Has the property timebomb been defused?

Almost ten years ago, we warned of a ‘property timebomb’ in respect of dealerships.  Our rationale was that networks were too dense, many individual dealer properties were too large and over-invested, and that the emerging omni-channel model would move the focus towards digital channels.  Whilst dealerships were and remain important to customers as a key part of their buying journey, we questioned whether the demand for dealer property would be sustained at a level that would maintain property values.  We felt that in combination with weakening profits from aftersales, anything other than prime properties in the best locations would become unviable with poor returns and low demand.  Rather than dealer property being an asset, some would become a liability with over-supply and collapsing values.  This in turn would cause banks to reconsider their financial exposure to dealer groups whose balance sheets would be weakened.  This was the ticking timebomb that we warned about.

So has something changed?  In some respects, things have got worse.  The accelerating pace of BEV penetration brings forward the point at which aftersales ceases to be a support for the whole dealership.  The cost of capital today is much higher than those that applied for most of the period from the financial crisis until the pandemic.  Improving capabilities of digital channels means that the dealership role becomes even more focused on validation of a choice, rather than a traditional competitive sales process.

However, in one respect things have changed for the better in respect of dealer property.  Values are dictated by the balance of supply and demand, and compared to the slow and steady decline in total franchise network numbers through the 2010s, we now have multiple new brands, mainly Chinese, trying to build dealer networks in parallel.  They all have aggressive volume ambitions and believe that they need to have dealer networks of a similar size to their much-longer established competitors to achieve this.  Not all will succeed, but some will, and it does not alter the fact that in the next few years they will each be trying to add a hundred or so franchise points in the major markets.

Just because they’re newcomers does not mean that they are prepared to accept lower quality sites.  They want ‘A’ grade sites in prime locations, rather than lower grade sites that might have been very acceptable to Hyundai or Kia in the equivalent stage of their growth plans.  However, there are only so many high grade, prime location sites, and whilst some investors might be open to switching the franchise or dualling with a newcomer because of concerns about the longer term franchise viability, most will remain committed to their existing partners.

Because of the near term volume ambitions of the newcomers, they are now competing for the same sites.  Some may offer more favourable terms for showroom fitout and launch costs, but investors should be cautious and assess their options on the basis of the long term prospects of the brand, not short-term financial incentives.  Others, driven by internal objectives of signing up a target number of dealers within two years, are compromising and taking on less desirable investors and locations in order to hit the target network size.

What we are now seeing is a land grab, because some newcomers are starting to panic that all the available opportunities will have been taken by competitors, and they will be left short of their targets.  There is a view that network size has a direct connection with sales volume, but this is flawed.  ICDP is currently conducting research in conjunction with Urban Science which will demonstrate that there is no such direct connection.  Multiple factors have an influence including the brand strength and product attractiveness and the strength of the dealer investor.  A smaller network of strong investors will perform better than a larger network of weaker investors.  Some manufacturers will come to regret choices that they make to meet the short term ambitions and then go through restructuring and terminations to adapt their network at a later stage.  Disappointing for the investors and disruptive for the customers.

What this means for the timebomb is that the clock has stopped running – at least for now.  However, it is a bit like a James Bond film.  The timer may have stopped with a couple minutes to run, but the evil villain is still out there and the timer may restart.  If this marks the success of the newcomers in achieving viable volumes, then it almost certainly follows that some established players will be suffering badly and will need to restructure their networks, with a few potentially exiting the market completely.  At that point, the clock will restart but possibly running down at an even faster rate.

For dealers, the changed environment provides a short term opportunity to reconsider how they are utilising their property portfolio.  For established OEMs, the need for a positive relationship with their dealer partners is even more critical than before.  For the newcomers, there are real opportunities to recruit partners for the long term that will help create a sustainable future, but they need to avoid creating tomorrow’s legacy by focusing on network growth over network quality.