Audi of America defied the softening luxury market and maintained its record-setting momentum in 2016. Its dealers are in the middle of a $2 billion dealership construction boom, and the brand's product pipeline is as full as ever.
But to keep the momentum going, Audi dealers have had to sacrifice profits.
Restoring dealer profitability is the No. 1 priority of the Audi National Dealer Council, says outgoing chairman Ralph Mauro.
Mauro, 59, and president of International Autos Group in West Allis, Wis., says a new dealer profits task force of dealers and Audi executives has formed to find new ways to enhance dealers' bottom lines.
Those efforts will play out as Audi enters a major year for new product launches, starting with the redesigned Q5 crossover, Audi's top-selling model.
Mauro spoke with Automotive News about the year just completed and what's ahead for Audi dealers.
Q: How was 2016 for Audi dealers?
A: It was challenging. The challenge was to keep the momentum going. Between the Q7 and the A4 we thought this would give us the opportunity to increase gross and dramatically affect our return-on-sales. What we didn't forecast was a luxury high group that was going to decline and an A4 segment that was going to struggle.
The Q7 gave us a tremendous boost in profitability. We were able to maintain market share with the Q7 and actually increase market share with the A4, yet it wasn't as profitable as we thought it was going to be because the segment was shrinking. But if you look at the numbers and look at how Audi has performed compared to their competitors you'd have to say it was a successful year. We've increased market share and we've increased our sales by approximately 3 percent while you see other luxury manufacturers declining in market share and declining in sales.
Last year, you said improving profitability was a key priority. Did dealers see improvements?
I would say it was partially successful. We went from below 2 percent return on sales to slightly above 2 percent, but we didn't get back to those days of 3 percent or more.
What needs to happen this year to get back above that number?
The luxury market is still softening and I don't think we're going to have record-breaking luxury high-group sales in the next 12 months. At one of our recent dealer council meetings, dealer council came in and said, "We need help with dealer profitability." We said, "We want to sit down and figure out ways that we can make money, changes that need to take place," and [Audi of America President] Scott Keogh immediately said, "We're in." We thought it would be more of a battle, but he immediately said, "No, we're in. Let's start a task force."
Since 2012, we've grown sales to more than 200,000 units. But while we've been increasing sales we saw front-end gross drop drastically, almost $1,000 per car. Because of the new facilities we built, we saw our rental factor grow up more than 33 percent across the country. What we've seen is we're selling more cars but it's producing less gross profit and even though our fixed operations have gone up, we still have not moved the needle on fixed absorption. In effect, dealer profitability has gone down.
What can dealers do about it?
So what we've decided to do is come up with a way to review things like our mobility (loaner) program, like the margin that we have and our expense structure. A lot of those things are defensive tactics to lower our expenses and retain more of our profits. One of the things that the profitability task force is challenged with is offensive tactics, things we can do to create more gross and more profitability, to retain more gross.
Were you on the task force?
I sat on the task force and it was probably the most open dialogue that I have ever seen with a manufacturer in my 30-plus years of doing this. We came out of there with real ideas and real changes that we think we're going to be able to get the return on sales and move that needle to where we need to be.
What are some of those ideas or changes?
Our mobility program has been a tremendous drag on our profitability. At one point in time, we had one-too-few Audis in inventory. A lot of dealers used the mobility program in order to get extra cars. What's happened is we're not in that situation where we have one car too few. As we continue to strive toward customer satisfaction that means we need to continue to add to our mobility fleet and it's become a very expensive proposition.
We're hoping to announce a new mobility program after the first of the year, which I think is going to cut dealers' costs in half [compared to the current program].
What about certified pre-owned sales?
We're working on a program, calling it Pre-Owned Revolution. We want to make our CPO and used-car departments more profitable, so we're looking at ways of driving that business in our Audi dealerships. We've gone 100,000 to 200,000 cars, and a big way we got there is through leasing. We've got a lot of these leases maturing in 2017 and 2018, so we've got to make sure that we have a used-car program that puts these off-lease cars in demand. The higher demand we can create for our pre-owned vehicles, the higher we're able to keep those new-car residuals, which continue to fuel our new-car business.
We're also looking at the best way to protect the margin. You could argue that the way the margin system works today is broken. I'm not saying broken only for Audi, but for every luxury manufacturer. They're not retaining the gross that they once did. So we need to maybe take a look at the selling process today, and maybe there's a better mousetrap.
What are some of the things you're rethinking when it comes to the selling process or margin structure?
The problem right now is that there's such pressure on hitting numbers to keep the momentum going.
We kept pushing. We kept selling cars. We reduced our front-end grosses. We kept the momentum growing and we continue to break records every single month. We're up 3 percent when you've got a luxury high-group that's down, BMW's down double-digits, BMW and Lexus are down and Audi's gaining market share. But at what cost did that come? In our case, we've seen grosses go down by $1,000 per car. The pressure to keep that momentum going has cost the front end.
The system is strained, at the very least. Is there a better way of operating? Is there a better way of taking that stress away from the dealerships and the manufacturer-dealer relationship and still being able to hit sales targets and sales records?
Maintaining discipline with sales goals and inventory has been a component of Audi's strategy recently. Is Audi getting away from that?
I have a number of manufacturers, and Audi management is really in tune with their dealer body. I'm not going to say that my three years have been the easiest three years. That doesn't mean that the relationship of the dealer council and the dealer body with Scott Keogh isn't as strong as it once was. It may be stronger.
Scott Keogh realizes that we have to make changes. He's the first one to go to Germany, knock on the door and say, "We need more marketing money." And he got it. He got some $70 million more in marketing money a year ago. He continues to battle to control the supply side. We've seen inventories go from more than 100 days down to 65 days. How did it go there? They cut the supply side.
I think they're disciplined but they've maintained that increase at a tremendous cost, and a lot of dealers have argued over that cost. Maybe 200,000 vehicles wasn't a good thing for the dealer body. Maybe the 70-something months of increases is not something we want to celebrate. But yet again, when you have that conversation on the golf course, and somebody asks, "Is Audi still breaking records?" and "Is VW going to make it?" you say to yourself, "Wow, maybe it is worth it."
Are dealers satisfied with Audi?
With the new products we have coming, I'm pretty bullish on Audi. I fought to get a new dealership in Bloomington, Minn., and we're building a new facility in a brand new market for Audi and we'll open up next February. I like the management team. I like the direction they're going with product.
When we had the oldest product on the market in 2015, we still saw an increase. I like the direction that they're going in. I don't agree with everything but at the same point in time, they're going to have the newest product in 2017.
How much is Audi's big push for dealers to build Terminal facilities a factor in dealership profitability challenges?
Our rental factors have gone up over 30 percent. A lot of it is new facilities. When you go from 100,000 to 200,000 vehicles, you increase your units in operation considerably. Hopefully we're going to see our fixed absorption go way up. Right now we're hovering at 70 percent and we need to get it to 75 to 80 percent.
There's no question that the Terminals have added to our expense structure. One of the things that I think Audi has done well is that the cost of building the Terminal has gone down in the last three years, considerably. They have become more flexible on furniture options and on some of the things that have caused the expense of the Terminals to rise. There's flexibility on the carpeting and a lot of the design elements that weren't as important customer-facing features as they once thought they were.
Is your mix of SUVs and cars appropriate for the market?
It's better than it has been in a few years, there's no question. The increase in Q7 will help us. The new plant in Mexico building Q5s is going to help us. We need more SUVs.
There was a point in time a few years back when you drove to an Audi store and you saw 10 SUVs on the lot. If you drove another two miles and went to the Lexus store, you had a whole lot of 'em. You had more SUVs than you could possibly think, and you had really strong programs because you had to move the inventory.
We were at a competitive disadvantage in the SUV market to some of our competitors but we're not anymore, inventorywise.
After the Q5 this spring, Audi's product cadence shifts heavily toward passenger cars. Are you concerned about that given the weakness of the sedan market right now?
SUVs are definitely the trend right now. You wonder if it's going to shift back, so you can't lose track of the sedan business. You have to maintain balance because if history tells us anything, it's children typically don't buy what their parents bought. I've got a 29-year-old daughter who lives in California and she drives a Q5. Her lease is up at the end of this month and she's already sending me cars in my inventory that she's interested in, and not one is an SUV. She's sending me pictures of dolled-up A4's and A6s.
I don't think we can ignore that side of the market. We have to remain competitive.
What product most excites dealers?
Q5. The Q5 and the availability of the Q5 is going to help us considerably. If they don't flood us with cars I think we'll be able to retain some of that gross that we haven't been able to in the past and it would be a step toward increasing profitability from 2 percent to 3 percent.