealer bonus program in which dealers who meet BMW’s brand standard, customer satisfaction, and used vehicle sales targets will be paid a monthly bonus of one percent of the sticker price of new vehicles sold.[8]

Facility Standard Targets

Volvo, for example, has established a Facility Investment Initiative, which is a tier-based program. This program provides higher bonuses per vehicle sold and larger allocations of high-in-demand vehicles to dealerships that exclusively sell Volvo’s products and invest in the OEM’s design standards.[9] The initiative was a response by the OEM to address the gap in facility appearance between Volvo and its luxury competitors. By providing a bonus incentive based on its facility investment initiative, Volvo supports dealers that have made an investment in the appearance of their facilities and rewards those who choose to make a new investment in their facilities consistent with the OEM’s branding.

Customer Experience Targets

In today’s competitive market, improving the dealer model is beneficial for OEMs, dealers, and customers, who by and large want a haggle-free, simple experience. By rewarding dealers for providing excellent customer experience, the OEMs seek to improve the customer’s shopping experience, train sales and after-sales personnel on product and customer handling skills to deliver excellent customer service, and ensure that by improving the after-sales performance, including sufficiency of inventory levels and reduction of repair days, the customer experience will be enhanced. As stated by Alan Batey, GM’s president of North America, “We’re going to continue to reward those dealers who are providing a world-class ownership experience that drives customer retention.”[10]

Nissan has also revised its traditional incentives program. Nissan recently announced a revamped incentive bonus plan that, “encourages a store’s brand-enhancement efforts, one that rewards a dealer for improving customer-satisfaction grades, one that benefits store managers for improving their market share in parts and service, or for increasing Web traffic, or improving results in a previously overlooked product segment, such as full-size pickups.”[11] Ultimately, the OEM believes that these are the types of factory incentives that boost dealer profitability and raise Nissan's overall brand value.

Certified Pre-Owned Performance Targets

OEMs such as Mazda[12], Audi[13] and Mercedes-Benz[14] have implemented Certified Pre-Owned  (CPO) programs to reward dealers that achieve certain CPO sales targets. As with the performance elements described above, dealers receive a percentage of MSRP for meeting these targets. For example, Mercedes-Benz implemented an incentive program offering its dealers three levels of per-vehicle payments – gold, silver and bronze – for achieving individualized sales targets for certified vehicles.[15] The U.S. auto industry sold a record 2.6 million CPO vehicles in 2017 and sales in the first half of 2018 were higher than the first half of 2017. OEMs see that CPO sales are at historic levels and each OEM wants to maximize its share of these sales. The OEMs have put CPO incentive programs in place to align higher sales figures for the OEM with increased profitability for the dealerships.

Overall, It’s a Win for Customers

With most OEMs and dealers focused on improving customer experience and the resulting increases in brand loyalty and service growth, these incentive-based bonus plans drive both behavior and dollars in ways that improve the automotive sales and service experience for consumers. And while some dealers remain skeptical about the long-term economic benefits of the targeted incentive-based bonus plans, perhaps the automotive industry is aligning with the thoughts of legendary football coach Vince Lombardi, who said it best: “Individual commitment to a group effort – that is what makes a team work, a company work, a society work, a civilization work.”[16]

In the near future, as OEMs and dealers expand their cooperative efforts, it will be interesting to see how the new road map, driven by a more collaborative approach, will improve both dealers’ and OEMs’ volume sales, consumer satisfaction and economic margins.