Rising overhead and immature business structure hit profitability of Chinese auto dealers

Published: 18 March 2014

Auto dealers in China are having a tough time maintaining their profitability partly because of rising operational, labor and financial expenses. Also hurting net margins is their heavy reliance on the sales of new vehicle, in which there is intense price competition. The fact that business potential in the back-end segments has not been fully exploited is also behind the pessimism of auto dealers' profitability, according to the latest report from Deloitte.

The report said net margin (measured by return on sales) of Chinese auto dealers stood below 2 percent in the first half of 2013, versus the industry benchmark of 3.0 percent. Statistics also show that the ratio of dealers' overhead (including sales, management and financial expenses) was over 7 percent by the end of 2013, up one percent from the end of 2012.

Since 2011, Deloitte has been conducting research and studies about the auto dealer industry, seeking to provide insights about the inherent risks and challenges of the industry and help formulate strategies to address them. Titled "2013 Deloitte China Auto Dealership Performance Study", the report was put together based on a questionnaire survey, together with nearly 100 in-depth interviews with executives of auto dealer and carmaker companies.

"While auto sales will be buoyed by sustained economic growth, the auto market structure is relatively less-than-mature when compared with the western world. Heavy reliance on new car sales can leave the overall profitability exposed to uncertainties of the external environment. There is a long way to go for the profit structure to tilt toward the back-end segments. Chinese auto dealers also need to bear the brunt from increased overhead costs," said Winhon Chow, Automobile Dealership Managing Partner, Deloitte China.

The report also covered other challenges faced by auto dealers in China, including high liquidity risk and the pile-up of inventory. In the first half of 2013, drastic increase in production against a modest growth has led to excessive inventory for the auto industry. Industry practitioners are aware of the inventory problem and 74 percent of survey respondents attributed this problem to fierce market competition. High inventory will give rise to funding and liquidity problem, which is also exacerbated by the lack of external financing and the dearth of self-owned capital.
"After all, it is a capital intensive industry, auto dealers have always been operating with great balance sheet stress. Usually, dealers are highly leveraged in order to meet capital needs. Loans from local commercial banks are cited by 64 percent of respondents to be one of their major sources of financing." said Mr. Chow.

One of the emerging trends for the industry is the expansion of sales network by auto dealers into second and third tier cities, partly because of government's purchase restriction for in the mature tier one cities and partly because of insatiable consumer demand in tier two and three cities. Yet, this emerging trend will make it harder for auto dealers to manage their sales network, especially when qualified administrative and technical professionals are in shortage at the lower-tier cities.

Taking into account the steady recovery of China's auto market, as well as other emerging challenges in 2013, the report advocated stronger cooperation among automakers, dealer groups and independent dealers, as well as tighter control over capital, expenses and staff management. Equally important would be improvement in staff retention, and transition of business models and operations for more rapid, sustainable and steady business growth.

About Deloitte China Auto Dealership Excellence
The Deloitte China Auto Dealership Excellence("we/us") is a professional consulting team focusing on serving the auto dealership market. We are committed to enhancing the competitiveness, improving the profits and maintaining the healthy development of auto manufacturers and dealers. Through our years of service, we have accumulated extensive knowledge on dealership management, and continuously updated our dealership management database. Our service scope covers Vehicle Sales (new and used vehicles), After Sales (accessories and services), Finance and Insurance, Market and Customer Retention Management, and Dealership Network Development. Our service offerings include: Dealership Excellence Reporting System, Dealership Risk Management, Human Resources Development Excellence, Dealership Performance and Improvement, and Dealership Audit.