Behind Hyundai's sales struggle

LOS ANGELES — The headlines for Hyundai Motor America's 2016 sales results were the kind any automaker would be proud of: Hyundai and the new Genesis brand combined for a seventh consecutive year of record sales, despite a car-heavy lineup, tight crossover supplies and thin incentive support.

But how Hyundai got there raises questions about the brand's sales tactics and its prospects heading into a softening market, including whether it relies too heavily on sales to rental agencies and to dealerships themselves, dealers and people familiar with Hyundai's sales operations say.

The struggle to sustain sales growth is reflected in the turmoil within Hyundai's sales operations. Hyundai Motor America CEO Dave Zuchowski was fired in December for failing to hit aggressive growth targets, and U.S. sales chief Derrick Hatami left the company for Volkswagen last month after weak sales reports in 2017. Hyundai is still searching for successors to both, while Hyundai Motor America's general counsel, Jerry Flannery, is interim CEO.

Hyundai Motor America's sales grew 1.7 percent last year, to a record 775,005 vehicles. Of those, 203,826 — 26 percent — were fleet sales, according to the automaker. That represents a 15 percent increase in fleet sales from the 175,955 vehicles it sold to fleets in 2015.

Registration numbers paint Hyundai Motor America's growth in a more conservative light. In 2016, Hyundai eked out a gain of 316 vehicles — less than one-20th of 1 percent — to 759,088 new-vehicle registrations, according to IHS Markit.

Registrations tend to lag sales numbers a few months and don't match up exactly but are seen as a better gauge of demand that filters out the effect of sales to dealer fleets.

Hyundai's 2 percent disparity between sales and registrations compared with an industrywide average of 0.66 percent in 2016, according to figures from IHS and the Automotive News Data Center (Ram, Jaguar Land Rover, Ford and Porsche had wider gaps); the largest industrywide disparity of the past decade was 1.62 percent in 2015.

Sources familiar with Hyundai's sales operations point to the service loaners as a key factor in the disparity. Such sales to dealerships are common, especially for luxury brands whose dealers are increasingly expected to provide new, same-brand loaner vehicles to their service customers.

But since Hyundai's torrid U.S. sales growth began to taper off in 2013, these sources say, Hyundai Motor America has relied increasingly on selling to dealers in order to meet monthly sales quotas set by headquarters in South Korea.

The process worked like this: When Hyundai was close to hitting a quota at the end of the month, regional field reps would begin calling dealers to see who could pick up extra loaner cars, known within Hyundai Motor America as service rental cars, or SRCs. Some dealers generally balked at the idea while others accepted the extra cars hoping to score goodwill points with Hyundai, people familiar with the practice said.

One dealer who asked not to be identified recounted the last day of one month when a regional sales representative entered a handful of SRCs into the records as having been sold by that dealer, without the dealer's knowledge. When the dealer confronted the rep about it the next day, the rep reversed the sales in the system, but by then they had counted toward Hyundai's monthly goal.

Such practices may explain why Hyundai Motor America reported single-digit gains in vehicle sales for some months in 2016 — just eight units in June, and three units in August — people familiar with Hyundai's sales operations say.

Hyundai denies pushing service loaners on its dealers any more than other manufacturers and says the discrepancy between sales and registrations results from standard gaps in timing between when sales are recorded and when the vehicles are registered with state agencies.

Hyundai also points to high recall volume in 2016 that led its dealers to stock more service loaners. Last year, it had 18 recalls affecting 643,418 vehicles.

Last week, Hyundai notified dealers that it would begin reimbursing them for customer use of SRCs at a higher daily rate than for third-party rentals, a reversal of the previous formula. The goal of the move is to "support dealers in growing their service business," according to the letter, a copy of which was obtained by Automotive News.

As for 2017, registrations of Hyundai Motor America vehicles through April outpaced reported sales by 2.6 percent, Hyundai says, citing data it has gathered from Experian.

Hyundai does acknowledge that — like all brands — it's always under pressure to sell as many vehicles as it can. That pressure has intensified in recent years for Hyundai thanks to a car-truck mix that's off-kilter with the demands of U.S. consumers.

Despite declining car sales industrywide, parent company Hyundai Motor Corp. has declined to cut car production, highlighting a persistent tension point between the U.S. sales team and headquarters in South Korea, which considers the changing U.S. sales mix a reality that Hyundai Motor America must adapt to on its own. That has left Hyundai Motor America to funnel excess sedans into SRCs or fleet sales, insiders say.

Dealers fear the long-term effects of over-reliance on fleet sales, and their frustrations are mounting. "We are going to continue the message to the powers that be that the overproduction of vehicles in the wrong segments is really affecting our ability to grow the brand and the brand value," Andrew DiFeo, chairman of the Hyundai National Dealer Council, told Automotive News.

Dealers want to see Hyundai hold its fleet share closer to 10 percent, even if that means scaling back production or cutting into volumes.

"When you start getting over 20 percent and the levels that Hyundai has been at, it's unhealthy for the long-term brand value," DiFeo said.

Hyundai Motor America sales this year are down 4.8 percent through May for the Hyundai and Genesis brands. May sales dropped 16 percent overall, largely because of a drop in fleet demand.

"The products that Hyundai has and makes are looking less appealing to the fleets because of the poor residuals of passenger cars," said Ed Kim, vice president of industry analysis at AutoPacific.

Dealers in 2017 have been getting more cash to work with. Incentive spending is up 31 percent through May, according to Motor Intelligence, to ease the sell-down of the core 2017 models: Elantra, Sonata, Tucson and Santa Fe Sport. But those incentives will drop once the 2018 versions arrive, DiFeo said.

The executive turmoil is another worry; it has slowed response times from sales and parts managers, one dealer said.

Hyundai has also been slow to respond with replacement engines tied to two large-scale recalls. The first was issued in 2015 and covers 470,000 Sonatas from 2011 and 2012; the second was issued in April and covers 572,000 Sonatas and Santa Fe Sports from 2013 and 2014. Hyundai's four recalls in 2017 cover nearly 1.6 million vehicles.

"Many of us have 20 to 30-plus vehicles in our service parking waiting on engines at any given time," said this dealer who asked not to be identified.

Flannery — well-liked by those who have worked with him — doesn't have a sales background and has largely been absent from dealer interactions, dealers say. Most of his sales-related responsibilities have been picked up by Sam Brnovich, Hyundai's southern region general manager, who assumed some of Hatami's duties after his departure.

"Sam's got a lot of support from the dealers to be in that operational role," DiFeo said. "We feel that he's the right man for the job because he has intimate knowledge of Hyundai and the retail car business and he's got a lot of experience in the finance end, which is very important right now."