Service contracts bounce back

Extended service contracts are making a comeback.

"Business is extraordinary," said Joe Buslow, sales manager for Ford Motor Credit Co.'s ESP extended service contract program.

Ford Credit expects to sell 100,000 more service contracts this year than it did in 2000, Buslow said. Through October, Ford Credit sold 136,043 service contracts, representing about 26 percent of new-vehicle volume financed by Ford Credit. Through October last year, Ford Credit had sold 85,207 service contracts, or 23 percent of sales.

After years of steady decline, the extended service contract business is growing again because dealers are selling harder and consumers are more receptive.

As a result, dealer profits are up, too.

For the industry, the average dealer grossprofit on service contracts so far this year is $548 each, a 7 percent increase over 2000, according to J.D. Power and Associates. The average retail price is $1,178, up $81, Power said, which makes the average dealer gross margin 48.2 percent of the retail price, based on data from 7,500 franchises in 22 U.S. markets.

Steady improvement

Penetration also has increased. Twenty-eight percent of new-vehicle buyers bought service contracts, according to Power's 2001 New Vehicle Service Contract Report, which is based on consumer surveys conducted around April 2001.

Service contract penetration has increased steadily, from 27 percent last year and 25 percent in 1999, the firm said. Service contracts accounted for only about 21 percent of new-vehicle sales in 1996, said John Harbicht, senior manager of service satisfaction for Power.

Leasing and service contract sales tend to move in opposite directions. Leasing peaked at just over 30 percent of retail volume in 1997. Burned by losses on off-lease units, the factories cut back on leasing incentives and started steering customers to loans. The present 0 percent loan craze accelerated the trend.

Meanwhile, softer underlying demand for new vehicles has driven dealers to pay more attention to F&I profits. All of those factors set the stage for higher service contract volume.

The lease factor

"Penetration on lease customers is difficult," conceded John Gressa, director of mechanical products for GMAC Insurance, which includes the GM Protection Plan service contract program.

Gressa said lease customers who expect to put a lot of miles on a vehicle might want to buy a service contract because the factory warranty may expire while they still have the vehicle.

"If they're driving more than 12,000 miles per year, they're going to drive out of the warranty, in 28 to 32 months. Dealers have to get the F&I manager to profile customers. If they say they drive 15,000 miles a year, there are going to be 9,000 miles where the manufacturer's warranty is not going to cover them anymore," he said.

Some lease customers do buy service contracts. According to J.D. Power's latest data, about 17 percent of customers who leased a new vehicle bought a service contract.

Lessees also may buy relatively new products, such as a maintenance contract that covers the cost of scheduled maintenance or insurance for the cost of "excess wear and tear.''

Mike McHugh, executive vice president for Universal Underwriters, estimates that one-third of all retail sales included a service contract in the late 1980s, before the leasing boom.

"It's now back on the upswing, probably due to the fact that leasing is subsiding, and dealers are paying more attention to their F&I people," he said.

Many dealers leave money on the table by ignoring F&I, said Sid DeBoer, chairman of Lithia Motors Inc., a publicly traded dealer group based in Medford, Ore. One of the first things Lithia does when it acquires an underperforming dealership is to add more people to sell F&I products.

"Most stores we buy have one strong F&I guy. He's just brooming, sweeping up the easy business. If you have one guy looking at 150 cars a month, he can do $350 (in F&I sales) a car and make a good living," DeBoer said.

"In the smaller stores we're buying, we're normally adding F&I staff. We break that down, so that each F&I person looks at no more than 40-50-60 car deals a month. I've seen a car dealer do $1,300 (F&I sales) per car," by pitching all F&I products, all of the time, he said.

Lithia said in its third-quarter report that its F&I sales per unit increased 9.6 percent from the year-ago quarter, to $934 per unit.

That compares with F&I sales of $730 per unit for UnitedAuto Group, based in Detroit, an increase of $54 over last year. UnitedAuto had a gross margin in the F&I department of 58.7 percent, compared with an average for all dealership departments of 13.9 percent.

Bill Stoothoff, vice president of F&I for Universal Underwriters in Overland Park, Kan., said the Power number is too high for an average dealer markup. Still, he cited an estimate of about $465, compared with dealer cost of $500 to $600.

Universal Underwriters expects to sell just over 200,000 service contracts this year, an increase of about 15 percent, said McHugh. The company sells service contracts through about 1,300 dealers, he said.

"Service contract sales are up significantly, especially in the second half,'' said Soothoff. "We expect more of the same next year."

You can reach Jim Henry at autonews@crain.com

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