1. FTC CARS Rule

In December 2023, the FTC surprised the auto industry when it announced the Combating Auto Retail Scams (CARS) Rule. The FTC claims the purpose of the Rule is to “fight two common types of illegal tactics consumers face when buying a car: bait-and-switch tactics and hidden junk fees.” The Rule would subject vehicle dealers to numerous new disclosure requirements, along with record retention requirements. Originally, the Rule was going to become effective on July 30.

In early January, the National Automobile Dealers Association (NADA) and the Texas Automobile Dealers Association (TADA) filed a Petition for Review of the Rule, challenging the Rule on multiple grounds. In response, the FTC has postponed the effective date of the Rule until after the court issues a decision. The dispute is being handled on an expedited basis, with the last brief due on June 13. Below is a summary of the key aspects of the Rule:

1. Scope: The Rule applies to covered motor vehicles sold by covered motor vehicle dealers (excludes off-road vehicles, motorcycles, and recreational vehicles [RVs]). [§ 463.2€]
2. Offering Price: When advertising a specific vehicle, any monetary amount, or finance term, the offering price must be disclosed. [463.4(a)] Offering price means the full cash price for which a dealer will sell or finance the vehicle to any consumer, provided that the dealer may exclude only required government charges. [§ 463.2(k)] In other words, documentary fees and other dealer fees must be included in the offering price.
3. Finance and Lease Offers/Total of Payments: In addition to Regulation Z and Regulation M disclosures, when advertising a monthly payment, a dealer must disclose the Total of Payments for lease or financed transactions. [§ 463.4(d)]
4. Limited Rebates: The Rule prohibits any misrepresentation, expressly or by implication, regarding material information about the “availability of any rebates or discounts that are factored into the advertised price but not available to all consumers." [463.3(d)]
5. First Communication Between Dealer and Consumer: A dealer’s first communication to a consumer that references a specific vehicle or finance term must disclose the offering price. [§ 463.4(a)(3)]
6. Add-On Products: Dealers cannot offer add-on products that offer no actual benefit. [§ 463.5(a)] Any representation about an add-on product must disclose that it is not required [§ 463.4(c)] and must disclose total payments for the add-on product versus total payments if the add-on product is not purchased. [§ 463.2(g)] A customer must provide express informed consent to purchase an add-on product. [§ 463.5(c)]
7. Monthly Payment Comparison: When making any comparison between payment options, dealers must disclose that a lower monthly payment may increase the total amount to purchase or lease the vehicle, if true. [§ 463.4(e)]
8. Record Retention Requirement: Dealers must retain certain records relating to advertisements, communications with consumers and vehicle sale/lease transactions for a period of two years. [§ 463.6]

ArentFox Schiff will continue to monitor the NADA/TADA Petition for review and will provide periodic updates in our Managing Automotive blog.

2. Online Sales

Some vehicle buyers prefer not to shop in person at a traditional brick-and-mortar store. Instead, they want to buy a vehicle online from the comfort of their sofa, where they can shop, finance a vehicle, and arrange for delivery or pickup. The onset of the COVID-19 pandemic prompted retailers to change how they sold vehicles when customers were unable to visit brick-and-mortar stores, spurring dealers to offer end-to-end online car buying services. Consumer demand for online sales has continued to rise ever since.

In November 2023, Amazon announced it was partnering with Hyundai to sell vehicles online making it more convenient for customers to find and buy their vehicle of choice. Launching later in 2024, customers will log onto Amazon.com to search for available vehicles in their area based on a range of preferences, including model, trim, color, and features, choose their preferred car, and then check out online with their chosen payment and financing options. Customers will be able to sign most if not all of the paperwork online. Pickup and delivery are managed by the customer’s local Hyundai dealership.

The KPMG 24th Annual Global Automotive Executive Survey found that while driving performance remains the most important priority when purchasing a vehicle, a seamless and hassle-free customer experience has moved up to second place. The increase was particularly marked in the United States, where the share of respondents saying a seamless experience is extremely important jumped from 24%to 39%.

Consumers find the benefits of online sales include a broad selection of vehicles from all over the country, no-haggle pricing, and the ability to compare vehicles more easily . The disadvantages of buying a vehicle online include the lack of a test drive or in-person quality assessment and no face-to-face customer service.

The goal of all online retailers is to provide the same simplicity and transparency that online sellers of other products offer their customers. Gen Z, the generation that spans ages 12 to 26 is expected to account for 40% of consumers in the United States. Nearly one-third of Gen Z consumers shop online at least once a day, according to data from marketing firm Tinuiti. Yet, 80% of Gen Z drivers prefer to buy a car in person. Only 9% prefer to do so online, according to a recent report by Cars.com. Automobile sellers must figure out how to make online car buying attractive to this segment of the population. While online sales appear to be the wave of the future, sellers will have to address both ends of the consumer spectrum, those who favor the traditional brick-and-mortar store customer experience, and those who want to buy a car without the hassle of going to a dealership.

3. Direct to Consumer Sales

The rise of EV makers like Tesla and Rivian that sell directly to consumers rather than through a franchised dealer network has caught the attention of vehicle dealers and state legislators alike. All 50 states have some dealer franchise laws that limit manufacturer sales to varying degrees, from outright prohibitions of manufacturer direct sales to only limiting manufacturers from establishing dealerships within a number of miles of an existing franchisee. Even in states with strong direct sales prohibitions, some manufacturers are able to sell and deliver vehicles to consumers due to federal prohibitions on restricting interstate commerce. For example, Tesla was able to circumvent a complete ban on direct sales in Texas by selling vehicles from out-of-state locations for delivery in Texas. In New Mexico, Tesla operates multiple stores on tribal land outside of the state’s jurisdiction. Such circumvention of state law has led to regulators and franchised dealers (as well as their dealer associations) entering into legal battles with manufacturers over state franchise laws. The stakes are high as Automotive News estimates that direct sales cost California dealerships alone over $900 Million in profits in 2022.

The future of automotive direct-to-consumer sales remains uncertain as manufacturers navigate legal challenges and dealer pushback. A recent proposal to the Washington state legislature recommended that the state allow direct sales of electric vehicles to consumers, ignoring comments from state dealers opposing such an exemption. Florida recently signed a more robust ban on direct-to-consumer sales for automakers that have franchise agreements in place with dealerships in the state, exempting newer electric vehicle makers like Tesla that have not entered into such agreements. And a very recent Nebraska legislative proposal could prevent Tesla from even operating a service center in the state. As the industry continues to adapt to the rise of electric vehicles, the inconsistent patchwork of state law limitations on direct sales offers no clear direction on the future of direct sales by manufacturers. For the time being, however, most states continue to effectively prohibit manufacturers that do have franchised dealers from competing with those dealers via direct sales. Manufacturers facing a difficult and inconsistent regulatory climate in America may also look elsewhere for direct sales opportunities, as General Motors (GM) recently did by reentering Europe with direct-to-consumer Cadillac sales.

4. Autonomous Vehicles, Continuing Evolution of the Federal and State Regulatory Landscape

The autonomous vehicle (AV) industry is continuing to evolve and 2024 is poised for additional significant regulatory developments. In just the first two months of 2024, we have already seen shifts in the regulatory climate.

On January 9, a bill was introduced in the California State Senate, SB 915, that would allow local municipalities to regulate AVs within their territories for the first time in the state’s history. On February 2, South Dakota passed the state’s first AV legislation. On February 6, an administrative law judge for the California Public Utilities Commission held a hearing to consider whether to levy unprecedented sanctions against an AV company based in San Francisco for alleged failures to comply with its regulations. Finally, on February 13, Waymo, the industry leader, filed its first-ever voluntary recall of driverless technology following a driverless incident in Phoenix, Arizona.

Some of the AV industry’s leaders continue to expand their AV operations, including multiple companies that have announced their goal to launch fully driverless operations in 2024. In some locations, there has been vocal public opposition to their deployment. This combination of factors sets up for a 2024 that may see many local and federal regulators increase their use of existing tools to oversee AV operations within their jurisdiction and potentially create new tools of regulation.

AV companies with plans to expand their operations in 2024, especially those that plan to conduct fully driverless operations, should review their existing safety personnel, protocols, and regulatory compliance programs to plan for the long-term reality where AV operations and technology will be much more highly regulated at both the state and federal level.

5. Electrification: Cars, Electric Vehicle Sales, and Infrastructure

White House goals to mandate a near-term EV future are unrealistic without either significant customer migration to smaller vehicles, rapid progress on battery technology, or a regulatory shift to include hybrid plugin vehicles.

US sales for EV’s are too low, with customers resisting over battery anxiety and high prices.

• In California alone, where EVs have had a significant historical share of new vehicle sales, new-vehicle registrations for EVs have fallen over the past three months.
• Range anxiety is dampening consumer demand for battery electric vehicles (BEVs), as technical limits on batteries are preventing drivers from realizing ranges stated by manufacturers. Manufacturers (e.g., Kia and Toyota) are recognizing this by increasing their focus on plugin hybrids.

EPA compromises on federal EV mandates on tailpipe emission reductions.

• The EPA released a final rule last week on tailpipe pollution limits for 2027-32 model-year vehicles that pushes more aggressive emissions cuts out toward the end of that period. This gives manufacturers more time to offer market-ready EV’s that can capture significantly more of the US new vehicle market share by 2032.
• Manufacturers can increase profitability and match consumer price expectations by driving more consumers to sedans instead of sports utility vehicles (SUVs), crossovers, and light trucks. However, this migration will be daunting, as SUVs and car-based crossovers accounted for 79% of light vehicle sales in the US market last year. Ford has recently signaled its intent on offering more smaller EV vehicle options.
• The addition of plug-in hybrids to the White House EV agenda could help better align customer references to avoid the range anxiety of BEVs while significantly reducing carbon emissions.

Dealers looking at Ford’s Model e tm Program as a Trojan Horse for eliminating the franchise dealership model under the guise of selling and servicing E’s.

• Ford’s Model e Program drastically changes the dealership model by attempting to cut its dealers almost entirely out the EV sales process. Under the program, Ford is attempting drive sales entirely online, take away cars available on dealer lots, and prevent dealers from negotiating price with customers.
• Ford is also demanding dealers provide a public place to fuel EVs in addition to selling and servicing EVs. This demand is unprecedented in the hundred-plus year history of the franchise model, equivalent to requiring dealers have a gas station on site for gas-powered vehicles. And dealers will have to put up one million dollars just to make this happen.
• Ford dealers face a Hobson’s Choice; either accept a program that significantly diminishes their roles as franchisees at great capital expense or see the sales diminish over time as they are limited to only selling gas-powered vehicles.
• To date, dealers in six states (Illinois, South Dakota, New York, North Carolina, Florida, and Maine) have challenged Ford in court and with motor vehicle regulators that the Model e Program is an illegal modification to their franchises.

(Source: Automotive News, New York Times, manufacturer materials, Goldman Sachs, court records, and direct dealer conversations)

6. Profitability/Reduced Grosses

2024 expected profits are down from the COVID-19 peak but are still attractive.

• While the high dealership earnings from the peak years of 2021 and 2022 are clearly over, most dealers are not pessimistic, as 2024 earnings are still expected to be higher than earnings from pre-pandemic years. Pre-tax profit per US dealership rose to $6.38 million for September 2023 TTM versus annual estimates for 2018-20 of $3.2 million or less. Public dealership groups had average new vehicle gross profits through Q3 2023 that were 145% above pre-pandemic averages, even accounting for EV profit struggles. Dealerships have kept profits high in part by continuing to turn new car inventory at a higher level than pre-pandemic years. This trend should accelerate further once interest rates decline as expected this year.
• For some larger dealer groups, new vehicle profitability has reached a “Goldilocks” moment where they have just the right amount of inventory on hand now to take advantage of customers ready to purchase without having the additional floorplan financing costs that come with having too many vehicles in stock. Other dealers have profitability challenges. Dealers in the 10 to 20 rooftop range that have added more stores over the past few years are now looking at some of their stores and offloading them to better align their business strategies with the number of experienced managers they have in sales, finance, and fixed operations. Without adding additional experienced managers, some of these dealers are simply stretched too thin from recent acquisitions to manage all their rooftops at the most profitable level.
• Fixed operations profits (i.e., vehicle repairs) have normalized from pandemic lows, representing 44% of total average dealership profit. This is likely due to increased aging of vehicles on the road, miles driven since pandemic periods, and greater complexity in vehicle systems that have increased profit per order.
• Profits on used vehicles have come back down but remain significantly above pre-pandemic levels. Gross profit per used vehicle in 2023 for public dealership groups was 32% higher than pre-pandemic lows. However, pure-play used car businesses have suffered, as evidenced by the recent exits of e-commerce players Vroom and Shift Technologies. These businesses have struggled with increased costs to acquire inventory and the loss of potential late model-year buyers who instead purchased new vehicles as more have become available.

(Sources: Kerrigan Advisors, Automotive News, and direct dealer conversations)

7. Valuation of Dealerships/Assets

Valuations continue to remain high as profits normalize, while experienced dealers retire and the “dry powder” of buyer cash is put to work.

Dealership valuations remained near peak levels in 2023, twice their pre-pandemic values but lower than valuations in 2022. However, it is expected that valuations should steadily increase due to several important factors.

• Steadier profits that are higher than pre-pandemic levels are expected to attract more buyers. Expected profits are at the core of any business valuation and, as discussed above, dealership profits are expected to remain relatively high against pre-pandemic levels. This expectation has resulted in many buyers recognizing that pre-2019 earnings estimates are not relevant to valuations today. Dealership profits seem to have hit a “new normal” that should entice buyers looking to capitalize on more reliable earnings opportunities.
• The exodus of “Boomer” dealers continues to put more higher-value stores on the market. Though exceptions exist, many older dealers are looking to retire, especially as the industry transitions to electric vehicles and more of the sales process moves online. Unlike in prior years, though, more of the dealerships up for sale will have good financials because retiring sellers are not necessarily exiting due to poor store performance. The influx of sale prices for these higher-earning stores into comparative analysis valuation models should help increase dealership valuations more generally.
• Outside investors will continue to partner with experienced operators. The next generation of dealers have made their presence known. For many of these rising operators, their success will be inextricably tied to pairing their expertise with outside investors. These kinds of partnerships continue to be on the rise, increasing demand for acquisitions and valuations for stores generally.
• Valuations could nonetheless face a significant risk of decline tied to EVs. Profitability in 2024 and 2025 will be negatively impacted by the EV market, particularly if dealers are faced with having to hold EVs on their lots longer than is financially reasonable and take on significant capital expenses for EV-related infrastructure.
• Changes in valuations by brand appear to represent long-term trends, as Toyota, Subaru, Honda, and Kia store valuations are on the increase and Ford, Stellantis, and Nissan store valuations have declined. Valuations for all other brand stores have remained steady.

(Sources: Kerrigan Advisors, Automotive News, and direct dealer conversations)