Dealers push back harder against mandates to upgrade stores

Even as New England dealer David Rosenberg heeds automakers' requests for store renovations, he braces himself for business disruption and millions of dollars in expense that he often considers pointless.

And he's not alone. While a dealership that attracts customers is important to retailers and automakers, some dealers and the brands they represent are at odds on whether automaker-mandated updates deliver any return on investment for the millions spent.

For Rosenberg, who operates 58 stores, it's one thing to overhaul a tired dealership in need of repair or build a new store when the business has outgrown its old one.

But a renovation at one of his already-nice luxury-brand dealerships won't "generate one more dollar" in revenue. And it will hurt business in the meantime.

"It's actually going to cost me a lot of money," said Rosenberg, CEO of Prime Automotive Group. "Never mind the construction cost, but the disruption to our facility and to our employees and our customers is going to be enormous."

Rosenberg is among a group of dealers getting increasingly vocal about the costly store investments. While many states have legislated limits on the frequency of automaker-requested renovations, dealership improvement pressure continues to be a perennial headache.

And the nature of retailer pushback has changed since the years immediately after the Great Recession. Then, dealers griped about pricey improvement mandates because many of them, still fragile from the dramatic plunge in auto sales in 2008-10, just couldn't afford it. Today, after years of sales near record highs, retailers are more likely to be on strong financial footing, but they just don't see the value of big dealership investments in a tight-margin market that's moving increasingly toward online transactions.

It means dealers are more likely to negotiate the details and timing of the renovations with automakers. The pressure can trigger retailers to sell stores designated for renovation by the automakers — but it can also trip up the acquisition deals that result.

Colorado dealer lawyer Stephen Dietrich, who works primarily on buy-sell transactions, said store improvement mandates are part of the negotiations for up to 40 percent of the acquisitions he works on. The mandates killed two of his deals last year. Beyond buy-sell deals, at least 70 percent of his clients are having conversations with automakers about store renovations, he said.

While the frequency of automakers' requests has remained relatively consistent, "the stress on the problem is probably increasing because the other costs for a dealership are increasing, so that whole ROI conversation is becoming more highlighted," said Dietrich, a partner at Holland & Knight in Denver. Dealers are asking themselves: "Do I really want to commit and expend this capital for that purpose?"

The answer is increasingly "no."

The publicly traded dealership groups often cite costs of store improvements and their low return on investment as a reason for divesting dealerships, reports Kerrigan Advisors, a California buy-sell firm. Through the first nine months of 2018, the public retailers sold twice as many stores as they acquired — 48 vs. 24.

Sonic Automotive said last year it sold several dealerships rather than revamp them. Penske Automotive Group CEO Roger Penske said last year the retailer would "look at what the capital expenditure requirements" by the automakers are, study the market and then "take our capital and be very strategic."

In December, dealer adviser Alan Haig said in his third-quarter report on the dealership acquisition market that store improvement programs by Jaguar Land Rover and Lexus are drivers of potential buy-sell activity. Facility costs for Jaguar Land Rover dealerships are reaching into the tens of millions of dollars, a heavy investment for a low-volume franchise, Haig said.

And Lexus' push for dealership improvements has led to more buy-sell transactions as dealers choose to "cash checks from buyers rather than write checks to contractors," Haig added in the report.

Dealers often negotiate with automakers when a request makes little sense because of property size, geography or other factors. They may propose completing the construction in two years, rather than one, for example.

Some automakers are listening. Porsche's strict store guidelines have been a challenge for landlocked dealerships, said Robert DiStanislao, president of Porsche of the Main Line in suburban Philadelphia. But Porsche recognized the problem and has exempted dealerships that meet the previous-generation standards from having to update to the current one, said DiStanislao, a member of the Porsche Dealer Board of Regents.

Mike Colleran, vice president of Infiniti Americas, said 92 percent of its dealerships have made the requested improvements.

"We'd like to see all of our facilities be in our image, and we're mostly there," Colleran told Automotive News. "Especially in our larger metro stores, we see a great willingness to invest."

In December, Lincoln postponed a program that called for dozens of dealers with dual Ford-Lincoln dealerships to invest in standalone stores after retailers expressed concerns. The brand had wanted those dealers to commit to the projects by July.

"We just want to take some time to listen to all our partners," Greg Wood, Lincoln's sales and service manager, told Automotive News last month.

In legislation introduced in California's State Assembly this month, automakers would have to limit their dealership improvement requests to once a decade.

California is just the latest state to get involved. According to the Alliance of Automobile Manufacturers, 22 states have passed seven- or 10-year limits on how often manufacturers can demand dealership updates. One state, New Hampshire, has a 15-year provision.

In 2017, Mercedes said it intended to give its dealers a 10-year cushion on store renovations after dealerships complete the brand's second-generation Autohaus image standards. The rise of state laws setting limits was seen as a factor influencing the move.

Many store improvements pay off, some dealers acknowledge. More customers come in, and employees perform better, said Paul Walser, who oversees acquisitions and manufacturer relations for Walser Automotive Group, which has stores in Kansas and Minnesota.

Rosenberg experienced that firsthand when he divided a dual Porsche-Audi dealership about two years ago at the behest of those brands. "We had outgrown it, admittedly, and we set records almost the first month going into the new facilities," he said. Prime is making about 50 percent more in net profit with the separate operations.

But, Walser said, if automakers are "making changes on a frequent basis that don't really mean a lot, all that does is cause heartache." A request to swap out dark gray tile for light gray could cost $80,000, and "no customer would ever detect the difference."

Rosenberg will soon renovate his Mercedes-Benz store at a cost of $3 million to meet the latest Autohaus standards, much to his chagrin.

"By changing the blue poles to black and by building a glass facade … that's not going to bring me more customers," he said. "But Mercedes-Benz is a very valuable brand, and it's important for Mercedes-Benz to have an image that's consistent. And I get that."

The project is less expensive than others Rosenberg has encountered. He says a dealership renovation can easily reach $8 million or more, not including real estate costs.

Such costs, with no measurable return, are causing stress.

"We only have so much money as retailers. It's a finite number," said Wes Lutz, outgoing National Automobile Dealers Association chairman and president of Extreme Dodge-Chrysler-Jeep-Ram in Jackson, Mich. "Everything we need to do is vying for that money. If you can't show me where it's going to sell more cars, I don't think it's fair to ask us to do it."

It can be especially unfair to small dealerships, whether or not they spend for the improvements, Walser said.

"If you're a guy in a small community and you're being asked to invest millions of dollars and your franchise potential is 30 units a month, the economics can kick you right out of the game," he said. "If you have a program that gives dealers that invest an economic advantage, the dealers that can't afford it find themselves in a situation where they can't compete with those that could because now they have a differentiation in terms of their cost."

The investments also draw more scrutiny because, with pickup and delivery services and steps toward online transactions, customers have fewer reasons to spend time in a showroom, said Bob Tasca, president of Tasca Automotive Group in Cranston, R.I.

"I'm just concerned that the future of our business is changing, and we have to pay attention to the change," Tasca said.

A flashy new building may not help, given that evolution in how people are buying cars, lawyer Dietrich said.

Bernie Moreno, head of a luxury-brand dealership group in Ohio, says automakers should help dealerships create websites and technology to aid online sales instead of requesting expensive store renovations.

"The expectation of the manufacturer is [that] I'm going to spend $500 to $1,000 for a website. But they want me to spend the equivalent of $800,000 to $900,000 a year for a facility. That's perverse," Moreno said this month at the KPMG Annual Automotive Executive Forum as part of the Detroit auto show.

Moreno was recently at a dealer meeting for an automaker he wouldn't name, where executives were "proudly boasting" that their dealers were spending $80 million on facilities this year. Said Moreno: "Imagine instead if that person said we're going to spend together $80 million on retail automotive technology to make the system frictionless."

Now that's a return on investment that more dealers might buy in to.

Vince Bond Jr., Melissa Burden, Urvaksh Karkaria and Michael Martinez contributed to this report.